**UNITED STATES**

**SECURITIES 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: March 31, 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, an accelerated filer, or anon-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 markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes x   No o

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of April 30,2006:

Common Stock, $.01 par value, 49,670,981 shares

 

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**ALLIANCEIMAGING,  INC.FORM 10-Q**

**March 31, 2006**

**Index**

|                                        | ** ** | ** **                                                                                                                        | ** ** | **Page** |
|----------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| PART I—FINANCIAL INFORMATION |       |                                                                                                                              |       |
|                                   |       | Item  1—Financial Statements:                                                                                                |       |     |   |
|                                   |       | Condensed Consolidated  Balance Sheets  December 31, 2005 and March 31, 2006 (Unaudited)                                     |       | 3        |   |
|                                   |       | Condensed Consolidated Statements  of Operations and Comprehensive Income  Quarter ended March 31, 2005 and 2006 (Unaudited) |       | 4        |   |
|                                   |       | Condensed Consolidated  Statements of Cash Flows  Quarter ended March 31, 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                                                           |       | 25       |   |
|                                   |       | Item 4—Controls and Procedures                                                                                               |       | 26       |   |
| PART II—OTHER INFORMATION    |       |                                                                                                                              |       |
|                                   |       | Item 1—Legal Proceedings                                                                                                     |       | 27       |   |
|                                   |       | Item 1A—Risk Factors                                                                                                         |       | 27       |   |
|                                   |       | Item 2—Unregistered Sales of  Equity Securities and Use of Proceeds                                                          |       | 27       |   |
|                                   |       | Item 3—Defaults Upon Senior  Securities                                                                                      |       | 27       |   |
|                                   |       | Item 4—Submission of Matters  to a Vote of Security Holders                                                                  |       | 27       |   |
|                                   |       | Item 5—Other Information                                                                                                     |       | 27       |   |
|                                   |       | Item 6—Exhibits                                                                                                              |       | 27       |   |
| SIGNATURES                             |       | 31                                                                                                                                |       |

 

2

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**PART I—FINANCIALINFORMATION**

**ITEM 1.     FINANCIAL STATEMENTS**

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

| ** **                                                   | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                                   | ** ** | **2005**              | ** ** | **2006**           | ** ** |
| **ASSETS**                                                   |       |                  |       |               |       | ** ** |   |
| Current assets:                                              |       |                  |       |               |       |   |   |
| Cash and cash equivalents                                    |       |                  | $          | 13,421             |       |   | $ | 9,744 |   |
| Accounts receivable, net  of allowance for doubtful accounts |       |                  | 48,236     |               |       | 52,847 |   |
| Deferred income taxes                                        |       |                  | 6,186      |               |       | 15,118 |   |
| Prepaid expenses and  other current assets                   |       |                  | 3,686      |               |       | 2,836 |   |
| Other receivables                                            |       |                  | 8,983      |               |       | 10,986 |   |
| Total current assets                                         |       |                  | 80,512     |               |       | 91,531 |   |
| Equipment, at cost                                           |       |                  | 752,128    |               |       | 759,177 |   |
| Less accumulated  depreciation                               |       |                  | (393,179   | )                  |       | (398,987 | ) |
| Equipment, net                                               |       |                  | 358,949    |               |       | 360,190 |   |
| Goodwill                                                     |       |                  | 154,656    |               |       | 154,715 |   |
| Other intangible assets,  net                                |       |                  | 39,071     |               |       | 38,843 |   |
| Deferred financing costs,  net                               |       |                  | 8,236      |               |       | 7,977 |   |
| Other assets                                                 |       |                  | 33,918     |               |       | 29,447 |   |
| Total assets                                                 |       |                  | $          | 675,342            |       |   | $ | 682,703 |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**               |       |                  |       |               |       |   |   |
| Current liabilities:                                         |       |                  |       |               |       |   |   |
| Accounts payable                                             |       |                  | $          | 23,672             |       |   | $ | 13,843 |   |
| Accrued compensation and  related expenses                   |       |                  | 14,088     |               |       | 14,209 |   |
| Accrued interest payable                                     |       |                  | 4,561      |               |       | 7,557 |   |
| Income taxes payable                                         |       |                  | 87         |               |       | 238 |   |
| Other accrued liabilities                                    |       |                  | 29,064     |               |       | 29,271 |   |
| Current portion of  long-term debt                           |       |                  | 7,781      |               |       | 7,618 |   |
| Total current liabilities                                    |       |                  | 79,253     |               |       | 72,736 |   |
| Long-term debt, net of  current portion                      |       |                  | 418,260    |               |       | 412,754 |   |
| Senior subordinated notes                                    |       |                  | 153,541    |               |       | 153,541 |   |
| Minority interests and  other liabilities                    |       |                  | 4,400      |               |       | 4,320 |   |
| Deferred income taxes                                        |       |                  | 60,144     |               |       | 72,826 |   |
| Total liabilities                                            |       |                  | 715,598    |               |       | 716,177 |   |
| Commitments and contingencies (Note 11)                      |       |                  |       |               |       |   |   |
| Stockholders’ deficit:                                  |       |                  |       |               |       |   |   |
| Common stock                                                 |       |                  | 496        |               |       | 496 |   |
| Additional paid-in  deficit                                  |       |                  | (11,876    | )                  |       | (10,979 | ) |
| Accumulated comprehensive  income                            |       |                  | 3,217      |               |       | 4,034 |   |
| Accumulated deficit                                          |       |                  | (32,093    | )                  |       | (27,025 | ) |
| Total stockholders’  deficit                            |       |                  | (40,256    | )                  |       | (33,474 | ) |
| Total liabilities and stockholders’ deficit             |       |                  | $          | 675,342            |       |   | $ | 682,703 |   |

 

*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** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                        | ** ** | **March 31,**     | ** ** |
| ** **                                                                                        | ** ** | **2005**               | ** ** | **2006** | ** ** |
| Revenues                                                                                          |       | $                      | 105,964    |   | $ | 115,343 |   |
| Costs and  expenses:                                                                              |       |                   |       |   |   |
| Cost of revenues,  excluding depreciation and amortization                                        |       | 53,936                 |       | 59,867 |   |
| Selling, general  and administrative expenses                                                     |       | 11,686                 |       | 13,756 |   |
| Employment  agreement costs                                                                       |       | 274                    |       | — |   |
| Severance and  related costs                                                                      |       | —                 |       | 489 |   |
| Depreciation  expense                                                                             |       | 20,463                 |       | 21,001 |   |
| Amortization  expense                                                                             |       | 881                    |       | 1,244 |   |
| Interest expense,  net of interest income                                                         |       | 9,061                  |       | 10,216 |   |
| Other (income)  and expense, net                                                                  |       | (332                   | )          | 728 |   |
| Total costs and  expenses                                                                         |       | 95,969                 |       | 107,301 |   |
| Income before income taxes, minority interest  expense and earnings from unconsolidated investees |       | 9,995                  |       | 8,042 |   |
| Income tax  expense                                                                               |       | 4,132                  |       | 3,474 |   |
| Minority interest  expense                                                                        |       | 412                    |       | 540 |   |
| Earnings from  unconsolidated investees                                                           |       | (684                   | )          | (1,040 | ) |
| Net income                                                                                        |       | $                      | 6,135      |   | $ | 5,068 |   |
| Comprehensive  income, net of taxes:                                                              |       |                   |       |   |   |
| Net income                                                                                        |       | $                      | 6,135      |   | $ | 5,068 |   |
| Unrealized gain  on hedging transactions, net of taxes                                            |       | 2,745                  |       | 817 |   |
| Comprehensive  income                                                                             |       | $                      | 8,880      |   | $ | 5,885 |   |
| Earnings per  common share:                                                                       |       |                   |       |   |   |
| Basic                                                                                             |       | $                      | 0.12       |   | $ | 0.10 |   |
| Diluted                                                                                           |       | $                      | 0.12       |   | $ | 0.10 |   |
| Weighted average  number of shares of common stock and common stock equivalents:                  |       |                   |       |   |   |
| Basic                                                                                             |       | 49,132                 |       | 49,608 |   |
| Diluted                                                                                           |       | 50,312                 |       | 49,974 |   |

 

*See accompanying notes.*

4

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

| ** **                                                                          | ** ** | **Quarter Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                               | ** ** | **2006** | ** ** |
| **Operating activities:**                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Net income                                                                          |       | $                                      | 6,135      |   | $ | 5,068 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:  |       |                                   |       |   |   |
| Provision for  doubtful accounts                                                    |       | 403                                    |       | 761 |   |
| Non-cash share-based  compensation                                                  |       | 63                                     |       | 715 |   |
| Depreciation and  amortization                                                      |       | 21,344                                 |       | 22,245 |   |
| Amortization of  deferred financing costs                                           |       | 514                                    |       | 396 |   |
| Distributions  greater than (less than) equity in undistributed income of investees |       | 175                                    |       | (489 | ) |
| Deferred income  taxes                                                              |       | 3,922                                  |       | 3,242 |   |
| (Gain) loss on  sale of assets                                                      |       | (332                                   | )          | 728 |   |
| Changes in operating assets and liabilities:                                        |       |                                   |       |   |   |
| Accounts  receivable                                                                |       | 633                                    |       | (5,439 | ) |
| Prepaid expenses  and other current assets                                          |       | (132                                   | )          | 850 |   |
| Other receivables                                                                   |       | (1,424                                 | )          | (2,003 | ) |
| Other assets                                                                        |       | (913                                   | )          | (306 | ) |
| Accounts payable                                                                    |       | (7,198                                 | )          | (9,718 | ) |
| Accrued  compensation and related expenses                                          |       | (1,947                                 | )          | 121 |   |
| Accrued interest  payable                                                           |       | 5,034                                  |       | 2,996 |   |
| Income taxes  payable                                                               |       | (34                                    | )          | 151 |   |
| Other accrued  liabilities                                                          |       | 920                                    |       | 339 |   |
| Minority interests  and other liabilities                                           |       | (65                                    | )          | (168 | ) |
| Net cash provided  by operating activities                                          |       | 27,098                                 |       | 19,489 |   |
| **Investing activities:**                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Equipment  purchases                                                                |       | (13,500                                | )          | (24,331 | ) |
| (Increase)  decrease in deposits on equipment                                       |       | (255                                   | )          | 5,734 |   |
| Proceeds from sale  of assets                                                       |       | 788                                    |       | 427 |   |
| Net cash used in  investing activities                                              |       | (12,967                                | )          | (18,170 | ) |
| **Financing activities:**                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Principal payments  on equipment debt                                               |       | (1,285                                 | )          | (1,129 | ) |
| Principal payments  on term loan facility                                           |       | (25,000                                | )          | — |   |
| Principal payments  on revolving loan facility                                      |       | —                                 |       | (12,500 | ) |
| Proceeds from  revolving loan facility                                              |       | —                                 |       | 8,500 |   |
| Payments of debt  issuance costs                                                    |       | (72                                    | )          | (137 | ) |
| Proceeds from  exercise of employee stock options                                   |       | 605                                    |       | 270 |   |
| Net cash used in  financing activities                                              |       | (25,752                                | )          | (4,996 | ) |
| Net decrease in  cash and cash equivalents                                          |       | (11,621                                | )          | (3,677 | ) |
| Cash and cash  equivalents, beginning of period                                     |       | 20,721                                 |       | 13,421 |   |
| Cash and cash  equivalents, end of period                                           |       | $                                      | 9,100      |   | $ | 9,744 |   |
| **Supplemental disclosure of cash flow  information:**                              | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Interest paid                                                                       |       | $                                      | 3,601      |   | $ | 6,977 |   |
| Income taxes paid,  net of refunds                                                  |       | 244                                    |       | 128 |   |
| **Supplemental disclosure of non-cash investing  and financing activities:**        | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Net book value of  assets exchanged                                                 |       | $                                      | 1,824      |   | $ | 4,442 |   |
| Capital lease  obligations assumed for the purchase of equipment debt               |       | —                                 |       | 1,839 |   |
| Equipment debt  transferred to unconsolidated investee                              |       | —                                 |       | (2,379 | ) |
| Comprehensive  income from hedging transactions, net of taxes                       |       | 2,745                                  |       | 817 |   |

 

*See accompanying notes.*

5

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**ALLIANCEIMAGING, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSMarch 31, 2006(Unaudited)(Dollars in thousands, except per share amounts)**

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

**Basisof Presentation—****The**accompanying unauditedcondensed consolidated financial statements have been prepared by AllianceImaging, Inc. (the “Company”) in accordance with accounting principlesgenerally accepted in the United States of America and with the instructions toForm 10-Q and Article 10 of Regulation S-X of the Securitiesand Exchange Commission. Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesfor 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 quarter ended March 31,2006 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2006. The accompanying unaudited condensedconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements and notes to the consolidatedfinancial statements for the year ended December 31, 2005.

**Principles of Consolidation—**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 innon-consolidated 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. Non-Cash 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) requires entitiesto 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 March 31, 2006, atotal of 1,201,625 shares are available for grant under the 1999 Equity Plan.Options are granted with exercise prices equal to fair value of the Company’scommon stock 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 ended March 31, 2005, theCompany recorded $63 in non-cash share-based compensation for stock optionsgranted with exercise prices below the fair value of the Company’s common stockat the date of grant and for certain stock options subject to amendedperformance targets under the 1999 Equity Plan, as discussed below. For thequarter ended March 31, 2006, of the total $715 in non-cash share-basedcompensation recorded, $553 was incremental share-based compensation as aresult 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  March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **  2005  **       | ** ** | **  2006  ** | ** ** |
| Risk free  interest rate          |       |                                   | 3.78       | % |   |   | 4.55 | % |   |
| Expected dividend  yield          |       |                                   | 0.00       | % |   |   | 0.00 | % |   |
| Expected stock  price volatility  |       |                                   | 52.6       | % |   |   | 56.7 | % |   |
| Average expected life  (in years) |       |                                   | 5.45       |   |   |   | 6.69 |   |   |

 

7

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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 March 31,2006. 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. TheCompany recorded non-cash share-based compensation of $6 for the quarter ended March 31,2005, with an offset to paid-in-capital deficit. As the Company adopted SFAS123 (R) effective January 1, 2006, any non-cash share-basedcompensation as a result of granting these stock options is included in theCompany’s consolidated total of non-cash share-based compensationof $715 for the quarter ended March 31, 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 share-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 ended March 31, 2005 the Companyrecorded $57 in non-cash share-based compensation as a result of theamendment. As the Company adopted SFAS 123 (R) effective January 1,2006, any non-cash share-based compensation as a result of theseamendments is included in the Company’s consolidated total of non-cash share-basedcompensation of $715 for the quarter ended March 31, 2006.

Thefollowing table summarizes the Company’s stock option activity:

| ** **                                                             | ** ** | ** **         | ** ** | ** **              | ** ** | **Weighted-**   | ** ** | ** **              | ** ** |
|------------------------------------------------------------------------|------------|--------------------|------------|-------------------------|------------|-----------------|------------|-------------------------|------------|
| ** **                                                             | ** ** | ** **         | ** ** | ** **              | ** ** | **Average**     | ** ** | **Aggregate**           | ** ** |
| ** **                                                             | ** ** | ** **         | ** ** | **Weighted-**           | ** ** | **Remaining**   | ** ** | **Intrinsic**           | ** ** |
| ** **                                                             | ** ** | **Number of** | ** ** | **Average**             | ** ** | **Contractual** | ** ** | **Value**               | ** ** |
| ** **                                                             | ** ** | **Shares**         | ** ** | **Exercise Price** | ** ** | **Term**        | ** ** | **(in thousands)** | ** ** |
| Outstanding at  December 31, 2005                                 |       | 3,571,275          |       |                    | $          | 6.25            |       |                    |       |   |   |   |   |   |   |   |
| Granted                                                                |       | 861,500            |       |                    | 4.27       |            |       |                    |       |   |   |   |   |   |   |
| Exercised                                                              |       | (61,375            | )          |                    | 4.41       |            |       |                    |       |   |   |   |   |   |   |
| Canceled                                                               |       | (163,400           | )          |                    | 8.06       |            |       |                    |       |   |   |   |   |   |   |
| Outstanding at  March 31, 2006                                    |       | 4,208,000          |       |                    | $          | 5.80            |       |                    |       | 7.72 |   |   |   | $ | 14,031 |   |   |
| Vested and expected to vest in the future at  March 31, 2006 |       | 4,109,000          |       |                    | $          | 5.79            |       |                    |       | 7.69 |   |   |   | $ | 13,687 |   |   |
| Exercisable at  March 31, 2006                                    |       | 1,498,098          |       |                    | $          | 5.20            |       |                    |       | 6.26 |   |   |   | $ | 4,607 |   |   |

 

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The weighted average grant-date fair value of optionsgranted during the quarters ended March 31, 2005 and 2006 was $6.11 pershare and $2.58 per share, respectively. The total intrinsic value of optionsexercised during the quarters ended March 31, 2005 and 2006 was $1,642 and$91, respectively. The total cash received from employees as a result of stockoption exercises was $605 and $270 for the quarters ended March 31, 2005and 2006, respectively.

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

| ** **                          | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------|------------|----------------------------------------------------|------------|
| Unvested at  December 31, 2005 |       | 2,243,851  |       |                                               | $          | 3.86 |   |   |
| Granted                             |       | 861,500    |       |                                               | 2.58       |   |   |
| Vested                              |       | (246,349   | )          |                                               | 3.38       |   |   |
| Canceled                            |       | (149,100   | )          |                                               | 4.43       |   |   |
| Unvested at  March 31, 2006    |       | 2,709,902  |       |                                               | $          | 3.47 |   |   |

 

At March 31, 2006,the total unrecognized fair value compensation cost related to unvested stockoptions granted to both employees and non-employees was $9,080, which isexpected to be recognized over a remaining weighted-average period of 4.63years. 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 ofunrecognized compensation expense noted above does not necessarily representthe value that will ultimately be realized by the Company in the statements ofoperations. The total fair value of shares vested during the quarters ended March 31,2005 and 2006 were $502, and $857, respectively.

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

Thetable below shows the amounts recognized in the financial statements for thethree months ended March 31, 2006 for awards newly subject to compensationexpense under SFAS 123(R). Prior to the adoption of SFAS 123(R), the Companyrecorded compensation expense for stock options granted with exercise pricesbelow the fair value of the Company’s common stock at the date of grant,certain stock options subject to amended performance targets under the 1999Equity Plan, and non-employee share-based awards granted to members ofthe Company’s advisory committee. The table below, therefore, excludes theeffect of these awards.

| ** **                                                                             | ** ** | **Quarter Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                               | ** ** |
| Selling, general,  and administrative expenses                                         |       |                                   | $          | 553 |   |   |
| Total cost of  non-cash share-based compensation included in income, before income tax |       |                                   | 553        |   |   |
| Amount of income  tax recognized in earnings                                           |       |                                   | (225       | ) |   |
| Amount charged  against income                                                         |       |                                   | $          | 328 |   |   |
| Impact on net income per share:                                                        |       |                                   |       |   |   |
| Basic earnings  per share:                                                             |       |                                   | $          | 0.01 |   |   |
| Diluted earnings  per share:                                                           |       |                                   | $          | 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.” Prior to the adoption ofSFAS 123(R), the Company recognized compensation cost for only certainawards, as discussed above. All other employee share-based awards were grantedwith an exercise price equal to the market value of the underlying common stockon the date of grant and no compensation cost was reflected in the statement ofoperations for those awards. SFAS 123, as amended by SFAS 148, requiredpresentation of pro forma information regarding net income and earnings pershare determined as if the Company had accounted for its employee stock optionsunder 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 planconsistent with 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 ended March 31, 2005 would have approximated thepro forma amount indicated below: 

| ** **                                                                                                           | ** ** | **Quarter Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2005**                               | ** ** |
| Net income:                                                                                                          |       |                                   |       |   |   |
| As reported                                                                                                          |       |                                   | $          | 6,135 |   |   |
|                                                                                                                 |       |                                   |       |   |   |
| Add: Share-based  compensation expense included in reported net income, net of related tax  effects                  |       |                                   | 38         |   |   |
| Deduct:  Share-based compensation expense determined under fair value based method,  net of related tax effects |       |                                   | (371       | ) |   |
| Pro forma net  income                                                                                                |       |                                   | $          | 5,802 |   |   |
| Basic earnings  per share:                                                                                           |       |                                   |       |   |   |
| As reported                                                                                                          |       |                                   | $          | 0.12 |   |   |
| Pro forma                                                                                                            |       |                                   | 0.12       |   |   |
| Diluted earnings  per share:                                                                                         |       |                                   |       |   |   |
| As reported                                                                                                          |       |                                   | $          | 0.12 |   |   |
| Pro forma                                                                                                            |       |                                   | 0.12       |   |   |

 

**3. RecentAccounting Pronouncements**

**Accounting Changes and Error Corrections—****In**May 2005,the FASB issued SFAS 154, “Accounting for Changes and Error Corrections” (“SFAS 154”),which is a replacement of APB Opinion No. 20, “Accounting Changes,” andSFAS 3, “Reporting Accounting Changes in Interim Financial Statements.”This statement changes the requirements for the accounting for and reporting ofall voluntary changes in accounting principle and in the instance that apronouncement does not include specific transition provisions. This statementrequires retrospective application to prior periods’ financial statements ofchanges in accounting principle, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change.SFAS 154 is effective for accounting changes and corrections of errorsmade in fiscal 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.

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**Limited Partnerships—****In**June 2005,the FASB issued Emerging Issues Task Force Issue No. 04-05, “DeterminingWhether a General Partner, or the General Partners as a Group, Controls aLimited Partnership or Similar Entity When the Limited Partners Have CertainRights”(“EITF 04-05”). EITF 04-05 clarifies how generalpartners in a limited partnership should determine whether they control alimited partnership. A general partner of a limited partnership is presumed tocontrol 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.

**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 additional considerationas an adjustment to goodwill. Adjustments to goodwill may occur in futureperiods as a result of changes in the original valuation of assets andliabilities acquired. During the quarter ended March 31, 2006, the companyincreased goodwill by $26 as a result of changes in the original valuation ofassets and liabilities acquired. The Company has not included pro formainformation as this acquisition did not have a material impact on the Company’sconsolidated financial position or results of operations.

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 assigned to certificates of need held by PSA,which have indefinite useful lives and are not subject to amortization. Theseassets were recorded at fair value at the acquisition date. The Companyrecorded total goodwill of $22,472, which includes $3,007 of goodwill relatedto income tax timing differences as a result of the acquisition. None of thegoodwill recorded is deductible for tax purposes. Adjustments to goodwill mayoccur in future periods as a result of changes in the original valuation ofassets and liabilities acquired. During the quarter ended March 31, 2006,the company decreased goodwill by $23 as a result of changes in the originalvaluation of assets and liabilities acquired. The Company has not included proforma information as this acquisition did not have a material impact on theCompany’s consolidated financial position or results 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 

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revolvingline of credit. The Company now owns 80% of AO. As a result of this acquisitionthe Company recorded goodwill of $6,946, which is deductible for tax purposesand will be amortized over 15 years for tax purposes. Adjustments to goodwillmay occur in future periods as a result of changes in the original valuation ofassets and liabilities acquired. During the quarter ended March 31, 2006,the company increased goodwill by $56 as a result of changes in the originalvaluation of assets and liabilities acquired. During the quarter ended March 31,2005 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 and IntangibleAssets**

Changesin the carrying amount of goodwill are as follows:

| Balance at  December 31, 2005       |   | $  | 154,656 |   |
|------------------------------------------|--------|----|---------|--------|
| Additions to  goodwill during the period |   | 59 |    |
| Balance at  March 31, 2006          |   | $  | 154,715 |   |

 

Intangibleassets consisted of the following:

| ** **                                     | ** ** | **December 31, 2005** | ** ** | **March 31, 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 |   |   | $ | (19,820 | ) |   |   | $ | 31,243 |   |   |
| Other                                          |       | 4,467                           |       |                         | (1,910     | ) |   |   | 2,557 |   |   | 7,083 |   |   | (2,125 | ) |   |   | 4,958 |   |   |
| Total amortizing  intangible assets            |       | $                               | 55,530     |                         |       | $ | (20,701 | ) |   |   | $ | 34,829 |   |   | $ | 58,146 |   |   | $ | (21,945 | ) |   |   | $ | 36,201 |   |   |
| Intangible assets not  subject to amortization |       |                            |       |                         |       |   |   |   | $ | 4,242 |   |   |   |   |   |   |   |   |   | $ | 2,642 |   |   |
| Total other intangible assets                  |       |                            |       |                         |       |   |   |   | $ | 39,071 |   |   |   |   |   |   |   |   |   | $ | 38,843 |   |   |

 

The Company reviews the recoverability of the carryingvalue of goodwill on an annual basis or more frequently when an event occurs orcircumstances change to indicate an impairment of these assets has possiblyoccurred. Goodwill is allocated to the Company’s various reporting units whichrepresent the Company’s geographical regions. The Company compares the fairvalue of the reporting unit to its carrying amount to determine if there ispotential impairment. The implied fair value for goodwill is determined basedon the fair value of assets and liabilities of the respective reporting units,in accordance with SFASNo. 142, “Goodwill and Other Intangible Assets,” based ondiscounted cash flows, market multiples, or appraised values as appropriate.

Amortization expense for intangible assets subject toamortization was $881 and $1,244 for the quarters ended March 31, 2005 and2006, respectively. The intangible assets not subject to amortization representcertificates of need and regulatory authority rights which have indefiniteuseful lives.

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

| 2006 |   | $     | 4,928  |   |
|------|--------|-------|--------|--------|
| 2007 |   | 4,713 |   |
| 2008 |   | 4,499 |   |
| 2009 |   | 4,177 |   |
| 2010 |   | 4,111 |   |

 

**6. Other AccruedLiabilities**

Otheraccrued liabilities consisted of the following:

| ** **                                    | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                    | ** ** | **2005**              | ** ** | **2006**           | ** ** |
| Accrued systems  rental and maintenance costs |       |                  | $          | 5,801              |       |   |   | $ | 4,476 |   |   |
| Accrued site  rental fees                     |       |                  | 1,242      |               |       |   | 1,692 |   |   |
| Accrued property  and sales taxes payable     |       |                  | 10,569     |               |       |   | 10,685 |   |   |
| Accrued  self-insurance expense               |       |                  | 5,725      |               |       |   | 6,296 |   |   |
| Other accrued  expenses                       |       |                  | 5,727      |               |       |   | 6,122 |   |   |
| Total                                         |       |                  | $          | 29,064             |       |   |   | $ | 29,271 |   |   |

 

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

Long-termdebt consisted of the following:

| ** **                                 | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **2005**              | ** ** | **2006**           | ** ** |
| Term loan  facility                        |       |                  | $          | 384,875            |       |   | $ | 384,875 |   |
| Revolving loan  facility                   |       |                  | 29,500     |               |       | 25,500 |   |
| Senior  subordinated notes                 |       |                  | 153,541    |               |       | 153,541 |   |
| Equipment debt                             |       |                  | 11,666     |               |       | 9,997 |   |
| Long-term debt,  including current portion |       |                  | 579,582    |               |       | 573,913 |   |
| Less current  portion                      |       |                  | 7,781      |               |       | 7,618 |   |
| Long-term debt                             |       |                  | $          | 571,801            |       |   | $ | 566,295 |   |

 

**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 March 31, 2005, and 2006, thefair value of the Company’s interest rate swap agreements was an accumulatedincome of $1,970 and $3,266, 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 ended March 31, 2005 the Company paid a netsettlement amount of $478. For the quarter ended March 31, 2006, theCompany received a net settlement amount of $306. The Company has designatedthese swaps as cash flow hedges of variable future cash flows associated withits long-term debt. For the quarters ended March 31, 2005 and 2006, theCompany recognized comprehensive income, net of tax, of $1,460 and $265,respectively, based on the change in fair value of these instruments for thequarter 

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ended March 31, 2006.The Company will continue to record subsequent changes in the fair value of theswaps through comprehensive income during the period these instruments aredesignated 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 March 31,2005 and 2006, the fair value of the Company’s interest rate collar agreementswas an accumulated income of $2,142 and $3,446, respectively. For the quarterended March 31, 2005, the Company did not record any net settlementamount. For the quarter ended March 31, 2006, the Company received a netsettlement amount of $68. The Company has designated these collars as cash flowhedges of variable future cash flows associated with its long-term debt. Forthe quarters ended March 31, 2005 and 2006 the Company recognized a gain,net of tax, of $1,285 and $552, respectively, based on the change in fair valueof these instruments. The Company will record subsequent changes in the fairvalue of the collars through comprehensive income during the period theseinstruments are designated as hedges.

The Company accounts for derivative instruments and hedging activitiesin accordance with the provisions of SFAS 133, “Accounting for DerivativeInstruments and Hedging Actvities” (“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, both at the hedgeinception and on an ongoing basis, in accordance with its risk managementpolicy. The Company would discontinue hedge accounting prospectively (i) ifit is determined that the derivative is no longer effective in offsettingchange in the cash flows of a hedged item, (ii) when the derivativeexpires or is sold, terminated or exercised, (iii) because it is probablethat the forecasted transaction will not occur, (iv) because a hedged firmcommitment no longer meets the definition of a firm commitment, or (v) ifmanagement determines that designation of the derivative as a hedge instrumentis no longer appropriate. The Company’s derivatives are recorded on the balancesheet at their fair value. For derivatives accounted for as cash flow hedgesany unrealized gains or losses on fair value are included in comprehensiveincome, net of tax.

**9. Income Taxes**

For the quarter ended March 31,2005 and 2006, the Company recorded a provision for income taxes of $4,132 and$3,474, or 40.2% and 40.7% of the Company’s pretax income, respectively. TheCompany’s effective tax rate was higher than statutory rates primarily as aresult of state income taxes.

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**10. Earnings PerCommon Share**

Thefollowing table sets forth the computation of basic and diluted earnings pershare (amounts in thousands, except per share amounts):

| ** **                                                                                           | ** ** | **Quarter Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                           | ** ** | **2005**                               | ** ** | **2006** | ** ** |
| Numerator:                                                                                           |       |                                   |       |   |   |
| Net income                                                                                           |       | $                                      | 6,135      |   | $ | 5,068 |   |
| Denominator:                                                                                         |       |                                   |       |   |   |
| Denominator for basic earnings per share—weighted-average  shares                               |       | 49,132                                 |       | 49,608 |   |
| Effect of  dilutive securities:                                                                      |       |                                   |       |   |   |
| Employee stock options                                                                               |       | 1,180                                  |       | 366 |   |
| Denominator for diluted earnings per share—adjusted  weighted-average shares                    |       | 50,312                                 |       | 49,974 |   |
| Earnings per common  share:                                                                          |       |                                   |       |   |   |
| Basic                                                                                                |       | $                                      | 0.12       |   | $ | 0.10 |   |
| Diluted                                                                                              |       | $                                      | 0.12       |   | $ | 0.10 |   |
| 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 |       | 769                                    |       | 1,130 |   |
| Average exercise  price per share that exceeds average market price of common stock                  |       | $                                      | 12.40      |   | $ | 11.76 |   |

 

**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 orindemnification clauses. These disclosure provisions expand those required byFASB Statement No. 5, “Accounting for Contingencies,” by requiring aguarantor to disclose certain type of guarantees, even if the likelihood ofrequiring the guarantor’s performance is remote. The following is a descriptionof arrangements in which the Company is the 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 March 31, 2006 the Company hasdetermined that no liability is necessary related to these guarantees andindemnities.

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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 $173 at March 31,2006. The Company has not recorded an obligation for this guarantee.

On May 5, 2005, Alliance Imaging, Inc. was servedwith a complaint filed in Alameda County Superior Court alleging wage and hourclaims on behalf of a putative class of approximately 400 former and currentCalifornia employees of the Company. On August 19, 2005, the plaintiffsfiled an amended complaint, which the Company answered on September 23,2005. In this suit, captioned Linda S. Jones, et al. v. Alliance Imaging, Inc.,et al., the plaintiffs allege violations of California’s wage, meal period, andbreak time laws and regulations. Plaintiffs sought recovery of unspecifiedeconomic damages, statutory penalties, attorneys’ fees, and costs of suit. Theparties are currently taking discovery to develop facts relevant to the namedplaintiffs’ expected motion for certification of one or more classes. On orabout March 10, 2006, plaintiffs filed a second amended complaint adding acause of action for conversion and a plea for punitive damages. The Company hasfiled a demurrer seeking to strike the new claim and plea. A hearing on thismotion was held on May 4, 2006, but the court has not yet issued a ruling.No date for the filing or hearing of a motion for class certification has beenset and no trial date has been set. The Company continues to evaluate theallegations of the second amended complaint and is unable to predict the likelytiming or outcome of the lawsuit.

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 for each of the quarters ended March 31, 2005 and 2006, andwill continue to receive financial advisory services from KKR on an ongoingbasis. At March 31, 2005 and 2006, the Company has accrued $163 related tothese services.

Revenue from managementagreements with unconsolidated equity investees was $3,706 and $4,356 for thequarters ended March 31, 2005 and 2006, respectively.

**13. Investments in Unconsolidated Investees**

The Company has direct ownership in six investees at March 31,2006. The Company owns between 30 percent and 50 percent of theseinvestees, and provides management services under agreements with four of theseinvestees, expiring at various dates through 2023. As discussed in Note 4, inlate December 2005 the Company purchased an additional equity interest inAO, a joint venture formed in 2004, which was an unconsolidated investee priorto purchase of the additional equity interest. The Company’s earnings inunconsolidated investees for the quarter ended March 31, 2005 includes theCompany’s percentage of AO’s earnings for this period. At March 31, 2006the Company also has ownership in an unconsolidated investee of AO. AO owns 50%of this investee and provides management services under an agreement whichexpires in 2025. All of these investees are accounted for under the equitymethod since the Company does not exercise control over the operations of theseinvestees.

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

| ** **                    | ** ** | **December 31,** | ** ** | **March 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                    | ** ** | **2005**              | ** ** | **2006**           | ** ** |
| Combined Balance  Sheet Data: |       |                  |       |               |       |   |   |   |   |
| Current assets                |       |                  | $          | 11,232             |       |   |   | $ | 12,698 |   |   |
| Noncurrent assets             |       |                  | 31,958     |               |       |   | 35,035 |   |   |
| Current  liabilites           |       |                  | 12,230     |               |       |   | 9,721 |   |   |
| Noncurrent liabilites         |       |                  | 12,779     |               |       |   | 18,249 |   |   |
|                               |            |                       |            |                    |            |  |  |  |  |  |  |

 

| ** **                                      | ** ** | **Quarters Ended   March 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                      | ** ** | **2006** | ** ** |
| Combined  Operating Results:                    |       |                                          |       |   |   |
| Revenues                                        |       | $                                             | 7,828      |   | $ | 10,281 |   |
| Expenses                                        |       | 6,164                                         |       | 7,999 |   |
| Net income                                      |       | 1,664                                         |       | 2,283 |   |
| Equity in earnings of  unconsolidated investees |       | 684                                           |       | 1,040 |   |
|                                                 |            |                                               |            |  |  |  |  |

 

 

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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 servicesprimarily to hospitals and other healthcare providers on a shared and full-timeservice basis. 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 andfixed-site diagnostic imaging operations. We also provide non scan-basedservices, which includes only the use of our imaging systems under a short-termcontract. In the first quarter of 2006, MRI services and PET and PET/CTservices generated 62% and 28% of our revenue, respectively. The remainingrevenue was comprised of other modality diagnostic imaging services revenue,primarily computed tomography (CT), and management contract revenue. We had 509diagnostic imaging systems, including 345 MRI systems and 74 PET or PET/CTsystems and served over 1,000 clients in 44 states at March 31, 2006. Ofthese 509 diagnostic imaging systems, 73 were located in fixed-sites,which constitutes 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 73 fixed-sites, 60 were MRI fixed-sites, 3 PET orPET/CT fixed-sites and 10 other modality fixed sites.

Approximately 87% of ourrevenues for the quarter ended March 31, 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, although some pay us a flat fee for a period of time regardless of thenumber of scans we perform. These payments are due to us independent of ourclients’ receipt of reimbursement from third-party payors. We typically deliverour services for a set number of days per week through exclusive, long-termcontracts with hospitals and other healthcare providers. The initial terms ofthese contracts’ average approximately three years in length for mobileservices and approximately seven to ten years in length for fixed-sitearrangements. These contracts often contain automatic renewal provisions andcertain contracts have cancellation clauses if the hospital or other healthcareprovider purchases their own system. We price our contracts based on the typeof system used, the scan volume, and the number of ancillary services provided.Pricing is also affected by competitive pressures.

Approximately 13% of ourrevenues for the year ended March 31, 2006 were generated by providingservices directly to patients from our sites located at or near hospitals orother healthcare provider facilities, which we refer to as retail revenue. Ourrevenue from these sites is generated from direct billings to patients or theirthird-party payors, which are recorded net of contractual discounts and otherarrangements for providing services at discounted prices. We typically charge ahigher price per scan under retail billing than we do under wholesale billing.

Revenue from our fixed-sites areincluded in both our wholesale and retail revenues.

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 and PET, 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 those services.This change is to apply to services furnished on or after January 1, 2007.The limitation is applicable to the technical components of the services only(which is the payment we receive for the 

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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, the DRA directs thatthe hospital outpatient payment rate be substituted for the otherwiseapplicable Physician Fee Schedule payment rate. The implementation of thisreimbursement reduction contained in the DRA will have a significant effect onour financial condition and results of operations beginning in 2007. For fullyear 2005, approximately 4% of our revenue was billed directly to Medicare contractors.Basing our calculation on our 2005 revenues, if the provisions were in effectfor 2005, we estimate that the reduction in Medicare revenue due to DRA paymentrate decreases would have totaled approximately $6 million. The estimatedreduction in revenue based on 2005 results is consistent with our expectationof what the impact on full year 2006 revenues would be. Because a highpercentage of our expenses are fixed, we expect a significant portion of thisdecrease in revenue to directly effect 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 quarterended March 31, 2006. We continue to believe that the implementation ofthis reimbursement reduction will not have a material impact on ourconsolidated financial position or results of operations in the future.

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 improveour 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 quarter of2006, the growth rate of MRI industry wide scan volumes has slowed in part dueto weak hospital volumes as reported by several investor-owned hospitalcompanies, the increasing trend of third-party payors intensifying theirutilization management efforts to control MRI scan volume growth rate andadditional patient-related cost-sharing programs. We expect that this trendwill continue throughout 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 OEMs, selling systems directly to certain of our clients.Typically, OEMs target our higher scan volume clients. This increase inactivity by OEMs 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 

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with lower volume clients. During 2006, our MRI revenuesmodestly declined compared to 2005 levels and we believe that MRI revenues willcontinue to modestly decline in future years.

**Seasonality**

We experience seasonalityin the revenues and margins generated for our services. First and fourthquarter revenues are typically lower than those from the second and thirdquarters. First quarter revenue is affected primarily by fewer calendar daysand inclement weather, typically resulting in fewer patients being scannedduring the period. Fourth quarter revenue is affected primarily by holiday andclient and patient vacation schedules and inclement weather, also resulting infewer scans during the period. The variability in margins is higher than thevariability in revenues due to the fixed nature of our costs.

**Results ofOperations**

Thefollowing table shows our consolidated statements of income as a percentage ofrevenues for each of the quarters ended March 31:

| ** **                                                                                        | ** ** | **2005** | ** ** | **2006** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Revenues                                                                                          |       | 100.0    | %          | 100.0    | %          |
| Costs and expenses:                                                                               |       |     |       |     |       |
| Cost of revenues,  excluding depreciation and amortization                                        |       | 50.9     |       | 51.9     |       |
| Selling, general  and administrative expenses                                                     |       | 11.0     |       | 11.9     |       |
| Employment  agreement costs                                                                       |       | 0.3      |       | —   |       |
| Severance and  related costs                                                                      |       | —   |       | 0.4      |       |
| Depreciation  expense                                                                             |       | 19.3     |       | 18.2     |       |
| Amortization  expense                                                                             |       | 0.8      |       | 1.1      |       |
| Interest expense,  net of interest income                                                         |       | 8.6      |       | 8.9      |       |
| Other (income)  and expense, net                                                                  |       | (0.3     | )          | 0.6      |       |
| Total costs and expenses                                                                          |       | 90.6     |       | 93.0     |       |
| Income before income taxes, minority interest  expense and earnings from unconsolidated investees |       | 9.4      |       | 7.0      |       |
| Income tax  expense                                                                               |       | 3.9      |       | 3.0      |       |
| Minority interest  expense                                                                        |       | 0.4      |       | 0.5      |       |
| Earnings from  unconsolidated investees                                                           |       | (0.7     | )          | (0.9     | )          |
| Net income                                                                                        |       | 5.8      | %          | 4.4      | %          |

 

Thetable below provides MRI statistical information for each of the quarters endedMarch 31:

| ** **                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| MRI statistics                                |       |     |       |     |       |
| Average number of total systems               |       | 332.2    |       | 328.1    |       |
| Average number of scan-based systems          |       | 281.9    |       | 279.7    |       |
| Scans per system per day (scan-based systems) |       | 9.45     |       | 9.36     |       |
| Total number of scan-based MRI scans          |       | 191,042  |       | 182,422  |       |
| Price per scan                                |       | $        | 355.86     |     | $          | 358.60 |   |
|                                               |            |          |            |          |            |  |  |

 

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Thetable below provides PET and PET/CT statistical information for each of thequarters ended March 31:

| ** **                           | ** ** | **2005** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| PET and PET/CT  statistics           |       |     |       |     |       |
| Average number of systems            |       | 50.3     |       | 67.1     |       |
| Scans per system per day             |       | 5.18     |       | 5.82     |       |
| Total number of PET and PET/CT scans |       | 15,784   |       | 24,464   |       |
| Price per scan                       |       | $        | 1,371      |     | $          | 1,312 |   |
|                                      |            |          |            |          |            |  |  |

 

Followingare the components of revenue (in millions) for each of the quarters endedMarch 31:

| ** **                          | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Total MRI revenue                   |       | $        | 74.7       |     | $          | 71.9 |   |
| PET and PET/CT  revenue             |       | 21.8     |       | 32.3     |       |
| Other modalities  and other revenue |       | 9.5      |       | 11.1     |       |
| Total                               |       | $        | 106.0      |     | $          | 115.3 |   |

 

| ** **                                                                           | ** ** | **2005** | ** ** | **2006** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Total fixed-site  revenue (in millions) for each of the quarters ended March 31 |       | $        | 15.6       |     | $          | 17.8 |   |
|                                                                                      |            |          |            |          |            |  |  |

 

***Quarter Ended March 31, 2006 Compared to QuarterEnded March 31, 2005***

Revenue increased $9.3 million, or 8.9%, to $115.3 millionin the first quarter of 2006 compared to $106.0 million in the first quarter of2005 primarily due to higher PET and PET/CT revenue and higher other modalitiesand other revenue, offset by lower MRI revenue. PET and PET/CT revenue in thefirst quarter of 2006 increased $10.5 million, or 48.1%, compared to the firstquarter of 2005. Total PET and PET/CT scan volumes increased 55.0% to 24,464scans in the first quarter of 2006 from 15,784 scans in the first quarter of2005, primarily as a result of growth in our core PET business and the PETScans of America Corp. acquisition. The average number of PET and PET/CTsystems in service increased to 67.1 systems in the first quarter of 2006 from50.3 systems in the first quarter of 2005. Scans per system per day alsoincreased 12.4%, to 5.82 scans per system per day in the first quarter of 2006,from 5.18 in the first quarter of 2005. These increases were partially offsetby a 4.3% decline in the average price per PET and PET/CT scan, to $1,312 perscan in the first quarter of 2006 compared to $1,371 per scan in the firstquarter of 2005. Other modalities and other revenue increased $1.6 million, or16.9%, to $11.1 million in the first quarter of 2006 compared to $9.5 millionin the first quarter 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 $2.8 million in the first quarter of 2006, or 3.6%,compared to the first quarter of 2005. Scan-based MRI revenue decreased $2.6million, or 3.8%, to $68.0 million in the first quarter of 2006 from $65.4million in the first quarter of 2005, primarily as a result of a 4.5% decreasein our scan-based MRI scan volume. Scan-based MRI scan volume decreased to182,422 scans in the first quarter of 2006 from 191,042 scans in the firstquarter of 2005, primarily due to a decrease in the average number ofscan-based systems in service due to lower client demand. Scan-based systems inservice decreased to 279.7 systems in the first quarter of 2006 from 281.9systems in the first quarter of 2005 to adjust to modestly declining scan volumesand to increase the efficiency of our mobile MRI systems. Average scans persystem per day also decreased by 1.0% to 9.36 in first quarter of 2006 from9.45 in first quarter of 2005. Non-scan based MRI revenue decreased $0.2million in the first quarter of 2006 over the same period in 2005. Thesedecreases were partially offset by a 0.8% increase in average price per MRIscan to $358.60 per scan in first quarter of 2006 compared to $355.86 per scanin first quarter of 2005.

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We had 345 MRI systems at March 31, 2006 comparedto 354 MRI systems at March 31, 2005. We had 74 PET and PET/CT systems at March 31,2006 compared to 56 PET and PET/CT systems at March 31, 2005. We operated73 fixed sites at March 31, 2006, compared to 62 fixed sites at March 31, 2005.Of the 73 fixed-sites at March 31, 2006, 60 MRI fixed-sites and 3 PET or PET/CTfixed-sites were included in our respective system counts. Of the 62fixed-sites at March 31, 2005, 54 MRI fixed-sites and 3 PET or PET/CTfixed-sites were included in our respective system counts.

Cost of revenues, excluding depreciation andamortization, increased $6.0 million, or 11.0%, to $59.9 million inthe first quarter of 2006 compared to $53.9 million in the first quarterof 2005. Compensation and related employee expenses increased$2.7 million, or 10.3%, primarily as a result of the increase of PET andPET/CT technologists who have a higher average hourly wage rate than MRItechnologists and an increase in mileage reimbursement rates. This increase incompensation 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 $1.1 million, or 26.6%, 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 $0.5 million, or 16.5%, primarily as a result of an increasein expenses incurred on behalf of unconsolidated investees. Equipment rentalexpense increased $0.5 million, or 49.1%, primarily due to a higher number ofrental systems in use to support current clients while continuing to improveroute efficiency. Fuel expenses increased $0.3 million, or 25.2%, primarily dueto higher average diesel fuel prices in 2006. Maintenance and related costsincreased $0.2 million, or 1.4%, primarily due to an increase in the averageservice cost per system, offset by a decrease in cryogen expense as a result ofa decrease in MRI systems in service and cryogen sourcing discounts. Outsidemedical services increased $0.2 million, or 10.3%, primarily as a result of anincrease in outside radiologists service costs associated with PET and PET/CTservices. All other cost of revenues, excluding depreciation and amortization,increased $0.5 million, or 8.1%. Cost of revenues, as a percentage of revenue,increased to 51.9% in the first quarter of 2006 from 50.9% in the first quarterof 2005 as a result of the factors described above.

Selling, general and administrative expenses increased$2.0 million, or 17.7%, to $13.7 million in the first quarter of 2006 comparedto $11.7 million in the first quarter of 2005. Compensation and relatedemployee expenses increased $0.8 million, or 9.6%, primarily due to an increasein the headcount of sales and marketing personnel, an increase in salescommissions, as well as an increase in travel and entertainment associated withour annual national meeting. The provision for doubtful accounts increased $0.4million, or 89.0%. The provision for doubtful accounts as a percentage ofrevenue was 0.7% and 0.4% for each of the quarters ended March 31, 2006and 2005, respectively. Share-based compensation increased $0.6 million in thefirst quarter of 2006 from the first quarter of 2005, primarily as a result ofthe adoption of SFAS 123 (R), effective January 1, 2006. All otherselling, general and administrative expenses increased $0.2 million, or 9.0%.Selling, general and administrative expenses as a percentage of revenue were 11.9%and 11.0% in the first quarter of 2006 and 2005, respectively.

We recorded employment agreement expenses of $0.3million in the first 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 $0.5million in the first quarter of 2006 primarily for severance costs associatedwith reductions-in-force due to our consolidation of 5 geographic regions to 4 geographicregions.

Depreciation expense increased $0.5 million, or 2.6%,to $21.0 million in the first quarter of 2006 compared to $20.5 million in thefirst quarter of 2005.

Amortization expense increased by $0.3 million, or41.2%, to $1.2 million in the first quarter of 2006 compared to$0.9 million in the first quarter of 2005, primarily due to theamortization of intangible assets acquired in conjunction with our acquisitionsin the third and fourth quarters of 2005.

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Interest expense, net, increased $1.1 million, or12.8%, to $10.2 million in the first quarter of 2006 compared to $9.1 millionin the first quarter of 2005. This increase is due to higher average debtbalances during the first 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 a portion of our variablerate term loans.

Income tax expense was $3.5 million and$4.1 million in the first quarter of 2006 and 2005, respectively,resulting in effective tax rates of 40.7% and 40.2% in the first quarter of2006 and 2005, respectively. Our effective tax rates were higher than statutoryrates principally as a result of state income taxes.

Minority interest expense increased $0.1 million,or 31.2%, to $0.5 million in the first quarter of 2006 compared to$0.4 million in the first quarter of 2005.

Earnings from unconsolidated investees increased by$0.3 million, or 52.0%, to $1.0 million in the first quarter of 2006 comparedto $0.7 million in the first quarter of 2005.

Our net income was$5.1 million, or $0.10 per share on a diluted basis, in the first quarterof 2006 compared to $6.1 million, or $0.12 per share on a diluted basis,in the first quarter of 2005.

**Liquidity andCapital Resources**

Our primary source of liquidity is cash provided byoperating activities. We generated $19.5 million and $27.1 million of cash flowfrom operating activities in the first quarters of 2006 and 2005, respectively.Our ability to generate cash flow is affected by numerous factors, includingdemand for MRI, PET and other diagnostic imaging services. Our ability to generatecash flow from operating activities is also dependent upon the collections ofour accounts receivable. The provision for doubtful accounts increased by $0.4million in the first quarter of 2006 compared to the first quarter of 2005. Webelieve that the number of days of revenue outstanding for our accountsreceivable, which was 46 days as of March 31, 2006 and 2005, is among themore favorable in the healthcare service industry. In addition, as of March 31,2006, we had $39.1 million available borrowings under our revolving line ofcredit.

Our primary use ofcapital resources is to fund capital expenditures. We used cash of $18.2million and $13.0 million for investing activities in the first quarter of 2006and 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 $24.3 million and $13.5million in the first quarter of 2006 and 2005, respectively. During the firstquarter of 2006 we purchased 2 MRI systems, 12 PET/CT systems and 2 CT systems.We traded-in or sold a total of 14 total systems for the quarter ended March 31,2006. Our decision to purchase a new system is typically predicated onobtaining new or extending existing client contracts, which serve as the basisof demand for the new system. We expect to purchase additional systems in 2006and finance substantially all of these purchases with our available cash, cashfrom operating activities, our revolving line of credit, and equipment leases.Based upon the client demand described above, which dictates the type ofequipment purchased, we expect capital expenditures to total approximately $85to $90 million in 2006.

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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 issuedSFAS 154, “Accounting for Changes and Error Corrections” (“SFAS 154”),which is a replacement of APB Opinion No. 20, “Accounting Changes,” andSFAS 3, “Reporting Accounting Changes in Interim Financial Statements.”This statement changes the requirements for the accounting for and reporting ofall voluntary changes in accounting principle and in the instance that apronouncement does not include specific transition provisions. This statementrequires retrospective application to prior periods’ financial statements ofchanges in accounting principle, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change.SFAS 154 is effective for accounting changes and corrections of errorsmade in fiscal years beginning after December 15, 2005. The adoption ofSFAS 154 did not have a material impact on our consolidated financialposition or results of operations.**

In June 2005, theFASB issued Emerging Issues Task Force Issue No. 04-05, “DeterminingWhether a General Partner, or the General Partners as a Group, Controls aLimited Partnership or Similar Entity When the Limited Partners Have CertainRights”(“EITF 04-05”). EITF 04-05 clarifies how generalpartners in a limited partnership should determine whether they control alimited partnership. A general partner of a limited partnership is presumed tocontrol 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 onour consolidated financial position or results of operations.

**CautionaryStatement Pursuant to the Private Securities Litigation Reform Act of 1995**

Certain statements containedin Management’s Discussion and Analysis of Financial Condition and Results ofOperations, particularly in the section entitled “Liquidity and CapitalResources”, and elsewhere in this quarterly report on Form 10-Q, are“forward-looking statements,” within the meaning of the safe harbor provisionsof the Private Securities Litigation Reform Act of 1995. Statements whichaddress activities, events or developments that we expect or anticipate will ormay occur in the future, including such things as results of operations andfinancial condition, capital expenditures, the consummation of acquisitions andfinancing transactions and the effect of such transactions on our business andour plans and objectives for future operations and expansion are examples offorward-looking statements. In some cases you can identify these statements byforward-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 thecounter-parties to our interest rate swap agreements fail to satisfy theirobligations under these agreements, our ability to incur financing, the effectof operating and financial restrictions in our debt instruments, the accuracyof our estimates regarding our capital requirements, the effect of intenselevels of competition in our industry, changes in the rates or methods of thirdparty reimbursements for diagnostic imaging services, changes in the healthcareregulatory environment, our ability to keep pace with technologicaldevelopments within our industry, and other risks and uncertainties, includingthose enumerated and 

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describedunder “Risk Factors” in our Form 10-K, as filed with the Securitiesand Exchange Commission, for the fiscal year ended December 31, 2005. Theforegoing should not be construed as an exhaustive list of all factors whichcould cause actual results to differ materially from those expressed inforward-looking statements made by us.

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

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

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 March 31,2006. Under the terms of these agreements, we receive three-month LIBOR and paya fixed 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 ended March 31, 2006, we received a net settlement amount of $0.3 million. For the quarter ended March 31,2005 we paid a net settlement amount of $0.5 million. The swapagreements 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 ended March 31,2006, we received a net settlement amount of $0.1 million on these collaragreements. For the quarter ended March 31, 2005, we did not record anynet settlement on these collar agreements. The collar agreements mature atvarious 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.

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

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**ITEM 4.**                CONTROLSAND PROCEDURES

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that 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), we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the quarter covered by this report. Based on theforegoing, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective at the reasonableassurance level.

There has been no change 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 filed in Alameda County Superior Court alleging wageand hour claims on behalf of a putative class of approximately 400 former andcurrent California employees of the Company. On August 19, 2005, theplaintiffs filed an amended complaint, which the Company answered on September 23,2005. In this suit, captioned Linda S. Jones, et al. v. Alliance Imaging, Inc.,et al., the plaintiffs allege violations of California’s wage, meal period, andbreak time laws and regulations. Plaintiffs sought recovery of unspecifiedeconomic damages, statutory penalties, attorneys’ fees, and costs of suit. Theparties are currently taking discovery to develop facts relevant to the namedplaintiffs’ expected motion for certification of one or more classes. On orabout March 10, 2006, plaintiffs filed a second amended complaint adding acause of action for conversion and a plea for punitive damages. The Company hasfiled a demurrer seeking to strike the new claim and plea. A hearing on thismotion was held on May 4, 2006, but the court has not yet issued a ruling.No date for the filing or hearing of a motion for class certification has beenset and no trial date has been set. The Company continues to evaluate theallegations of the second amended complaint and is unable to predict the likelytiming or outcome of the lawsuit.

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

Not applicable.

**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)                                                                                                                                           |

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| 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 including the forms of option  agreements used thereunder, as amended.(5)                                                                                                                                            |
| 10.2  |   | The Alliance 1997  Stock Option Plan, including form of option agreement used thereunder, as  amended.(5)                                                                                                                                                                             |
| 10.3  |   | The Three Rivers  Holding Corp. 1997 Stock Option Plan, as amended.(5)                                                                                                                                                                                                                |
| 10.4  |   | Alliance  Directors’ Deferred Compensation Plan, as amended.(6)                                                                                                                                                                                                                  |
| 10.5  |   | 2003 Incentive  Plan (9)                                                                                                                                                                                                                                                              |
| 10.6  |   | Employment  Agreement dated as of July 23, 1997 between Alliance and Richard N.  Zehner.(1)                                                                                                                                                                                 |
| 10.7  |   | Agreement Not to  Compete dated as of July 23, 1999 between Alliance and RichardN. 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)                                                                                                                                                                                                                                            |

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| 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. Vivano.(15)                                                                         |
| 10.31       |   | Agreement Not to  Compete dated as of May 9, 2005 between Alliance and Paul S. Vivano(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)                                                                                    |
| 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.(18)                                               |
| 32          |   | Certifications of  Chief Executive Officer and Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.(18)                                               |

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

(2)          Incorporated byreference herein to the indicated Exhibit in response to Item 14(a)(3), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,1997 (File No. 000-16334).

(3)          Incorporated byreference herein to the indicated Exhibit in response to Item 14(a)(3), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,1998 (File No. 000-16334).

(4)          Incorporated byreference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended March 31,1998 (File No. 000-16334).

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

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

(7)          Incorporated byreference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended June 30,2001 (File No. 001-16609).

(8)          Incorporated byreference to exhibits filed in response to Item 6, “Exhibits” of the Company’sQuarterly Report on Form 10-Q for the quarter ended June 30,2002 (File No. 001-16609).

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(9)          Incorporated byreference herein to the indicated Exhibit response in Item 15(a)(3), “Exhibits”of the Company’s Annual Report on Form 10-K for the year ended December 31,2002 (File No. 001-16609).

(10)   Incorporated by reference toexhibits filed in response to Item 6, “Exhibits” of the Company’s QuarterlyReport on Form 10-Q for the quarter ended June 30, 2003 (File No. 001-16609).

(11)   Incorporated by referenceherein to the indicated Exhibit response in Item 15(a)(3), “Exhibits” ofthe Company’s Annual Report on Form 10-K for the year ended December 31,2003 (File No. 001-16609).

(12)   Incorporated by reference toexhibits filed in response to Item 6, “Exhibits” of the Company’s QuarterlyReport on Form 10-Q for the quarter ended March 31, 2004 (File No. 001-16609).

(13)   Incorporated by reference toexhibits filed in response to Item 9.01(c), “Exhibits” of the Company’s CurrentReport on Form 8-K, dated December 29, 2004 (File No. 001-16609).

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

(15)   Incorporated by reference toexhibits filed in response to Item 6, “Exhibits” of the Company’s QuarterlyReport on Form 10-Q for the quarter ended March 31, 2005 (File No. 001-16609).

(16)   Incorporated by reference toexhibits filed in response to Item 9.01(d) , “Exhibits” of the Company’sCurrent Report on Form 8-K, dated December 22, 2005 (File No. 001-16609).

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

(18)   Filed herewith

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

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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.** |
|-------------------|------------------------------|
| May 10, 2006 | By:                          | /s/ PAUL S. VIVIANO |
| * *          |                         | Paul S. Viviano |
| * *          |                         | *Chairman of the Board and Chief Executive Officer* |
| * *          |                         | *(Principal Executive Officer)* |
| May 10, 2006 | By:                          | /s/ HOWARD K. AIHARA |
| * *          |                         | Howard K. Aihara |
| * *          |                         | *Executive Vice President and Chief Financial  Officer* |
| * *          |                         | *(Principal Financial Officer)* |
| May 10, 2006 | By:                          | /s/ NICHOLAS A. POAN |
| * *          |                         | Nicholas A. Poan |
| * *          |                         | *Vice President and Corporate Controller* |
| * *          |                         | *(Principal Accounting Officer)* |

 

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