**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

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

**ForQuarter Ended: June 30, 2006**

**CommissionFile Number: 1-16609**

**ALLIANCE  IMAGING, INC.**

(Exact name of registrantas specified in its charter)

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

 

**1900 South State CollegeBoulevardSuite 600Anaheim, California 92806**

(Address of principalexecutive office)

**(714) 688-7100**

(Registrant’s telephonenumber, including area code)

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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 a large accelerated filer, or a non-accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o |
|--------------------------------|--------|--------------------------|--------|------------------------------|

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   Yes o   No x

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of July 31,2006:

Common Stock, $.01 par value, 49,871,449 shares

 

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**ALLIANCE  IMAGING, INC.FORM 10-Q**

**June 30, 2006**

**Index**

|                                                                                                                                                      | ** ** | **Page** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| PART I—FINANCIAL  INFORMATION                                                                                                              |       |     |
| Item 1—Financial  Statements:                                                                                                                   |       |     |
| Condensed Consolidated  Balance Sheets  December 31, 2005 and June 30, 2006 (Unaudited)                                                    |       | 3        |   |
| Condensed Consolidated Statements of  Operations and Comprehensive Income  Quarter and six months ended June 30, 2005 and 2006 (Unaudited) |       | 4        |   |
| Condensed Consolidated Statements of  Cash Flows  Six months ended June 30, 2005 and 2006 (Unaudited)                                           |       | 5        |   |
| Notes to Condensed  Consolidated Financial Statements (Unaudited)                                                                                    |       | 6        |   |
| Item 2—Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                              |       | 18       |   |
| Item 3—Quantitative and  Qualitative Disclosures about Market Risk                                                                              |       | 28       |   |
| Item 4—Controls and Procedures                                                                                                                  |       | 29       |   |
| PART II—OTHER  INFORMATION                                                                                                                 |       |     |   |
| Item 1—Legal Proceedings                                                                                                                        |       | 30       |   |
| Item 1A—Risk Factors                                                                                                                            |       | 30       |   |
| Item 2—Unregistered Sales of  Equity Securities and Use of Proceeds                                                                             |       | 30       |   |
| Item 3—Defaults Upon Senior  Securities                                                                                                         |       | 30       |   |
| Item 4—Submission of Matters  to a Vote of Security Holders                                                                                     |       | 30       |   |
| Item 5—Other Information                                                                                                                        |       | 31       |   |
| Item 6—Exhibits                                                                                                                                 |       | 31       |   |
| SIGNATURES                                                                                                                                           |       | 35       |   |

 

2

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**PART I—FINANCIALINFORMATION**

**ITEM 1.**                FINANCIALSTATEMENTS

**ALLIANCE IMAGING, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited)(in thousands)**

| ** **                                                   | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                   | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| **ASSETS**                                                   | ** ** |                  | ** ** | ** **        |       | ** ** | ** ** |
| Current assets:                                              |       |                  |       |              |       |   |   |
| Cash and cash  equivalents                                   |       |                  | $          | 13,421            |       |   | $ | 12,423 |   |
| Accounts  receivable, net of allowance for doubtful accounts |       |                  | 48,236     |              |       | 53,478 |   |
| Deferred income  taxes                                       |       |                  | 6,186      |              |       | 18,157 |   |
| Prepaid expenses  and other current assets                   |       |                  | 3,686      |              |       | 4,998 |   |
| Other receivables                                            |       |                  | 8,983      |              |       | 11,074 |   |
| Total current assets                                         |       |                  | 80,512     |              |       | 100,130 |   |
| Equipment, at cost                                           |       |                  | 752,128    |              |       | 760,475 |   |
| Less accumulated  depreciation                               |       |                  | (393,179   | )                 |       | (404,275 | ) |
| Equipment, net                                               |       |                  | 358,949    |              |       | 356,200 |   |
| Goodwill                                                     |       |                  | 154,656    |              |       | 154,612 |   |
| Other intangible assets,  net                                |       |                  | 39,071     |              |       | 38,155 |   |
| Deferred financing  costs, net                               |       |                  | 8,236      |              |       | 7,628 |   |
| Other assets                                                 |       |                  | 33,918     |              |       | 25,104 |   |
| Total assets                                                 |       |                  | $          | 675,342           |       |   | $ | 681,829 |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**               | ** ** |                  | ** ** | ** **        |       | ** ** | ** ** |
| Current liabilities:                                         |       |                  |       |              |       |   |   |
| Accounts payable                                             |       |                  | $          | 23,672            |       |   | $ | 14,646 |   |
| Accrued  compensation and related expenses                   |       |                  | 14,088     |              |       | 15,954 |   |
| Accrued interest  payable                                    |       |                  | 4,561      |              |       | 4,689 |   |
| Income taxes  payable                                        |       |                  | 87         |              |       | 76 |   |
| Other accrued  liabilities                                   |       |                  | 29,064     |              |       | 31,248 |   |
| Current portion  of long-term debt                           |       |                  | 7,781      |              |       | 7,016 |   |
| Total current  liabilities                                   |       |                  | 79,253     |              |       | 73,629 |   |
| Long-term debt, net of  current portion                      |       |                  | 418,260    |              |       | 398,158 |   |
| Senior subordinated  notes                                   |       |                  | 153,541    |              |       | 153,541 |   |
| Minority interests and  other liabilities                    |       |                  | 4,400      |              |       | 4,229 |   |
| Deferred income taxes                                        |       |                  | 60,144     |              |       | 79,073 |   |
| Total liabilities                                            |       |                  | 715,598    |              |       | 708,630 |   |
| Commitments and contingencies (Note 11)                      |       |                  |       |              |       |   |   |
| Stockholders’ deficit:                                  |       |                  |       |              |       |   |   |
| Common stock                                                 |       |                  | 496        |              |       | 498 |   |
| Additional  paid-in deficit                                  |       |                  | (11,876    | )                 |       | (9,647 | ) |
| Accumulated  comprehensive income                            |       |                  | 3,217      |              |       | 4,338 |   |
| Accumulated  deficit                                         |       |                  | (32,093    | )                 |       | (21,990 | ) |
| Total stockholders’  deficit                            |       |                  | (40,256    | )                 |       | (26,801 | ) |
| Total liabilities and stockholders’ deficit             |       |                  | $          | 675,342           |       |   | $ | 681,829 |   |

 

*See accompanying notes.*

3

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**ALLIANCE IMAGING, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSAND COMPREHENSIVE INCOME(Unaudited)(in thousands, except per share amounts)**

| ** **                                                                                          | ** ** | **Quarter Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                                                                                          | ** ** | **June 30,**      | ** ** | **June 30,**              | ** ** |
| ** **                                                                                          | ** ** | **2005**               | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues                                                                                            |       | $                      | 108,434    |                           | $          | 115,305 |   | $ | 214,398 |   | $ | 230,648 |   |
| Costs and  expenses:                                                                                |       |                   |       |                           |       |   |   |   |   |
| Cost of revenues,  excluding depreciation and amortization                                          |       | 53,892                 |       | 62,593                         |       | 107,828 |   | 122,460 |   |
| Selling, general  and administrative expenses                                                       |       | 13,677                 |       | 13,611                         |       | 25,363 |   | 27,367 |   |
| Employment agreement  costs                                                                         |       | 92                     |       | —                         |       | 366 |   | — |   |
| Severance and  related costs                                                                        |       | —                 |       | 47                             |       | — |   | 536 |   |
| Depreciation  expense                                                                               |       | 20,463                 |       | 20,919                         |       | 40,926 |   | 41,920 |   |
| Amortization  expense                                                                               |       | 901                    |       | 1,229                          |       | 1,782 |   | 2,473 |   |
| Interest expense,  net of interest income                                                           |       | 9,508                  |       | 10,074                         |       | 18,569 |   | 20,290 |   |
| Other (income)  and expense, net                                                                    |       | (55                    | )          | (256                           | )          | (387 | ) | 472 |   |
| Total costs and  expenses                                                                           |       | 98,478                 |       | 108,217                        |       | 194,447 |   | 215,518 |   |
| Income before income taxes, minority interest  expense, and earnings from unconsolidated  investees |       | 9,956                  |       | 7,088                          |       | 19,951 |   | 15,130 |   |
| Income tax  expense                                                                                 |       | 4,169                  |       | 3,535                          |       | 8,301 |   | 7,009 |   |
| Minority interest  expense                                                                          |       | 544                    |       | 495                            |       | 956 |   | 1,035 |   |
| Earnings from  unconsolidated investees                                                             |       | (912                   | )          | (1,977                         | )          | (1,596 | ) | (3,017 | ) |
| Net income                                                                                          |       | $                      | 6,155      |                           | $          | 5,035 |   | $ | 12,290 |   | $ | 10,103 |   |
| Comprehensive  income, net of taxes:                                                                |       |                   |       |                           |       |   |   |   |   |
| Net income                                                                                          |       | $                      | 6,155      |                           | $          | 5,035 |   | $ | 12,290 |   | $ | 10,103 |   |
| Unrealized (loss)  gain on hedging transactions, net of taxes                                       |       | (1,144                 | )          | 304                            |       | 1,601 |   | 1,121 |   |
| Comprehensive  income                                                                               |       | $                      | 5,011      |                           | $          | 5,339 |   | $ | 13,891 |   | $ | 11,224 |   |
| Earnings per  common share:                                                                         |       |                   |       |                           |       |   |   |   |   |
| Basic                                                                                               |       | $                      | 0.12       |                           | $          | 0.10 |   | $ | 0.25 |   | $ | 0.20 |   |
| Diluted                                                                                             |       | $                      | 0.12       |                           | $          | 0.10 |   | $ | 0.24 |   | $ | 0.20 |   |
| Weighted average  number of shares of common stock and common stock equivalents:                    |       |                   |       |                           |       |   |   |   |   |
| Basic                                                                                               |       | 49,286                 |       | 49,758                         |       | 49,210 |   | 49,684 |   |
| Diluted                                                                                             |       | 50,270                 |       | 50,232                         |       | 50,290 |   | 50,107 |   |

 

*See accompanying notes.*

4

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**ALLIANCEIMAGING, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(in thousands)**

| ** **                                                                          | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                                      | ** ** | **2006** | ** ** |
| **Operating activities:**                                                           |       |                                          |       |   |   |
| Net income                                                                          |       | $                                             | 12,290     |   | $ | 10,103 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities:  |       |                                          |       |   |   |
| Provision for  doubtful accounts                                                    |       | 1,478                                         |       | 1,593 |   |
| Non-cash  share-based compensation                                                  |       | 126                                           |       | 1,308 |   |
| Depreciation and  amortization                                                      |       | 42,708                                        |       | 44,393 |   |
| Amortization of  deferred financing costs                                           |       | 1,462                                         |       | 794 |   |
| Distributions greater  than (less than) equity in undistributed income of investees |       | 271                                           |       | (188 | ) |
| Deferred income  taxes                                                              |       | 7,236                                         |       | 6,354 |   |
| (Gain) loss on  sale of assets                                                      |       | (387                                          | )          | 472 |   |
| Changes in operating assets and liabilities:                                        |       |                                          |       |   |   |
| Accounts  receivable                                                                |       | (1,203                                        | )          | (6,903 | ) |
| Prepaid expenses  and other current assets                                          |       | (1,554                                        | )          | (1,312 | ) |
| Other receivables                                                                   |       | (2,901                                        | )          | (2,091 | ) |
| Other assets                                                                        |       | (2,243                                        | )          | (848 | ) |
| Accounts payable                                                                    |       | (11,977                                       | )          | (8,915 | ) |
| Accrued  compensation and related expenses                                          |       | (1,379                                        | )          | 1,866 |   |
| Accrued interest  payable                                                           |       | 2,737                                         |       | 128 |   |
| Income taxes  payable                                                               |       | (63                                           | )          | (11 | ) |
| Other accrued  liabilities                                                          |       | 3,802                                         |       | 1,934 |   |
| Minority interests  and other liabilities                                           |       | 342                                           |       | (259 | ) |
| Net cash provided  by operating activities                                          |       | 50,745                                        |       | 48,418 |   |
| **Investing activities:**                                                           |       |                                          |       |   |   |
| Equipment purchases                                                                 |       | (28,948                                       | )          | (43,035 | ) |
| Decrease in  deposits on equipment                                                  |       | 3,419                                         |       | 10,388 |   |
| Proceeds from sale  of assets                                                       |       | 1,251                                         |       | 2,322 |   |
| Net cash used in  investing activities                                              |       | (24,278                                       | )          | (30,325 | ) |
| **Financing activities:**                                                           |       |                                          |       |   |   |
| Principal payments  on equipment debt                                               |       | (2,972                                        | )          | (1,934 | ) |
| Principal payments  on term loan facility                                           |       | (25,000                                       | )          | (2,675 | ) |
| Principal payments  on revolving loan facility                                      |       | (15,000                                       | )          | (28,825 | ) |
| Proceeds from  revolving loan facility                                              |       | 15,000                                        |       | 13,500 |   |
| Payments of debt  issuance costs                                                    |       | (211                                          | )          | (186 | ) |
| Proceeds from  exercise of employee stock options                                   |       | 1,052                                         |       | 1,029 |   |
| Net cash used in  financing activities                                              |       | (27,131                                       | )          | (19,091 | ) |
| Net decrease in  cash and cash equivalents                                          |       | (664                                          | )          | (998 | ) |
| Cash and cash  equivalents, beginning of period                                     |       | 20,721                                        |       | 13,421 |   |
| Cash and cash  equivalents, end of period                                           |       | $                                             | 20,057     |   | $ | 12,423 |   |
| **Supplemental disclosure of cash flow  information:**                              |       |                                          |       |   |   |
| Interest paid                                                                       |       | $                                             | 14,580     |   | $ | 19,676 |   |
| Income taxes paid,  net of refunds                                                  |       | 1,291                                         |       | 767 |   |
| **Supplemental disclosure of non-cash investing  and financing activities:**        |       |                                          |       |   |   |
| Net book value of  assets exchanged                                                 |       | $                                             | 3,679      |   | $ | 5,439 |   |
| Capital lease  obligations assumed for the purchase of equipment debt               |       | —                                        |       | 1,839 |   |
| Equipment debt  transferred to unconsolidated investee                              |       | —                                        |       | (2,772 | ) |
| Comprehensive  income from hedging transactions, net of taxes                       |       | 1,601                                         |       | 1,121 |   |

 

*See accompanying notes.*

5

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**ALLIANCE IMAGING, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSJune 30, 2006(Unaudited)(Dollars in thousands, except per share amounts)**

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

**Basis ofPresentation—**The accompanyingunaudited condensed consolidated financial statements have been prepared byAlliance Imaging, Inc. (the “Company”) in accordance with accountingprinciples generally accepted in the United States of America and with theinstructions to Form 10-Q and Article 10 of Regulation S-X ofthe Securities and Exchange Commission. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments (including normal recurring accruals) considered necessary for afair presentation have been included. Operating results for the six-monthperiod ended June 30, 2006 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2006. 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 31,2005.

**Principles ofConsolidation—**Theaccompanying unaudited condensed consolidated financial statements of theCompany include the assets, liabilities, revenues and expenses of all majorityowned subsidiaries over which the Company exercises control. Intercompanytransactions have been eliminated. We record minority interest expense relatedto our consolidated subsidiaries which are not wholly owned. Investments inunconsolidated investees are accounted for under the equity method.

**Use of Estimates—**The preparation of condensed consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the amounts reported in the condensed consolidated financialstatements and accompanying notes. Actual results could differ from thoseestimates.

**2. Share-BasedCompensation**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123(R) (revisedDecember 2004), “Share-Based Payment” (“SFAS 123(R)”), which is arevision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”)and supersedes Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”). This statement requires that the fairvalue at the grant date resulting from all share-based payment transactions berecognized in the financial statements. Further, SFAS 123(R) requiresentities to apply a fair-value based measurement method in accounting for thesetransactions. This value is recorded over the vesting period. The statement iseffective for the first fiscal year beginning after June 15, 2005.

The Company adopted SFAS123(R) for the fiscal year beginning January 1, 2006, using themodified prospective application transition method and, accordingly, has notrestated the consolidated financial statements for prior interim periods orfiscal years. Under SFAS 123(R), the Company now records in its consolidatedstatements of operations (i) compensation cost for options granted,modified, repurchased or cancelled on or after January 1, 2006 under theprovisions of SFAS 123(R) and (ii) compensation cost for the unvestedportion of options granted prior to January 1, 2006 over their remainingvesting periods using the amounts previously measured under SFAS 123 for proforma disclosure purposes.

6

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***Stock Option Plans and Awards***

In December 1997, the Company adopted an employeestock option plan (“1997 Equity Plan”) pursuant to which options with respectto a total of 4,685,450 shares of the Company’s common stock were available forgrant. Options were granted at their fair value at the date of grant. Alloptions have 10-year terms. On November 2, 1999, in connection witha series of transactions contemplated by an Agreement and Plan of Mergerbetween Viewer Acquisition Corp and the Company in November 1999 (the “1999Recapitalization Merger”), all options under the 1997 Equity Plan became fullyvested.

In connection with the Company’s acquisition of all ofthe outstanding common stock of Three Rivers Holding Corporation (“Three Rivers”),the parent corporation of SMT Health Services, Inc., in 1999, outstandingemployee stock options under the 1997 Three Rivers Stock Option Plan wereconverted into options to acquire shares of the Company’s common stock. TheThree Rivers stock option plan allowed for options with respect to a total of2,825,200 shares of the Company’s common stock to be available for grant.Options were granted at their fair value at the date of grant. All options have10-year terms. On November 2, 1999, in connection with the 1999Recapitalization Merger, all options under the 1997 Three Rivers Stock OptionPlan became fully vested.

In connection with the 1999 Recapitalization Merger,the Company adopted an employee stock option plan (“the 1999 Equity Plan”)pursuant to which options with respect to a total of 6,325,000 shares of theCompany’s common stock became available for grant. As of June 30, 2006, a totalof 1,346,575 shares are available for grant under the 1999 Equity Plan. Optionsare granted with exercise prices equal to fair value of the Company’s commonstock at the date of grant, except as noted below. All options have 10-yearterms. A portion of the options vest in equal increments over five years and aportion vest after eight years (subject to acceleration if certain financialperformance targets are achieved). The Company settles stock option exerciseswith newly issued shares of common stock.

Consistent with the valuation method for thedisclosure-only provisions of SFAS 123, the Company is using the Black-Scholesoption pricing model to value the compensation expense associated withstock-based awards under SFAS 123(R). The fair value of each option award isestimated on the date of grant using the Black-Scholes option pricingmodel that uses the assumptions noted in the table below. In addition,forfeitures are estimated when recognizing compensation expense, and theestimate of forfeitures will be adjusted over the requisite service period tothe extent that actual forfeitures differ, or are expected to differ, from suchestimates. Changes in estimated forfeitures will be recognized through acumulative catch-up adjustment in the period of change and will also impact theamount of compensation expense to be recognized in future periods. For the quarter and six months ended June 30,2005, the Company recorded $63 and $126, respectively, in non-cash share-basedcompensation for stock options granted with exercise prices below the fairvalue of the Company’s common stock at the date of grant and for certain stockoptions subject to amended performance targets under the 1999 Equity Plan, asdiscussed below. For the quarter and six months ended June 30, 2006, ofthe total $593 and $1,308, respectively, in non-cash share-based compensationrecorded, $434 and $988, respectively, was incremental share-based compensationas a result of the adoption of SFAS 123 (R).

Thefollowing weighted average assumptions were used in the estimated grant datefair value calculations for stock option awards:

| ** **                        | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,**            | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                        | ** ** | **2005**                              | ** ** | **    2005    ** | ** ** | **    2006    ** | ** ** |
| Risk free  interest rate          |       |                                  | 3.96       | %                                                        |       |   | 3.79 | % |   |   | 4.55 | % |   |
| Expected dividend  yield          |       |                                  | 0.00       | %                                                        |       |   | 0.00 | % |   |   | 0.00 | % |   |
| Expected stock  price volatility  |       |                                  | 56.4       | %                                                        |       |   | 52.8 | % |   |   | 56.7 | % |   |
| Average expected life  (in years) |       |                                  | 6.50       |                                                     |       |   | 5.52 |   |   |   | 6.69 |   |   |

 

7

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There were no stock options granted during the secondquarter ended June 30, 2006.

The expected stock price volatility rates are based ona blend of the historical volatility of the Company’s common stock and peerimplied volatility. The risk free interest rates are based on the U.S. Treasuryyield curve in effect at the time of grant for periods corresponding with theexpected life of the option or award. The average expected life represents theweighted average period of time that options or awards granted are expected tobe outstanding, as calculated using the simplified method described in the Securitiesand Exchange Commission’s Staff Accounting Bulletin No. 107.

In November 2000, the Company granted stockoptions to certain employees at exercise prices below the fair value of theCompany’s common stock, of which 35,000 options were outstanding at June 30,2006. 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.The Company recorded non-cash share-based compensation of $6 and $12,respectively, for the quarter and six months ended June 30, 2005, with anoffset to paid-in-capital deficit. As the Company adopted SFAS 123 (R) effectiveJanuary 1, 2006, any non-cash share-based compensation as a resultof granting these stock options will be included in the Company’s consolidatedtotal of share-based compensation of $593 and $1,308, respectively, forthe quarter and six months ended June 30, 2006.

Under the 1999 Equity Plan, a portion of the optionsgranted are “performance options.” These options vest on the eighth anniversaryof the grant date if the option holder is still an employee, but the vestingaccelerates if the Company meets the operating performance targets specified inthe option agreements. 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 1,899,600 performance optionsout of the 2,284,222 performance options outstanding. On May 18, 2004, theCompany’s compensation committee authorized the Company to make a secondamendment to the option agreements under its 1999 Equity Plan to further reducethe performance targets for all of the 1,914,500 performance optionsoutstanding. As a result of the amendment, if the Company achieves the reducedperformance targets but does not achieve the original performance targets, andan option holder terminates employment prior to the eighth anniversary of theoption grant 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 amendment exceeded theoption’s exercise price. For the quarter and six months ended June 30,2005 the Company recorded $57 and $114, respectively, in non-cash share-basedcompensation as a result of the amendment. As the Company adopted SFAS 123 (R) effectiveJanuary 1, 2006, any non-cash share-based compensation as a resultof these amendments will be included in the Company’s consolidated total ofnon-cash stock-based compensation of $593 and $1,308, respectively, forthe quarter and six months ended June 30, 2006.

Thefollowing table summarizes the Company’s stock option activity:

| ** **                                                       | ** ** | ** **         | ** ** | ** **              | ** ** | **Weighted-**   | ** ** | ** **    | ** ** |
|------------------------------------------------------------------|------------|--------------------|------------|-------------------------|------------|-----------------|------------|---------------|------------|
| ** **                                                       | ** ** | ** **         | ** ** | ** **              | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                                                       | ** ** | ** **         | ** ** | **Weighted-**           | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                                                       | ** ** | **Number of** | ** ** | **Average**             | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                                                       | ** ** | **Shares**         | ** ** | **Exercise Price** | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Outstanding at  December 31, 2005                           |       | 3,571,275          |       |                    | $          | 6.25            |       |          |       |   |   |   |   |   |   |   |
| Granted                                                          |       | 866,500            |       |                    | 4.19       |            |       |          |       |   |   |   |   |   |   |
| Exercised                                                        |       | (238,125           | )          |                    | 4.32       |            |       |          |       |   |   |   |   |   |   |
| Canceled                                                         |       | (313,350           | )          |                    | 7.79       |            |       |          |       |   |   |   |   |   |   |
| Outstanding at  June 30, 2006                               |       | 3,886,300          |       |                    | $          | 5.78            |       |          |       | 8.76 |   |   |   | $ | 13,184 |   |   |
| Vested and expected to vest in the future at  June 30, 2006 |       | 3,696,748          |       |                    | $          | 5.78            |       |          |       | 7.87 |   |   |   | $ | 12,525 |   |   |
| Exercisable at  June 30, 2006                               |       | 1,315,138          |       |                    | $          | 5.14            |       |          |       | 6.63 |   |   |   | $ | 4,244 |   |   |

 

8

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The weighted average grant-date fair value of optionsgranted during the quarter ended June 30, 2005 was $6.20 per share. There were no stock options granted duringthe quarter ended June 30, 2006. The weighted average grant-datefair value of options granted during the six months ended June 30, 2005and 2006 was $6.11 per share and $2.58 per share, respectively. The totalintrinsic value of options exercised during the quarters ended June 30,2005 and 2006 was $664 and $298, respectively. The total intrinsic value ofoptions exercised during the six months ended June 30, 2005 and 2006 was$2,306 and $389, respectively. The total cash received from employees as aresult of stock option exercises was $447 and $759 for the quarters ended June 30,2005 and 2006, respectively. The total cash received from employees as a resultof stock option exercises was $1,052 and $1,029 for the six months ended June 30,2005 and 2006, respectively.

Thefollowing table summarizes the Company’s unvested stock option activity:

| ** **                          | ** ** | ** ** | ** ** | **Weighted**        | ** ** |
|-------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Grant-Date**      | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Unvested at  December 31, 2005 |       | 2,243,851  |       |                | $          | 3.86 |   |   |
| Granted                             |       | 866,500    |       |                | 2.58       |   |   |
| Vested                              |       | (311,739   | )          |                | 3.28       |   |   |
| Canceled                            |       | (227,450   | )          |                | 4.18       |   |   |
| Unvested at June 30, 2006      |       | 2,571,162  |       |                | $          | 3.47 |   |   |

 

At June 30, 2006, thetotal unrecognized fair value compensation cost related to unvested stockoptions granted to both employees and non-employees was $7,323, which isexpected to be recognized over a remaining weighted-average period of 4.38years. The valuation model applied in this calculation utilizes highlysubjective assumptions that could potentially change over time, including theexpected forfeiture rate and performance targets. Therefore the amount of unrecognizedcompensation expense noted above does not necessarily represent the value thatwill ultimately be realized by the Company in the statements of operations. Thetotal fair value of shares vested during the quarters ended June 30, 2005and 2006 were $171, and $167, respectively. The total fair value of sharesvested during the six months ended June 30, 2005 and 2006 were $673, and$1,024, respectively.

***Employee Share-Based Compensation Expense***

Thetable below shows the amounts recognized in the financial statements for thequarter and six months ended June 30, 2006 for awards newly subject tocompensation expense under SFAS 123(R). As discussed previously, prior to theadoption of SFAS 123(R), the Company recorded compensation expense for stockoptions granted with exercise prices below the fair value of the Company’scommon stock at the date of grant, certain stock options subject to amendedperformance targets under the 1999 Equity Plan, and non-employee share-basedawards granted to members of the Company’s advisory committee. The table below,therefore, excludes the effect of these awards.

| ** **                                                                             | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                              | ** ** | **2006**                                      | ** ** |
| Selling, general, and administrative expenses                                          |       |                                  | $          | 434                                           |       |   |   | $ | 988 |   |   |
| Total cost of non-cash share-based compensation  included in income, before income tax |       |                                  | 434        |                                          |       |   | 988 |   |   |
| Amount of income tax recognized in earnings                                            |       |                                  | (179       | )                                             |       |   | (404 | ) |   |
| Amount charged against income                                                          |       |                                  | $          | 255                                           |       |   |   | $ | 584 |   |   |
| Impact on net income per share:                                                        |       |                                  |       |                                          |       |   |   |   |   |
| Basic earnings per share:                                                              |       |                                  | $          | 0.01                                          |       |   |   | $ | 0.01 |   |   |
| Diluted earnings per share:                                                            |       |                                  | $          | 0.01                                          |       |   |   | $ | 0.01 |   |   |

 

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***Pro Forma Share-Based Compensation***

Prior to the adoption of SFAS 123(R), the Companyaccounted for non-cash share-based compensation awards using the intrinsicvalue method prescribed under APB 25, and its related interpretations, aspermitted by SFAS 123, as amended by SFAS 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure.” Under the intrinsic value method, thedifference between the market price on the date of grant and the exercise priceis charged to the consolidated statements of operations over the vestingperiod. Prior to the adoption of SFAS 123(R), the Company recognizedcompensation cost for only certain awards, as discussed above. All other employeeshare-based awards were granted with an exercise price equal to the marketvalue of the underlying common stock on the date of grant and no compensationcost is reflected in income from operations for those awards. SFAS 123, asamended by SFAS 148, required presentation of pro forma information regardingnet income and earnings per share determined as if the Company had accountedfor its employee stock options under the fair value method of that Statement.

Forpurposes of pro forma disclosures, the estimated fair value of the options isamortized to expense over the options’ expected vesting period. Hadcompensation cost for the Company’s stock option plan been determined based onthe estimated fair value at the grant dates for awards under the plan consistentwith the fair value method of SFAS 123 utilizing the Black-Scholesoption-pricing model, the Company’s net income and basic and diluted earningsper share for the quarter and six months ended June 30, 2005 would haveapproximated the pro forma amount indicated below:

| ** **                                                                                                                | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                | ** ** | **2005**                              | ** ** | **2005**                                      | ** ** |
| Net income:                                                                                                               |       |                                  |       |                                          |       |   |   |   |   |
| As reported                                                                                                               |       |                                  | $          | 6,155                                         |       |   |   | $ | 12,290 |   |   |
| Add: Non-cash share-based compensation expense included  in reported net income, net of related tax effects               |       |                                  | 38         |                                          |       |   | 75 |   |   |
| Deduct: Non- cash  share-based compensation expense determined under fair value based method,  net of related tax effects |       |                                  | (367       | )                                             |       |   | (725 | ) |   |
| Pro forma net  income                                                                                                     |       |                                  | $          | 5,826                                         |       |   |   | $ | 11,640 |   |   |
| Basic earnings per share:                                                                                                 |       |                                  |       |                                          |       |   |   |   |   |
| As reported                                                                                                               |       |                                  | $          | 0.12                                          |       |   |   | $ | 0.25 |   |   |
| Pro forma                                                                                                                 |       |                                  | 0.12       |                                          |       |   | 0.24 |   |   |
| Diluted earnings per share:                                                                                               |       |                                  |       |                                          |       |   |   |   |   |
| As reported                                                                                                               |       |                                  | 0.12       |                                          |       |   | 0.24 |   |   |
| Pro forma                                                                                                                 |       |                                  | 0.12       |                                          |       |   | 0.23 |   |   |

 

**3. RecentAccounting Pronouncements**

**Accounting Changes and ErrorCorrections—****In**May 2005, the FASB issued SFAS 154, “Accountingfor Changes and Error Corrections” (“SFAS 154”), which is a replacement ofAPB Opinion No. 20, “Accounting Changes,” and SFAS 3, “ReportingAccounting Changes in Interim Financial Statements.” This statement changes therequirements for the accounting for and reporting of all voluntary changes inaccounting principle and in the instance that a pronouncement does not includespecific transition provisions. This statement requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS 154 is effective foraccounting changes and corrections of errors 

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**made infiscal years beginning after December 15, 2005. The adoption ofSFAS 154 did not have a material impact on the Company’s consolidatedfinancial position or results of operations.**

**Limited Partnerships—****In******June 2005, the FASB issued Emerging Issues Task Force Issue No. 04-05,“Determining Whether a General Partner, or the General Partners as a Group,Controls a Limited Partnership or Similar Entity When the Limited Partners HaveCertain Rights”(“EITF 04-05”). EITF 04-05 clarifies howgeneral partners in a limited partnership should determine whether they controla limited partnership. A general partner of a limited partnership is presumedto control the limited partnership unless the limited partners have substantivekick-out rights or participating rights. For general partners of all newlimited partnerships formed and for existing limited partnerships for which thepartnership agreements are modified, EITF 04-05 is effective after June 29,2005. For general partners in all other limited partnerships, EITF 04-05is effective for the first period in fiscal years beginning after December 15,2005. The adoption of EITF 04-05 did not have a material impact onthe Company’s consolidated financial position or results of operations.

**Uncertaintyin Income Taxes—****In**July 2006, the FASB issued FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes”(“FIN 48”), an interpretation ofFASB Statement No. 109, “Accounting for Income Taxes” (“FASB 109”). FIN 48clarifies the accounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB 109. This Interpretationprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. FIN 48 is effective for fiscal years beginningafter December 15, 2006. The Company does not believe the adoption of FIN48 will have a material impact on the Company’s consolidated financial positionor results of operations.

**4. Transactions**

Effective September 1, 2005, the Company acquiredcertain assets associated with nine multi-modality fixed-site diagnosticimaging centers. The multi-modality fixed-site diagnostic imaging centersinclude one MRI system, six CT systems, and 29 other modality systems. Thepurchase price consisted of $7,650 in cash and $826 in assumed liabilities andtransaction costs. The acquisition was financed using the Company’s internallygenerated funds. As a result of this acquisition, the Company recorded goodwilland intangible assets of $2,246 and $2,400, respectively. The intangible assetswere recorded at fair value at the acquisition date. All recorded goodwill isdeductible for tax purposes and will be amortized over 15 years for taxpurposes. The acquisition also includes $246 of contingent payment due to theshareholders of the centers if certain performance targets are met over a threeyear period. When the contingency is resolved and consideration isdistributable, the Company will record the fair value of the consideration asadditional purchase price to goodwill. Adjustments to goodwill may occur infuture periods as a result of changes in the original valuation of assets andliabilities acquired. During the quarter ended June 30, 2006, the companydecreased goodwill by $103 as a result of changes in the original valuation ofassets and liabilities acquired. During the six months ended June 30,2006, the company decreased goodwill by $77 as a result of changes in theoriginal valuation of assets and liabilities acquired. The Company has notincluded pro forma information as this acquisition did not have a materialimpact on the Company’s consolidated financial position or results ofoperations.

Effective October 1, 2005, the Company acquired100% of the outstanding stock of PET Scans of America Corp. (“PSA”), a mobileprovider of PET and PET/CT services primarily to hospitals in 13 states. Thepurchase price consisted of $36,596 in cash and $3,692 in assumed liabilitiesand transaction costs. The acquisition was financed using the Company’srevolving line of credit, internally generated funds, and capital leases. As aresult of this acquisition the Company acquired intangible assets of $11,400,of which $9,100 was assigned to PSA customer contracts, which will be amortizedover 10 years, and $2,100 was 

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assigned to certificatesof need held by PSA, which have indefinite useful lives and are not subject toamortization. These assets were recorded at fair value at the acquisition date.The Company recorded total goodwill of $22,472, which includes $3,007 ofgoodwill related to income tax timing differences as a result of the acquisition.None of the goodwill recorded is deductible for tax purposes. Adjustments togoodwill may occur in future periods as a result of changes in the originalvaluation of assets and liabilities acquired. There were no adjustmentsrecorded to goodwill during the quarter ended June 30, 2006. During thesix months ended June 30, 2006, the company decreased goodwill by $23 as aresult of changes in the original valuation of assets and liabilities acquired.The Company has not included pro forma information as this acquisition did nothave a material impact on the Company’s consolidated financial position orresults of operations.

In late December 2005,the Company purchased an additional equity interest in a joint venture theCompany formed in 2004 with the University of Pittsburgh Medical Center. Thejoint venture, Alliance Oncology (“AO”), is designed to partner with hospitalsto build and operate radiation oncology centers, with an emphasis on intensitymodulated radiation therapy and image guided radiation therapy. The purchaseprice for the additional equity interest was $8,000, which was financed throughthe Company’s revolving line of credit. The Company now owns 80% of AO. As aresult of this acquisition the Company recorded goodwill of $6,946, which isdeductible for tax purposes and will be amortized over 15 years for taxpurposes. Adjustments to goodwill may occur in future periods as a result ofchanges in the original valuation of assets and liabilities acquired. Therewere no adjustments recorded to goodwill during the quarter ended June 30,2006. During the six months ended June 30, 2006, the company increasedgoodwill by $56 as a result of changes in the original valuation of assets andliabilities acquired. During the quarter and six months ended June 30,2005 the Company recorded earnings in unconsolidated investees for the Company’sshare of AO’s previously unconsolidated earnings. The Company has not includedpro forma information as this acquisition did not have a material impact on theCompany’s consolidated financial position or results of operations.

**5. Goodwill andIntangible Assets**

Changesin the carrying amount of goodwill are as follows:

| Balance at  December 31, 2005      |   | $   | 154,656 |   |
|-----------------------------------------|--------|-----|---------|--------|
| Decrease to  goodwill during the period |   | (44 | )       |
| Balance at June 30,  2006          |   | $   | 154,612 |   |

 

Intangibleassets consisted of the following:

| ** **                                    | ** ** | **December 31, 2005** | ** ** | **June 30, 2006** | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **Gross  Carrying**             | ** ** | **Accumulated**             | ** ** | **Intangible** | ** ** | **Gross  Carrying** | ** ** | **Accumulated** | ** ** | **Intangible** | ** ** |
| ** **                                    | ** ** | **Amount**                      | ** ** | **Amortization**            | ** ** | **Assets, net** | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Assets, net** | ** ** |
| Amortizing intangible  assets:                |       |                            |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Customer contracts                            |       | $                               | 51,063     |                        |       | $ | (18,791 | ) |   |   | $ | 32,272 |   |   | $ | 51,063 |   |   | $ | (20,850 | ) |   |   | $ | 30,213 |   |   |
| Other                                         |       | 4,467                           |       |                        | (1,910     | ) |   |   | 2,557 |   |   | 7,087 |   |   | (2,324 | ) |   |   | 4,763 |   |   |
| Total amortizing intangible assets            |       | $                               | 55,530     |                        |       | $ | (20,701 | ) |   |   | $ | 34,829 |   |   | $ | 58,150 |   |   | $ | (23,174 | ) |   |   | $ | 34,976 |   |   |
| Intangible assets not subject to amortization |       |                            |       |                        |       |   |   |   | $ | 4,242 |   |   |   |   |   |   |   |   |   | $ | 3,179 |   |   |
| Total other  intangible assets                |       |                            |       |                        |       |   |   |   | $ | 39,071 |   |   |   |   |   |   |   |   |   | $ | 38,155 |   |   |

 

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 

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possibly occurred. Goodwillis allocated to the Company’s various reporting units which represent theCompany’s geographical regions. The Company compares the fair value of thereporting unit to its carrying amount to determine if there is potentialimpairment. The implied fair value for goodwill is determined based on the fairvalue of assets and liabilities of the respective reporting units, inaccordance with SFAS No. 142,“Goodwill and Other Intangible Assets,” based on discounted cash flows,market multiples, or appraised values as appropriate.

Amortization expense for intangible assets subject toamortization was $901 and $1,229 for the quarters ended June 30, 2005 and2006, respectively, and $1,782 and $2,473 for the six months ended June 30,2005 and 2006, respectively. The intangible assets not subject to amortizationrepresent certificate of needs and regulatory authority rights which haveindefinite useful lives.

Estimatedannual amortization expense for each of the fiscal years ending December 31,is presented below:

| 2006 |   | $     | 4,929  |   |
|------|--------|-------|--------|--------|
| 2007 |   | 4,713 |   |
| 2008 |   | 4,499 |   |
| 2009 |   | 4,178 |   |
| 2010 |   | 4,112 |   |

 

**6. Other AccruedLiabilities**

Otheraccrued liabilities consisted of the following:

| ** **                                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                    | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| Accrued systems  rental and maintenance costs |       |                  | $          | 5,801             |       |   | $ | 1,921 |   |
| Accrued site  rental fees                     |       |                  | 1,242      |              |       | 1,408 |   |
| Accrued property  and sales taxes payable     |       |                  | 10,569     |              |       | 11,895 |   |
| Accrued  self-insurance expense               |       |                  | 5,725      |              |       | 6,342 |   |
| Other accrued  expenses                       |       |                  | 5,727      |              |       | 9,682 |   |
| Total                                         |       |                  | $          | 29,064            |       |   | $ | 31,248 |   |

 

**7. Long-Term Debtand Senior Subordinated Credit Facility**

Long-termdebt consisted of the following:

| ** **                                 | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| Term loan  facility                        |       |                  | $          | 384,875           |       |   | $ | 382,200 |   |
| Revolving loan  facility                   |       |                  | 29,500     |              |       | 14,175 |   |
| Senior  subordinated notes                 |       |                  | 153,541    |              |       | 153,541 |   |
| Equipment debt                             |       |                  | 11,666     |              |       | 8,799 |   |
| Long-term debt,  including current portion |       |                  | 579,582    |              |       | 558,715 |   |
| Less current  portion                      |       |                  | 7,781      |              |       | 7,016 |   |
| Long-term debt                             |       |                  | $          | 571,801           |       |   | $ | 551,699 |   |

 

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**8.**Derivatives

In the second quarter of 2004, the Company enteredinto interest rate swap agreements, with notional amounts of $56,813, $46,813and $48,438 to hedge the future cash interest payments associated with aportion of the Company’s variable rate bank debt. These agreements are threeyears in length and mature in 2007. As of June 30, 2005, and 2006, thefair value of the Company’s interest rate swap agreements was an accumulatedincome of $1,036 and $3,318, respectively. Under these arrangements, theCompany receives three-month London Interbank Offered Rate (“LIBOR”) and pays afixed rate of 3.15%, 3.89% and 3.69%, respectively. The net effect of thehedges is to record interest expense at fixed rates of 5.65%, 6.39% and 6.19 %,respectively, as the debt incurs interest based on three-month LIBOR plus2.50%. For the quarter and six months ended June 30, 2005 the Company paidnet settlement amounts of $268 and $746, respectively. For the quarter and sixmonths ended June 30, 2006, the Company received net settlement amounts of$465 and $771, respectively. The Company has designated these swaps as cashflow hedges of variable future cash flows associated with its long-term debt.For the quarter ended June 30, 2005, the Company recognized a loss, net oftax, of $560, based on the change in fair value of these instruments. For thequarter ended June 30, 2006, the Company recognized comprehensive income,net of tax, of $31, based on the change in fair value of these instruments. Forthe six months ended June 30, 2005 and 2006, the Company recognizedcomprehensive income, net of tax, of $900 and $296, respectively, based on thechange in fair value of these instruments. The Company will continue to recordsubsequent changes in the fair value of the swaps through comprehensive incomeduring the period these instruments are designated as hedges.

In the first quarter of 2005, the Company entered intomultiple interest rate collar agreements for its variable rate bank debt. Thetotal underlying notional amount of the debt was $178,000. Under thesearrangements the Company has purchased a cap on the interest rate of 4.00% andhas sold a floor of 2.25%. The Company paid a net purchase price of $1,462 forthese collars. These agreements are two and three years in length and mature atvarious dates between January 2007 and January 2008. As of June 30,2005 and 2006, the fair value of the Company’s interest rate collar agreementswas an accumulated income of $1,168 and $3,901, respectively. For the quarterand six month period ended June 30, 2005, the Company did not record anynet settlement amount. For the quarter and six month period ended June 30,2006, the Company received a net settlement amount of $287 and $355,respectively. The Company has designated these collars as cash flow hedges ofvariable future cash flows associated with its long-term debt. For the quarterended June 30, 2005, the Company recognized a loss, net of tax, of $584based on the change in fair value of these instruments. For the quarter ended June 30,2006, the Company recognized a gain, net of tax, of $273 based on the change infair value of these instruments. For the six months ended June 30, 2005and 2006 the Company recognized a gain, net of tax, of $701 and $825,respectively, based on the change in fair value of these instruments. TheCompany will record subsequent changes in the fair value of the collars throughcomprehensive income during the period these instruments are designated ashedges.

The Company accounts for derivative instruments and hedging activitiesin accordance with the provisions of SFAS 133, “Accounting for DerivativeInstruments and Hedging Activities” (“SFAS 133”) and SFAS 138, “Accountingfor Certain Derivative Instruments and Hedging Activities” (“SFAS 138”),an amendment of SFAS 133. On the date the Company enters into a derivativecontract, management designates the derivative as a hedge of the identifiedexposure. The Company does not enter into derivative instruments that do notqualify as cash flow hedges as described in SFAS 133 and SFAS 138.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, 

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both at the hedge inception and on an ongoingbasis, in accordance with its risk management policy. The Company woulddiscontinue hedge accounting prospectively (i) if it is determined thatthe derivative is no longer effective in offsetting change in the cash flows ofa hedged item, (ii) when the derivative expires or is sold, terminated orexercised, (iii) because it is probable that the forecasted transactionwill not occur, (iv) because a hedged firm commitment no longer meets thedefinition of a firm commitment, or (v) if management determines thatdesignation of the derivative as a hedge instrument is no longer appropriate.The Company’s derivatives are recorded on the balance sheet at their fairvalue. For derivatives accounted for as cash flow hedges any unrealized gainsor losses on fair value are included in comprehensive income, net of tax.

**9. Income Taxes**

For the quarter and sixmonths ended June 30, 2006, the Company recorded a provision for incometaxes of $3,535 and $7,009, or 41.2% and 41.0% of the Company’s pretax income,respectively. For the quarter and six months ended June 30, 2005, theCompany recorded a provision for income taxes of $4,169 and $8,301, or 40.4%and 40.3% of the Company’s pretax income, respectively. The Company’s effectivetax rate was higher than statutory rates primarily as a result of state incometaxes.

**10. Earnings PerCommon Share**

The following table sets forth the computation ofbasic and diluted earnings per share (amounts in thousands, except per shareamounts): 

| ** **                                                                                         | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                              | ** ** | **2006**                                      | ** ** | **   2005   ** | ** ** | **   2006   ** | ** ** |
| Numerator:                                                                                         |       |                                  |       |                                          |       |   |   |   |   |
| Net income                                                                                         |       | $                                     | 6,155      |                                          | $          | 5,035 |   | $ | 12,290 |   | $ | 10,103 |   |
| Denominator:                                                                                       |       |                                  |       |                                          |       |   |   |   |   |
| Denominator for basic  earnings per share—weighted-average shares                             |       | 49,286                                |       | 49,758                                        |       | 49,210 |   | 49,684 |   |
| Effect of dilutive  securities:                                                                    |       |                                  |       |                                          |       |   |   |   |   |
| Employee stock  options                                                                            |       | 984                                   |       | 474                                           |       | 1,080 |   | 423 |   |
| Denominator for diluted  earnings per share—adjusted weighted-average shares                  |       | 50,270                                |       | 50,232                                        |       | 50,290 |   | 50,107 |   |
| Earnings per common  share:                                                                        |       |                                  |       |                                          |       |   |   |   |   |
| Basic                                                                                              |       | $                                     | 0.12       |                                          | $          | 0.10 |   | $ | 0.25 |   | $ | 0.20 |   |
| Diluted                                                                                            |       | $                                     | 0.12       |                                          | $          | 0.10 |   | $ | 0.24 |   | $ | 0.20 |   |
| 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 |       | 1,223                                 |       | 1,141                                         |       | 766 |   | 1,182 |   |
| Average exercise price  per share that exceeds average market price of common stock                |       | $                                     | 11.74      |                                          | $          | 11.32 |   | $ | 12.40 |   | $ | 11.31 |   |

 

**11. Commitments andContingencies**

The Company has applied the disclosure provisions ofFASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others,” to its agreements that contain guarantee or indemnificationclauses. 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 

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guarantor’s performance isremote. The following is a description of arrangements in which the Company isthe guarantor or indemnifies a party.

In the normal course of business, the Company has madecertain guarantees and indemnities, under which it may be required to makepayments to a guaranteed or indemnified party, in relation to certaintransactions. The Company indemnifies other parties, including customers,lessors, and parties to other transactions with the Company, with respect tocertain matters. The Company has agreed to hold the other party harmlessagainst losses arising from certain events as defined within the particularcontract, which may include, for example, litigation or claims arising from abreach of representations or covenants. In addition, the Company has enteredinto indemnification agreements with its executive officers and directors andthe Company’s bylaws contain similar indemnification obligations. Under thesearrangements, we are obligated to indemnify, to the fullest extent permittedunder applicable law, our current or former officers and directors for variousamounts incurred with respect to actions, suits or proceedings in which theywere made, or threatened to be made, a party as a result of acting as anofficer or director.

It is not possible to determine the maximum potentialamount under these indemnification agreements due to the limited history ofprior indemnification claims and the unique facts and circumstances involved ineach particular agreement. Historically, payments made related to theseindemnifications have been immaterial. At June 30, 2006 the Company hasdetermined that no liability is necessary related to these guarantees andindemnities.

The Company guarantees a portion of a loan on behalfof an unconsolidated investee under an agreement executed prior to 2002. Themaximum potential future payment under this financial guarantee is $145 at June 30,2006. The Company has not recorded an obligation for this guarantee.

On May 5, 2005, Alliance Imaging, Inc. wasserved with a complaint (the “Class Action Complaint”) filed in AlamedaCounty Superior Court alleging wage and hour claims on behalf of a putativeclass of approximately 400 former and current California employees of theCompany. On August 19, 2005, the plaintiffs filed an amended complaint,which the Company answered on September 23, 2005. In this suit, captionedLinda S. Jones, et al. v. Alliance Imaging, Inc., et al., the plaintiffsallege violations of California’s wage, meal period, and break time laws andregulations. Plaintiffs sought recovery of unspecified economic damages,statutory penalties, attorneys’ fees, and costs of suit. On or about March 10,2006, plaintiffs filed a second amended complaint (later further amended by athird amended complaint) adding a cause of action for conversion and a plea forpunitive damages. The Company has filed a demurrer and motion to strike seekingto dismiss the new claim and plea. On July 19, 2006, the Company and thePlaintiffs entered into a tentative settlement of the Class Action Complaintpursuant to which the Company has agreed to pay $2,500 in exchange for adismissal with prejudice of all claims brought on behalf of the putative classunder the Class Action Complaint. The tentative settlement is subject tocourt approval, and a preliminary approval and conditional class certificationhearing has been scheduled for September 1, 2006.

The Company from time totime is involved in routine litigation and regulatory matters incidental to theconduct of its business. The Company believes that resolution of such matterswill not have a material adverse effect on its consolidated results ofoperations or financial position.

**12. Related-PartyTransactions**

The Company recorded management fees payable toKohlberg Kravis Roberts & Co (“KKR”) of $163 and $325 for each of the quarters and six months ended June 30,2005 and 2006, respectively, and will continue to receive financialadvisory services from KKR on an ongoing basis. At June 30, 2005 and 2006,the Company has accrued $163 related to these services.

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Revenue from managementagreements with unconsolidated equity investees was $3,593 and $4,173 for thequarters ended June 30, 2005 and 2006, respectively, and $7,299 and $8,529for the six months ended June 30, 2005 and 2006, respectively.

**13. Investments inUnconsolidated Investees**

The Company has direct ownership in five investees at June 30,2006. The Company owns between 33.3 percent and 50 percent of these investees,and provides management services under agreements with four of these investees,expiring at various dates through 2023. As discussed in Note 4, in late December 2005the Company purchased an additional equity interest in AO, a joint ventureformed in 2004, which was an unconsolidated investee prior to purchase of theadditional equity interest. The Company’s earnings in unconsolidated investeesfor the six months ended June 30, 2005 includes the Company’s percentageof AO’s earnings for this period. At June 30, 2006 the Company also hasownership in an unconsolidated investee of AO. AO owns 50% of this investee andprovides management services under an agreement which expires in 2025. All ofthese investees are accounted for under the equity method since the Companydoes not exercise control over the operations of these investees.

Setforth below is certain financial data of these investees (amounts inthousands):

| ** **                    | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                    | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| Combined Balance  Sheet Data: |       |                  |       |              |       |   |   |
| Current assets                |       |                  | $          | 11,232            |       |   | $ | 11,289 |   |
| Noncurrent assets             |       |                  | 31,958     |              |       | 33,031 |   |
| Current liabilites            |       |                  | 12,230     |              |       | 9,092 |   |
| Noncurrent liabilites         |       |                  | 12,779     |              |       | 16,406 |   |
|                               |            |                       |            |                   |            |  |  |  |  |

 

| ** **                                      | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                              | ** ** | **2006**                                      | ** ** | **   2005   ** | ** ** | **   2006   ** | ** ** |
| Combined  Operating Results:                    |       |                                  |       |                                          |       |   |   |   |   |
| Revenues                                        |       | $                                     | 8,170      |                                          | $          | 10,469 |   | $ | 15,997 |   | $ | 20,750 |   |
| Expenses                                        |       | 6,157                                 |       | 7,864                                         |       | 12,320 |   | 15,862 |   |
| Net income                                      |       | 2,013                                 |       | 2,605                                         |       | 3,677 |   | 4,888 |   |
| Equity in earnings of  unconsolidated investees |       | 912                                   |       | 1,977                                         |       | 1,596 |   | 3,017 |   |
|                                                 |            |                                       |            |                                               |            |  |  |  |  |  |  |  |  |

 

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**ITEM 2.**                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OFOPERATIONS

**Overview**

We are a leading nationalprovider of shared-service and fixed-site diagnostic imaging services, basedupon annual revenue and number of diagnostic imaging systems deployed. Ourprincipal sources of revenue are derived from magnetic resonance imaging (MRI)and positron emission tomography and positron emission tomography/computedtomography (PET and PET/CT). We provide imaging and therapeutic services primarilyto hospitals and other healthcare providers on a shared and full-time servicebasis. We also provide services through a growing number of fixed sitesprimarily to hospitals or health systems. Our services normally include the useof our imaging systems, technologists to operate the systems, equipmentmaintenance and upgrades and management of day-to-day shared-service and fixed-sitediagnostic imaging operations. We also provide non scan-based services, whichincludes only the use of our imaging systems under a short-term contract. Inthe first six months of 2006, MRI services and PET and PET/CT servicesgenerated 62% and 28% of our revenue, respectively. The remaining revenue wascomprised of other modality diagnostic imaging services revenue, primarilycomputed tomography (CT), and management contract revenue. We had 500diagnostic imaging systems, including 335 MRI systems and 74 PET or PET/CTsystems and served over 1,000 clients in 43 states at June 30, 2006. Ofthese 500 diagnostic imaging systems, 72 were located in fixed-sites, whichconstitutes systems installed in hospitals or other buildings on hospitalcampuses, including modular buildings, systems installed inside medical groups’offices or medical buildings, and free-standing fixed-sites, which includessystems installed in a medical office building, ambulatory surgical center, orother retail space. Of these 72 fixed-sites, 58 were MRI fixed-sites, 3PET or PET/CT fixed-sites and 11 other modality fixed sites.

Approximately 87% of our revenuesfor the first six months ended June 30, 2006 were generated by providingservices to hospitals and other healthcare providers, which we refer to aswholesale revenues. Our wholesale revenues are typically generated fromcontracts that require our clients to pay us based on the number of scans weperform on patients on our clients behalf, although some pay us a flat fee fora period of time regardless of the number of scans we perform. These paymentsare due to us independent of our clients’ receipt of reimbursement fromthird-party payors. We typically deliver our services for a set number of daysper week through exclusive, long-term contracts with hospitals and otherhealthcare providers. The initial terms of these contracts’ averageapproximately three years in length for mobile services and approximately sevento ten years in length for fixed-site arrangements. These contracts oftencontain automatic renewal provisions and certain contracts have cancellationclauses if the hospital or other healthcare provider purchases their ownsystem. We price our contracts based on the type of system used, the scanvolume, and the number of ancillary services provided. Pricing is also affectedby competitive pressures.

Approximately 13% of ourrevenues for the six months ended June 30, 2006 were generated byproviding services directly to patients from our sites located at or nearhospitals or other healthcare provider facilities, which we refer to as retailrevenue. Our revenue from these sites is generated from direct billings topatients or their third-party payors, including Medicare, which are recordednet of contractual discounts and other arrangements for providing services atdiscounted prices. We typically charge a higher price per scan under retailbilling than we do under wholesale billing.

Fixed-sites can be structured aseither wholesale or retail. Revenues from these fixed-sites are included inboth our wholesale or retail revenues, respectively.

On February 8, 2006, theDeficit Reduction Act of 2005 (“DRA”) was signed into law by President GeorgeW. Bush. The DRA imposes caps on Medicare payment rates for certain imagingservices, including MRI, PET and CT, furnished in physician’s offices and othernon-hospital based settings. Under the cap, payments for specified imagingservices cannot exceed the hospital outpatient payment rates for 

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thoseservices. This change is to apply to services furnished on or after January 1,2007. The limitation is applicable to the technical components of the servicesonly (which is the payment we receive for the non-professional servicesfor which we bill directly under the Medicare Physician Fee Schedule). If thetechnical component of the service established under the Physician Fee Schedule(without including geographic adjustments) exceeds the hospital outpatientpayment amount for the service (also without including geographic adjustments),then the payment is to be reduced. In other words, in those instances where thetechnical component for the particular service is greater at the non-hospitalsite, the DRA directs that the hospital outpatient payment rate be substitutedfor the otherwise applicable Physician Fee Schedule payment rate. Theimplementation of this reimbursement reduction contained in the DRA will have asignificant effect on our financial condition and results of operationsbeginning in 2007. For full year 2005, approximately 4% of our revenue wasbilled directly to Medicare contractors. Basing our calculation on our 2005revenues, if the provisions were in effect for 2005, we estimate that thereduction in Medicare revenue due to DRA payment rate decreases would havetotaled approximately $6 million. The estimated percentage reduction in revenuebased on 2005 results is consistent with our expectation of what the impact onfull year 2006 revenues would be. Because a high percentage of our expenses arefixed, we expect a significant portion of this decrease in revenue to directlyeffect earnings.

In addition, the DRA alsocodifies a reduction in Medicare payments for multiple images performed oncontiguous body parts which was previously established by CMS in the 2006Physician Fee Schedule Final Rule. Under that final rule, CMS is to pay 100% ofthe technical component of the higher priced imaging procedure and 50% for thetechnical component of each additional imaging procedure for multiple images ofcontiguous body parts within a family of codes performed in the same session.Prior to this change, Medicare paid 100% of the technical component of eachprocedure. CMS is phasing in this reimbursement reduction over a two-yearperiod so that payment rates for the technical components of second andsubsequent imaging procedures are to be paid 75% of the otherwise applicablerate in 2006 and 50% of the otherwise applicable rate beginning in 2007. Theimplementation of this reimbursement reduction did not have a material impacton our consolidated financial position or results of operations for the quarterand six months ended June 30, 2006. We continue to believe that theimplementation of this reimbursement reduction will not have a material impacton our consolidated financial position or results of operations in the future.

On July 18, 2006, the U.S.House of Representatives Energy and Commerce Committee’s Subcommittee on Healthconducted a hearing regarding quality and utilization of imaging services andthe provisions of the DRA that directly effect Medicare payment for imagingservices. Many members of Congress have expressed concern about the impact ofthe DRA, and a legislation bill has been introduced to delay the effective dateof the DRA for two years. Our current view is that the two year delay regardingimplementation of the DRA is unlikely to be upheld by Congress and that the DRAas it is currently structured will become effective January 1, 2007.

The principal components of ourcost of revenues are compensation paid to technologists and drivers, systemmaintenance costs, medical supplies, system transportation and technologists’travel costs. Because a majority of these expenses are fixed, increasedrevenues as a result of higher scan volumes per system significantly improvesour margins while lower scan volumes result in lower margins.

The principal components ofselling, general and administrative expenses are sales and marketing costs,corporate overhead costs, provision for doubtful accounts, and non-cashshare-based compensation.

We record minority interestexpense and earnings from unconsolidated investees related to our consolidatedand unconsolidated subsidiaries, respectively. These subsidiaries primarilyprovide shared-service and fixed-site diagnostic imaging and therapeuticservices.

In 2005 and the first six monthsof 2006, the growth rate of MRI industry wide scan volumes has slowed in partdue to weak hospital volumes as reported by several investor-owned hospitalcompanies, a 

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growingnumber of medical groups adding imaging capacity within their practice setting,the increasing trend of third-party payors intensifying their utilizationmanagement efforts to control MRI scan volume growth rate and additionalpatient-related cost-sharing programs. We expect that this trend will continuethroughout 2006.

Inrecent years, we began to see an increase in the competitive climate in the MRIindustry, resulting in an increase in activity by original equipmentmanufacturers, or OEM’s, selling systems directly to certain of our clients.Typically, OEM’s target our higher scan volume clients. This increase inactivity by OEM’s has resulted in overcapacity of systems in the marketplace,especially related to medical groups adding imaging capacity within theirpractice setting. This has caused an increase in the number of our higher scanvolume clients deciding not to renew their contracts. We replace these highervolume scan clients typically with lower volume clients. During 2006, our MRIrevenues modestly declined compared to 2005 levels and we believe that MRIrevenues will continue to modestly decline in future years.

**Seasonality**

We experience seasonality in the revenues and marginsgenerated for our services. First and fourth quarter revenues are historicallylower than those from the second and third quarters. First quarter revenue isaffected primarily by fewer calendar days and inclement weather, typicallyresulting in fewer patients being scanned during the period. Fourth quarterrevenue is affected primarily by holiday and client and patient vacationschedules and inclement weather, also resulting in fewer scans during theperiod. The variability in margins is higher than the variability in revenuesdue to the fixed nature of our costs.

In 2006, there are fiveless scanning days in the second half of 2006 compared to the first half of2006. We generated approximately $1.6 million per scanning day in the firsthalf of 2006. If our revenue per scanning day for the second half of 2006remains flat with the first half of 2006, this would result in a decrease inrevenue of approximately $8.0 million in the second half of 2006 compared tothe first half of 2006.

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**Results ofOperations**

Thefollowing table shows our consolidated statements of income as a percentage ofrevenues for each of the quarters ended June 30:

| ** **                                                                                        | ** ** | **Quarter Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                              | ** ** | **2006**                                      | ** ** | **  2005  ** | ** ** | **  2006  ** | ** ** |
| Revenues                                                                                          |       | 100.0                                 | %          | 100.0                                         | %          |   | 100.0 | % |   |   | 100.0 | % |   |
| Costs and expenses:                                                                               |       |                                  |       |                                          |       |   |   |   |   |   |   |   |   |
| Cost of revenues,  excluding depreciation and amortization                                        |       | 49.7                                  |       | 54.2                                          |       |   | 50.3 |   |   |   | 53.1 |   |   |
| Selling, general  and administrative expenses                                                     |       | 12.6                                  |       | 11.8                                          |       |   | 11.8 |   |   |   | 11.9 |   |   |
| Employment  agreement costs                                                                       |       | 0.1                                   |       | —                                        |       |   | 0.2 |   |   |   | — |   |   |
| Severance and  related costs                                                                      |       | —                                |       | 0.1                                           |       |   | — |   |   |   | 0.2 |   |   |
| Depreciation  expense                                                                             |       | 18.9                                  |       | 18.1                                          |       |   | 19.1 |   |   |   | 18.1 |   |   |
| Amortization  expense                                                                             |       | 0.8                                   |       | 1.1                                           |       |   | 0.8 |   |   |   | 1.1 |   |   |
| Interest expense,  net of interest income                                                         |       | 8.8                                   |       | 8.7                                           |       |   | 8.7 |   |   |   | 8.8 |   |   |
| Other (income)  and expense, net                                                                  |       | (0.1                                  | )          | (0.2                                          | )          |   | (0.2 | ) |   |   | 0.2 |   |   |
| Total costs and  expenses                                                                         |       | 90.8                                  |       | 93.8                                          |       |   | 90.7 |   |   |   | 93.4 |   |   |
| Income before income taxes, minority interest  expense and earnings from unconsolidated investees |       | 9.2                                   |       | 6.2                                           |       |   | 9.3 |   |   |   | 6.6 |   |   |
| Income tax  expense                                                                               |       | 3.8                                   |       | 3.1                                           |       |   | 3.9 |   |   |   | 3.0 |   |   |
| Minority interest  expense                                                                        |       | 0.5                                   |       | 0.4                                           |       |   | 0.4 |   |   |   | 0.5 |   |   |
| Earnings from  unconsolidated investees                                                           |       | (0.8                                  | )          | (1.7                                          | )          |   | (0.7 | ) |   |   | (1.3 | ) |   |
| Net income                                                                                        |       | 5.7                                   | %          | 4.4                                           | %          |   | 5.7 | % |   |   | 4.4 | % |   |

 

Thetable below provides MRI statistical information:

| ** **                                    | ** ** | **Quarter Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **June 30,**      | ** ** | **June 30,**              | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| MRI statistics                                |       |                   |       |                           |       |   |   |   |   |
| Average number of total systems               |       | 336.4                  |       | 323.0                          |       | 334.3 |   | 325.6 |   |
| Average number of scan-based systems          |       | 285.2                  |       | 274.1                          |       | 283.6 |   | 276.9 |   |
| Scans per system per day (scan-based systems) |       | 9.61                   |       | 9.38                           |       | 9.53 |   | 9.37 |   |
| Total number scan-based MRI scans             |       | 195,479                |       | 179,869                        |       | 386,521 |   | 362,291 |   |
| Price per scan                                |       | $                      | 354.60     |                           | $          | 361.54 |   | $ | 355.22 |   | $ | 360.06 |   |
|                                               |            |                        |            |                                |            |  |  |  |  |  |  |  |  |

 

Thetable below provides PET and PET/CT statistical information:

| ** **                           | ** ** | **Quarter Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **June 30,**      | ** ** | **June 30,**              | ** ** |
| ** **                           | ** ** | **2005**               | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| PET and PET/CT  statistics           |       |                   |       |                           |       |   |   |   |   |
| Average number of systems            |       | 52.4                   |       | 69.1                           |       | 51.3 |   | 68.1 |   |
| Scans per system per day             |       | 5.46                   |       | 5.89                           |       | 5.28 |   | 5.86 |   |
| Total number of PET and PET/CT scans |       | 17,025                 |       | 24,734                         |       | 32,809 |   | 49,198 |   |
| Price per scan                       |       | $                      | 1,327      |                           | $          | 1,314 |   | $ | 1,348 |   | $ | 1,313 |   |
|                                      |            |                        |            |                                |            |  |  |  |  |  |  |  |  |

 

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Followingare the components of revenue (in millions):

| ** **                          | ** ** | **Quarter Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **June 30,**      | ** ** | **June 30,**              | ** ** |
| ** **                          | ** ** | **2005**               | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2006** | ** ** |
| Total MRI revenue                   |       | $                      | 76.2       |                           | $          | 71.6 |   | $ | 150.9 |   | $ | 143.5 |   |
| PET and PET/CT  revenue             |       | 22.7                   |       | 32.9                           |       | 44.5 |   | 65.2 |   |
| Other modalities  and other revenue |       | 9.5                    |       | 10.8                           |       | 19.0 |   | 21.9 |   |
| Total                               |       | $                      | 108.4      |                           | $          | 115.3 |   | $ | 214.4 |   | $ | 230.6 |   |

 

| ** **                              | ** ** | **Quarter Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **June 30,**      | ** ** | **June 30,**              | ** ** |
| ** **                              | ** ** | **2005**               | ** ** | **2006**                       | ** ** | **  2005  ** | ** ** | **  2006  ** | ** ** |
| Total fixed-site  revenue (in millions) |       | $                      | 17.4       |                           | $          | 18.9 |   |   | $ | 33.0 |   |   |   | $ | 36.7 |   |   |
|                                         |            |                        |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Quarter Ended June 30, 2006 Compared to QuarterEnded June 30, 2005***

Revenue increased $6.9 million, or 6.3%, to $115.3million in the second quarter of 2006 compared to $108.4 million in the secondquarter of 2005 primarily due to higher PET and PET/CT revenue and higher othermodalities and other revenue, offset by lower MRI revenue. PET and PET/CTrevenue in the second quarter of 2006 increased $10.2 million, or 45.1%,compared to the second quarter of 2005. Total PET and PET/CT scan volumesincreased 45.3% to 24,734 scans in the second quarter of 2006 from 17,025 scansin the second quarter of 2005, primarily as a result of growth in our core PETbusiness and the PET Scans of America Corp. acquisition. The average number ofPET and PET/CT systems in service increased to 69.1 systems in the secondquarter of 2006 from 52.4 systems in the second quarter of 2005. Scans persystem per day also increased 7.9%, to 5.89 scans per system per day in thesecond quarter of 2006, from 5.46 in the second quarter of 2005. Theseincreases were partially offset by a 1.0% decline in the average price per PETand PET/CT scan, to $1,314 per scan in the second quarter of 2006 compared to$1,327 per scan in the second quarter of 2005. Other modalities and otherrevenue increased $1.3 million, or 13.1%, to $10.8 million in the secondquarter of 2006 compared to $9.5 million in the second quarter of 2005primarily due to an increase in other fixed-site modality revenue, managementcontract revenue for our managed contracts and reimbursement of out-of-pocketexpenses from unconsolidated investees. MRI revenue decreased $4.6 million inthe second quarter of 2006, or 6.1%, compared to the second quarter of 2005.Scan-based MRI revenue decreased $4.3 million in the second quarter of 2006, or6.2%, compared to the second quarter of 2005, from $65.0 million in the secondquarter of 2006 to $69.3 million in the second quarter of 2005, primarily as aresult of an 8.0% decrease in our scan-based MRI scan volume. Scan-based MRIscan volume decreased to 179,869 scans in the second quarter of 2006 from195,479 scans in the second quarter of 2005, primarily due to a decrease in theaverage number of scan-based systems in service due to lower client demand.Scan-based systems in service decreased to 274.1 systems in the second quarterof 2006 from 285.2 systems in the second quarter of 2005 to adjust to modestlydeclining scan volumes and to increase the efficiency of our mobile MRIsystems. Average scans per system per day also decreased by 2.4% to 9.38 in thesecond quarter of 2006 from 9.61 in the second quarter of 2005. Non-scan basedMRI revenue decreased $0.3 million in the second quarter of 2006 over the sameperiod in 2005. These decreases were partially offset by a 2.0% increase inaverage price per MRI scan to $361.54 per scan in second quarter of 2006compared to $354.60 per scan in second quarter of 2005.

We had 335 MRI systems at June 30, 2006 comparedto 352 MRI systems at June 30, 2005. We had 74 PET and PET/CT systemsat June 30, 2006 compared to 57 PET and PET/CT systems at June 30,2005. We operated 72 fixed sites at June 30, 2006, compared to 62 fixedsites at June 30, 2005.

Cost of revenues, excluding depreciation andamortization, increased $8.7 million, or 16.1%, to $62.6 million inthe second quarter of 2006 compared to $53.9 million in the second quarterof 2005. During the second quarter of 2006 we recorded a tentative settlementon our class action lawsuit of 

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$2.5 million, or$0.03 net of tax, per diluted share. Compensation and related employee expensesincreased $1.8 million, or 6.8%, primarily as a result of the increase ofPET and PET/CT technologists who have a higher average hourly wage rate thanMRI technologists and an increase in mileage reimbursement rates. This increasein compensation was partially offset by a lower average headcount of MRItechnologists as a result of a decrease in the average number of MRI systems inuse. Medical supplies increased $1.6 million, or 39.0%, primarily as a resultof an increase in the number of PET and PET/CT systems in operation, which usea radiopharmaceutical as a component of the PET scan. Management contractexpenses increased $0.8 million, or 32.8%, primarily as a result of an increasein expenses incurred on behalf of unconsolidated investees. Maintenance andrelated costs increased $0.7 million, or 7.0%, primarily due to an increase inthe number of PET/CT systems in service, as well as an increase in the averageservice cost per system. Fuel expenses increased $0.3 million, or 21.3%,primarily due to higher average diesel fuel prices in 2006. Tractor andtransportation expenses increased $0.2 million, or 32.4%, primarily due to anincrease in the number of tractors on operating leases. All other cost ofrevenues, excluding depreciation and amortization, increased $0.8 million, or9.1%. Cost of revenues, as a percentage of revenue, increased to 54.2% in thesecond quarter of 2006 from 49.7% in the second quarter of 2005 as a result ofthe factors described above.

Selling, general and administrative expenses decreased$0.1 million, or 0.5%, to $13.6 million in the second quarter of 2006 comparedto $13.7 million in the second quarter of 2005. Professional services decreased$0.3 million, or 16.3%, primarily due to costs associated with our Form S-3shelf registration statement in the second quarter of 2005. The provision fordoubtful accounts decreased $0.3 million, or 22.6%. The provision for doubtfulaccounts as a percentage of revenue was 0.7% and 1.0% for each of the quartersended June 30, 2006 and 2005, respectively. Non-cash share-basedcompensation increased $0.5 million in the second quarter of 2006 from thesecond quarter of 2005, primarily as a result of the adoption of SFAS 123 (R),effective January 1, 2006. Selling, general and administrative expenses asa percentage of revenue were 11.8% and 12.6% in the second quarter of 2006 and2005, respectively.

We recorded employment agreement expenses of $0.1million in the second quarter of 2005 related to payments under an amendment toan employment agreement with our former chairman of the board.

We recorded severance and related costs of $0.1million in the second quarter of 2006 primarily for severance costs associatedwith reductions-in-force primarily due to our consolidation of five geographicregions to four geographic regions.

Depreciation expense increased $0.5 million, or 2.2%,to $20.9 million in the second quarter of 2006 compared to $20.4 million in thesecond quarter of 2005.

Amortization expense increased by $0.3 million, or36.5%, to $1.2 million in the second quarter of 2006 compared to$0.9 million in the second quarter of 2005, primarily due to the amortizationof intangible assets acquired in conjunction with our acquisitions in the thirdand fourth quarters of 2005.

Interest expense, net, increased $0.6 million, or5.9%, to $10.1 million in the second quarter of 2006 compared to $9.5 millionin the second quarter of 2005. This increase is due to higher average debtbalances during the second quarter of 2006 as a result of 2005 acquisitions andhigher average interest rates on our variable rate term loans. The increase ininterest rates on our variable rate term loans was partially offset by theexecution of various interest rate swap and collar agreements in 2004 and 2005to hedge against future interest rate increases on most of our variable rateterm loans.

Income tax expense was $3.5 million and$4.2 million in the second quarter of 2006 and 2005, respectively,resulting in effective tax rates of 41.2% and 40.4% in the first quarter of2006 and 2005, respectively. Our effective tax rates were higher than statutoryrates principally as a result of state income taxes.

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Minority interest expense was $0.5 million in both thesecond quarter of 2006 and the second quarter of 2005.

Earnings from unconsolidated investees increased by$1.1 million, or 116.8%, to $2.0 million in the second quarter of 2006 comparedto $0.9 million in the second quarter of 2005.

Our net income was$5.0 million, or $0.10 per share on a diluted basis, in the second quarterof 2006 compared to $6.2 million, or $0.12 per share on a diluted basis,in the second quarter of 2005.

***Six Months Ended June 30, 2006 Compared to June 30,2005***

Revenue increased $16.2 million, or 7.6%, to $230.6million in the first six months of 2006 compared to $214.4 million in the firstsix months of 2005 primarily due to higher PET and PET/CT revenue and higherother modalities and other revenue, offset by lower MRI revenue. PET and PET/CTrevenue in the first six months of 2006 increased $20.7 million, or 46.6%,compared to the first six months of 2005. Total PET and PET/CT scan volumesincreased 50.0% to 49,198 scans in the first six months of 2006 from 32,809 scansin the first six months of 2005, primarily as a result of growth in our corePET business and the PET Scans of America Corp. acquisition. The average numberof PET and PET/CT systems in service increased to 68.1 systems in the first sixmonths of 2006 from 51.3 systems in the first six months of 2005. Scans persystem per day also increased 11.0%, to 5.86 scans per system per day in thefirst six months of 2006, from 5.28 scans per system per day in the first sixmonths of 2005. These increases were partially offset by a 2.6% decline in theaverage price per PET and PET/CT scan, to $1,313 per scan in the first sixmonths of 2006 compared to $1,348 per scan in the first six months of 2005.Other modalities and other revenue increased $2.9 million, or 15.0%, to $21.9million in the first six months of 2006 compared to $19.0 million in thefirst six months of 2005 primarily due to an increase in other fixed-sitemodality revenue, management contract revenue for our managed contracts andreimbursement of out-of-pocket expenses from unconsolidated investees. MRIrevenue decreased $7.4 million in the first six months of 2006, or 4.9%,compared to the first six months of 2005. Scan-based MRI revenue decreased $6.9million in the first six months of 2006, or 5.0%, compared to the first sixmonths of 2005, from $130.4 million in the first six months of 2006 to $137.3million in the first six months of 2005, primarily as a result of a 6.3%decrease in our scan-based MRI scan volume. Scan-based MRI scan volumedecreased to 362,291 scans in the first six months of 2006 from 386,521 scansin the first six months of 2005, primarily due to a decrease in the averagenumber of scan-based systems in service due to lower client demand.Scan-based systems in service decreased to 276.9 systems in the first sixmonths of 2006 from 283.6 systems in the first six months of 2005 to adjust tomodestly declining scan volumes and to increase the efficiency of our mobileMRI systems. Average scans per system per day also decreased by 1.7% to 9.37 inthe first six months of 2006 from 9.53 in the first six months of 2005.Non-scan based MRI revenue decreased $0.5 million in the first six months of2006 over the same period in 2005. These decreases were partially offset by a1.4% increase in average price per MRI scan to $360.06 per scan in first sixmonths of 2006 compared to $355.22 per scan in the first six months of 2005.

We had 335 MRI systems at June 30, 2006 comparedto 352 MRI systems at June 30, 2005. We had 74 PET and PET/CT systemsat June 30, 2006 compared to 57 PET and PET/CT systems at June 30,2005. We operated 72 fixed-sites at June 30, 2006 compared to 62 fixedsites at June 30, 2005.

Cost of revenues, excluding depreciation andamortization, increased $14.7 million, or 13.6%, to $122.5 million inthe first six months of 2006 compared to $107.8 million in the first sixmonths of 2005. Compensation and related employee expenses increased $4.5million, or 8.5%, primarily as a result of the increase of PET and PET/CTtechnologists who have a higher average hourly wage rate than MRI technologistsand an increase in mileage reimbursement rates. This increase in compensationwas partially offset by a lower average headcount of MRI technologists as aresult of a decrease in the average number of MRI systems in use. Medicalsupplies increased $2.7 million, or 32.6%, primarily as a result of an 

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increase in the number ofPET and PET/CT systems in operation, which use a radiopharmaceutical as acomponent of the PET scan. During the first six months of 2006, we recorded atentative settlement on our class action lawsuit of $2.5 million, or $0.03 netof tax, per diluted share. Management contract expenses increased $1.3 million,or 23.9%, primarily as a result of an increase in expenses incurred on behalfof unconsolidated investees. Maintenance and related costs increased $0.9million, or 4.2%, primarily due to an increase in the average service cost persystem, as well as an increase in the number of PET/CT systems in service.Equipment rental expense increased $0.6 million, or 27.5%, primarily due to ahigher number of rental systems in use to support current clients whilecontinuing to improve route efficiency. Fuel expenses increased $0.6 million,or 23.2%, primarily due to higher average diesel fuel prices in 2006. Site feeexpense increased $0.3 million, or 12.8%, primarily due to an increase in thenumber of retail fixed sites in operation. Tractor and transportation expensesincreased $0.2 million, or 15.1%, primarily due to an increase in the number oftractors on operating leases. Outside medical services increased $0.2 million,or 3.7%, primarily as a result of an increase in outside radiologists servicecosts and physicist service costs associated with PET and PET/CT services. Allother cost of revenues, excluding depreciation and amortization, increased $0.9million, or 12.1%. Cost of revenues, as a percentage of revenue, increased to53.1% in the first six months of 2006 from 50.3% in the first six months of2005 as a result of the factors described above.

Selling, general and administrative expenses increased$2.0 million, or 7.9%, to $27.4 million in the first six months of 2006 compared to $25.4 million in the first six months of 2005. Compensation and related employee expensesincreased $0.7 million, or 4.3%, primarily due to an increase in the headcountof sales personnel, an increase in sales commissions, and an increase inmanagement incentive compensation. These increases were partially offset by adecrease in recruiting costs. Non-cash share-based compensationincreased $1.2 million in the first six months of 2006 from the first sixmonths of 2005, primarily as a result of the adoption of SFAS 123 (R),effective January 1, 2006. The provision for doubtful accounts increased$0.1 million, or 7.8%. The provision for doubtful accounts as a percentage ofrevenue was 0.7% for both of the six month periods ended June 30, 2006 and2005. Professional services decreased $0.4 million, or 10.8%, primarily due tocosts associated with our Form S-3 shelf registration statement inthe second quarter of 2005. All other selling, general and administrativeexpenses increased $0.4 million, or 9.0%. Selling, general and administrativeexpenses as a percentage of revenue were 11.9% and 11.8% in the first sixmonths of 2006 and 2005, respectively.

We recorded employment agreementcosts of $0.4 million in the first six months of 2005 related to payments underan amendment to an employment agreement with our former chairman of the board.

We recorded severance and related costs of $0.6million in the second quarter of 2006 primarily for severance costs associatedwith reductions-in-force primarily due to our consolidation of five geographicregions to four geographic regions.

Depreciation expense increased$1.0 million, or 2.4%, to $41.9 million in the first six months of 2006compared to $40.9 million in the first six months of 2005.

Amortization expense increased by $0.7 million, or38.8%, to $2.5 million in the first six months of 2006 compared to$1.8 million in the first six months of 2005, primarily due to theamortization of intangible assets acquiredin conjunction with our acquisitions in the third and fourth quarters of 2005.

Interest expense, net, increased$1.7 million, or 9.3%, to $20.3 million in the first six months of 2006compared to $18.6 million in the first six months of 2005. This increase is dueto higher average debt balances during the second quarter of 2006 as a resultof 2005 acquisitions and higher average interest rates on our variable rateterm loans. The increase in interest rates on our variable rate term loans waspartially offset by the execution of various interest rate swap and collaragreements in 2004 and 2005 to hedge against future interest rate increases onmost of our variable rate term loans.

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Income tax expense was$7.0 million and $8.3 million in the first six months of 2006 and 2005,respectively, resulting in effective tax rates of 41.0% and 40.3% in the firstsix months of 2006 and 2005, respectively. Our effective tax rates were higherthan statutory rates for the first six months of 2006 and 2005 primarily as aresult of state income taxes.

Minority interest expense was $1.0 million inboth the first six months of 2006 and 2005.

Earnings from unconsolidated investees increased by$1.4 million, or 89.1%, to $3.0 million in the first six months of 2006compared to $1.6 million in the first six months of 2005.

Our net income was$10.1 million, or $0.20 per share on a diluted basis, in the first sixmonths of 2006 compared to $12.3 million, or $0.24 per share on a dilutedbasis, in the first six months of 2005.

**Liquidity andCapital Resources**

Our primary source of liquidity is cash provided byoperating activities. We generated $48.4 million and $50.7 million of cash flowfrom operating activities in the first six months of 2006 and 2005,respectively. Our ability to generate cash flow is affected by numerousfactors, including demand for MRI, PET and other diagnostic imaging services.Our ability to generate cash flow from operating activities is also dependentupon the collections of our accounts receivable. The provision for doubtfulaccounts increased by $0.1 million in the first six months of 2006 compared tothe first six months of 2005. Our number of days of revenue outstanding for ouraccounts receivable was 46 days and 45 days as of June 30, 2006 and 2005,which we believe is among the more favorable in the healthcare serviceindustry. In addition, as of June 30, 2006, we had $50.0 million availableborrowings under our revolving line of credit.

Our primary use ofcapital resources is to fund capital expenditures. We used cash of $30.3million and $24.3 million for investing activities in the first six months of2006 and 2005, respectively. We incur capital expenditures for the purposes of:

·       purchasingnew systems;

·       replacingless advanced systems with new systems;

·       providingupgrades of our MRI and PET and PET/CT systems and upgrading our corporateinfrastructure for future growth.

Capital expenditures totaled $43.0 million and $28.9million in the first six months of 2006 and 2005, respectively. During thefirst six months of 2006 we purchased 4 MRI systems, 18 PET/CT systems and 3 CTsystems. We traded-in or sold a total of 32 total systems for the six monthsended June 30, 2006. Our decision to purchase a new system is typicallypredicated on obtaining new or extending existing client contracts, which serveas the basis of demand for the new system. We expect to purchase additionalsystems in 2006 and finance substantially all of these purchases with ouravailable cash, cash from operating activities, our revolving line of credit,and equipment leases. Based upon the client demand described above, whichdictates the type of equipment purchased, we expect capital expenditures tototal approximately $85 to $90 million in 2006.

We believe that, based oncurrent levels of operations, our cash flow from operating activities, togetherwith other available sources of liquidity, including borrowings available underour revolving loan facility, will be sufficient over the next one to two yearsto fund anticipated capital expenditures and make required payments ofprincipal and interest on our debt.

**Recent AccountingPronouncements**

In May 2005, the FASB issued SFAS 154, “Accountingfor Changes and Error Corrections” (“SFAS 154”), which is a replacement ofAPB Opinion No. 20, “Accounting Changes,” and SFAS 3, 

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“Reporting AccountingChanges in Interim Financial Statements.” This statement changes therequirements for the accounting for and reporting of all voluntary changes inaccounting principle and in the instance that a pronouncement does not includespecific transition provisions. This statement requires retrospective applicationto prior periods’ financial statements of changes in accounting principle,unless it is impracticable to determine either the period-specific effects orthe cumulative effect of the change. SFAS 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. The adoption of SFAS 154 did not have a material impact on ourconsolidated financial position or results of operations.

In June 2005, the FASB issued Emerging IssuesTask Force Issue No. 04-05, “Determining Whether a General Partner,or the General Partners as a Group, Controls a Limited Partnership or SimilarEntity When the Limited Partners Have Certain Rights”(“EITF 04-05”).EITF 04-05 clarifies how general partners in a limited partnershipshould determine whether they control a limited partnership. A general partnerof a limited partnership is presumed to control the limited partnership unlessthe limited partners have substantive kick-out rights or participating rights.For general partners of all new limited partnerships formed and for existinglimited partnerships for which the partnership agreements are modified,EITF 04-05 is effective after June 29, 2005. For generalpartners in all other limited partnerships, EITF 04-05 is effectivefor the first period in fiscal years beginning after December 15, 2005.The adoption of EITF 04-05 did not have a material impact on ourconsolidated financial position or results of operations.

In July 2006, the FASBissued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes”(“FIN 48”), an interpretation of FASB Statement No. 109, “Accounting forIncome Taxes” (“FASB 109”). FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB 109. This Interpretation prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a tax return.FIN 48 also provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition. FIN 48 iseffective for fiscal years beginning after December 15, 2006. We do not believethe adoption of FIN 48 will have a material impact on our consolidatedfinancial position or results of operations.

**CautionaryStatement Pursuant to the Private Securities 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-partiesto our interest rate swap agreements fail to satisfy their obligations underthese agreements, our ability to incur financing, the effect of operating andfinancial restrictions in our debt instruments, the accuracy of our estimatesregarding our capital requirements, the effect of intense levels of competitionin our industry, changes in the rates or methods of third party reimbursementsfor diagnostic imaging services, changes in the healthcare regulatoryenvironment, our ability to keep pace 

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withtechnological developments within our industry, and other risks anduncertainties, including those enumerated and described under “Risk Factors” inour Form 10-K, as filed with the Securities and Exchange Commission,for the fiscal year ended December 31, 2005. The foregoing should not beconstrued as an exhaustive list of all factors which could cause actual resultsto differ materially from those expressed in forward-looking statements made byus.

**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 existing creditagreement approximates fair value as these borrowings have variable rates thatreflect currently available terms and conditions for similar debt. To decreasethe risk associated with interest rate increases, we entered into multipleinterest rate swap and collar agreements for a portion of our variable ratedebt. These swaps and collars are designated as cash flow hedges of variablefuture cash flows associated with our long-term debt.

During 2004 we entered into swap agreements which havenotional amounts of $56.8 million, $46.8 million and $48.4 million at June 30,2006. Under the terms of these agreements, we receive three-month LIBORand pay a fixed rate of 3.15%, 3.89%, and 3.69%, respectively. The net effectof the hedges is to record interest expense at fixed rates of 5.65%, 6.39% and6.19% respectively, as the debt incurs interest based on three-month LIBOR plus2.50%. For the quarter and six months ended June 30, 2006, we received a net settlement amount of $0.5 millionand $0.8 million, respectively. For the quarter and six months ended June 30,2005 we paid a net settlement amount of $0.3 million and $0.7 million,respectively. The swap agreements mature during 2007.

During 2005 we entered into multiple interest ratecollar agreements which have a notional amount of $178.0 million. Under theterms of these agreements, we have purchased a cap on the interest rate of4.00% and have sold a floor of 2.25%. For the quarter and six months ended June 30,2006, we received a net settlement amount of $0.3 million and $0.4 million,respectively, on these collar agreements. For the quarter and six months ended June 30,2005, we did not record any net settlement on these collar agreements. Thecollar agreements mature at various dates between January 2007 and January 2008.

The swap and collar agreements have been designated ascash flow hedges of variable future cash flows associated with our long termdebt. In accordance with SFAS 133, the swaps and collars are recorded at fairvalue. On a quarterly basis, the fair value of the swaps and collars will bedetermined based on quoted market prices and, assuming perfect effectiveness,the difference between the fair value and the book value of the swaps andcollars will be recognized in comprehensive income, a component of shareholders’equity. Any ineffectiveness of the swaps and collars is required to berecognized in earnings.

The outstanding interest rate swaps and collars exposeus to credit risk in the event that the counterparties to the agreements do notor cannot meet their obligations. The notional amount is used to measureinterest to be paid or received and does not represent the amount of exposureto credit loss. The loss would be limited to the amount that would have beenreceived, if any, over the remaining life of the swap and collar agreements.The counterparties to the swaps and collars are major financial institutionsand we expect the counterparties to be able to perform their obligations underthe swaps and collars. We use derivative financial instruments for hedgingpurposes only and not for trading or speculative purposes.

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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.

**ITEM 4.**                CONTROLSAND PROCEDURES

We maintain disclosure controls and procedures that aredesigned to ensure that information required to be disclosed in our ExchangeAct reports is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such informationis accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions 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, andmanagement necessarily was required to apply its judgment in evaluating thecost benefit relationship of possible controls and procedures. Also, we haveinvestments in certain unconsolidated entities. As we do not control or managethese entities, our disclosure controls and procedures with respect to suchentities are more limited than those we maintain with respect to ourconsolidated 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.Based on 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 changes in the Company’s internalcontrol over financial reporting occurring during the fiscal quarter covered bythis report which have materially affected or are reasonably likely tomaterially affect the Company’s internal control over financial reporting.

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**PART II—OTHERINFORMATION**

**ITEM 1.**                LEGALPROCEEDINGS

On May 5, 2005, Alliance Imaging, Inc. wasserved with a complaint (the “Class Action Complaint”) filed in AlamedaCounty Superior Court alleging wage and hour claims on behalf of a putativeclass of approximately 400 former and current California employees of theCompany. On August 19, 2005, the plaintiffs filed an amended complaint,which the Company answered on September 23, 2005. In this suit, captionedLinda S. Jones, et al. v. Alliance Imaging, Inc., et al., the plaintiffsallege violations of California’s wage, meal period, and break time laws andregulations. Plaintiffs sought recovery of unspecified economic damages,statutory penalties, attorneys’ fees, and costs of suit. On or about March 10,2006, plaintiffs filed a second amended complaint (later further amended by athird amended complaint) adding a cause of action for conversion and a plea forpunitive damages. The Company has filed a demurrer and motion to strike seekingto dismiss the new claim and plea. On July 19, 2006, the Company and thePlaintiffs entered into a tentative settlement of the Class ActionComplaint pursuant to which the Company has agreed to pay $2.5 million inexchange for a dismissal with prejudice of all claims brought on behalf of theputative class under the Class Action Complaint. The tentative settlementis subject to court approval, and a preliminary approval and conditional classcertification hearing has been scheduled for September 1, 2006.

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 1A.**        RISKFACTORS

There are no materialchanges from the risk factors included in Part I, Item 1A of ourAnnual Report on Form 10-K for the year ended December 31,2005.

**ITEM 2.**                UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

**ITEM 3.**                DEFAULTSUPON SENIOR SECURITIES

Not applicable.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

(a)  The AnnualMeeting of Stockholders of Alliance Imaging, Inc. was held on May 24,2006.

(b) The followingnominee was elected as a Class II Director for a three-year term expiringat the 2009 Annual Meeting: Anthony B. Helfet. The Class I Directors,Kenneth W. Freeman, Neil F. Dimick, and Paul S. Viviano, whose terms expire atthe 2008 Annual Meeting, and the Class III Directors, Michael W.Michelson, James C. Momtazee and Edward L. Samek, whose terms expire at the2007 Annual Meeting, continue to serve on our Board of Directors.

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(c)  Certain matters voted upon at the meeting and the votes cast withrespect to such matters are as follows:

**Proposal and Vote Tabulation**

| ** **                                                                                                                                | ** ** | **Votes Cast** | ** ** | ** **  | ** ** | **Broker**  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------|------------|-------------|------------|
| ** **                                                                                                                                | ** ** | **For**             | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Non-votes** | ** ** |
| Approval of the  appointment of Deloitte & Touche LLP as independent auditors for the  fiscal year ending December 31, 2006 |       | 49,496,887          |       | 11,048      |       |        | 6,007      |   |   | — |   |
| Approval of the  amended and restated 1999 Equity Plan                                                                                    |       | 44,744,894          |       | 1,861,144   |       |        | 4,897      |   |   | 2,903,007 |   |

 

**Election ofDirectors**

| **Director**      | ** ** | ** ** | ** ** | **Votes Received** | ** ** | **Votes Withheld** | ** ** |
|-------------------|------------|------------|------------|-------------------------|------------|-------------------------|------------|
| Anthony B. Helfet |       |       | 47,968,598 |                    |       |                    | 1,545,344  |   |   |
|                   |            |            |            |                         |            |                         |            |  |  |  |  |

 

**ITEM 5.**                OTHERINFORMATION

Not applicable.

**ITEM 6.**                EXHIBITS

(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 10 3/8% 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)                                                                                                                                                                                                              |
| 4.5           |       | Indenture dated  as of December 29, 2004 by and between the Registrant and the Bank of  New York with respect to $150 million aggregate principal amount of 71¤4%  Senior Subordinated Notes due 2012 and 71¤4%  Series B Senior Subordinated Notes due 2012.(13) |
| 4.6           |       | Supplemental  Indenture dated as of December 14, 2004 by and between Registrant and  the Bank of New York with respect to 103¤8%  Senior Subordinated Notes due 2011.(13)                                                                                                   |
| 4.7           |       | Third Amendment dated as of December 29, 2004  to Credit Agreement.(13)                                                                                                                                                                                                          |
| 4.8           |       | Fourth Amendment dated as of December 19, 2005  to Credit Agreement.(16)                                                                                                                                                                                                         |
| 10.1          |       | The 1999 Equity  Plan for Employees of Alliance and Subsidiaries, as amended and restated.(19)                                                                                                                                                                                        |
| 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)                                                                                                                                                                                                                  |
| 10.5          |       | 2003 Incentive Plan(9)                                                                                                                                                                                                                                                                |
| 10.6          |       | Employment  Agreement dated as of July 23, 1997 between Alliance and Richard N.  Zehner.(1)                                                                                                                                                                                 |

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| 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)                                                                    |
| 10.15 |   | 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)                                                                                                                                   |
| 10.23 |   | 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)                       |
| 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) |
| 10.29 |   | Amendment to  Employment Agreement and Stockholders’ Agreement, dated March 29, 2004  by and between Alliance, Viewer Holdings, LLC and Kenneth S. Ord.(12)            |
| 10.30 |   | Amended and  Restated Employment Agreement dated as of May 9, 2005 between Alliance  and Paul S. Viviano.(15)                                                               |
| 10.31 |   | Agreement Not to  Compete dated as of May 9, 2005 between Alliance and Paul S.  Viviano.(15)                                                                                |
| 10.32 |   | Employment  Agreement dated as of May 9, 2005 between Alliance and Andrew P.  Hayek.(15)                                                                                    |
| 10.33 |   | Agreement Not to  Compete dated as of May 9, 2005 between Alliance and Andrew P. Hayek.(15)                                                                                 |
| 10.34 |   | Employment  Agreement dated as of December 1, 2005 between Alliance and Howard K.  Aihara.(17)                                                                              |
| 10.35 |   | Agreement Not to  Compete dated as of December 1, 2005 between Alliance and Howard K.  Aihara.(17)                                                                          |

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| 10.36 |   | Separation and  Consulting Agreement and General Release, dated January 26, 2006,  between Alliance and Russell D. Phillips, Jr.(18) |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.37 |   | 2006 Executive Incentive Plan†(18)                                                                                                        |
| 21.1  |   | List of  subsidiaries.(17)                                                                                                                     |
| 31    |   | Certifications of  Chief Executive Officer and Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.(20)    |
| 32    |   | Certifications of  Chief Executive Officer and Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.(20)    |

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

(2)          Incorporatedby reference 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 yearended December 31, 1997 (File No. 000-16334).

(3)          Incorporatedby reference 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 yearended December 31, 1998 (File No. 000-16334).

(4)          Incorporatedby reference 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 (File No. 000-16334).

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

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

(7)          Incorporatedby reference 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 (File No. 001-16609).

(8)          Incorporatedby reference 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 (File No. 001-16609).

(9)          Incorporatedby reference 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 (File No. 001-16609).

(10)   Incorporatedby reference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended June 30,2003 (File No. 001-16609).

(11)   Incorporatedby reference 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 31,2003 (File No. 001-16609).

(12)   Incorporatedby reference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended March 31,2004 (File No. 001-16609).

(13)   Incorporatedby reference to exhibits filed in response to Item 9.01(c), “Exhibits” of theCompany’s Current Report on Form 8-K, dated December 29, 2004(File No. 001-16609).

(14)   Incorporatedby reference herein to the indicated Exhibit response in Item 15(a)(1), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,2004 (File No. 001-16609).

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(15)   Incorporatedby reference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended March 31,2005 (File No. 001-16609).

(16)   Incorporatedby reference to exhibits filed in response to Item 9.01(d) , “Exhibits” ofthe Company’s Current Report on Form 8-K, dated December 22,2005 (File No. 001-16609).

(17)   Incorporatedby reference herein to the indicated Exhibit response in Item 15(a)(1), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,2005 (File No. 001-16609).

(18)   Incorporatedby reference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended March 31,2006 (File No. 001-16609).

(19)   Incorporatedby reference to Appendix A to the Company’s Proxy Statement on Schedule 14Arelating to its 2006 Annual Meeting (File No. 001-16609).

(20)   Filedherewith

†                    Portionsof this Exhibit have been redacted due to a request for confidentialtreatment.

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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.** |
|---------------------|------------------------------|
| August 9, 2006 | By:                          | /s/ PAUL S. VIVIANO |
| * *            |                         | Paul S. Viviano |
| * *            |                         | *Chairman of the Board and Chief Executive Officer* |
| * *            |                         | *(Principal Executive Officer)* |
| August 9, 2006 | By:                          | /s/ HOWARD K. AIHARA |
| * *            |                         | Howard K. Aihara |
| * *            |                         | *Executive Vice President and Chief Financial  Officer* |
| * *            |                         | *(Principal Financial Officer)* |
| August 9, 2006 | By:                          | /s/ NICHOLAS A. POAN |
| * *            |                         | Nicholas A. Poan |
| * *            |                         | *Vice President and Corporate Controller* |
| * *            |                         | *(Principal Accounting Officer)* |

 

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