**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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FORM 10-Q

**QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OFSECURITIES EXCHANGE ACT OF 1934**

**ForQuarter Ended:  September 30, 2004**

**CommissionFile Number:  1-16609**

**ALLIANCE IMAGING, INC.**

(Exact name of registrantas specified in its charter)

| **DELAWARE**                                                     | **33-0239910**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | (IRS Employer  Identification Number) |

**1900South State College BoulevardSuite 600Anaheim, California 92806**

(Address of principalexecutive office)

**(714) 688-7100**

Registrant’s telephonenumber, including area code

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934, during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.    Yes   x        No   o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).     Yes   x         No   o

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of October 29,2004:

Common Stock, $.01 par value, 48,783,846 shares

 

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**ALLIANCE IMAGING,INC.FORM 10-QSeptember 30, 2004**

**Index**
|                                        | ** **                                                                                              | ** **                                                                                                                                                         | **Page** |
|----------------------------------------|---------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| PART I—FINANCIAL INFORMATION |                                                                                                    |
|                                   | Item 1—Financial Statements:                                                                       |                                                                                                                                                               |
|                                   |                                                                                                    | Condensed  Consolidated Balance Sheets  December 31, 2003 and September 30, 2004 (Unaudited)                                                             | 2        |
|                                   |                                                                                                    | Condensed  Consolidated Statements of Operations and Other Comprehensive Income (Loss)  Quarter and nine months ended September 30, 2003 and 2004 (Unaudited) | 3        |
|                                   |                                                                                                    | Condensed  Consolidated Statements of Cash Flows  Nine months ended September 30, 2003 and 2004 (Unaudited)                                                   | 4        |
|                                   |                                                                                                    | Notes  to Condensed Consolidated Financial Statements (Unaudited)                                                                                                  | 5        |
|                                   | Item 2—Management’s Discussion and  Analysis of Financial Condition and Results of Operations | 12                                                                                                                                                                 |
|                                   | Item 3—Quantitative and  Qualitative Disclosures about Market Risk                                 | 20                                                                                                                                                                 |
|                                   | Item 4—Controls and Procedures                                                                     | 21                                                                                                                                                                 |
| PART II—OTHER  INFORMATION   |                                                                                                    |
|                                   | Item 1—Legal Proceedings                                                                           | 22                                                                                                                                                                 |
|                                   | Item 2—Changes in Securities and  Use of Proceeds                                                  | 22                                                                                                                                                                 |
|                                   | Item 3—Defaults Upon Senior  Securities                                                            | 22                                                                                                                                                                 |
|                                   | Item 4—Submission of Matters to a  Vote of Security Holders                                        | 22                                                                                                                                                                 |
|                                   | Item 5—Other Information                                                                           | 22                                                                                                                                                                 |
|                                   | Item 6—Exhibits and Reports on  Form 8-K                                                      | 22                                                                                                                                                                 |
| SIGNATURES                             | 26                                                                                                      |
|                                        |                                                                                                         |                                                                                                                                                                    |          |  |

 

1

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**PART I—FINANCIAL INFORMATION**

**ITEM 1.   FINANCIAL STATEMENTS**

**ALLIANCE IMAGING,INC.CONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited)(in thousands)**
| ** **                                                   | ** ** | **December 31,  2003** | ** ** | **September 30,  2004** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| **ASSETS**                                                   | ** ** |                        | ** ** | ** **                   |       |   | ** ** | ** ** |   |
| Current assets:                                              |       |                        |       | ** **                   |       |   |   | ** ** |   |
| Cash and cash  equivalents                                   |       |                        | $          | 20,931                       |       |   |   | $ | 44,772 |   |   |
| Accounts receivable, net  of allowance for doubtful accounts |       |                        | 45,276     |                         |       |   | 48,078 |   |   |
| Deferred income taxes                                        |       |                        | 15,783     |                         |       |   | 15,783 |   |   |
| Prepaid expenses                                             |       |                        | 2,718      |                         |       |   | 3,667 |   |   |
| Other receivables                                            |       |                        | 2,975      |                         |       |   | 3,405 |   |   |
| Total current assets                                         |       |                        | 87,683     |                         |       |   | 115,705 |   |   |
| Equipment, at cost                                           |       |                        | 677,089    |                         |       |   | 718,070 |   |   |
| Less accumulated  depreciation                               |       |                        | (324,458   | )                            |       |   | (360,525 | ) |   |
| Equipment, net                                               |       |                        | 352,631    |                         |       |   | 357,545 |   |   |
| Goodwill                                                     |       |                        | 122,992    |                         |       |   | 122,992 |   |   |
| Other intangible assets,  net                                |       |                        | 30,953     |                         |       |   | 29,025 |   |   |
| Deferred financing  costs, net                               |       |                        | 12,313     |                         |       |   | 10,204 |   |   |
| Deposits and other  assets                                   |       |                        | 21,604     |                         |       |   | 18,618 |   |   |
| Total assets                                                 |       |                        | $          | 628,176                      |       |   |   | $ | 654,089 |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**               |       |                        |       |                         |       |   |   |   |   |
| Current liabilities:                                         |       |                        |       |                         |       |   |   |   |   |
| Accounts payable                                             |       |                        | $          | 15,993                       |       |   |   | $ | 21,697 |   |   |
| Accrued compensation and  related expenses                   |       |                        | 9,832      |                         |       |   | 14,401 |   |   |
| Accrued interest payable                                     |       |                        | 7,076      |                         |       |   | 13,727 |   |   |
| Income taxes payable                                         |       |                        | 10,137     |                         |       |   | 1,167 |   |   |
| Other accrued  liabilities                                   |       |                        | 19,660     |                         |       |   | 22,989 |   |   |
| Current portion of  long-term debt                           |       |                        | 4,927      |                         |       |   | 5,236 |   |   |
| Total current  liabilities                                   |       |                        | 67,625     |                         |       |   | 79,217 |   |   |
| Long-term debt, net of  current portion                      |       |                        | 316,320    |                         |       |   | 289,175 |   |   |
| Senior subordinated  notes                                   |       |                        | 260,000    |                         |       |   | 260,000 |   |   |
| Minority interests and  other liabilities                    |       |                        | 3,292      |                         |       |   | 4,478 |   |   |
| Deferred income taxes                                        |       |                        | 51,737     |                         |       |   | 66,372 |   |   |
| Total liabilities                                            |       |                        | 698,974    |                         |       |   | 699,242 |   |   |
| Commitments and contingencies *(Note 12)*                    |       |                        |       |                         |       |   |   |   |   |
| Stockholders’ deficit:                                  |       |                        |       |                         |       |   |   |   |   |
| Common stock                                                 |       |                        | 480        |                         |       |   | 487 |   |   |
| Paid-in-capital deficit                                      |       |                        | (19,822    | )                            |       |   | (16,689 | ) |   |
| Accumulated other comprehensive  income (loss)               |       |                        | —     |                         |       |   | (724 | ) |   |
| Accumulated deficit                                          |       |                        | (51,456    | )                            |       |   | (28,227 | ) |   |
| Total stockholders’  deficit                            |       |                        | (70,798    | )                            |       |   | (45,153 | ) |   |
| Total liabilities and stockholders’ deficit             |       |                        | $          | 628,176                      |       |   |   | $ | 654,089 |   |   |

 

See accompanying notes.

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**ALLIANCE IMAGING, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONSAND OTHER COMPREHENSIVE INCOME (LOSS)**

**(Unaudited)**

**(in thousands,except per share amounts)**
| ** **                                          | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                          | ** ** | **2003**                                   | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues                                            |       | $                                          | 105,660    |                                                | $          | 109,760 |   | $ | 313,728 |   | $ | 324,887 |   |
| Costs and  expenses:                                |       |                                       |       |                                                |       |   |   |   |   |
| Operating expenses,  excluding depreciation         |       | 49,742                                     |       | 54,832                                              |       | 147,913 |   | 162,640 |   |
| Selling, general  and administrative expenses       |       | 11,900                                     |       | 10,336                                              |       | 35,098 |   | 32,033 |   |
| Minority interest expense                           |       | 251                                        |       | 524                                                 |       | 1,384 |   | 1,956 |   |
| Employment  agreement costs                         |       | 471                                        |       | 275                                                 |       | 2,125 |   | 1,790 |   |
| Severance and related costs                         |       | 139                                        |       | 627                                                 |       | 1,855 |   | 627 |   |
| Non-cash  stock-based compensation                  |       | 418                                        |       | 63                                                  |       | 1,254 |   | 259 |   |
| Impairment charges                                  |       | 73,225                                     |       | —                                              |       | 73,225 |   | — |   |
| Depreciation  expense                               |       | 19,955                                     |       | 19,832                                              |       | 56,559 |   | 60,466 |   |
| Amortization expense                                |       | 676                                        |       | 885                                                 |       | 2,029 |   | 2,640 |   |
| Interest expense,  net of interest income           |       | 10,851                                     |       | 11,192                                              |       | 33,074 |   | 32,620 |   |
| Other (income) and expense,  net                    |       | —                                     |       | (473                                                | )          | (243 | ) | (600 | ) |
| Total costs and  expenses                           |       | 167,628                                    |       | 98,093                                              |       | 354,273 |   | 294,431 |   |
| Income (loss) before income  taxes                  |       | (61,968                                    | )          | 11,667                                              |       | (40,545 | ) | 30,456 |   |
| Income tax  expense (benefit)                       |       | (11,292                                    | )          | 4,701                                               |       | (2,402 | ) | 7,227 |   |
| Net income (loss)                                   |       | $                                          | (50,676    | )                                                   | $          | 6,966 |   | $ | (38,143 | ) | $ | 23,229 |   |
| Other  comprehensive income, net of tax:            |       |                                       |       |                                                |       |   |   |   |   |
| Net income (loss)                                   |       | $                                          | (50,676    | )                                                   | $          | 6,966 |   | $ | (38,143 | ) | $ | 23,229 |   |
| Unrealized loss  on hedging transaction             |       | —                                     |       | (601                                                | )          | — |   | (724 | ) |
| Other comprehensive income  (loss), net of tax      |       | $                                          | (50,676    | )                                                   | $          | 6,365 |   | $ | (38,143 | ) | $ | 22,505 |   |
| Earnings (loss)  per common share:                  |       |                                       |       |                                                |       |   |   |   |   |
| Basic                                               |       | $                                          | (1.06      | )                                                   | $          | 0.14 |   | $ | (0.80 | ) | $ | 0.48 |   |
| Diluted                                             |       | $                                          | (1.06      | )                                                   | $          | 0.14 |   | $ | (0.80 | ) | $ | 0.48 |   |
| Weighted average number of  shares of common stock: |       |                                       |       |                                                |       |   |   |   |   |
| Basic                                               |       | 47,929                                     |       | 48,344                                              |       | 47,835 |   | 48,169 |   |
| Diluted                                             |       | 47,929                                     |       | 48,943                                              |       | 47,835 |   | 48,562 |   |

 

See accompanying notes.

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**ALLIANCE IMAGING,INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(in thousands)**
| ** **                                                                                          | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2003**                                            | ** ** | **2004** | ** ** |
| **Operating activities:**                                                                           |       |                                                |       |   |   |
| Net income (loss)                                                                                   |       | $                                                   | (38,143    | ) | $ | 23,229 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                                                |       |   |   |
| Provision for  doubtful accounts                                                                    |       | 2,002                                               |       | 322 |   |
| Non-cash  stock-based compensation                                                                  |       | 1,254                                               |       | 259 |   |
| Depreciation and  amortization                                                                      |       | 58,588                                              |       | 63,106 |   |
| Impairment charges                                                                                  |       | 73,225                                              |       | — |   |
| Amortization of  deferred financing costs                                                           |       | 2,265                                               |       | 2,279 |   |
| Distributions greater than (less than) equity  in undistributed income of investee                  |       | 340                                                 |       | (1,310 | ) |
| Deferred income  taxes                                                                              |       | (5,082                                              | )          | 15,117 |   |
| Gain on sale of  equipment                                                                          |       | (264                                                | )          | (600 | ) |
| Changes in operating assets and liabilities:                                                        |       |                                                |       |   |   |
| Accounts  receivable                                                                                |       | (3,739                                              | )          | (3,124 | ) |
| Prepaid expenses                                                                                    |       | (829                                                | )          | (949 | ) |
| Other receivables                                                                                   |       | 115                                                 |       | (430 | ) |
| Other assets                                                                                        |       | (223                                                | )          | (2,067 | ) |
| Accounts payable                                                                                    |       | (2,897                                              | )          | 5,704 |   |
| Accrued  compensation and related expenses                                                          |       | 1,522                                               |       | 4,569 |   |
| Accrued interest  payable                                                                           |       | 6,593                                               |       | 6,651 |   |
| Income taxes  payable                                                                               |       | (161                                                | )          | (8,970 | ) |
| Other accrued  liabilities                                                                          |       | 1,187                                               |       | 3,329 |   |
| Minority interests  and other liabilities                                                           |       | 785                                                 |       | (20 | ) |
| Net cash provided  by operating activities                                                          |       | 96,538                                              |       | 107,095 |   |
| **Investing activities:**                                                                           |       |                                                |       |   |   |
| Equipment  purchases                                                                                |       | (69,648                                             | )          | (68,950 | ) |
| (Increase)  decrease in deposits on equipment                                                       |       | (4,722                                              | )          | 4,386 |   |
| Acquisitions, net  of cash received                                                                 |       | (10,981                                             | )          | — |   |
| Investment in  unconsolidated joint ventures                                                        |       | —                                              |       | (145 | ) |
| Proceeds from sale  of assets                                                                       |       | 1,165                                               |       | 5,580 |   |
| Net cash used in  investing activities                                                              |       | (84,186                                             | )          | (59,129 | ) |
| **Financing activities:**                                                                           |       |                                                |       |   |   |
| Principal payments  on equipment debt                                                               |       | (5,297                                              | )          | (4,762 | ) |
| Proceeds from  equipment debt                                                                       |       | —                                              |       | 4,176 |   |
| Proceeds from  revolving loan facility                                                              |       | 10,000                                              |       | — |   |
| Principal payments  on term loan facility                                                           |       | (29,875                                             | )          | (26,250 | ) |
| Payments of debt  issuance costs                                                                    |       | (170                                                | )          | (170 | ) |
| Proceeds from  issuance of common stock                                                             |       | 348                                                 |       | 50 |   |
| Proceeds from  exercise of employee stock options                                                   |       | 231                                                 |       | 2,831 |   |
| Net cash used in  financing activities                                                              |       | (24,763                                             | )          | (24,125 | ) |
| Net (decrease)  increase in cash and cash equivalents                                               |       | (12,411                                             | )          | 23,841 |   |
| Cash and cash  equivalents, beginning of period                                                     |       | 31,413                                              |       | 20,931 |   |
| Cash and cash  equivalents, end of period                                                           |       | $                                                   | 19,002     |   | $ | 44,772 |   |
| **Supplemental disclosure of cash flow  information:**                                              |       |                                                |       |   |   |
| Interest paid                                                                                       |       | $                                                   | 24,374     |   | $ | 23,812 |   |
| Income taxes paid,  net of refunds                                                                  |       | 2,841                                               |       | 777 |   |
| **Supplemental disclosure of non-cash investing  and financing activities:**                        |       |                                                |       |   |   |
| Net book value of  assets exchanged                                                                 |       | $                                                   | 974        |   | $ | 262 |   |
| Capital lease  obligations assumed for the purchase of equipment                                    |       | 7,001                                               |       | — |   |
| Capital lease  obligations transferred for the sale of equipment                                    |       | (1,139                                              | )          | — |   |
| Other  comprehensive loss from hedging transaction                                                  |       | —                                              |       | (724 | ) |

 

See accompanying notes.

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**ALLIANCE IMAGING,INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSSeptember 30, 2004(Unaudited)(dollars in thousands, except per share amounts)**

**1.   Basis ofPresentation, Principles of Consolidation, and Use of Estimates**

**Basisof****Presentation**—Theaccompanying unaudited condensed consolidated financial statements have beenprepared by Alliance Imaging, Inc. (the “Company”) in accordance withaccounting principles generally accepted in the United States of America andwith the instructions to Form 10-Q and Article 10 of Regulation S-Xof the Securities and Exchange Commission. Accordingly, they do not include allof the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the nine-monthperiod ended September 30, 2004 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2004. Theaccompanying unaudited condensed consolidated financial statements should beread in conjunction with the audited consolidated financial statements andnotes to the consolidated financial statements for the year ended December 31,2003.

**Principlesof Consolidation**—The accompanying unaudited condensedconsolidated financial statements of the Company include the assets,liabilities, revenues and expenses of all majority owned subsidiaries overwhich the Company exercises control, and for which control is other thantemporary. Intercompany transactions have been eliminated. Investments innon-consolidated affiliates are accounted for under the equity method.

**Use of Estimates**—Thepreparation of condensedconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the amounts reported in the condensed consolidated financialstatements and accompanying notes. Actual results could differ from thoseestimates.

**2.   Stock-BasedCompensation**

The Company accounts for stock-based compensationawards using the intrinsic value method prescribed under Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”),and its related interpretations. Other than the awards discussed in Note 7, allother employee stock-based awards were granted with an exercise price equal tothe market value of the underlying common stock on the date of grant and nocompensation cost is reflected in net income from operations for those awards.

Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by SFAS148, requires presentation of pro forma information regarding net income andearnings per share determined as if the Company had accounted for its employeestock options granted subsequent to December 31, 1994 under the fair valuemethod of that statement. The fair value for these options was estimated as ofthe date of grant using the Black-Scholes option pricing model with thefollowing weighted-average assumptions for the third quarter of 2003 and thirdquarter of 2004, respectively: risk-free interest rates of 3.43% and 3.76%; nodividend yield; volatility factors of the expected market price of the Company’scommon stock of 86.3% and 42.6%; and a weighted-average expected life of theoptions of 6.50 years in each quarter. The Company used the followingweighted-average assumptions for the first nine months of 2003 and 2004,respectively: risk-free interest rates of 

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3.25% and 3.32%; nodividend yield; volatility factors of the expected market price of the Company’scommon stock of 78.0% and 53.4%; and a weighted-average expected life of theoptions of 6.50 years and 5.68 years. Theweighted-average fair value of options granted during the third quarter of 2003and 2004 is $2.66 and $2.01, respectively, and $3.32 and $1.99 in the firstnine months of 2003 and 2004, respectively.

The Black-Scholes option valuation model wasdeveloped for use in estimating the fair value of traded options, which have novesting restrictions and are fully transferable. In addition, option valuationmodels require the input of highly subjective assumptions including theexpected stock price volatility. Because the Company’s employee stock optionshave characteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management’s opinion, the existing models do not necessarilyprovide a reliable single measure of the fair value of its employee stockoptions.

Forpurposes of pro forma disclosures, the estimated fair value of the options isamortized to expense over the options’ expected vesting period. Had compensationcost for the Company’s stock option plan been determined based on the estimatedfair value at the grant dates for awards under the plan consistent with thefair value method of SFAS 123 utilizing the Black-Scholes option-pricingmodel, the Company’s net income and basic and diluted earnings per share forthe periods ended below, would have approximated the pro forma amountsindicated below:
| ** **                                                                                                            | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2003**                                   | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income  (loss):                                                                                                   |       |                                       |       |                                                |       |   |   |   |   |
| As reported                                                                                                           |       | $                                          | (50,676    | )                                                   | $          | 6,966 |   | $ | (38,143 | ) | $ | 23,229 |   |
| Add: Stock-based  compensation expense included in reported net income (loss), net of related  tax effects            |       | 245                                        |       | 37                                                  |       | 734 |   | 154 |   |
| Add (deduct):  Stock-based compensation expense determined under fair value based method,  net of related tax effects |       | (293                                       | )          | (265                                                | )          | 32 |   | (881 | ) |
| Pro forma net  income (loss)                                                                                          |       | $                                          | (50,724    | )                                                   | $          | 6,738 |   | $ | (37,377 | ) | $ | 22,502 |   |
| Basic earnings (loss) per share:                                                                                      |       |                                       |       |                                                |       |   |   |   |   |
| As reported                                                                                                           |       | $                                          | (1.06      | )                                                   | $          | 0.14 |   | $ | (0.80 | ) | $ | 0.48 |   |
| Pro forma                                                                                                             |       | (1.06                                      | )          | 0.14                                                |       | (0.78 | ) | 0.47 |   |
| Diluted earnings (loss) per share:                                                                                    |       |                                       |       |                                                |       |   |   |   |   |
| As reported                                                                                                           |       | (1.06                                      | )          | 0.14                                                |       | (0.80 | ) | 0.48 |   |
| Pro forma                                                                                                             |       | (1.06                                      | )          | 0.14                                                |       | (0.78 | ) | 0.46 |   |

 

**3.   Recent AccountingPronouncements**

**Accountingfor Certain Instruments with Characteristics of Both Liabilities and Equity**—InMay 2003, the Financial Accounting Standards Board (“FASB”) issued SFAS150, “Accounting for Certain Instruments with Characteristics of BothLiabilities and Equity,” which establishes standards for how an issuerclassifies and measures certain financial instruments with characteristics ofboth liabilities and equity. SFAS 150 requires that an issuer classify afinancial instrument that is within its scope, which may have previously beenreported as equity, as a liability (or an asset in some circumstances). Thisstatement is effective for financial instruments entered into or modified afterMay 31, 2003, and otherwise is effective at the beginning of the firstinterim period beginning after June 15, 2003. In October 2003, the FASBdeferred implementation of paragraphs 9 and 10 of SFAS 150 regarding parentcompany treatment of minority interest for certain limited life entities andcertain other mandatorily redeemable financial 

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instruments. This deferralis for an indefinite period. The adoption of SFAS 150 did not have a materialimpact on the Company’s financial position or results of operations.

**Revenue Recognition**—InDecember 2003, the Securities and Exchange Commission released StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition”, whichsupersedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104clarifies existing guidance regarding revenues for contracts which containmultiple deliverables to make it consistent with Emerging Issues Task Force (“EITF”)No. 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables,” The adoption of SAB 104 did not have a material impact on theCompany’s revenue recognition policies, nor its financial position or resultsof operations.

**4.   Goodwill and IntangibleAssets**

Changesin the carrying amount of goodwill are as follows:
| Balance at  December 31, 2003       |   | $      | 122,992 |   |
|------------------------------------------|--------|--------|---------|--------|
| Additions to  goodwill during the period |   | — |    |
| Balance at  September 30, 2004      |   | $      | 122,992 |   |

 

Intangibleassets consisted of the following:
| ** **                                    | ** ** | **December 31, 2003** | ** ** | **September 30, 2004** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **Gross**                       | ** ** | ** **                       | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Carrying**                    | ** ** | **Accumulated**                  | ** ** | **Intangible** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Intangible** | ** ** |
| ** **                                    | ** ** | **Amount**                      | ** ** | **Amortization**                 | ** ** | ** Assets, net ** | ** ** | **Amount** | ** ** | **Amortization** | ** ** | ** Assets, net ** | ** ** |
| Amortizing  intangible assets:                |       |                            |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Customer contracts                            |       | $                               | 40,426     |                             |       | $ | (12,480 | ) |   |   | $ | 27,946 |   |   | $ | 40,426 |   |   | $ | (14,766 | ) |   |   | $ | 25,660 |   |   |
| Other                                         |       | 2,890                           |       |                             | (1,536     | ) |   |   | 1,354 |   |   | 3,223 |   |   | (1,890 | ) |   |   | 1,333 |   |   |
| Total amortizing intangible assets            |       | $                               | 43,316     |                             |       | $ | (14,016 | ) |   |   | $ | 29,300 |   |   | $ | 43,649 |   |   | $ | (16,656 | ) |   |   | $ | 26,993 |   |   |
| Intangible assets not subject to amortization |       |                            |       |                             |       |   |   |   | $ | 1,653 |   |   |   |   |   |   |   |   |   | $ | 2,032 |   |   |
| Total other  intangible assets                |       |                            |       |                             |       |   |   |   | $ | 30,953 |   |   |   |   |   |   |   |   |   | $ | 29,025 |   |   |

 

The Company reviews the recoverability of the carryingvalue of goodwill on an annual basis or more frequently when an event occurs orcircumstances change to indicate an impairment of these assets has possiblyoccurred. Goodwill is allocated to the Company’s various reporting units whichrepresent the Company’s ten geographical regions. The Company compares the fairvalue of the reporting unit to its carrying amount to determine if there ispotential impairment. The implied fair value for goodwill is determined basedon the fair value of assets and liabilities of the respective reporting unitsbased on discounted cash flows, market multiples, or appraised values asappropriate.

Amortization expense for intangible assets subject toamortization was $676 and $885 for the quarters ended September 30, 2003and 2004, respectively, and $2,029 and $2,640 for the nine months ended September 30,2003 and 2004, respectively. The intangible assets not subject to amortizationrepresent certificate of needs and regulatory authority rights which have indefinite useful lives.

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Estimatedannual amortization expense for each of the fiscal years ending December 31is presented below:
| 2004 |   | $     | 3,521  |   |
|------|--------|-------|--------|--------|
| 2005 |   | 3,504 |   |
| 2006 |   | 3,444 |   |
| 2007 |   | 3,227 |   |
| 2008 |   | 3,016 |   |

 

**5.   Other AccruedLiabilities**

Otheraccrued liabilities consisted of the following:
| ** **                                   | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **2003**              | ** ** | **2004**               | ** ** |
| Accrued systems rental and maintenance costs |       |                  | $          | 2,472                  |       |   |   | $ | 2,643 |   |   |
| Accrued site  rental fees                    |       |                  | 1,795      |                   |       |   | 1,656 |   |   |
| Accrued property  tax and sales tax payable  |       |                  | 7,125      |                   |       |   | 8,133 |   |   |
| Accrued equipment  payments                  |       |                  | 1,274      |                   |       |   | 564 |   |   |
| Accrued  self-insurance expense              |       |                  | 3,072      |                   |       |   | 4,328 |   |   |
| Other accrued  expenses                      |       |                  | 3,922      |                   |       |   | 5,665 |   |   |
| Total other accrued  liabilities             |       |                  | $          | 19,660                 |       |   |   | $ | 22,989 |   |   |

 

**6.   Long-Term Debt**

Long-termdebt consisted of the following:
| ** **                                 | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **2003**              | ** ** | **2004**               | ** ** |
| Term loan facility                         |       |                  | $          | 307,125                |       |   |   | $ | 280,875 |   |   |
| Senior  subordinated notes                 |       |                  | 260,000    |                   |       |   | 260,000 |   |   |
| Equipment debt                             |       |                  | 14,122     |                   |       |   | 13,536 |   |   |
| Long-term debt,  including current portion |       |                  | 581,247    |                   |       |   | 554,411 |   |   |
| Less current  portion                      |       |                  | 4,927      |                   |       |   | 5,236 |   |   |
| Long-term portion                          |       |                  | $          | 576,320                |       |   |   | $ | 549,175 |   |   |

 

**7.   Non-CashStock-Based Compensation**

In November 2000, the Company granted stockoptions to certain employees at exercise prices below the fair value of theCompany’s common stock, of which 47,500 options are outstanding at September 30,2004. The exercise prices of these options and the fair value of the Company’scommon stock on the grant date were $5.60 and $9.52 per share, respectively. Compensationexpense of $50 will be recognized on a straight-line basis over the remainingvesting period of the options. The Company recorded non-cash stock-basedcompensation of $18 and $6 in the quarters ended September 30, 2003 and2004, respectively, and $54 and $42 in the first nine months of 2003 and 2004,respectively, with an offset to paid-in-capital deficit.

On June 20, 2001, the Company’s compensationcommittee authorized the Company to amend the option agreements under its 1999Equity Plan to reduce the performance targets for the performance options. On May 18,2004, the Company’s compensation committee authorized the Company to make asecond amendment to the option agreements under its 1999 Equity Plan to furtherreduce the performance targets for the outstanding performance options. Theseoptions vest on the eighth anniversary 

8

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of the grant date if theoption holder is still an employee, but the vesting accelerates if the Companymeets the operating performance targets specified in the option agreements. Asa result of the amendments, if the Company achieves the reduced performancetargets but does not achieve the previous performance targets, and an optionholder terminates employment prior to the eighth anniversary of the optiongrant date, the Company would be required to record a non-cash stock-basedcompensation charge equal to the amount by which the actual value of the sharessubject to the performance option on the date of the respective amendmentexceeded the option’s exercise price. Under the first amendment, managementestimates that the Company could incur an additional $100 to $500 in theaggregate of these non-cash stock-based compensation charges over the next 11¤4years. Under the second amendment, management estimates that the Company couldincur an additional $100 to $200 in the aggregate of these non-cash stock-basedcompensation charges over the next 43¤4years. These charges, however, may not be evenly distributed over each of theserespective periods or over the four quarters in any one year, depending uponthe timing of employee turnover and the number of shares subject to the optionsheld by departing employees.

Forthe quarters ended September 30, 2003 and 2004, the Company recorded $400and $57, respectively, in non-cash stock-based compensation as a result ofthese amendments. For the nine months ended September 30, 2003 and 2004,the Company recorded $1,200 and $217, respectively, in non-cash stock-basedcompensation as a result of these amendments.

**8.   Accumulated OtherComprehensive Income (Loss)**

In the second quarter of 2004, the Company enteredinto interest rate swap agreements, with notional amounts of $56,813 and$46,813 to hedge the future cash interest payments associated with a portion ofthe Company’s variable rate bank debt. These agreements mature in the secondquarter of 2007. Under these arrangements, the Company receives three-monthLondon Interbank Offered Rate (“LIBOR”) and pays a fixed rate of 3.15% and3.89%, respectively. The net effect of the hedges is to record interest expenseat fixed rates of 5.53% and 6.27%, respectively, as the debt incurs interestbased on three-month LIBOR plus 2.38%. For thequarter ended September 30, 2004, the Company recorded net interestexpense on the swap of $564. The Company has designated theseswaps as cash flow hedges of variable future cash flows associated with itslong-term debt. The Company recognized a loss, net of tax, of $601 and $724based on the change in fair value of these instruments for the third quarterand nine months ended September 30, 2004, respectively. The Company willcontinue to record subsequent changes in the fair value of the swaps throughother comprehensive income during the period these instruments are designatedas hedges.

On the date the Companyenters into a derivative contract, management designates the derivative as ahedge of the identified exposure. The Company does not enter into derivativeinstruments that do not qualify as cash flow hedges as described in SFAS No. 133.The Company formally documents all relationships between hedging instrumentsand hedged items, as well as the risk-management objective and strategy forundertaking various hedge transactions. In this documentation, the Companyspecifically identifies the firm commitment or forecasted transaction that hasbeen designated as a hedged item and states how the hedging instrument isexpected to hedge the risks related to the hedged item. The Company formallymeasures effectiveness of its hedging relationships, both at the hedgeinception and on an ongoing basis, in accordance with its risk managementpolicy. The Company would discontinue hedge accounting prospectively (i) ifit is determined that the derivative is no longer effective in offsettingchange in the cash flows of a hedged item, (ii) when the derivativeexpires or is sold, terminated or exercised, (iii) when the derivative isdesignated as a hedge instrument, because it is probable that the forecastedtransaction will not occur, (iv) because a hedged firm commitment nolonger meets the definition of a firm commitment, or (v) if managementdetermines that designation of the derivative as a hedge instrument is nolonger appropriate.

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**9.   IncomeTaxes**

For the quarter and ninemonths ended September 30, 2004, the Company recorded income tax expenseof $4,701 and $7,227, respectively. The third quarter 2004 effective income taxrate was 40.3% of the Company’s pretax income, which was higher than federalstatutory rates primarily as a result of state income taxes. For the ninemonths ended September 30, 2004, the effective income tax rate was 23.7%,which was lower than federal statutory rates due to the reversal of income taxreserves of $5,099 primarily related to the favorable outcome of examinationsof the Company’s 1998 and 1999 federal income tax returns and a favorable finalIRS determination letter related to the treatment of an income item in afederal income tax return of one of the Company’s subsidiaries.

For the quarter and ninemonths ended September 30, 2003, the Company recorded an income taxbenefit of $11,292 and $2,402, or 18.2% and 5.9%, of the Company’s pretax loss,respectively. The Company recorded a lower than statutory income tax benefitbecause a portion of the impairment charges discussed in Note 10 related tonon-deductible goodwill.

**10.   ImpairmentCharge**

In2003, the Company saw an increase in the competitive climate in the MRIindustry, resulting in an increase in activity by original equipmentmanufacturers selling systems directly to certain of the Company’s clients. Thiscaused an increase in the number of the Company’s clients deciding not to renewits contracts, and as a result, the Company’s MRI revenues have declined. Theseevents triggered an acceleration of the review of the recoverability of thecarrying value of certain equipment, goodwill, and other intangible assets inthe third quarter of 2003 according to the provisions of Statement of FinancialAccounting Standards No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets”) (“SFAS 144”) and Statement of Accounting Standards No. 142,“Goodwill and Other Intangible Assets” (“SFAS 142”). Due to the factorsnoted above, in the third quarter of 2003 and nine months ending September 30,2003, the Company recognized a non-cash impairment charge totaling $73,225 associatedwith goodwill and other intangible assets and certain equipment in accordancewith the provisions of SFAS 142 and 144, and an impairment of aninvestment in a joint venture, the components of which are described in moredetail below.

Inthe third quarter and nine months ended September 30, 2003, theCompany recorded an impairment charge of $41,916 under SFAS 142 related togoodwill and an impairment charge of $802 under SFAS 144 related tocertain customer contract intangible assets.

In the third quarter of2003, the Company evaluated the recoverability of the carrying amount ofcertain long-lived assets, specifically its 1.0 Tesla and 0.2 Tesla MRIsystems, as a result of the decline in client demand for these systems. Animpairment is assessed when the undiscounted expected future cash flows derivedfrom the asset is less than its carrying amount. The Company used its bestjudgment based upon the most current facts and circumstances when applyingthese impairment rules. Based upon the analysis performed on the 1.0 Tesla and0.2 Tesla MRI systems, an impairment charge of $22,793 was recognized to reduce certain of these assets totheir fair market value as of September 30, 2003. The Company revised itsestimate of residual values on all of its MRI equipment from 20% to 10%. Inaddition, the Company changed its estimate of useful lives of 1.5 Tesla MRIsystems from 8 years to 7 years. Both of these changes in estimates are being recognized on aprospective basis beginning in the fourth quarter of 2003.

In the third quarter of2003, the Company recognized a $7,714 impairment charge relating to an otherthan temporarily decline in the fair value of the Company’s investment in ajoint venture. The Company concluded that its investment was other thantemporarily impaired because the Company’s carrying value of the investmentexceeded the calculated fair value of the investment and the prospects ofrecovery were considered weak. The fair value of the investment was based uponthe Company’s best estimate of the expected future cash flows of the jointventure.

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**11.   EarningsPer Common Share**

Thefollowing table sets forth the computation of basic and diluted earnings pershare (amounts in thousands, except per share amounts): 
| ** **                                                                                         | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2003**                                   | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2004** | ** ** |
| Numerator:                                                                                         |       |                                       |       |                                                |       |   |   |   |   |
| Net income (loss)                                                                                  |       | $                                          | (50,676    | )                                                   | $          | 6,966 |   | $ | (38,143 | ) | $ | 23,229 |   |
| Denominator:                                                                                       |       |                                       |       |                                                |       |   |   |   |   |
| Denominator for basic earnings per share—weighted-average  shares                             |       | 47,929                                     |       | 48,344                                              |       | 47,835 |   | 48,169 |   |
| Effect of dilutive securities:                                                                     |       |                                       |       |                                                |       |   |   |   |   |
| Employee stock options                                                                             |       | —                                     |       | 599                                                 |       | — |   | 393 |   |
| Denominator for diluted earnings per share—adjusted weighted-average  shares             |       | 47,929                                     |       | 48,943                                              |       | 47,835 |   | 48,562 |   |
| Earnings per common share:                                                                         |       |                                       |       |                                                |       |   |   |   |   |
| Basic                                                                                              |       | $                                          | (1.06      | )                                                   | $          | 0.14 |   | $ | (0.80 | ) | $ | 0.48 |   |
| Diluted                                                                                            |       | $                                          | (1.06      | )                                                   | $          | 0.14 |   | $ | (0.80 | ) | $ | 0.48 |   |
| Stock options excluded from the computation of  diluted per share amounts:                         |       |                                       |       |                                                |       |   |   |   |   |
| Weighted-average shares for which the exercise  price exceeds average market price of common stock |       | 3,704                                      |       | 607                                                 |       | 4,338 |   | 3,241 |   |
| Average exercise price per share that exceeds  average market price of common stock                |       | $                                          | 6.37       |                                                | $          | 11.28 |   | $ | 6.30 |   | $ | 6.44 |   |

 

**12.   Commitmentsand Contingencies**

The Company from time to time is involved in routinelitigation and regulatory matters incidental to the conduct of its business.The Company believes that resolution of such matters will not have a materialadverse effect on its consolidated results of operations or financial position.

The Company has applied the disclosure provisions ofFASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtednessof Others,” to its agreements that contain guarantee or indemnification clauses.These disclosure provisions expand those required by FASB Statement No. 5,“Accounting for Contingencies,” by requiring a guarantor to disclose certaintype of guarantees, even if the likelihood of requiring the guarantor’sperformance is remote. The following is a description of an arrangement inwhich the Company is the guarantor.

The Company guarantees aportion of a loan on behalf of an unconsolidated investee under an agreementexecuted prior to 2002. The maximum potential future payment under thisfinancial guarantee is $331 at September 30, 2004. TheCompany has not recorded an obligation for this guarantee.

**13.   Related-PartyTransactions**

The Company recorded management fees payable toKohlberg Kravis Roberts & Co. (“KKR”) of $163 and $488 for each of thequarters and nine months ended September 30, 2003 and 2004, respectively,and will continue to receive financial advisory services from KKR on an ongoingbasis.

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**ITEM 2.   MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**Overview**

We are a leading nationalprovider of diagnostic imaging services. We provide imaging services primarilyto hospitals and other healthcare providers on a shared and full-time servicebasis, in addition to operating a growing number of free-standing imagingcenters. Our principal sources of revenue are derived from magnetic resonanceimaging (MRI) and positron emission tomography (PET) services. In the firstnine months of 2004, MRI services and PET services generated 73% and 18% of ourrevenues, respectively. Our services normally include the use of our imagingsystems, technologists to operate the systems, equipment maintenance andupgrades and management of day-to-day operations. We had 481 diagnostic imagingsystems, including 362 MRI systems and 53 PET or PET/CT systems, and 1,342clients in 43 states at September 30, 2004.

Approximately 88% of ourrevenues for the first nine months ended September 30, 2004 were generatedby providing services to hospitals and other healthcare providers, which werefer to as wholesale revenues. Our wholesale revenues are typically generatedfrom contracts that require our clients to pay us based on the number of scanswe perform, although some pay us a flat fee for a period of time regardless ofthe number of scans we perform. These payments are due to us independent of ourclients’ receipt of reimbursement from third-party payors. We typically deliverour services for a set number of days per week through exclusive, long-termcontracts with hospitals and other healthcare providers. These contractsaverage approximately three years in length and often contain automatic renewalprovisions. We price our contracts based on the type of system used, the scanvolume, and the number of ancillary services provided. Our pricing is alsoinfluenced by competitive market pressures andreimbursement practices.

In November 2004, the Center for Medicare andMedicaid Studies announced a 21% reduction in PET hospital reimbursement rateseffective January 1, 2005.  Although theeffect of this rate reduction is unclear, this could have a significantnegative impact on our PET revenues.  Ourhealthcare provider clients on whom we depend for the majority of our revenuesgenerally rely on reimbursement from third-party payors.   Because unfavorable reimbursement policiesmay constrict the profit margins of the hospitals and clinics we bill directly,we may need to lower our fees to retain existing PET clients and attract newones.

Approximately 12% of our revenues for the nine monthsended September 30, 2004 were generated by providing services directly topatients from our sites located at or near hospital or other healthcareprovider facilities, which we refer to as retail revenues. Our revenues fromthese sites are generated from direct billings to patients or their third-partypayors, which are recorded net of contractual discounts and other arrangementsfor providing services at discounted prices. We typically charge a higher priceper scan under retail billing than we do under wholesale billing.

We have recently seen an increase in the competitiveclimate in the MRI industry, resulting in an increase in activity by originalequipment manufacturers, or OEM’s, selling systems directly to certain of ourclients. Typically, OEM’s target our higher scan volume clients. This hascaused an increase in the number of our higher scan volume clients deciding notto renew their contracts. We replace these higher volume scan clients typicallywith lower volume clients. As a result, we expect our 2004 MRI revenues todecline compared to 2003 levels and we believe that MRI revenues from ourshared service operations will continue to decline in future years.

The principal components of our operating costs,excluding depreciation, are compensation paid to technologists and drivers,including travel costs, system maintenance costs, medical supplies, systemtransportation and fuel costs. Because a majority of these expenses are fixed,increased revenues as a result 

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of higher scan volumes persystem significantly improves our margins while lower scan volumes result inlower margins.

The principal components of our selling, general andadministrative expenses are sales force compensation, marketing costs,corporate overhead costs, provision for doubtful accounts, and equity interestearnings in unconsolidated partnerships.

Forthe nine months ended September 30, 2004, we recorded $0.3 million innon-cash stock-based compensation primarily as a result of amending certainstock option agreements in June 2001 and May 2004 to reduceperformance targets and granting options in November 2000 to purchase ourcommon stock at an exercise price below its fair value. One-half of theoptions granted under our 1999 Equity Plan are “performance options.”  These options vest on the eighth anniversaryof the grant date if the option holder is still our employee, but the vestingaccelerates if we meet the operating performance targets specified in theoption agreements. On June 20, 2001, our compensation committee authorizedus to enter into amended option agreements to reduce the performance targetsfor the performance options. On May 18, 2004, our compensation committeeauthorized us to enter into a second amendment to the option agreements tofurther reduce the performance targets for the outstanding performance options.As a result, if we achieve the reduced performance targets but do not achievethe previous performance targets, and an option holder terminates employmentprior to the eighth anniversary of the option grant date, we would be requiredto record a non-cash stock-based compensation charge equal to the amount bywhich the actual value of the shares subject to the performance option on thedate of the respective amendment exceeded the option’s exercise price. Underthe first amendment, we estimate that we could incur an additional $0 to $0.5million in the aggregate of non-cash stock-based compensation charges over thenext 11¤4years. Under the second amendment, we estimate that we could incur anadditional $0.1 million to $0.2 million in the aggregate of non-cashstock-based compensation charges over the next 43¤4 years. Thesecharges, however, may not be evenly distributed over each of these respectiveperiods or over the four quarters in any one year, depending upon the timing ofemployee turnover and the number of shares subject to the options held bydeparting employees.

**Seasonality**

We experience seasonalityin the revenues and margins generated for our services. First and fourthquarter revenues are typically lower than those from the second and thirdquarters. First quarter revenue is affected primarily by fewer calendar daysand inclement weather, the results of which are fewer patient scans during theperiod. Fourth quarter revenue is affected primarily by holiday and client andpatient vacation schedules and inclement weather, the results of which arefewer patient scans during the period. The variability in margins is higherthan the variability in revenues due to the fixed nature of our costs.

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**Results of Operations**

Thefollowing table shows our condensed consolidated statements of income as apercentage of revenues:
| ** **                                    | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **2003**                                   | ** ** | **2004**                                            | ** ** | **   2003   ** | ** ** | **   2004   ** | ** ** |
| Revenues                                      |       | 100.0                                      | %          | 100.0                                               | %          |   | 100.0 | % |   |   | 100.0 | % |   |
| Costs and  expenses:                          |       |                                       |       |                                                |       |   |   |   |   |   |   |   |   |
| Operating  expenses, excluding depreciation   |       | 47.1                                       |       | 50.0                                                |       |   | 47.2 |   |   |   | 50.0 |   |   |
| Selling, general  and administrative expenses |       | 11.3                                       |       | 9.4                                                 |       |   | 11.2 |   |   |   | 9.9 |   |   |
| Minority interest  expense                    |       | 0.2                                        |       | 0.5                                                 |       |   | 0.4 |   |   |   | 0.6 |   |   |
| Employment  agreement costs                   |       | 0.4                                        |       | 0.2                                                 |       |   | 0.7 |   |   |   | 0.5 |   |   |
| Severance and  related costs                  |       | 0.1                                        |       | 0.6                                                 |       |   | 0.6 |   |   |   | 0.2 |   |   |
| Non-cash  stock-based compensation            |       | 0.4                                        |       | 0.0                                                 |       |   | 0.4 |   |   |   | 0.1 |   |   |
| Impairment  charges                           |       | 69.3                                       |       | —                                              |       |   | 23.3 |   |   |   | — |   |   |
| Depreciation  expense                         |       | 18.9                                       |       | 18.1                                                |       |   | 18.0 |   |   |   | 18.6 |   |   |
| Amortization  expense                         |       | 0.6                                        |       | 0.8                                                 |       |   | 0.7 |   |   |   | 0.8 |   |   |
| Interest expense,  net of interest income     |       | 10.3                                       |       | 10.2                                                |       |   | 10.5 |   |   |   | 10.1 |   |   |
| Other income and  expense, net                |       | —                                     |       | (0.4                                                | )          |   | (0.1 | ) |   |   | (0.2 | ) |   |
| Total costs and  expenses                     |       | 158.6                                      |       | 89.4                                                |       |   | 112.9 |   |   |   | 90.6 |   |   |
| Income (loss) before income taxes             |       | (58.6                                      | )          | 10.6                                                |       |   | (12.9 | ) |   |   | 9.4 |   |   |
| Income tax  expense (benefit)                 |       | (10.6                                      | )          | 4.3                                                 |       |   | (0.7 | ) |   |   | 2.3 |   |   |
| Net income (loss)                             |       | (48.0                                      | )%         | 6.3                                                 | %          |   | (12.2 | )% |   |   | 7.1 | % |   |

 

Thetable below provides scan-based MRI statistical information:
| ** **                               | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                               | ** ** | **2003**                                   | ** ** | **2004**                                            | ** ** | **2003** | ** ** | **2004** | ** ** |
| MRI scan-based                           |       |                                       |       |                                                |       |   |   |   |   |
| Average number of scan-based MRI systems |       | 308.1                                      |       | 291.7                                               |       | 308.2 |   | 293.9 |   |
| Scans per system per day                 |       | 9.54                                       |       | 9.73                                                |       | 9.49 |   | 9.65 |   |
| Total number of MRI scans                |       | 211,090                                    |       | 204,318                                             |       | 628,370 |   | 613,766 |   |
| Price per scan                           |       | $                                          | 357.62     |                                                | $          | 360.26 |   | $ | 362.32 |   | $ | 356.09 |   |
|                                          |            |                                            |            |                                                     |            |  |  |  |  |  |  |  |  |

 

Followingare the components of revenue (in millions):
| ** **                    | ** ** | **Quarter Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                    | ** ** | **2003**                                   | ** ** | **2004**                                            | ** ** | **   2003   ** | ** ** | **   2004   ** | ** ** |
| Scan-based MRI                |       | $                                          | 75.5       |                                                | $          | 73.6 |   | $ | 227.7 |   | $ | 218.6 |   |
| PET                           |       | 15.1                                       |       | 20.2                                                |       | 40.5 |   | 57.4 |   |
| Non-scan based  MRI and other |       | 15.1                                       |       | 16.0                                                |       | 45.5 |   | 48.9 |   |
| Total                         |       | $                                          | 105.7      |                                                | $          | 109.8 |   | $ | 313.7 |   | $ | 324.9 |   |

 

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***Quarter Ended September 30, 2004 Compared toQuarter Ended September 30, 2003***

Revenue increased $4.1 million, or 3.9%, to$109.8 million in the third quarter of 2004 compared to $105.7 million inthe third quarter of 2003 primarily due to higher PET revenue and highernon-scan based MRI revenue, offset by lower scan-based MRI revenue. PET revenuein the third quarter of 2004 increased $5.1 million, or 33.6%, compared to thethird quarter of 2003 primarily due to an increase in our base PET business and an increase in thenumber of PET systems in service. Non-scan based MRI revenue and other revenuein the third quarter of 2004 increased $0.9 million, or 6.0%, primarily due tohigher MRI fixed-fee and short-term MRI rental revenue. Scan-based MRI revenuein the third quarter of 2004 decreased $1.9 million, or 2.5%, compared tothe third quarter of 2003 primarily as a result of a 3.2% decrease in our MRIscan volume, partially offset by a 0.7% increase in the average MRI price perscan. The decrease in MRI scan volume was primarily due to a decrease in theaverage number of scan-based systems in service, to 291.7 systems in the thirdquarter of 2004 from 308.1 systems in the third quarter of 2003, partiallyoffset by an increase in the average scans per system per day to 9.73 in thethird quarter of 2004 from 9.54 in the third quarter of 2003. The average priceper MRI scan increased to $360.26 per scan in the third quarter of 2004 from$357.62 per scan in the third quarter of 2003.

We had 362 MRI systems at September 30, 2004compared to 365 MRI systems at September 30, 2003. We had 53 PET or PET/CTsystems at September 30, 2004 compared to 38 PET or PET/CT systems at September 30,2003.

Operating expenses, excluding depreciation, increased$5.1 million, or 10.2%, to $54.8 million in the third quarter of 2004compared to $49.7 million in the third quarter of 2003. Compensation and related employee expensesincreased $2.4 million, or 9.8%, primarily as a result of an increase intechnologists’ wage rates and the number of technologists necessary to supportnew PET/CT systems in operation. Maintenance costs increased $0.8 million, or8.1%, primarily due to an increase in the average maintenance cost per systemand an increase in the number of PET/CT systems in service. Medical suppliesincreased $0.7 million, or 17.9%, primarily as a result of an increase in thenumber of PET/CT systems in operation, which use a radiopharmaceutical as acomponent of the PET scan. Management contract expense increased $0.4 million,or 15.8%, primarily as a result of an increase in expenses of unconsolidatedjoint ventures. Licenses, taxes and fees expense increased $0.3 million, or49.4%, primarily due to an increase in property taxes. All other operatingexpenses, excluding depreciation, increased $0.5 million, or 6.0%. Operatingexpenses, excluding depreciation, as a percentage of revenue, increased to50.0% in the third quarter of 2004 from 47.1% in the third quarter of 2003 as aresult of the factors described above.

Selling, general andadministrative expenses decreased $1.6 million, or 13.1%, to $10.3 million inthe third quarter of 2004 compared to $11.9 million in the third quarter of2003. The provision for doubtful accounts decreased $1.0 million, or 115%,primarily as a result of higher than normal collections of older accountsreceivable. The provision for doubtful accounts decreased to (0.1%) of revenuein the third quarter of 2004 compared to 0.8% of revenue in the third quarterof 2003. Professional services decreased $0.8 million, or 36.1% primarily dueto a decrease in management consulting expenses. All other selling, general andadministrative expenses decreased $1.8 million, or 63.6%, primarily due to equity interest earnings from unconsolidated jointventures. These decreases were offset by an increase in compensation andrelated employee expenses of $2.0 million, or 32.7%, primarily due to increasesin sales, business development, and management infrastructure and an increasein bonus expenses.  Selling, general and administrative expensesas a percentage of revenue were 9.4% and 11.3% in the third quarter of 2004 and2003, respectively.

Minority interest expense increased $0.2 million to$0.5 million, or 0.5% of revenue, in the third quarter of 2004 from $0.3million, or 0.2% of revenue, in the third quarter of 2003.

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We recorded employment agreementexpenses of $0.3 million and $0.5 million in the third quarters of 2004 and2003, respectively, related to an amendment to an employment agreement with ourformer chairman of the board. We expect to incur approximately $0.7 million ofcosts over the remaining 8-month term of the amended employment agreementwith our former chairman of the board.

We recorded severance andrelated costs of $0.6 million in the third quarter of 2004 primarily forseverance costs associated with reductions-in-force due to our consolidation ofoperating in 10 geographic regions to 6 geographic regions and a furtherconsolidation of our retail billing and scheduling functions. We recordedseverance and related costs of $0.1 million in the third quarter of 2003.

We recorded non-cash stock-basedcompensation of $0.1 million and $0.4 million in the third quarter of 2004 and2003, respectively, as a result of amending certain stock option agreements in June 2001and May 2004 to reduce performance targets and granting options in November 2000to purchase our common stock at an exercise price below its fair value.

Depreciation expense decreased $0.1 million, or0.6%, to $19.8 million in the third quarter of 2004 compared to$19.9 million in the third quarter of 2003.

Amortization expense increased $0.2 million, or 30.9%,to $0.9 million in the third quarter of 2004 compared to $0.7 millionin the third quarter of 2003.

Interest expense, net, increased$0.3 million, or 3.1%, to $11.2 million in the third quarter of 2004 comparedto $10.9 million in the third quarter of 2003. This increase was due to higheraverage interest rates on our term loans because we entered into interest rate swapagreements in the second quarter of 2004 to hedge against future interest rateincreases on a portion of our term loans. This increase was partially offset by areduction in interest expense due to a lower average debt balance in the thirdquarter of 2004 compared to the third quarter of 2003.

For the quarter ended September 30,2004, we recorded income tax expense of $4.7 million, which was 40.3% of ourpretax income. This effective tax rate was higher than federal statutory ratesprimarily due to state income taxes. For the quarter ended September 30,2003, the Company recorded an income tax benefit of $11.3 million, or 18.2% ofour pretax loss. We recorded a lower than statutory income tax benefit becausea portion of the asset impairment charges related to non-deductible goodwill.

Ournet income was $7.0 million, or $0.14 per share on a diluted basis, in thethird quarter of 2004 compared to a net loss of $(50.7) million, or $(1.06) pershare on a diluted basis, in the third quarter of 2003.

***Nine Months Ended September 30, 2004 Compared toNine Months Ended September 30, 2003***

Revenue increased$11.2 million, or 3.6%, to $324.9 million in the first nine months of2004 compared to $313.7 million in the first nine months of 2003,primarily due to higher PET revenue and higher non-scan based MRI revenue andother revenue, offset by lower scan-based MRI revenue. PET revenue in the firstnine months of 2004 increased $16.9 million,or 41.7%, compared to the first nine months of 2003 primarily due to an increase in our base PET business and anincrease in the number of PET systems in service. Non-scan based MRI revenueand other revenue in the first nine months of 2004 increased $3.4 million, or7.4%, primarily due to higher MRI fixed-fee and short-term MRI rental revenue. Scan-basedMRI revenue in the first nine months of 2004 decreased $9.1 million, or 4.0%,primarily as a result of a 2.3% decrease in our MRI scan volume and a 1.7%decrease in the average MRI price per scan. The decrease in MRI scan volume wasprimarily due to a decrease in the average number of scan-based systems inservice, to 293.9 systems in the first nine months of 2004 from 308.2 systemsin the first nine months of 2003, partially offset by an increase in theaverage scans per system per day to 9.65 in the first nine months of 2004 from 9.49 in the first nine months of2003. The average price per MRI scan decreased to $356.09 per scan in the firstnine months of 2004 from $362.32 per scan in the first nine months of 2003.

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We had 362 MRI systems at September 30, 2004compared to 365 MRI systems at September 30, 2003. We had 53 PET or PET/CTsystems at September 30, 2004 compared to 38 PET or PET/CT systems at September 30,2003.

Operating expenses, excluding depreciation, increased$14.7 million, or 10.0%, to $162.6 million in the first nine monthsof 2004 compared to $147.9 million in the first nine months of 2003. Compensation and related employee expensesincreased $6.6 million, or 8.9%, primarily as a result of an increase intechnologists’ wage rates and the number of technologists necessary to supportnew PET/CT systems in operation. Maintenance costs increased $2.4 million, or8.3%, primarily due to an increase in the average maintenance cost per systemand an increase in the number of PET/CT systems in service. Medical suppliesincreased $2.2 million, or 20.2%, primarily as a result of an increase in thenumber of PET/CT systems in operation, which use a radiopharmaceutical as acomponent of the PET scan. Management contract expenses increased $1.5 million,or 27.3%, primarily as a result of an increase in expenses of unconsolidatedjoint ventures. Outside medical services increased $1.3 million, or 24.1%,primarily as a result of an increase in outside radiologists servicesassociated with PET. All other operating expenses, excluding depreciation,increased $0.7 million, or 3.0%. Operating expenses, excluding depreciation, asa percentage of revenue, increased to 50.0% in the first nine months of 2004 from47.2% in the first nine months of 2003 as a result of the factors describedabove.

Selling, general andadministrative expenses decreased $3.1 million, or 8.7%, to $32.0 million inthe first nine months of 2004 compared to $35.1 million in the first ninemonths of 2003. The provision for doubtful accounts decreased $1.7 million, or83.9%, primarily as a result of higher than normal collections of olderaccounts receivable. The provision for doubtful accounts decreased as apercentage of revenue to 0.1% in the first nine months of 2004 compared to 0.6%in the corresponding period of 2003. Professional services decreased $0.5million, or 12.4%, primarily due to a decrease in management consultingexpenses. These decreases were offset by an increase in compensation andrelated employee expenses of $3.0 million, or 14.2%, primarily due to increasesin sales, business development, and management infrastructure, and an increasein bonus expenses. All other selling, general and administrative expensesdecreased $3.9 million, or 54.2% primarily due to equity interestearnings from unconsolidated joint ventures. Selling, general andadministrative expenses as a percentage of revenue were 9.9% and 11.2% in thefirst nine months of 2004 and 2003, respectively.

Minority interest expense increased $0.6 million, or41.3%, to $2.0 million in the first nine months of 2004 compared to $1.4million in the first nine months of 2003.

We recorded employment agreementexpenses of $1.8 million in the first nine months of 2004 related to anemployment agreement with our former chief financial officer and payments underan amendment to an employment agreement with our former chairman of the board. Werecorded employment agreement expenses of $2.1 million in the first nine monthsof 2003 related to payments under an amendment to an employment agreement withour former chairman of the board. We expect to incur approximately $0.7 millionof costs over the remaining 8-month term of the amended employmentagreement with our former chairman of the board.

We recorded severance andrelated costs of $0.6 million in the first nine months of 2004 primarily forseverance costs associated with reductions-in-force due to our consolidation ofoperating in 10 geographic regions to 6 geographic regions and a furtherconsolidation of our retail billing and scheduling functions. We recordedseverance and related costs of $1.9 million in the first nine months of 2003primarily related to severance and settlement payments made as a result ofreductions-in-force.

We recorded non-cash stock basedcompensation of $0.3 and $1.3 million in the first nine months of 2004 and2003, respectively, as a result of amending certain stock option agreements in June 2001and May 2004 to reduce performance targets and granting options in November 2000to purchase our common stock at an exercise price below its fair value.

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Depreciation expense increased $3.9 million, or6.9%, to $60.5 million in the first nine months of 2004 compared to$56.6 million in the first nine months of 2003, principally due to anincrease in the number of PET and PET/CT systems which have a shorterdepreciable life than MRIs, as well as the change in estimate of new MRI systemuseful lives from eight years to seven years in the third quarter of 2003.

Amortization expense increased $0.6 million, or 30.1%,to $2.6 million in the first nine months of 2004 compared to$2.0 million in the first nine months of 2003.

Interest expense, net, decreased$0.5 million, or 1.4%, to $32.6 million in the first nine months of 2004compared to $33.1 million in the first nine months of 2003. This decrease wasprimarily due to lower average debt balances, offset by higher average interestrates on our variable rate term loans because we entered into interest rateswap agreements in the second quarter of 2004 to hedge against future interestrate increases on a portion of our variable rate term loans.

In the first nine months of2004, we recorded a provision for income taxes of $7.2 million, which was 23.7%of our pretax income. This effective tax rate was lower than statutory ratesprimarily due to the reversal ofincome tax reserves of $5.1 million primarily related to the favorable outcomeof examinations of our 1998 and 1999 federal income tax returns and a favorablefinal IRS determination letter related to the treatment of an income item in afederal income tax return of one of our subsidiaries. In the first nine months of 2003, we recorded anincome tax benefit of $2.4 million, which was 5.9% of our pretax loss. We recordeda lower than statutory income tax benefit because a portion of the impairmentcharges recorded in 2003 related to non-deductible goodwill.

Ournet income was $23.2 million, or $0.48 per share on a diluted basis, in thefirst nine months of 2004 compared to a net loss of $(38.1) million, or $(0.80)per share on a diluted basis, in the first nine months of 2003.

**Liquidity and Capital Resources**

Our primary source of liquidity is cash provided byoperating activities. Cash provided by operating activities totaled $107.1million and $96.5 million in the first nine months of 2004 and 2003,respectively. Our ability to generate cash flow is affected by numerousfactors, including demand for MRI and PET scans, the price we can charge ourclients for providing our services, andthe costs to us of providing these services. Our ability to generate cash flow from operatingactivities is also dependent upon the collections of our accounts receivable.We believe that the number of days of revenue outstanding for our accountsreceivable, which was 43 days as of December 31, 2003 and 44 days as ofSeptember 30, 2004, is among the more favorable in the healthcare servicesindustry. In addition, as of September 30, 2004, we had$145.5 million of available borrowings under our revolving line of credit. As of September 30, 2004, we were incompliance with all of the financial covenants required by our creditagreement.

Our primary use ofcapital resources is to fund capital expenditures. We incur capitalexpenditures for the purposes of:

·  purchasing new systems;

·  replacing less advanced systems with newsystems;

·  providing upgrades of our MRI systems andupgrading our corporate infrastructure for future growth; and

·  purchasing systems upon termination ofoperating leases.

Capital expenditures totaled $69.0 million and $69.6million in the first nine months of 2004 and 2003, respectively. During thefirst nine months of 2004, we purchased 22 MRI systems, 10 PET/CT systems, twoCT systems and two other imaging systems, including replacement systems. Ourdecision to purchase a new 

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system is typicallypredicated on obtaining new or extending existing client contracts and thedevelopment of fixed-site centers, which serve as the basis of demand for thenew system. We expect to purchase additional systems in 2004 and to financesubstantially all of these purchases with our available cash, cash provided byoperating activities, our revolving line of credit and equipment leases. Weexpect capital expenditures to total approximately $80 million to $85 millionin 2004.

Webelieve that, based on current levels of operations, our cash provided byoperating activities, together with other available sources of liquidity,including borrowings available under our revolving loan facility, will besufficient over the next one to two years to fund anticipated capitalexpenditures and make required payments of principal and interest on our debt.

**Recent Accounting Pronouncements**

In May 2003, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards No. 150,“Accounting for Certain Instruments with Characteristics of Both Liabilitiesand Equity” (“SFAS 150”), which establishes standards for how an issuerclassifies and measures certain financial instruments with characteristics ofboth liabilities and equity. SFAS No. 150 requires that an issuer classifya financial instrument that is within its scope, which may have previously beenreported as equity, as a liability (or an asset in some circumstances). Thisstatement is effective for financial instruments entered into or modified afterMay 31, 2003, and otherwise is effective at the beginning of the firstinterim period beginning after June 15, 2003. In October 2003, theFASB deferred implementation of paragraphs 9 and 10 of SFAS 150 regardingparent company treatment of minority interest for certain limited life entitiesand certain other mandatorily redeemable financial instruments. This deferralis for an indefinite period. The adoption of SFAS No. 150 did not have amaterial impact on our financial position or results of operations.

In December 2003, theSecurities and Exchange Commission released Staff Accounting Bulletin (“SAB”) No. 104,“Revenue Recognition”, which supersedes SAB 101, “Revenue Recognition inFinancial Statements.” SAB 104 clarifies existing guidance regarding revenuesfor contracts which contain multiple deliverables to make it consistent withEmerging Issues Task Force (“EITF”) No. 00-21, “Accounting forRevenue Arrangements with Multiple Deliverables.”  The adoption of SAB 104 did not have amaterial impact on our revenue recognition policies, nor our financial positionor results of operations.

**Cautionary Statement Pursuant to the PrivateSecurities Litigation Reform Act of 1995**

Certain statementscontained in Management’s Discussion and Analysis of Financial Condition andResults of Operations, particularly in the section entitled “Liquidity andCapital Resources,” and elsewhere in this quarterly report on Form 10-Q,are “forward-looking statements,” within the meaning of the safe harborprovisions of the Private Securities Litigation Reform Act of 1995. Statementswhich address activities, events or developments that we expect or anticipatewill or may occur in the future, including such things as results of operationsand financial condition, capital expenditures, the consummation of acquisitionsand financing transactions and the effect of such transactions on our businessand our plans and objectives for future operations and expansion are examplesof forward-looking statements. In some cases you can identify these statementsby forward-looking words like “may,” “will,” “should,” “expect,” “anticipate,” “believe,”“estimate,” “predict,” “continue” or similar words. These forward-lookingstatements are subject to risks and uncertainties which could cause actualoutcomes and results to differ materially from our expectations, forecasts andassumptions. These risks and uncertainties include factors affecting ourleverage, including fluctuations in interest rates, the risk that the counter-parties to our interestrate swap agreements fail to satisfy their obligations under these agreements,our ability to incur financing, the effect of operating and financialrestrictions in our debt instruments, the accuracy of our estimates regardingour capital requirements, the effect of intense levels of competition in ourindustry, changes in the healthcare regulatory environment, our ability to keeppace with technological 

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developmentswithin our industry, and other risks and uncertainties, including thoseenumerated and described under “Risk Factors” in our Form 10-K, asfiled with the Securities and Exchange Commission, for the fiscal year ended December 31,2003. The foregoing should not be construed as an exhaustive list of allfactors which could cause actual results to differ materially from thoseexpressed in forward-looking statements made by us.

**ITEM 3.**   QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We sell our services exclusively in the United Statesand receive payment for our services exclusively in United States dollars. As aresult, our financial results are unlikely to be affected by factors such aschanges in foreign currency exchange rates or weak economic conditions inforeign markets.

Our interest expense is sensitive to changes in thegeneral level of interest rates in the United States, particularly because themajority of our indebtedness has interest rates which are variable. Therecorded carrying amount of our long-term debt under our credit agreementapproximates fair value as these borrowings have variable rates that reflectcurrently available terms and conditions for similar debt. To decrease the riskassociated with interest rate increases, we entered into interest rate swapagreements for a portion of this variable rate debt. These swaps are designatedas cash flow hedges of variable future cash flows associated with our long-termdebt.

These swap agreements have notional amounts of $56.8million and $46.8 million at September 30, 2004. Under the terms of theseagreements, we receive three-month LIBOR and pay a fixed rate of 3.15% and3.89%, respectively. The net effect of the hedges is to record interest expenseat fixed rates of 5.53% and 6.27%, respectively, as the debt incurs interestbased on three-month LIBOR plus 2.38%. For thequarter ended September 30, 2004, we recorded net interest expense on theswap of $0.6 million. The swap agreements mature in thesecond quarter of 2007.

The swap agreements have been designated as cash flowhedges of variable future cash flows associated with our long term debt. Inaccordance with SFAS 133, the swaps are recorded at fair value. On a quarterlybasis, the fair value of the swaps will be determined based on quoted marketprices and, assuming perfect effectiveness, the difference between the fairvalue and the book value of the swaps will be recognized in other comprehensiveincome, a component of shareholders’ equity. Any ineffectiveness of the swapsis required to be recognized in earnings.

The outstanding interest rate swaps expose us tocredit risk in the event that the counterparties to the agreements do not orcannot meet their obligations. The notional amount is used to measure interestto be paid or received and does not represent the amount of exposure to creditloss. The loss would be limited to the amount that would have been received, ifany, over the remaining life of the swap agreements. The counterparties to theswaps are major financial institutions and we expect the counterparties to beable to perform their obligations under the swaps. We use derivative financialinstruments for hedging purposes only and not for trading or speculativepurposes

Our interest income issensitive to changes in the general level of interest rates in the UnitedStates, particularly because the majority of our investments are in cashequivalents. The recorded carrying amounts of cash and cash equivalentsapproximate fair value due to their short-term maturities.

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**ITEM 4.   CONTROLS AND PROCEDURES**

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures. Also, we have investments incertain unconsolidated entities. As we do not control or manage these entities,our disclosure controls and procedures with respect to such entities arenecessarily substantially more limited than those we maintain with respect toour consolidated subsidiaries. These unconsolidated entities are not consideredmaterial to our consolidated financial position or results of operations.

As required by SEC Rule 13a-15(b), wecarried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the quarter covered by this report. Basedon the foregoing, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective at thereasonable assurance level.

There has been no change in our internal controls overfinancial reporting during our most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlsover financial reporting.

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**PART II—OTHER INFORMATION**

**ITEM 1.**   LEGALPROCEEDINGS

From time to time, we areinvolved in routine litigation incidental to the conduct of our business. Webelieve that none of this litigation pending against us will have a materialadverse effect on our business.

**ITEM 2.   CHANGES IN SECURITIES AND USE OFPROCEEDS**

On July 26, 2004, wesold and issued to R. Brian Hanson, Executive Vice President and ChiefFinancial Officer, 11,933 shares of our common stock for a purchase price of$4.19 per share in a private placement. Mr. Hanson paid cash in full forthese shares at the fair market value of the shares. The proceeds from thistransaction was $49,999. No underwriter orplacement agent was involved in the transaction. The sale of shares was madepursuant to Section 4(2) of the Securities Act of 1933, as amended,in reliance on, among other facts, Mr. Hanson’s financial sophisticationand access to information and the absence of general solicitation oradvertising.

**ITEM 3.   DEFAULTS UPON SENIOR SECURITIES**

Not applicable.

**ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

Not applicable.

**ITEM 5.   OTHER INFORMATION**

Not applicable.

**ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K**

(a)   Exhibits
| Exhibit No.                                                                                                                         | ** ** | ** **                                                                                                                                                                                                              | ** ** | **Description** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
|                       3.1       |       | Amended and  Restated Certificate of Incorporation of Alliance. (7)                                                                                                                                                |
|                        3.2 |       | Amended and  Restated By-laws of Alliance. (7)                                                                                                                                                                     |
|                        4.1 |       | Indenture dated  as of April 10, 2001 by and between the Registrant and the Bank of New  York with respect to $260 million aggregate principal amount of 103¤8%  Senior Subordinated Notes due 2011. (5) |
|                        4.2 |       | Credit Agreement  dated as of November 2, 1999, as amended. (5)                                                                                                                                               |
|                        4.3 |       | Specimen  certificate for shares of common stock, $.01 par value, of Alliance. (7)                                                                                                                                 |
|                        4.4 |       | Second Amendment  dated as of June 10, 2002 to Credit Agreement. (8)                                                                                                                                          |
|                 10.1                                          |       | The 1999 Equity  Plan for Employees of Alliance and Subsidiaries including the forms of option  agreements used thereunder, as amended. (5)                                                                        |
|                 10.2                                          |       | The Alliance 1997  Stock Option Plan, including form of option agreement used thereunder, as  amended. (5)                                                                                                         |
|                 10.3                                          |       | The Three Rivers  Holding Corp. 1997 Stock Option Plan, as amended. (5)                                                                                                                                            |
|                 10.4                                          |       | Alliance  Directors’ Deferred Compensation Plan, as amended. (6)                                                                                                                                              |

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|                 10.5  |   | 2003 Incentive  Plan (9)                                                                                                                                    |
|--------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 10.6  |   | Employment  Agreement dated as of July 23, 1997 between Alliance and Richard N.  Zehner. (1)                                                      |
|                 10.7  |   | Agreement Not to  Compete dated as of July 23, 1999 between Alliance and Richard N.  Zehner. (1)                                                  |
|                 10.8  |   | Amendment to  Employment Agreement dated as of July 23, 1997 between Alliance and  Richard N. Zehner. (2)                                         |
|                 10.9  |   | Amendment to  Employment Agreement dated as of December 31, 1997 between Alliance and  Richard N. Zehner. (3)                                     |
|                 10.10 |   | Second Amendment  to Employment Agreement dated as of February 5, 1998 between Alliance  and Richard N. Zehner. (3)                               |
|                 10.11 |   | Employment  Agreement dated as of January 19, 1998 between Alliance and  Kenneth S. Ord. (4)                                                      |
|                 10.12 |   | Agreement Not to  Compete dated as of January 19, 1998 between Alliance and Kenneth S.  Ord. (4)                                                  |
|                 10.13 |   | Amended and  Restated Employment Agreement dated June 6, 1994 between Alliance and  Terry A. Andrues. (5)                                         |
|                 10.14 |   | Amended and  Restated Employment Agreement dated as of June 6, 1994 between Alliance  and Cheryl A. Ford. (5)                                     |
|                 10.15 |   | Employment  Agreement dated as of April 29, 1998 between Alliance and Russell D.  Phillips, Jr. (3)                                          |
|                 10.16 |   | Agreement Not to  Compete dated as of April 29, 1998 between Alliance and Russell D.  Phillips, Jr. (3)                                      |
|                 10.17 |   | Employment  Agreement dated as of January 1, 2003 between Alliance and Paul S.  Viviano. (9)                                                      |
|                 10.18 |   | Agreement Not to  Compete dated as of January 1, 2003 between Alliance and Paul S.  Viviano. (9)                                                  |
|                 10.19 |   | Stock  Subscription Agreement dated as of January 2, 2003 between Alliance and  Paul S. Viviano. (9)                                              |
|                 10.20 |   | Stock  Subscription Agreement dated as of February 3, 2003 between Alliance and  Paul S. Viviano. (9)                                             |
|                 10.21 |   | Form of  Stockholder’s Agreement. (5)                                                                                                             |
|                 10.22 |   | Agreement and  Plan of Merger dated as of September 13, 1999 between Alliance and View  Acquisition Corporation, as amended. (5)                       |
|                 10.23 |   | Registration  Rights Agreement dated as of November 2, 1999. (5)                                                                                       |
|                 10.24 |   | Management  Agreement, dated as of November 2, 1999, between Alliance and Kohlberg  Kravis Roberts & Co., LLP. (5)                            |
|                 10.25 |   | Amendment  No. 1 to Management Agreement, effective as of January 1, 2000,  between Alliance and Kohlberg Kravis Roberts & Co., LLP. (5) |

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|                 10.26 |   | Form of  Indemnification Agreement. (6)                                                                                                                                           |
|--------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 10.27 |   | Amendment to  Employment Agreement, Non-Qualified Stock Option Agreement and Non-Compete  Agreement, dated as of May 21, 2003, between Alliance and Richard N.  Zehner. (10) |
|                 10.28 |   | Amendment to Amended and Restated Employment  Agreement, dated as of May 9, 2003, between Alliance and Cheryl A.  Ford. (10)                                                 |
|                 10.29 |   | Amendment to Employment Agreement and Stockholders’  Agreement, dated March 29, 2004 by and between Alliance, Viewer  Holdings, LLC and Kenneth S. Ord. (12)            |
|                 21.1  |   | List of  subsidiaries. (11)                                                                                                                                                            |
|                 31    |   | Certifications of  Chief Executive Officer and Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. (13)                                           |
|                 32    |   | Certifications of  Chief Executive Officer and Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. (13)                                           |

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(1)          Incorporated byreference to exhibits filed with the Company’s Registration Statement on Form S-2,No. 333-33817.

(2)          Incorporated byreference herein to the indicated Exhibit in response to Item 14(a)(3), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,1997.

(3)          Incorporated byreference herein to the indicated Exhibit in response to Item 14(a)(3), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,1998.

(4)          Incorporated byreference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended March 31,1998.

(5)          Incorporated byreference to exhibits filed with the Company’s Registration Statement on Form S-4,No. 333-60682, as amended.

(6)          Incorporated byreference to exhibits filed with the Company’s Registration Statement on Form S-1,No. 333-64322, as amended.

(7)          Incorporated byreference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended June 30,2001.

(8)          Incorporated byreference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended June 30,2002.

(9)          Incorporated byreference herein to the indicated Exhibit response in Item 15(a)(3), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,2002.

(10)   Incorporated by reference toexhibits filed in response to Item 6, “Exhibits” of the Company’s QuarterlyReport on Form 10-Q for the quarter ended June 30, 2003.

(11)   Incorporated by referenceherein to the indicated Exhibit response in Item 15(a)(3), “Exhibits” ofthe Company’s Annual Report on Form 10-K for the year ended December 31,2003.

(12)   Incorporated by reference toexhibits filed in response to Item 6, “Exhibits” of the Company’s QuarterlyReport on Form 10-Q for the quarter ended March 31, 2004.

(13)   Filed herewith

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(b)   Reports on Form 8-K in the third quarter of 2004:

On July 6,2004, we filed a Form 8-K containing a press release issued on July 1,2004, announcing that R. Brian Hanson will become our executive vice presidentand chief financial officer effective July 26, 2004.

On August 10, 2004, we filed a Form 8-Kcontaining a press release issued on August 9, 2004, announcing ourresults of operations for the quarter and six months ended June 30, 2004and raising guidance for full year2004.

On September 14, 2004, we filed a Form 8-Kcontaining a press release issued on September 8, 2004, announcing thateffective September 8, 2004, Henry R. Kravis resigned from the our Boardof Directors. The resignation of Mr. Kravis from our Board of Directorsdid not involve any disagreement with us. On September 8, 2004, our Boardof Directors appointed Adam H. Clammer as a Class I director to fill thevacancy crated by the resignation of Mr. Kravis. Mr. Clammer is adirector of Kohlberg Kravis Roberts & Co., L.P., an investment firm.

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                       | **ALLIANCE, IMAGING, INC.** |
|-----------------------|-----------------------------|
| ** **            | ** **                  |
| ** **            | ** **                  |
| November 9, 2004 | By:                         | /s/ PAUL S.  VIVIANO |
|                  |                        | Paul S. Viviano |
|                  |                        | *Chairman  of the Board and Chief Executive Officer* |
|                  |                        | *(Principal  Executive Officer)* |
|                  |                        |   |
| November 9, 2004 | By:                         | /s/ R. BRIAN  HANSON |
|                  |                        | R. Brian Hanson |
|                  |                        | *Executive  Vice President and Chief Financial Officer* |
|                  |                        | *(Principal  Financial Officer)* |
|                  |                        |   |
| November 9, 2004 | By:                         | /s/ HOWARD K.  AIHARA |
|                  |                        | Howard K. Aihara |
|                  |                        | *Vice  President and Corporate Controller* |
|                  |                        | *(Principal  Accounting Officer)* |

 

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