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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-QSB



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended September 30, 2004



| ̈ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
|- | --------------------------------------------------------------------------



For the transition period from  to



Commission file number 000-27915



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MOLECULAR IMAGING CORPORATION

A Delaware Corporation

(Exact name
of small business issuer as specified in its charter)



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|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|Delaware                                                       |  | 11-2787966                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)



9530 Towne Centre
Drive, Suite #120

San Diego, California 92121

(Address of principal executive offices)



(858) 642-0032

(Issuers telephone number)



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Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



There were
56,267,801 shares outstanding of the issuers Common Stock as of November 9, 2004.



Transitional Small Business Disclosure Format (Check one):    Yes ̈No  x



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MOLECULAR IMAGING CORPORATION AND SUBSIDIARIES



For the quarterly period ended September 30, 2004



Table of Contents



|               |  |                       |  |                                            |  |         
|-------------- |  | --------------------- |  | ------------------------------------------ |  | --------
|               |  |                       |  |                                            |  | Page No.
|PART I.        |  | FINANCIAL INFORMATION |  |                                           
|               |  |                       | 
|               |  | Item 1.               |  | Financial Statements (unaudited)           |  |         
|               |  |                       | 
|               |  |                       |  | Consolidated Balance Sheets                |  | 3       
|               |  |                       | 
|               |  |                       |  | Consolidated Statements of Operations      |  | 4       
|               |  |                       | 
|               |  |                       |  | Consolidated Statements of Cash Flows      |  | 5       
|               |  |                       | 
|               |  |                       |  | Notes to Consolidated Financial Statements |  | 6       
|               |  |                       | 
|               |  | Item 2.               |  | Managements Discussion and Analysis       |  | 13      
|               |  |                       | 
|               |  | Item 3.               |  | Controls and Procedures                    |  | 24      
|               |  |                      
|PART II.       |  | OTHER INFORMATION     |  |                                           
|               |  |                       | 
|               |  | Item 1.               |  | Legal Proceedings                          |  | 24      
|               |  |                       | 
|               |  | Item 2.               |  | Changes in Securities                      |  | 24      
|               |  |                       | 
|               |  | Item 6.               |  | Exhibits and Reports on Form 8-K           |  | 25      
|               |  |                      
|SIGNATURES     |  |                       |  | 25                                        
|               | 
|CERTIFICATIONS |  |                      



2



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MOLECULAR IMAGING CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheet

September 30, 2004 (Unaudited) and June 30, 2004 (Audited)



|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | - | ------------- | - | ----------- | -
|                                                                                                                                                  |  | September 30, 2004 |             |   | June 30, 2004 |  
|ASSETS                                                                                                                                            |  |                    |             |   |               |   |             |  
|Current assets                                                                                                                                    |  |                    |             |   |               |   |             |  
|Cash                                                                                                                                              |  | $                  | 203,380     |   |               | $ | 213,571     |  
|Accounts receivable, net                                                                                                                          |  |                    | 2,950,511   |   |               |   | 3,086,335   |  
|Prepaid expenses                                                                                                                                  |  |                    | 275,471     |   |               |   | 198,784     |  
|Deposits and other assets                                                                                                                         |  |                    | 157,766     |   |               |   | 146,707     |  
|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|Total current assets                                                                                                                              |  |                    | 3,587,128   |   |               |   | 3,645,397   |  
|                                                                                                                                                  |  |                   
|Property and equipment, net                                                                                                                       |  |                    | 13,244,447  |   |               |   | 14,141,267  |  
|                                                                                                                                                  |  |                   
|Other assets                                                                                                                                      |  |                    |             |   |               |   |             |  
|Due from London Radiosurgical Centre, Ltd                                                                                                         |  |                    | 52,761      |   |               |   | 103,685     |  
|Prepaid rent and financing costs                                                                                                                  |  |                    | 1,114,442   |   |               |   | 1,131,803   |  
|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|Total assets                                                                                                                                      |  | $                  | 17,998,778  |   |               | $ | 19,022,152  |  
|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)                                                                                                    |  |                    |             |   |               |   |             |  
|                                                                                                                                                  |  |                   
|Current liabilities                                                                                                                               |  |                    |             |   |               |   |             |  
|Accounts payable                                                                                                                                  |  | $                  | 1,072,845   |   |               | $ | 1,673,697   |  
|Asset backed financing facility                                                                                                                   |  |                    | 1,477,232   |   |               |   | 1,480,405   |  
|Current portion of long-term debt                                                                                                                 |  |                    | 45,551      |   |               |   | 20,149      |  
|Loans payable to related parties                                                                                                                  |  |                    | 50,000      |   |               |   | 60,000      |  
|Deferred rent                                                                                                                                     |  |                    | 675,122     |   |               |   | 575,000     |  
|Accrued and other liabilities                                                                                                                     |  |                    | 1,691,841   |   |               |   | 1,617,438   |  
|Obligations under capital lease - current                                                                                                         |  |                    | 16,725,231  |   |               |   | 17,013,360  |  
|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|Total current liabilities                                                                                                                         |  |                    | 21,737,822  |   |               |   | 22,440,049  |  
|                                                                                                                                                  |  |                   
|Noncurrent liabilities                                                                                                                            |  |                    |             |   |               |   |             |  
|Obligations under capital lease, net                                                                                                              |  |                    |            |   |               |   |            |  
|Long-term debt                                                                                                                                    |  |                    | 235,736     |   |               |   | 21,280      |  
|Deferred gain                                                                                                                                     |  |                    | 85,492      |   |               |   | 89,063      |  
|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|Total liabilities                                                                                                                                 |  |                    | 22,059,050  |   |               |   | 22,550,392  |  
|                                                                                                                                                  |  |                   
|Minority interest                                                                                                                                 |  |                    | (73,814     | ) |               |   |            |  
|                                                                                                                                                  |  |                   
|Stockholders equity (deficit)                                                                                                                    |  |                    |             |   |               |   |             |  
|Common stock; $0.0001 par value; 140,000,000 shares authorized; 56,267,801 shares issued and outstanding at September 30, 2004 and June 30,
2004  |  |                    | 5,628       |   |               |   | 5,628       |  
|Preferred stock; $0.0001 par value; 10,000,000 shares authorized; 1,100,000 shares issued and outstanding at September 30, 2004 and June 30,
2004 |  |                    | 1,025,000   |   |               |   | 1,025,000   |  
|Additional paid in capital                                                                                                                        |  |                    | 30,009,306  |   |               |   | 30,009,306  |  
|Accumulated deficit                                                                                                                               |  |                    | (35,026,392 | ) |               |   | (34,568,174 | )
|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|Total stockholders (deficit)                                                                                                                     |  |                    | (3,986,458  | ) |               |   | (3,528,240  | )
|                                                                                                                                                  |  |                    |             |   |               |   |             |  
|Total liabilities and stockholders (deficit)                                                                                                     |  | $                  | 17,998,778  |   |               | $ | 19,022,152  |  
|                                                                                                                                                  |  |                    |             |   |               |   |             |  



See accompanying notes.



3



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MOLECULAR IMAGING CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

For the Quarter ended September 30, 2004 and 2003

(Unaudited)



|                                                             |  |                                   |            |   |                                   |   |            |  
|------------------------------------------------------------ |  | --------------------------------- | ---------- | - | --------------------------------- | - | ---------- | -
|                                                             |  | Quarter Ending September 30, 2004 |            |   | Quarter Ending September 30, 2003 |  
|Revenue, net                                                 |  |                                   |            |   |                                   |   |            |  
|Service Revenue                                              |  | $                                 | 5,018,076  |   |                                   | $ | 5,624,237  |  
|Cyclotron revenue                                            |  |                                   | 16,800     |   |                                   |   |           |  
|                                                             |  |                                   |            |   |                                   |   |            |  
|Total revenue, net                                           |  |                                   | 5,034,876  |   |                                   |   | 5,624,237  |  
|                                                             |  |                                  
|Cost of revenues                                             |  |                                   |            |   |                                   |   |            |  
|Cost of service revenue                                      |  |                                   | 2,806,156  |   |                                   |   | 3,472,017  |  
|Cost of cyclotron revenue                                    |  |                                   | 47,698     |   |                                   |   |           |  
|                                                             |  |                                   |            |   |                                   |   |            |  
|Total cost of revenues                                       |  |                                   | 2,853,854  |   |                                   |   | 3,472,017  |  
|                                                             |  |                                   |            |   |                                   |   |            |  
|Gross profit                                                 |  |                                   | 2,181,022  |   |                                   |   | 2,152,220  |  
|                                                             |  |                                  
|Expenses                                                     |  |                                   |            |   |                                   |   |            |  
|Selling and marketing                                        |  |                                   | 346,691    |   |                                   |   | 284,459    |  
|General and administrative                                   |  |                                   | 1,503,422  |   |                                   |   | 1,598,534  |  
|Asset impairment loss                                        |  |                                   | 177,231    |   |                                   |   |           |  
|                                                             |  |                                   |            |   |                                   |   |            |  
|Total expenses                                               |  |                                   | 2,027,344  |   |                                   |   | 1,882,993  |  
|                                                             |  |                                   |            |   |                                   |   |            |  
|Income from operations                                       |  |                                   | 153,678    |   |                                   |   | 269,227    |  
|                                                             |  |                                  
|Other income (expense)                                       |  |                                   |            |   |                                   |   |            |  
|Interest income                                              |  |                                   | 130        |   |                                   |   | 317        |  
|Other income (expense)                                       |  |                                   | 2,235      |   |                                   |   | (9,089     | )
|Interest expense                                             |  |                                   | (688,075   | ) |                                   |   | (681,382   | )
|                                                             |  |                                   |            |   |                                   |   |            |  
|Total other income (expense)                                 |  |                                   | (685,710   | ) |                                   |   | (690,154   | )
|                                                             |  |                                   |            |   |                                   |   |            |  
|Loss before provision for income taxes and minority interest |  |                                   | (532,032   | ) |                                   |   | (420,927   | )
|Provision for income taxes                                   |  |                                   |           |   |                                   |   |           |  
|                                                             |  |                                   |            |   |                                   |   |            |  
|Net loss before minority interest                            |  |                                   | (532,032   | ) |                                   |   | (420,927   | )
|                                                             |  |                                  
|Minority interest                                            |  |                                   | (73,814    | ) |                                   |   | (12,878    | )
|                                                             |  |                                   |            |   |                                   |   |            |  
|                                                             |  |                                  
|Net loss                                                     |  | $                                 | (458,218   | ) |                                   | $ | (408,049   | )
|                                                             |  |                                   |            |   |                                   |   |            |  
|                                                             |  |                                  
|Earnings per share                                           |  |                                   |            |   |                                   |   |            |  
|Loss per share - basic                                       |  | $                                 | (0.01      | ) |                                   | $ | (0.01      | )
|                                                             |  |                                   |            |   |                                   |   |            |  
|Loss per share - diluted                                     |  | $                                 | (0.01      | ) |                                   | $ | (0.01      | )
|                                                             |  |                                   |            |   |                                   |   |            |  
|                                                             |  |                                  
|Weighted average number of shares - basic                    |  |                                   | 56,267,801 |   |                                   |   | 55,808,104 |  
|                                                             |  |                                   |            |   |                                   |   |            |  
|Weighted average number of shares - diluted                  |  |                                   | 72,685,711 |   |                                   |   | 55,808,104 |  
|                                                             |  |                                   |            |   |                                   |   |            |  



See accompanying notes.



4



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MOLECULAR IMAGING CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Quarters Ended September 30, 2004 and 2003

(Unaudited)



|                                                                               |  |      |           |   |      |   |           |  
|------------------------------------------------------------------------------ |  | ---- | --------- | - | ---- | - | --------- | -
|                                                                               |  | 2004 |           |   | 2003 |  
|Cash flows from operating activities                                           |  |      |           |   |      |   |           |  
|Net loss                                                                       |  | $    | (458,218  | ) |      | $ | (408,049  | )
|Adjustments to reconcile net loss to net cash provided by operating activities |  |      |           |   |      |   |           |  
|Depreciation and amortization                                                  |  |      | 1,040,366 |   |      |   | 991,401   |  
|Noncash asset impairment                                                       |  |      | 177,231   |   |      |   |          |  
|Loss on sale and lease back                                                    |  |      |          |   |      |   | (150,000  | )
|Minority interest in net loss of subsidiary                                    |  |      | (73,814   | ) |      |   | (12,878   | )
|Interest                                                                       |  |      |          |   |      |   | 10,000    |  
|Deferred gain                                                                  |  |      | (3,571    | ) |      |   | (2,632    | )
|Deferred rent                                                                  |  |      | 100,122   |   |      |   |          |  
|(Increase) decrease in operating assets                                        |  |      |           |   |      |   |           |  
|Accounts receivable                                                            |  |      | 135,824   |   |      |   | (950,131  | )
|Due from London Radiosurgical Centre, Ltd.                                     |  |      | 50,924    |   |      |   |          |  
|Prepaid rent and financing costs                                               |  |      | (59,326   | ) |      |   | 11,420    |  
|Deposits and other assets                                                      |  |      | (11,059   | ) |      |   | (31,742   | )
|Increase (decrease) in operating liabilities                                   |  |      |           |   |      |   |           |  
|Accounts payable                                                               |  |      | (359,495  | ) |      |   | 1,042,414 |  
|Accrued and other liabilities                                                  |  |      | 74,403    |   |      |   | 16,595    |  
|                                                                               |  |      |           |   |      |   |           |  
|Net cash provided by operating activities                                      |  |      | 613,387   |   |      |   | 516,398   |  
|                                                                               |  |     
|Cash flows from investing activities                                           |  |      |           |   |      |   |           |  
|Capital expenditures                                                           |  |      | (15,413   | ) |      |   | (900,000  | )
|Proceeds from sale of capital assets                                           |  |      |          |   |      |   | 1,250,000 |  
|                                                                               |  |      |           |   |      |   |           |  
|Net cash (used in) provided by investing activities                            |  |      | (15,413   | ) |      |   | 350,000   |  
|                                                                               |  |     
|Cash flows from financing activities                                           |  |      |           |   |      |   |           |  
|Asset backed financing facility, net                                           |  |      | (3,173    | ) |      |   | 464,455   |  
|Payments on loans                                                              |  |      | (11,499   | ) |      |   | (46,747   | )
|Payments on obligations under capital lease                                    |  |      | (593,493  | ) |      |   | (980,652  | )
|Common stock issued through exercise of options                                |  |      |          |   |      |   | 78,749    |  
|Investment in subsidiary                                                       |  |      |          |   |      |   | 250,000   |  
|                                                                               |  |      |           |   |      |   |           |  
|Net cash used in financing activities                                          |  |      | (608,165  | ) |      |   | (234,195  | )
|                                                                               |  |      |           |   |      |   |           |  
|Net (decrease) increase in cash                                                |  |      | (10,191   | ) |      |   | 632,203   |  
|Cash - beginning of period                                                     |  |      | 213,571   |   |      |   | 113,130   |  
|                                                                               |  |      |           |   |      |   |           |  
|Cash - end of period                                                           |  | $    | 203,380   |   |      | $ | 745,333   |  
|                                                                               |  |      |           |   |      |   |           |  
|SUPPLEMENTAL DISCLOSURES                                                       |  |      |           |   |      |   |           |  
|Interest paid                                                                  |  | $    | 688,075   |   |      | $ | 681,382   |  
|                                                                               |  |     
|NON CASH INVESTING AND FINANCING ACTIVITIES                                    |  |      |           |   |      |   |           |  
|Equipment under capital lease                                                  |  | $    | 112,717   |   |      | $ | 6,195,179 |  
|Obligations under capital lease                                                |  | $    | 289,948   |   |      | $ | 6,195,179 |  
|Conversion of note receivable to capital expenditure                           |  | $    |          |   |      | $ | 500,000   |  
|Capitalized interest                                                           |  | $    |          |   |      | $ | 27,679    |  
|Conversion of liability to note payable                                        |  | $    | 241,357   |   |      | $ |          |  



See accompanying notes.



5



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PART 1.



MOLECULAR IMAGING CORPORATION AND SUBSIDIARIES



Notes to Consolidated Financial Statements

(Unaudited)



NOTE 1THE COMPANY



Molecular Imaging Corporation and subsidiaries, (the Company) were organized to provide Positron Emission Tomography
(PET or MI) systems and services to hospitals and other health care providers on a mobile, shared user basis. The Companys MI services include providing high technology imaging systems, technologists to operate the
imaging systems, the management of day-to-day operations and educational and marketing support.



NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation



The accompanying
unaudited consolidated financial statements have been prepared by Molecular Imaging Corporation (the Company) in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form
10-QSB and Regulation S-B of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended September 30, 2004 are not necessarily indicative of the
results that may be expected for the year ending June 30, 2005. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes to the consolidated financial
statements for the year ended June 30, 2004.



The consolidated financial
statements include the accounts of the Company and its subsidiaries (Sorrento Valley Pet L.L.C., Cyclotron L.L.C. and Molecular Imaging Houston L.L.C.). All significant intercompany transactions have been eliminated in consolidation.



Cash and Cash Equivalents



The Company considers all highly liquid debt instruments purchased with a maturity of three
months or less to be cash and cash equivalents.



Property, Equipment and
Leasehold Improvements



Property and equipment are recorded at cost less
depreciation and amortization. Depreciation and amortization are accounted for on the straight-line method based on estimated useful lives. The amortization of leasehold improvements is based on the shorter of the lease term or the life of the
improvement. Betterments and large renewals, which extend the life of an asset, are capitalized; whereas, maintenance and repairs and small renewals are expensed as incurred.



Impairment of Long-Lived Assets



The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment
or Disposal of Long Lived Assets (SFAS 144). SFAS 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash flows that are expected to be generated by the asset. If the carrying amount of an asset exceeds its
estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less
costs to sell.



Revenue Recognition



Service revenues are recognized when services are rendered. Product revenues are recognized
when products are shipped.



Service revenues from third party payors are
reported net of contractual allowances. Contractual allowances are a normal industry practice and are a result of third party reimbursements for services performed based on allowable cost. Revenue under third party payor agreements is subject to
adjustment. Provisions for estimated third party payor settlements are provided in the period the related services are rendered. Differences between estimated amounts and accrued and interim and final settlements are reported in operations in the
year of settlement. Contractual allowances are $271,126 at September 30, 2004 and June 30, 2004, respectively.



6



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Estimates



The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.



Recent accounting Pronouncements



There are no recent accounting pronouncements that have had or are expected to have a
material affect on the Companys financial statements.



Reclassifications



Certain prior period amounts have been
reclassified to conform to the current period presentation. These changes had no impact on previously reported results of operations or stockholders (deficit).



NOTE 3ACQUISITIONS



Amendments to UCSD Agreement



On September 24, 2004, the Company, Molecular Imaging Cyclotron LLC (Cyclotron LLC), Molecular Imaging Sorrento Valley LLC (Sorrento Valley LLC),
and The Regents of the University of California (UCSD) entered into a binding term sheet in which the parties agreed to amend the Asset Purchase and LeaseBack Agreement dated August 15, 2003 (the UCSD Agreement). Under the
terms of the UCSD Agreement, UCSD may elect to contribute certain assets to Cyclotron LLC and Sorrento Valley LLC in exchange for a membership interest in such LLCs. The material terms of the amendment extended the deadline by which UCSD may elect
to become a member of Cyclotron LLC and Sorrento Valley LLC; extended the date by which Cyclotron LLC and Sorrento Valley LLC must accrue for additional rent to UCSD, from fiscal years 2004 and 2005, to fiscal years 2006 and 2007, and requires the
Company to use commercially reasonable efforts to cause MarCap Corporation to consent to the assignment of the MI scanner equipment lease from UCSD to a third party in order to allow for the financing of a new MI/CT unit at the Sorrento Valley
center.



NOTE 4ACCOUNTS RECEIVABLE



Accounts receivable consist of the following at September 30, 2004 and June 30, 2004:



|                                      |  |                    |           |   |               |   |           |  
|------------------------------------- |  | ------------------ | --------- | - | ------------- | - | --------- | -
|                                      |  | September 30, 2004 |           |   | June 30, 2004 |  
|Accounts receivable                   |  | $                  | 4,075,737 |   |               | $ | 4,211,561 |  
|Less: Allowance for doubtful accounts |  |                    | (854,100  | ) |               |   | (854,100  | )
|Contractual allowance                 |  |                    | (271,126  | ) |               |   | (271,126  | )
|                                      |  |                    |           |   |               |   |           |  
|                                      |  |                   
|Accounts receivable, net              |  | $                  | 2,950,511 |   |               | $ | 3,086,335 |  
|                                      |  |                    |           |   |               |   |           |  



NOTE 5PROPERTY AND EQUIPMENT



Property and equipment consist of the following at September 30, 2004 and
June 30, 2004:



|                                               |  |                    |             |   |               |   |             |  
|---------------------------------------------- |  | ------------------ | ----------- | - | ------------- | - | ----------- | -
|                                               |  | September 30, 2004 |             |   | June 30, 2004 |  
|Computer equipment                             |  | $                  | 1,176,171   |   |               | $ | 1,160,758   |  
|Office furniture and fixtures                  |  |                    | 164,562     |   |               |   | 164,562     |  
|Office equipment                               |  |                    | 13,291      |   |               |   | 13,291      |  
|Leasehold improvements                         |  |                    | 265,417     |   |               |   | 250,000     |  
|MI and related equipment                       |  |                    | 25,731,041  |   |               |   | 25,618,324  |  
|                                               |  |                    |             |   |               |   |             |  
|                                               |  |                   
|                                               |  |                    | 27,350,482  |   |               |   | 27,206,935  |  
|Less accumulated depreciation and amortization |  |                    | (14,106,035 | ) |               |   | (13,065,668 | )
|                                               |  |                    |             |   |               |   |             |  
|Property and equipment, net                    |  | $                  | 13,244,447  |   |               | $ | 14,141,267  |  
|                                               |  |                    |             |   |               |   |             |  



7



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Depreciation and amortization expense for the three months ended September 30, 2004 and 2003 was $1,040,366 and $991,401,
respectively.



NOTE 6ASSET BASED FINANCING



In May 2003, the Company entered into a $3,200,000 asset-based financing arrangement with a
financial institution, which expires on May 12, 2006. The amounts borrowed by the Company under this financing arrangement are secured by accounts receivable and are used to pay its general operating expenses. The arrangement is subject to certain
restrictive covenants. Amounts available under the arrangement are limited to approximately 85% of qualified accounts receivable following an amendment dated May 1, 2004. The balance at September 30, 2004 and June 30, 2004 was $1,477,232 and
$1,480,405, respectively. The purchase fee percent is calculated at 0.032% per day.



The Company issued warrants to purchase 10,000 shares of common stock to the financial institution at an exercise price of $0.20 per share, expiring in three years.



NOTE 7PREPAID RENT AND FINANCING COSTS



Prepaid rent and financing costs consist of the following at September 30, 2004 and June 30, 2004:



|                                 |  |                    |           |               |   |          
|-------------------------------- |  | ------------------ | --------- | ------------- | - | ---------
|                                 |  | September 30, 2004 |           | June 30, 2004
|Prepaid equipment rent           |  | $                  | 1,073,986 |               | $ | 1,073,986
|Prepaid financing costs          |  |                    | 40,456    |               |   | 57,817   
|                                 |  |                    |           |               |   |          
|Prepaid rent and financing costs |  | $                  | 1,114,442 |               | $ | 1,131,803
|                                 |  |                    |           |               |   |          



NOTE 8CAPITALIZATION



Stock Options



The Companys Board of Directors and stockholders adopted the 1999 Stock Option Plan
pursuant to which incentive stock options or nonstatutory stock options to purchase up to 8,000,000 shares of common stock may be granted to employees, directors and consultants. Stock options expire through April 10, 2013 and vesting over service
periods that range from zero to ten years.



As of September 30, 2004, the
Company has granted options to purchase 2,708,913 shares of common stock as follows:



|                    |  |                                       |            |                  |                          |   |                |   |                  |  |            |  
|------------------- |  | ------------------------------------- | ---------- | ---------------- | ------------------------ | - | -------------- | - | ---------------- |  | ---------- | -
|                    |  | Three Months Ended September 30, 2004 |            |                  | Year Ended June 30, 2004 |  
|                    |  | Exercise Price                        |            | Number of Shares |                          |   | Exercise Price |   | Number of Shares | 
|Beginning of period |  | $                                     | 0.17-$3.00 |                  | 3,123,070                |   |                | $ | 0.17-$4.63       |  | 4,319,157  |  
|Granted             |  |                                       |           |                  |                         |   |                | $ | 0.22-$0.34       |  | 450,000    |  
|Exercised           |  |                                       |           |                  |                         |   |                | $ | 0.17             |  | (2,000     | )
|Cancelled           |  | $                                     | 0.17-$2.40 |                  | (414,157                 | ) |                | $ | 0.17-$4.63       |  | (1,644,087 | )
|                    |  |                                       |            |                  |                          |   |                |   |                  |  |            |  
|                    |  |                                       |            |                 
|End of period       |  | $                                     | 0.17-$3.00 |                  | 2,708,913                |   |                | $ | 0.17-$3.00       |  | 3,123,070  |  
|Vested              |  |                                       |            |                  | 1,929,619                |   |                |   |                  |  | 2,294,112  |  



The Company accounts for stock-based
compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, under which no compensation cost for stock options issued to employees is recognized for
the stock option awards granted at or above fair market value. Compensation expense is recognized for stock option awards granted below fair market value with credits recorded from previously recognized expense for grants cancelled by termination of
employment. However, during the three months ended September 30, 2004 and 2003 the Company recognized no compensation expense.



Had compensation expense for the Companys 1999 Stock Option Plan been determined based on fair values at the grant dates for awards under the plan in accordance
with SFAS No. 123, Accounting for Stock-Based Compensation, the Companys net income (loss) and income (loss) per share would have been reduced to the following pro forma amounts:



|                                                    |  |                                  |          |   |      |   |          |  
|--------------------------------------------------- |  | -------------------------------- | -------- | - | ---- | - | -------- | -
|                                                    |  | Three Months Ended September 30, |         
|                                                    |  | 2004                             |          |   | 2003 |  
|Net loss per share available to common stockholders |  |                                  |          |   |      |   |          |  
|As reported                                         |  | $                                | (458,218 | ) |      | $ | (408,049 | )
|                                                    |  |                                  |          |   |      |   |          |  
|Pro forma                                           |  |                                  | (476,251 | ) |      |   | (424,477 | )
|                                                    |  |                                  |          |   |      |   |          |  
|Loss per sharebasic                                |  |                                  |          |   |      |   |          |  
|As reported                                         |  | $                                | (0.01    | ) |      | $ | (0.01    | )
|Pro forma                                           |  |                                  | (0.01    | ) |      |   | (0.01    | )
|Loss per sharediluted                              |  |                                  |          |   |      |   |          |  
|As reported                                         |  | $                                | (0.01    | ) |      | $ | (0.01    | )
|Pro forma                                           |  |                                  | (0.01    | ) |      |   | (0.01    | )



8



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Warrants



At September 30, 2004 warrants were outstanding to purchase 7,640,756 shares of common stock at exercise prices between $0.29 to $7.00 per share, and at the average of
the last reported sale price of common stock for the five trading days preceding the issue date. These warrants expire between December 1, 2004 and December 31, 2008.



NOTE 9RELATED PARTY TRANSACTIONS



Due from London Radiosurgical Centre, Ltd



There is a balance due to the Company from London Radiosurgical Centre, Ltd (LRC) in the amount of $52,761 and $103,685, including interest of $10,573 at
September 30, 2004 and June 30, 2004, respectively. Paul Crowe, a former director and officer of the Company and a stockholder of the Company, is an affiliate of LRC.



Loans



On August 23, 2000, the Company received an eight percent (8%) bridge loan from Robert C. Bush, a director and stockholder of the Company, in the amount of $200,000, with
an original due date of October 11, 2000. The loans due date has been extended several times and the Company has agreed to make monthly payments of $10,000 per month beginning on January 8, 2002, until paid in full. The loan is past due. At
September 30, 2004, and June 30, 2004, the loan has a principal balance of $50,000 and $60,000, respectively.



NOTE 10LONG TERM DEBT



Long-term
debt at September 30, 2004 and June 30, 2004 consist of the following:



|                                                                                                                                                                                                            |  |                    |         |   |               |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ------------- | - | ------- | -
|                                                                                                                                                                                                            |  | September 30, 2004 |         |   | June 30, 2004 |  
|Promissory Note unsecured with no interest, due in monthly installments of $500, with first payment beginning on February 1,
2002                                                                           |  | $                  | 3,500   |   |               | $ | 5,000   |  
|Promissory Note unsecured with interest at a rate of 11% per annum, due in monthly installments of $2,343, with the first payment beginning on
January 1, 2002, with a variable 5% to 1% prepayment penalty |  |                    | 36,429  |   |               |   | 36,429  |  
|Promissory Note unsecured with interest at a rate of 13.71% per annum, due in monthly installments of $4,973, with the first payment beginning
on July 1, 2004,                                             |  |                    | 241,358 |   |               |   |        |  
|                                                                                                                                                                                                            |  |                    |         |   |               |   |         |  
|                                                                                                                                                                                                            |  |                    | 281,287 |   |               |   | 41,429  |  
|                                                                                                                                                                                                            |  |                   
|Less current portion                                                                                                                                                                                        |  |                    | (45,551 | ) |               |   | (20,149 | )
|                                                                                                                                                                                                            |  |                    |         |   |               |   |         |  
|                                                                                                                                                                                                            |  |                   
|Long-term debt, net of current portion                                                                                                                                                                      |  | $                  | 235,736 |   |               | $ | 21,280  |  
|                                                                                                                                                                                                            |  |                    |         |   |               |   |         |  



9



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The maturities of long-term debt for each of the three years subsequent to September 30, 2004, are as follows:



|              |  |   |        
|------------- |  | - | -------
|September 30, |  |  
|              | 
|2005          |  | $ | 45,551 
|2006          |  |   | 58,618 
|2007          |  |   | 177,118
|              |  |   |        
|              |  | $ | 281,287
|              |  |   |        



NOTE 11COMMITMENTS



Equipment under capital lease is included in property and equipment as
follows:



|                                  |  |                    |             |   |               |   |             |  
|--------------------------------- |  | ------------------ | ----------- | - | ------------- | - | ----------- | -
|                                  |  | September 30, 2004 |             |   | June 30, 2004 |  
|MI scanners and related equipment |  | $                  | 25,731,041  |   |               | $ | 25,618,324  |  
|Less accumulated amortization     |  |                    | (13,217,195 | ) |               |   | (12,247,488 | )
|                                  |  |                    |             |   |               |   |             |  
|Net capital lease assets          |  | $                  | 12,513,846  |   |               | $ | 13,370,836  |  
|                                  |  |                    |             |   |               |   |             |  



The Company leases office space and
certain MI equipment under non-cancelable operating leases. The office lease expires in August 2008.



The Company leases certain other MI equipment under capital leases. The equipment leases expire through January 2008. The Companys assets secure the capital leases. The leases are subject to certain restrictive
covenants. Rent expense under these operating leases was $449,612 and $434,756, respectively for the three months ended September 30, 2004 and 2003, respectively.



The Company obtained a waiver of its noncompliance with its financial ratio covenant with one of its equipment lessors through December 31,
2004.



The following is a schedule by year of the future minimum lease payments
at September 30, 2004 based on contracted payments. Obligations under capital lease have been classified as short term in the consolidated balance sheets.



|                                                    |  |               |            |   |                  |   |          
|--------------------------------------------------- |  | ------------- | ---------- | - | ---------------- | - | ---------
|Years Ending September 30,                          |  | Capital Lease |            |   | Operating Leases
|2005                                                |  | $             | 7,431,098  |   |                  | $ | 1,875,542
|2006                                                |  |               | 6,993,075  |   |                  |   | 2,178,257
|2007                                                |  |               | 2,726,854  |   |                  |   | 632,364  
|2008                                                |  |               | 2,294,622  |   |                  |   | 268,829  
|2009                                                |  |               | 931,450    |   |                  |   |         
|2010                                                |  |               | 468,531    |   |                  |   |         
|                                                    |  |               |            |   |                  |   |          
|                                                    |  |               | 20,845,630 |   |                  | $ | 4,954,992
|                                                    |  |               |            |   |                  |   |          
|Less amount representing interest at 10.76%         |  |               | (4,120,399 | ) |                  |   |          
|                                                    |  |               |            |   |                  |   |          
|Present value of minimum lease payments, short term |  | $             | 16,725,231 |   |                  |   |          
|                                                    |  |               |            |   |                  |   |          



10



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NOTE 12CONCENTRATIONS OF CREDIT RISK



The Company maintains cash with various major financial institutions in excess of the Federal Deposit Insurance Corporation limits. The
Company continually monitors its position with the financial institutions and management believes the risk of incurring losses related to this credit risk is remote.



NOTE 13EARNINGS (LOSS) PER SHARE



The weighted average shares diluted includes 16,417,910 shares-diluted of common stock which would result from the assumed conversion of the 1,100,000 outstanding
shares of Series C Convertible Preferred Stock based on the conversion price as of September 30, 2004.



The weighted average shares listed below were not included in the computation of diluted loss per share for the three months ended September 30, 2004 because to do so would have been antidilutive.



|                       |  |          
|---------------------- |  | ---------
|Employee Stock Options |  | 2,708,913
|Warrants               |  | 7,640,756



NOTE 14  SEGMENT INFORMATION



The Companys principal business is providing molecular imaging
services to hospitals and other health care providers on a fixed or mobile-shared user basis within the United States.



In August of 2003, a subsidiary of the Company acquired a cyclotron facility located in San Diego, California. A cyclotron is used to produce radiopharmaceuticals such as
Fluorine-18, Nitrogen-13, Oxygen-15 and Flurodeoxyglucose (FDG), which are some of the radiopharmaceuticals used for MI procedures. FDG is the primary radiopharmaceutical that is injected into a patient before a MI procedure. Sales of
radiopharmaceuticals to third parties were $16,800 and $0 during the three months ended September 30, 2004 and 2003, respectively. $84,742 of operating costs were classified as start up costs in the quarter and are included in general and
administrative expenses.



NOTE 15IMPAIRMENT OF LONG-LIVED ASSETS



The wide spread acceptance of the MI/CT combined technology has caused
the demand for non combined MI systems to soften and as a result an evaluation of the recoverability of the carrying amount of long-lived MI system assets, in accordance with SFAS No. 144. An impairment is assessed when the undiscounted expected
future cash flow derived from the asset is less than its carrying amount. Management used judgment based upon the most current facts and circumstances when applying these impairment rules.



On September 30, 2004, the Company entered into a lease restructuring agreement with GE
Financial Services. Under current accounting standards if a restructure of a lease obligation results in a change in the present value of the lease obligation the present balances of the asset and the obligation shall be adjusted by an amount equal
to the difference between the present value of the future minimum lease payments under the revised or new agreement and the present balance of the original obligation. A large portion of these assets were written down to their expected net present
value of future cash flows as the result of an asset impairment analysis performed as of June 30, 2004. As a result of the lease restructure, an additional $177,231 was recorded as an impairment loss in the three months ended September 30, 2004.



NOTE 16GOING CONCERN



The accompanying financial statements have been prepared assuming the Company will continue
as a going concern. However, the Company experienced a net loss for the quarter ended September 30, 2004 of $(458,218), compared to a net loss for September 30, 2003 of $(408,049), and has an accumulated deficit of $(35,026,392) as of September 30,
2004. The Company also became overdue to several of its critical vendors during the fiscal year ended June 30, 2004. The Company was required to restructure its equipment leases with Siemens Financial Services, Inc. (Siemens) and GE
Healthcare Financial Services, Inc. (GE) in order to lower the monthly lease payments until December 31, 2004. However, the Companys monthly lease obligations to Siemens and GE will resume to full payment commencing January 2005.
There is substantial uncertainty with respect to the Companys ability to resume such full payments in January 2005. The Company has therefore classified the entire amount of the Companys outstanding lease obligations to Siemens and GE
under current liabilities on its consolidated balance sheet.



This net loss,
accumulated deficit, and resumption of full payment of its monthly lease obligations to Siemens and GE in January 2005, raise substantial doubt about the Companys ability to continue as a going concern. The Companys continued existence
is dependent upon its ability to resolve its liquidity problems, principally by increasing revenues to cover operating expenses, reducing operating expenses, and obtaining additional equity or debt financing. While pursuing additional equity or debt
financing, the Company must continue to operate on limited cash flows generated internally. In the event the Company cannot raise additional debt



11



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or equity financing, or increase its revenues and/or decrease its operating expenses, by January 2005 in order to resume
full payments to Siemens and GE under the monthly equipment leases, the Company will likely become in default under the lease restructuring agreements with Siemens and GE. In the event of such a default, Siemens and GE would have the right to
terminate the Siemens leases and GE leases, respectively; repossess the molecular imaging equipment operated by the Company under the leases; and demand payment for all costs and expenses related to repossessing and reselling the equipment. A
default under the Siemens leases and GE leases could also result in a default under the three molecular imaging equipment leases assigned to Ascendant PET Partners-I, LLC (PET Partners) in May of 2003. In the event of such a default, PET
Partners would also be entitled to repossess their equipment and demand payment for costs and expenses. The Company generates substantially all of its revenue from the operation of the molecular imaging equipment under these leases. The repossession
of all or a portion of this molecular imaging equipment would result in the Companys inability to generate further revenues.



In addition, the Company will be required to raise additional debt or equity capital to add or acquire additional mobile or stationary molecular imaging sites. However,
there can be no assurance as to whether, when, or upon what terms the Company will be able to consummate any financing to raise any additional debt or equity capital.



NOTE 17SUBSEQUENT EVENTS



On October 12, 2004, the Board of Directors appointed Kenneth Frederick as Chief Executive Officer of the Company and entered into an employment agreement with Mr.
Frederick. At the time of his appointment, Mr. Frederick was a director of the Company, having been nominated by Dragon Nominees Limited (Dragon) pursuant to the terms of the July 2002 Securities Purchase Agreement between the Company and Dragon. In
connection with the employment agreement, the Company has issued Mr. Frederick 250,000 options under the Companys 1999 Stock Option Plan. The options vest monthly over a period of 12 months and have an exercise price of $.08 per share. The
Company also issued Mr. Frederick 900,000 warrants to purchase Company common stock. These warrants also vest monthly over a period of 12 months and have an exercise price of (i) $.08 per share for the purchase of shares 1 to 300,000 vested and
purchased; (ii) $0.16 per share for the purchase of shares 300,001 to 599,999 vested and purchased; and (iii) $0.24 per share for the purchase of shares 600,00 to 900,000 vested and purchased.



In October 2004, Dragon agreed to waive certain rights it has under the July 2002 Securities
Purchase Agreement with the Company with respect to the nomination of a designee to the Companys Board of Directors until the first to occur of (i) the date which is six (6) months after the effective date that Mr. Frederick became Chief
Executive Officer or (ii) the date which Mr. Frederick is no longer a member of the Companys Board of Directors.



In October 2004, Dragon and the Company entered into an amendment to the June 2004 Subscription Agreement to allow the Company to delay the requirement to file a
registration statement with respect to Company securities held by Dragon until February 15, 2005.



In October 2004, Robert Bush, a director of the Company, notified the Company that he did not intend to stand for re-election as a director at the Companys upcoming fiscal year 2004 annual stockholders meeting.



12



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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS



The discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and the related notes. This Quarterly Report on Form 10-QSB contains forward-looking statements
based upon current expectations that involve risks and uncertainties, including those identified below. For this purpose, any statements contained in it that are not statements of historical fact should be regarded as forward-looking statements
within the meaning of the Act and the Exchange Act. For example, the words believes, anticipates, plans, intends, will, may and expects, or any variation of these
words including the negative of these words, are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on any forward-looking statement contained herein, which speak only as of the date hereof. We
undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unexpected events.



Overview



Molecular Imaging Corporation is a leading national provider of molecular imaging (MI) services to the healthcare industry. MI
is a powerful diagnostic imaging procedure used to diagnose, monitor and assess disease severity for many cancers, cardiovascular disease and neurological disorders. MI procedures display metabolic and functional characteristics of disease, which
typically are the first indications of disease. Unlike Computed Tomography (CT) or Magnetic Resonance Imaging (MRI), which provide physicians with changes in anatomy, MI detects the altered metabolism typically before
anatomical changes occur. MI can help physicians effectively detect disease at the very earliest stages. We also provide a newer combined MI/CT system. This combined imaging



13



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system offers physicians un-paralleled diagnostic information, which includes both metabolic, and anatomical information
in one co-registered image. The new combined MI/CT technology improves the time to diagnosis, staging of many cancers, cardiovascular disease and neurological disorders and is also used to observe patient response to treatment.



We provide our services to hospitals, physician groups, diagnostic imaging centers and other
healthcare providers in selected marketplaces in the United States. Our shared service model provides mobile MI units or mobile MI/CT units, which we provide on a daily basis or per procedure basis to our clients. We are also working to develop and
operate long-term permanent facilities with clients interested in full time MI or MI/CT services.



Mobile Services. With our mobile imaging business, we integrate MI or MI/CT systems on mobile coaches and enter into multi-year contracts with our clients to provide mobile services for a specified number of
days per week. We also provide our customers with technical personnel to operate the equipment and implement the MI procedure under the direction of hospital physicians. In some cases, we also train hospital technical personnel to conduct the MI
procedures. Our mobile services allow hospitals, physician groups, imaging center operators and other healthcare providers to access this state-of-the art diagnostic imaging technology conveniently and cost effectively.



Stationary Facilities. We have a stationary MI imaging facility in San Diego,
California that is owned by our subsidiary, Molecular Imaging Sorrento Valley, LLC (Sorrento Valley LLC), and is managed by the Company. The center is operated with the University of California, San Diego (UCSD) as the
University of California, San Diego Center For Molecular Imaging. The UCSD School of Medicine radiology faculty provides all clinical patient support services at the center and the Company manages the business operations of the center.
The facility is intended to serve the UCSD Healthcare patient population and the greater San Diego metropolitan area.



In most situations we operate in conjunction with a hospital facility. We bill our clients for the technical component of the patient procedure and the client bills the
insurer for the balance of patient services rendered. Under this model we invoice the client for our services at a discounted rate and they invoice the insurer directly.



We also operate our stationary facility and three of our mobile MI imaging centers as Independent Diagnostic Testing Facilities
(IDTF). Under the IDTF model, the Company submits patient billings directly to public and private insurance carriers. We invoice our MI services that are inclusive of all patient services, at retail rates, rather than wholesale rates. In
addition, insurance reimbursement rates are currently higher for MI services performed at an IDTF facility than for the same services performed at a hospital.



In November 2004, the Center for Medicare and Medicaid Studies announced a 21% reduction in MI hospital reimbursement rates effective January 1, 2005. Although the
effect of this rate reduction is unclear, this could have a negative impact on our revenues derived from our mobile services business model. Our healthcare provider clients on whom we depend for the majority of our revenues under our mobile services
business model generally rely on reimbursement from third-party payors. Because unfavorable reimbursement policies may constrict the profit margins of the hospitals and clinics we bill directly under our mobile services business model, we may need
to lower our fees to retain existing MI clients and attract new ones. This reduction in MI reimbursement is not applicable to MI services provided in an IDTF and therefore should not adversely impact the revenues we derive under our IDTF business
model.



Radiopharmaceuticals.We also operate a cyclotron facility
located in San Diego, California. A cyclotron is used to produce radiopharmaceuticals such as Fluorine-18, Nitrogen-13, Oxygen-15 and Flurodeoxyglucose (FDG), which are some of the radiopharmaceuticals used for MI procedures. FDG is the
primary radiopharmaceutical that is injected into a patient before a MI procedure. Abnormal concentrations of FDG can indicate areas of malignancies. In conjunction with UCSD, the Company plans to use the cyclotron in future research programs for
the development of other radioisotopes that may be useful in the fields of neuroscience and cardiology. In August 2004 we entered into a Radiopharmaceutical Distribution Agreement with Anazao Health Corporation, dba Custom Care Pharmacy
(Custom Care), pursuant to which we have appointed Custom Care to distribute radiopharmaceuticals to customers in the Southern California marketplace. Under the terms of this distribution agreement, we are also permitted to distribute
Custom Cares other cardiac products to new and existing customers for which we will be paid a commission by Custom Care.



The November 2004 Center for Medicare and Medicaid Studies announcement also included a 32% reduction in hospital reimbursement rates for FDG effective January 1, 2005.
Although the effect of this rate reduction is unclear, this could have a negative impact on our revenues derived from sale of FDG to third parties.



On September 30, 2004, the Company entered into a Restructuring Agreement (the GE Restructuring Agreement) with GE Medical Systems to restructure certain of
the Companys lease obligations for certain molecular imaging equipment. The specific terms of the GE Restructuring Agreement are contained in the Companys Annual Report for the fiscal year ended June 30, 2004. As discussed below, during
the three months ended September 30, 2004, the Company recorded an impairment charge of $177,231 related to the write down of the leased equipment subject to the GE leases.



14



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Critical Accounting Policies



Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States of America. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and
related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Estimated amounts may differ under different
assumptions or conditions, and actual results could differ from the estimates. There are many critical accounting policies discussed in the notes to our financial statements including the following critical accounting policy that affects the
judgments and estimates used in the preparation of our financial statements.



Revenue Recognition



Service revenues are recognized
when services are rendered. Service revenues from third party payors are reported at net realizable amounts. Revenue under third party payor agreements is subject to adjustment. Provisions for estimated third party payor settlements are provided in
the period the related services are rendered and are based on final settlement history. Differences between estimated amounts and accrued and interim and final settlements are reported in operations in the period of settlement.



Recent Accounting Pronouncements



There are no recent accounting pronouncements that affect the Company in the recent quarter.



Results of Operations



Three Months Ended September 30, 2004



Service revenues for the three months ended September 30, 2004 were $5,018,076, compared to
service revenues for the three months ended September 30, 2003 of $5,624,237. Approximately $400,000 of this $606,161 decline in service revenues is attributable to the election by many of our customers over the course of 2004 to buy FDG direct from
third party suppliers instead of including the FDG in the price of the service as they did during the quarter ending September 30, 2003. Because our sale of FDG to customers during the quarter ending September 30, 2003 was largely a pass through of
costs, our gross profit percentage for the quarter ending September 30, 2004 also increased, as discussed below. The remaining decline in service revenues was attributable to our discontinuation of service in two locations due to the nonpayment of
monies owed to the Company for services performed at those locations. We were not able to secure contracts to fully replace the revenue lost from those two locations.



Our cost of service revenues for the three months ended September 30, 2004 were $2,806,156, compared to $3,472,017 for the three months
ended September 30, 2003. The cost of service revenues represents salaries paid to technologists and drivers, system maintenance, transportation, FDG, depreciation and insurance on our mobile MI systems.



Depreciation expense decreased in the three months ended September 30, 2004, mainly due to
the impairment charge we took last year, which reduced the asset value and the corresponding depreciation, however, this was offset by a change in the estimated lives of some of the leased scanners during the year ended June 30, 2004. Our cost of
capital equipment service contracts and repairs decreased during the three months ended September 30, 2004 over the three months ended September 30, 2003 due to the termination of certain maintenance contracts that were replaced with time and
materials service. Our FGD (glucose injections) costs decreased in the quarter as more of our customers now buy directly from the suppliers.



The resulting services gross profit percentage increased from 38.3% for the three months ended September 30, 2003, to 44.1% for the three months ended September 30, 2004,
primarily for the following reasons:



|                                                                      |  |      |  
|--------------------------------------------------------------------- |  | ---- | -
|Gross profit percentage for the three months ended September 30, 2003 |  | 38.3 | %
|Personnel costs                                                       |  | (0.5 | )
|Depreciation expense                                                  |  | 1.0  |  
|Capital equipment rental                                              |  | 0.1  |  
|Capital equipment service contracts and repairs                       |  | 0.4  |  
|FDG (glucose injection)                                               |  | 4.9  |  
|Other                                                                 |  | (0.1 | )
|Gross profit percentage for the three months ended September 30, 2004 |  | 44.1 | %



Selling and marketing expenses
increased by 22% from $284,459 for the three months ended September 30, 2003, to $346,691 for the three months ended September 30, 2004. Actual expenditures for selling and marketing expenses for the period ended September 30, 2003 were $384,459,
offset by a $100,000 manufacturers co-op promotion credit as a result of the PET/CT system purchase. Setting



15



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aside the impact of the co-promotion credit, selling and marketing expenditures decreased $37,768 for the three month
ended September 30, 2004 versus the three months ended September 30, 2003. The decrease was the result of a reduction in personnel cost and travel cost, offset by a slight increase in spending in trade shows and marketing communications.



General and administrative expenses decreased by 6% from $1,598,534 for the three months
ended September 30, 2003, to $1,503,422 for the three months ended September 30, 2004. This decrease was due mainly to costs associated with savings in personnel cost, travel and professional fees.



We recorded an asset impairment loss of $(177,231) for the three months ended September 30,
2004 as a result of the restructure lease arrangement with GE. Under current accounting standards if a restructure of a lease obligation results in a change in the present value of the lease obligation the balances of the asset and the obligation
are adjusted by an amount equal to the difference between the present value of the future minimum lease payments under the revised or new agreement and the balance of the obligation at the date of the change in terms. A large portion of these assets
were written down to the net present value of cash flows as the result of an asset impairment analysis performed as of June 30, 2004. An additional impairment charge of, $(177,231) of the adjusted asset value was written off as a result of the
restructuring of the lease arrangement during the three months ended September 30, 2004.



Our income from operations decreased by $115,549 from $269,227 for the three months ended September 30,2003, to $153,678 for the three months ended September 30, 2004 as a result of the $(177,231) impairment charge
and the changes described above.



Interest expense was $681,382 for the three
months ended September 30, 2003, and $688,075 for the three months ended September 30, 2004.



Net loss for the three months ended September 30, 2004 was $(458,218), compared to a net loss of $(408,409) for the three months ended September 30, 2003.



Focusing On Our Core Business



We intend to focus our efforts to increase utilization of our existing units to achieve operational profitability. As discussed above, we are also working with existing
customers to convert them to Independent Diagnostic Testing Facilities (IDTF), which are currently eligible for higher reimbursement rates from third party payors.



One measure that management uses to evaluate our progress is average revenues per weekday for all operating units. We calculate average
revenues per weekday for all units by dividing total weekday revenues by the number of weekdays in the relevant period, excluding holidays. We exclude Saturdays from this calculation since not all of our units are scheduled for Saturday service. For
reasons described above, for the three months ended September 30, 2004, our average revenues per weekday for all units decreased to approximately $78,522, from average revenues per weekday for all units of approximately $89,271 for the three months
ended September 30, 2003. Our future revenues will principally be a function of the number of operating units in service, the volume of patient procedures and the fees earned per procedure.



We generate substantially all our revenues from our service agreements with hospitals and
other health care providers. We have a satisfactory record of account collections, however there can be no assurance that this trend will continue and, accordingly, we have established an allowance for un-collectable accounts receivable. Lower
reimbursement by public and private insurers may also impact the revenues we can generate from our operations. There can be no assurance that we will be able to maintain or increase the number of patient procedures or that our allowances for
doubtful accounts receivable will be sufficient.



We will finance and deploy
additional mobile or stationary MI/CT systems only for projects that are financially viable. The deployment of additional mobile units or stationary sites should reduce our per unit operating costs. However, we can give no assurances that we will be
able to deploy such additional units or sites, or that the deployment of such additional units or sites would reduce our per unit operating costs. As a result, in order to obtain profitability, we will need to continue to increase revenues and
effectively manage our operating overhead.



Liquidity and Capital Resources



Our primary source of liquidity is cash from ongoing operations. However,
since our inception we have incurred significant losses which we have financed primarily through the sale of equity securities. Through September 30, 2004, we have an accumulated deficit of $(35,026,392).



At September 30, 2004, our total assets were $17,998,778, compared to $19,022,152 at June 30,
2004. The decrease was primarily the



16



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result of a decrease in net property and equipment as a result of depreciation expense for the period. Our current assets
at September 30, 2004 totaled $3,587,128 and our current liabilities were $21,737,822, compared to current assets of $3,645,397 and current liabilities of $22,440,049 at June 30, 2004. Our current liabilities exceed current assets because, under
Generally Accepted Accounting Principles, we are required to record as a current liability our capital lease obligations due within the next twelve months. As discussed in Note 11Commitments, several of our units are also financed under
non-cancelable operating leases that are not recorded as liabilities until the monthly payment is due. Our current assets, on the other hand, include only those accounts receivable that are outstanding from service revenues recognized and typically
represent 30 to 60 days of service revenues. Stockholders deficit increased to $(3,986,458) at September 30, 2004, from $(3,528,240) at June 30, 2004, due primarily to the net loss of $(458,218).



We operate in a capital intensive industry. In order to provide services we are required to
obtain and maintain expensive equipment. We have secured that equipment from two primary vendors, Siemens Medical Systems and GE Medical Systems, and financed its purchase through lease arrangements with affiliate entities. During the fiscal year
ended June 30, 2004, we defaulted on our lease obligations to Siemens and to GE. We entered into a restructuring agreement with Siemens in June 2004. We subsequently entered into a restructuring agreement with GE in September 2004. Copies of the
restructuring agreements and a description of their terms is included in our Annual Report on Form 10-KSB for the fiscal year ended June 30, 2004. The restructuring agreements each reduced the aggregate lease payments by 30 to 50% from the period
extending from November 2003 to December 2004. We are required under the terms of the current restructuring agreements to commence full lease payments commencing in January 2005. We will need to increase cash flow from operations in order to meet
those higher lease payments, or attempt to further restructure the lease payments. Although we have begun discussions with Siemens and GE to further restructure the lease obligations, there is no present agreement in place with either Siemens or GE
to further restructure these obligations, and there can be no assurances that Siemens and GE will agree to any such restructuring.



We need to raise additional capital in order to meet our ongoing cost of operations. In addition, we will be required to raise additional capital in the future if we are
to add or acquire additional mobile units or stationary sites. We do not have any debt or credit facility available in place at this time. We are actively exploring various financing alternatives. However, there can be no assurance as to whether,
when, or upon what terms the Company will be able to consummate any financing.



Risks Related to Our Business



You should carefully
consider the risks described below before investing in our publicly-traded securities. The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as competition,
technological obsolescence, labor relations, general economic conditions and geopolitical changes. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business operations and our liquidity.



Risks Related to Our Financial Condition



We have lost money in the past and may lose money in the future.



We have incurred significant losses since our formation. We may not be able to generate
sufficient revenues to fund continuing operations or achieve sustained profitability.



We May Not Be Able to Continue as a Going Concern as Our Funds Are Insufficient to Fund Our Current Operations



Peterson & Co., LLP our independent auditors, have included a going concern modification in their audit opinion on our consolidated financial statements for the
fiscal year ended June 30, 2004 in our Form 10KSB filed with the Securities and Exchange Commission, which states that:



The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 18 to the
financial statements [See Item 7 of Form 10KSB], the Company has suffered recurring losses from operations and a net capital deficiency that raise substantial doubt about is ability to continue as a going concern. Managements plans in regard
to these matters are also described in Note 18 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty



We do not expect our cash position as of the date of this report to fund our operations under
our current operating plan. We are assessing our ability to raise additional capital through equity offerings, debt financing and other financing vehicles, but we cannot assure you that sufficient funds will be available to us on terms that we deem
acceptable, if they are available at all. The inclusion of a going concern modification in Peterson & Co., LLPs audit opinion may materially and adversely affect our stock price and our ability to raise new equity or debt capital.



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Our financial statements for fiscal year 2004 have been prepared on the basis of a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course of business. We have not made any adjustments to our financial statements as a result of the going concern issue. If we cannot continue as a going concern, we may have to
liquidate our assets and we may receive significantly less than the values at which they are carried on our financial statements. Any shortfall in the proceeds from the liquidation of our assets would directly reduce the amounts that holders of our
common stock could receive in liquidation.



Our substantial indebtedness has
restricted our operations and made us more vulnerable to adverse economic conditions.



We are a highly leveraged company and our substantial indebtedness has had important consequences. For example, our indebtedness:



| |  | makes it more difficult for us to satisfy our obligations to our creditors;
| | - | ---------------------------------------------------------------------------



| |  | requires us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working
capital, capital expenditures and acquisitions and for other general corporate purposes;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | increases our vulnerability to economic downturns and competitive pressures in our industry;
| | - | --------------------------------------------------------------------------------------------



| |  | places us at a competitive disadvantage compared to our competitors that have less debt in relation to cash flow; and
| | - | ---------------------------------------------------------------------------------------------------------------------



| |  | limits our flexibility in planning for, or reacting to, changes in our business and our industry.
| | - | -------------------------------------------------------------------------------------------------



Equipment and other assets of the Company secure certain of our indebtedness. If the Companys creditors foreclose as a result of the
Companys default under its debt obligations, the Company and its operations would be materially and adversely affected.



If we are unable to generate or borrow sufficient cash to make payments on our indebtedness or to refinance our indebtedness on acceptable terms, our financial
condition would be materially harmed, our business may fail and you may lose all of your investment.



Our ability to make payments on our indebtedness will depend on our ability to generate cash flow in the future which, to a certain extent, is subject to general economic, financial, competitive, legislative,
regulatory and other factors that are beyond our control. In addition, future borrowings may not be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other cash needs. We may not be able to timely service
all of our indebtedness.



Additionally, as discussed above, the Company has
entered into the Siemens Restructuring Agreement and the GE Restructuring Agreement. Should the Company default under the Siemens Restructuring Agreement or the GE Restructuring Agreement, Siemens and GE would have the right to terminate the Siemens
Leases and GE Leases, respectively; repossess the molecular imaging equipment operated by the Company under the leases; and demand payment for all costs and expenses related to repossessing and reselling the equipment. A default under the Siemens
Restructuring Agreement or GE Restructuring Agreement could also result in a default under the three molecular imaging equipment leases assigned to Ascendant PET Partners-I, LLC (PET Partners) in May of 2003. In the event of such a
default, PET Partners would also be entitled to repossess the equipment and demand payment for costs and expenses. The Company generates substantially all of its revenue from the operation of the molecular imaging equipment under the Siemens Leases,
GE Leases and PET Partners leases. The repossession of all or a portion of the molecular imaging equipment under these leases would result in the Companys inability to generate further revenues and, therefore, would have a material adverse
affect on the Companys operations and its ability to continue as a going concern.



We will need to obtain additional financing and if we are unable to obtain it our business may fail.



Our capital requirements associated with our operations have been and will continue to be substantial. Our available short-term assets and investment income are
insufficient to meet our operating expenses and capital expenditures through the current fiscal year. Even if additional investment is obtained, insufficient funds may prevent us from implementing our business strategy or may require us to delay,
scale back or eliminate certain contracts for the provision of MI services. We cannot assure you that we will be able to obtain additional financing when needed, or that, if available, such financing will be on terms acceptable to us. In any such
financing, the interests of our existing security holders could be substantially diluted. If adequate funds are either not available or not available on acceptable terms, our business, revenues, financial condition and results of operations will
suffer. If we raise additional funds through the issuance of equity or convertible securities, the percentage ownership of our stockholders will be reduced. Moreover, any newly issued securities may have powers, preferences and rights that are
senior to those of the rights of our common stock. Also, our ability to raise additional funds through the issuance of equity or convertible securities is restricted by our number of authorized shares and may be restricted by certain covenants,
including, without limitation, a right of first refusal to purchase any new securities issued by the Company, contained in the July 2002 private placement agreements.



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We have a single stockholder with a large concentration of shares that will be able to exert significant influence
over matters requiring stockholder approval, including change of control transactions.



Ivan Bradbury beneficially owns a significant amount of our Common Stock, as well as warrants to purchase our Common Stock, and all of our outstanding Series C Convertible Preferred Stock. Based upon a review of
filings made by Mr. Bradbury with the SEC, on a fully diluted basis, Mr. Bradbury beneficially owns approximately 38% of our common equity. This concentration of shares allows Mr. Bradbury, and his nominee Dragon Nominees Limited, to exert influence
over matters requiring stockholder approval. This concentration of ownership may also delay or prevent a change of control of our company or reduce the price investors might be willing to pay for our common stock. Additionally, Dragon has certain
rights under the July 2002 Securities Purchase Agreement, including the right to appoint a nominee to the Companys Board of Directors, and a right of first refusal to purchase additional securities offered by the Company. The interests of Mr.
Bradbury may conflict with the interests of other holders of our common stock.



We have a significant number of shares that are eligible for future sale.



Virtually all of the Companys outstanding stock was issued and sold pursuant to exemptions from registration with the Securities and Exchange Commission and state securities agencies. These shares and shares
held by our affiliates are considered restricted securities and may be resold pursuant to an effective registration statement or in compliance with SEC Rule 144. Rule 144 generally provides that a person holding restricted securities for
one year from the date the securities were purchased from the issuer, or from an affiliate of the issuer, and fully paid, may sell limited quantities of the securities to the public without registration, provided certain public information with
respect to the issuer is available. Pursuant to Rule 144, securities held by non-affiliates for more than two years may generally be sold without reference to the current public information or broker transaction requirements, or the volume
limitations. A significant number of shares are currently available for resale pursuant to Rule 144 and more shares will become so in the future.



In addition, the Company has granted registration rights in connection with the sale of a significant number of its shares. The exercise of such rights would require the
Company to prepare and file one or more registration statements for the resale of the Companys shares. The resale of formerly restricted shares, whether pursuant to Rule 144 or a registration statement, could have a material negative impact
upon the market price for the common shares.



We may maintain cash in excess
of federally insured limits with various banks.



The Federal Deposit
Insurance Corporation (FDIC) insures deposits up to $100,000 in virtually all United States banks and savings associations. In the event an FDIC-insured bank fails and depositors lose their money, the FDIC pays depositors up to $100,000
of the money lost. Although our funds are deposited in accounts with FDIC-insured banks, the amounts of cash in these accounts may exceed federally insured limits. In the event of a failure of one of our banks where our funds were lost, we could
only recover from the FDIC up to $100,000 of the funds lost. The loss of the excess funds could have a material adverse effect on our business.



Risks Related to Our Business



Acceptance of our services by the medical community or by patients may not grow, which may impair our future sales and profitability.



Our future revenues and profitability depend in part on our ability to demonstrate to
hospitals and other potential new clients the cost and performance advantages of the MI and MI/CT system over traditional diagnostic imaging systems. Our ability to achieve sustained profitability in the future will depend in part on our ability to
successfully market and sell MI services on a wide scale. High cost, concerns by patients and physicians relating to safety and efficacy, and the substantial acceptance of other diagnostic tools such as MRI or CT scans may interfere with the growing
acceptance of MI technology. We believe MI technology is now accepted as a valid diagnostic and staging tool for certain conditions, but we cannot promise this acceptance will continue to expand to other conditions. If we are unable to secure this
acceptance, we will be unable to achieve sustained profitability from operations.



We may not be able to renew or maintain our client contracts that would result in a loss of revenue.



Upon expiration of our clients contracts, we are subject to the risk that clients will cease using our MI systems and purchase or lease their own MI systems or
MI/CT systems, use our competitors MI systems or MI/CT systems, or rely on alternate imaging technologies. Approximately thirty-one percent of our multi-year client contracts expire in 2004; approximately forty-six percent expire in 2005; and
approximately twenty-three percent in 2006/2007. Moreover, approximately one-third of our client contracts permit the client, upon typically 180 days notice, to terminate the contract without cause, and approximately two-thirds of our
client contracts permit the client, upon typically 180 days notice, to terminate the contract if the client obtains a fixed site for a MI system. In addition, many of our contracts do not have minimum usage requirements. If we lose a client, we may
not be able to immediately secure a replacement client, or secure a client with the same number of patient scans.



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Because we have high fixed costs, lower scan volumes per system could significantly impact our profitability.



Our expenses are comprised primarily of compensation paid to
technologists, equipment rental and purchase expenses, transportation expenses and equipment maintenance costs. Because a majority of these expenses are fixed, a relatively small change in our revenue could have a disproportionate effect on our
operating and financial results. Thus decreased revenue from lower scan volumes per system could significantly impact our profitability and adversely affect our business.



We will continue to face substantial competition, and if we fail to compete successfully, our revenues and operating results will be
adversely affected.



Many of our competitors have substantially greater
financial and marketing resources and experience than us. We believe some of our competitors are offering MI services to our existing and potential customers at lower rates than we are charging or proposing to charge such customers. These lower
rates could cause us to lose our existing customers or fail to gain new customers that could have a material adverse impact on our business and results of operations. Furthermore, we expect that other companies will enter the mobile and stationary
MI and MI/CT market, particularly as MI and MI/CT systems gain increasing market acceptance. Our competitors may be able to develop technologies, procedures or products that are more effective or economical than ours, or that would render the MI
system obsolete or noncompetitive. Some of our customers may be capable of providing the same services to their patients directly by purchasing or leasing their own imaging systems. In addition, the hospital industry has been experiencing a trend
towards consolidation, which trend will reduce our potential customer base and increase competition for available customers.



The MI system may become technologically obsolete and our business could be harmed.



The markets in which our MI services compete are subject to rapid technological change as well as the potential development of alternative
diagnostic imaging techniques or products, or the combination of modalities such as MI/CT. While MI currently provides advantages over alternative imaging solutions, the industry is subject to rapid technical changes, and new technologies may be
developed which provide superior diagnostic or economic advantages. The development of combination MI/CT systems has resulted in the reduction in the value of, and reduced need for, our MI systems. These changes could also render the MI system
technologically or economically obsolete. There can be no assurance that we will be able to acquire the new or improved systems MI/CT systems that may be demanded by new and existing customers.



We have experienced turnover in our executive management, and the replacement of that
management may impact the direction and operations of the Company.



In
September 2004, Paul Crowe, founder of the Company, resigned his position as Chairman of the Board, Chief Executive Officer, and as a Director. In October 2004, the Company appointed Kenneth Frederick as its new Chief Executive Officer. The
appointment of a new Chief Executive Officer could be expected to have a significant impact upon the operations, earnings and prospects of the Company.



We depend on a small number of suppliers, the loss of which would adversely affect our business.



We obtain our MI and MI/CT systems from a limited group of qualified suppliers: CTI Molecular Imaging; Siemens Medical Systems, Inc.; and GE
Medical Systems. To date, we have leased substantially all of our systems from Siemens and GE. From time to time, we have been in default under those leases and we have recently negotiated reduced terms with Siemens and GE. There is no assurance
that Siemens or GE will continue to lease to us on the future on favorable terms, or on any terms at all. While there are alternative suppliers for the MI and MI/CT systems, there can be no assurance that any supplier could be replaced in a timely
manner, or that the alternative systems and service contracts would be sufficient to allow us to effectively and economically service our clients. Any interruption in the supply and/or delivery of the MI or MI/CT systems could materially harm our
ability to expand our revenues and thereby adversely affect our financial condition and results from operations. In addition, the small number of potential suppliers may adversely impact the Companys ability to negotiate the most favorable
terms.



The most commonly used radiotracer is fluorodeoxy glucose (FDG). We
obtain FDG from multiple sources including our own cyclotron facility; however, FDG is highly perishable and we may not have multiple sources for each of our operating sites or routes. Any interruption in the supply and/or delivery of FDG could
materially harm our ability to expand out revenues and thereby adversely affect our financial condition and results of operations.



We may be unable to provide adequate support to our customers, and this may adversely affect our relationship with them.



We have limited experience with widespread deployment of our products and services to a
diverse customer base, and there can be no assurance that we will have adequate personnel to provide the level of support that our customers may require during initial product deployment or on an ongoing basis. An inability to provide sufficient
support to our customers could have an adverse affect on our reputation and relationship with our customers; prevent us from gaining new customers; and adversely affect our business, financial condition or results of operations.



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The success of the IDTF business model depends on our ability to accurately predict patient demand for our services;
the maintenance of higher reimbursement rates for IDTF procedures; and our selection of quality business partners.



As of the date of this report, we have five IDTFs, one of which is stationary and four of which are mobile. We are actively working with third parties to develop
additional stationary and mobile imaging centers that we will operate as IDTFs. These imaging centers are identified and selected based on input from hospital administrators, imaging center operators or physician groups who want to offer MI on their
campus. We analyze the marketplace demographics, local competition, tumor board statistics, referring physician demographics and the availability of an on-site MI champion to increase the vitality of the MI service. As permitted under state and
federal laws, we may also partner with third parties in the development and operation of these stationary imaging centers, as we have done with The Regents of the University of California for our stationary imaging center in San Diego, California.
We anticipate that these partnerships would be in the form of a limited liability company or similar legal entity in which we would have a majority ownership, control and management rights.



While we will use our experience and knowledge of the MI marketplace to select IDTF imaging
centers that we believe will be successful, there can be no assurances that our selection process will result in an IDTF that is profitable. Also, the factors upon which we select the IDTF imaging center may change after commencement of operations
of the site that could result in reduced patient use and revenues and have an adverse impact on our business. There are no assurances that the current reimbursement rates for IDTF imaging centers will remain higher than those for hospital based
services. A reduction in such reimbursement rates could have an adverse impact on the operation of the IDTF model. The IDTF model may also result in a longer period of time between when we perform the MI procedure and receive payment then under our
typical mobile services model. This could have an adverse impact on our cash flow.



The success of our IDTF model will also depend on our ability to select quality partners who can assist in the development and operation of those imaging centers and our ability to execute and implement agreements with such third parties
that will protect our rights with respect to the management and operation of these imaging centers. While we will use our experience to select quality business partners, there can be no assurance that such partners will act in our best interest, or
that our agreements with such partners will adequately protect our rights in the event of a dispute with such partners. The federal and state laws and regulations described below also impact our ability to partner with third parties for the
development and operation of IDTF imaging centers, and any changes in such laws, or changes in the interpretations of such laws, could restrict our ability to enter into such partnerships. Also, the failure by such partners to comply with the
applicable state and federal laws and regulations described above could result in penalties, damages, fines or a curtailment in our operations which could adversely affect our ability to operate our business.



Our revenues may fluctuate or be unpredictable and this may harm our financial results.



The amount and timing of revenues that we may derive from our business
will fluctuate based on, among other variables:



| |  | variations in the rate at which clients terminate or fail to renew their contracts; and
| | - | ---------------------------------------------------------------------------------------



| |  | changes in the number of days of service we can offer with respect to a given system due to equipment malfunctions or the seasonal factors discussed below.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------



We may experience seasonality in the sale of our services. For example, first quarter
client and patient vacation schedules may affect revenues. Second quarter revenues may be affected by client and patient holiday and vacation schedules and inclement weather, the results of which may be fewer patient scans during the period. Third
quarter revenues may be affected by fewer calendar days and inclement weather, the results of which may be fewer patient scans during the period. We may not be able to reduce our expenses, including our debt service obligations, quickly enough to
respond to these factors, which would make our business difficult to operate and would harm our financial results. In addition, we may be unable to adjust our expenditures if revenues in a particular period fail to meet our expectations, which would
harm our operating results for that period.



The loss of any of our key
personnel could adversely affect our business, including our ability to develop and market our services and products.



We depend to a considerable degree on a limited number of key personnel. The loss of the services of key personnel could harm our business. Our success will also depend,
among other factors, on the successful recruitment and retention of qualified business development, education, marketing, and technological personnel. It is impossible to predict the availability of qualified sales persons and technologists or the
compensation levels that will be required to hire them. In particular, there is a very high demand for qualified MI technologists who are necessary to operate our systems. We may not be able to hire or retain a sufficient number of MI technologists,
and we may be required to pay higher salaries to our MI technologists, which would increase our expenses. The loss of the services of any member of our senior management or our inability to hire or retain qualified sales persons and skilled
technologists at economically reasonable compensation levels could adverse affect our ability to operate and grow our business.



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We have a very limited operating history with respect to the cyclotron.



We completed the purchase of the cyclotron in August of 2003 and have a very limited
operating history with respect to the cyclotron. To date, we have produced only a limited amount of FDG for sale to third parties, and have produced only a limited amount of FDG for our own use. Although our officers and employees have substantial
business experience in the MI industry and the healthcare industry generally, and we have retained skilled and qualified employees, consultants and a third party pharmaceutical distribution company to assist us with the day-to-day operation of the
cyclotron and delivery of FDG, there can be no assurances that our cyclotron operations will be successful. The operation of the cyclotron and delivery of FDG is also subject to local, state and federal licensing and permitting requirements.
Although we have retained a consultant to assist us with this licensing and permitting, and have contracted with a third party for the distribution of the FDG, any failure to maintain these licenses and permits, or retain the third party
pharmaceutical distribution company under the terms of the agreement, could have a material adverse impact on our operations.



A successful liability claim asserted against us due to a defect in the MI system, MI/CT system, or FDG, in excess of our insurance coverage, would harm our business.



Providing mobile MI and MI/CT shared services, and producing, selling and
distributing FDG, involves the inherent risk of professional and product liability claims against us. We currently maintain insurance coverage in the types and amounts which we deem adequate for our operations, but this insurance is expensive,
subject to various coverage exclusions and may not be obtainable in the future on terms acceptable to us. We do not know whether claims against us arising from our use of the MI and MI/CT systems, or the production, delivery and sale of FDG, will be
successfully defended or that our insurance will be sufficient to cover liabilities arising from these claims. A successful claim against us in excess of our insurance coverage could materially harm our business.



We may be unable to effectively maintain our systems or generate revenue when our systems
are not working.



Timely, effective service is essential to maintaining
our reputation and high utilization rates on our systems. Repairs to one of our systems can take up to two weeks and result in a loss of revenue. Our warranties and maintenance contracts do not compensate us for loss of revenue when our systems are
not working. The majority of our operating costs are fixed, so a reduction in the number of scans performed due to out-of-service equipment will result in lower revenues and margins. The equipment manufacturers perform repairs of our equipment for
us. We cannot guarantee that these manufacturers will be able to perform repairs or supply needed parts in a timely manner. Thus, if we experience greater than anticipated system malfunctions, or if we are unable to promptly obtain the service
necessary to keep our systems functioning effectively, our revenues could decline and our ability to provide services would be harmed.



Risks relating to Government Regulation of Our Business



Our MI service and production of FDG requires the use of radioactive materials, which subjects us to regulation, related costs and delays and could subject us to
potential liabilities for injuries or violations of environmental, health and safety laws.



Our MI service involves the controlled storage, use and disposal of material containing radioactive isotopes. Our cyclotron business involves the production and delivery of radioactive isotopes. While this material
has a short half-life, meaning it quickly breaks down into inert, or non-radioactive substances, using these materials presents the risk of accidental environmental contamination and physical injury.



We are subject to federal, state and local regulations governing the production, delivery,
use, storage, handling and disposal of materials and waste products. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, we cannot
completely eliminate the risk of accidental contamination or injury from those hazardous materials. In the event of an accident or a defect in the FDG, we could be held liable for any damages that result, and any liability could exceed the limits or
fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could incur significant costs and the diversion of our managements attention in order to comply with current or future
environmental, health and safety laws and regulations.



Managed care and
healthcare reform legislation may impact third party reimbursement, which is critical to market acceptance of our services.



Our MI services are generally purchased by hospitals, which then seek reimbursement from various third-party payers, such as government programs, and private insurance
plans, for the procedures conducted using the MI system. Third party payers carefully review, and are increasingly challenging, the prices charged for medical products and services, and scrutinizing whether to cover new products and evaluating the
level of reimbursement for covered products. While we believe that the hospitals using the MI system have generally been reimbursed, payers may deny coverage and reimbursement for the MI system if they determine that the device was not reasonable
and necessary for the purpose for which it was used, was investigational or not cost-effective. As a result, we cannot assure that reimbursement from third-party payers for use of the MI system will be available or, if available, that reimbursement
will not be limited. If third-party reimbursement of these procedures is not available, it will be more difficult for us to offer our services on a profitable basis.



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Moreover initiatives are periodically proposed which, if implemented, would have the effect of substantially decreasing
reimbursement rates for diagnostic imaging services. We cannot guarantee that these or similar initiatives will not be adopted in the future. Any change in the rates of or conditions for reimbursement could substantially reduce the number of
procedures for which these healthcare providers can obtain reimbursement or the amounts reimbursed to our clients for services provided by us. Any change in the rates of or conditions for reimbursement could also substantially reduce the number of
procedures that we perform under our IDTF model. Because unfavorable reimbursement policies have constricted, and may continue to constrict, the profit margins of the hospitals and clinics we bill directly, we have lowered, and may continue to need
to lower, our fees to retain existing clients and attract new ones. These reductions could have a significant adverse effect on our revenues and financial results by decreasing demand for our services or creating downward pricing pressure.



Complying with federal and state regulations is an expensive and
time-consuming process, and any failure to comply could result in substantial penalties.



We are, directly or indirectly through our clients, subject to extensive regulation by both the federal government and the states in which we conduct our business. The laws that directly or indirectly affect our
ability to operate our business include the following:



| |  | the federal Medicare and Medicaid Anti-Kickback Law, which prohibits persons from soliciting, receiving or providing remuneration, directly or indirectly, to induce either the
referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the federal False Claims Act, which imposes civil and criminal liability on individuals and entities who submit false or fraudulent claims for payment to the government;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the federal Health Insurance Portability and Accountability Act of 1996, which prohibits executing a scheme to defraud any healthcare benefit program, including private payers;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the federal False Statements Statute, which prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false statement in
connection with the delivery of or payment for healthcare benefits, items or services;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the federal physician self-referral prohibition commonly known as the Stark Law which, in the absence of a statutory or regulatory exception, prohibits the referral of Medicare
patients by a physician to an entity for the provision of certain designated health services, including MRI and other imaging services, if the physician or a member of the physicians immediate family has an ownership interest in, or a
compensation arrangement with, the entity;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | state law equivalents of the foregoing;
| | - | ---------------------------------------



| |  | state laws that prohibit the practice of medicine by non-physicians and fee-splitting arrangements between physicians and non-physicians;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------



| |  | federal and state laws governing the diagnostic imaging equipment we use in our business concerning patient safety, equipment operating specifications and radiation exposure levels;
and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the federal Health Insurance Portability and Accountability Act (HIPAA) of 1996, which requires covered entities to comply with national standards for security and privacy of
protected health information and with standards for transactions and code sets.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



If our operations are found to be in violation of any of the laws described in this risk factor or the other governmental regulations to which our clients or we are subject, we may be subject to the applicable penalty
associated with the violation, including civil and criminal penalties, damages, fines and the curtailment of our operations. Any penalties, damages, fines or curtailment of our operations would adversely affect our ability to operate our business
and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts and their provisions are open to a variety of
interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our managements attention from the operation of our business.



The impact of federal regulations could have a negative impact on the
attractiveness of our services to some of our clients.



Federal
regulations affect the ability of a Medicare provider such as a hospital to include a service or facility as provider-based for purposes of Medicare reimbursement. Historically, provider-based status has allowed a provider to obtain more favorable
Medicare reimbursement for services like the ones we provide. While the Medicare, Medicaid and SCHIP Benefits and Improvement Act of 2000 offers some relief for facilities recognized as provider-based on October 1, 2000, under these new regulations,
some of our clients may have difficulty qualifying our services for provider-based status. If a client cannot obtain provider-based status for our services, then the provider might decide not to contract or to continue to contract with us or might
acquire a fixed base MI system.



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The application or repeal of state certificate of need regulations could harm our business and financial results.



Some states require a certificate of need or similar regulatory approval
prior to the acquisition of high-cost capital items, including diagnostic imaging systems, or provision of diagnostic imaging services by us or our clients. While currently only a few of the states in which we operate require a certificate of need,
more states are adopting similar licensing requirements. In many cases, a limited number of these certificates are available in a given state. If we are unable to obtain the applicable certificate or approval or additional certificates or approvals
necessary to expand our operations, these regulations may limit or preclude our operations in the relevant jurisdictions. Conversely, states in which we have obtained or will obtain a certificate of need may repeal existing certificate of need
regulations or liberalize exemptions from the regulations. The repeal of certificate of need regulations in states in which we have obtained a certificate of need or a certificate of need exemption would lower barriers to entry for competition in
those states and could adversely affect our business.



If we fail to comply
with various licensing, certification and accreditation standards, we may be subject to loss of licensing, certification or accreditation, which would adversely affect our operations.



All of the states in which we operate require that the imaging technologists that operate
our systems be licensed or certified. In the healthcare industry, various types of organizations are accredited to meet certain Medicare certification requirements, expedite third-party payment, and fulfill state licensure requirements. Some managed
care providers prefer to contract with accredited organizations. There can be no assurances that we will be able to obtain accreditation with the applicable organizations. Any lapse in our licenses, certifications or accreditations, or those of our
technologists, could increase our costs and adversely affect our operations and financial results.



Managed care organizations may prevent healthcare providers from using our services, which would cause us to lose current and prospective clients.



Healthcare providers participating as providers under managed care plans may be required to refer diagnostic imaging tests to specific
imaging service providers depending on the plan in which each covered patient is enrolled. These requirements currently inhibit healthcare providers from using our diagnostic imaging services in some cases. The proliferation of managed care may
prevent an increasing number of healthcare providers from using our services in the future, which would cause our revenues to decline.



ITEM 3. CONTROLS AND PROCEDURES



As of the end of
the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures, as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, the Chief Executive Officer and our Chief Financial Officer, concluded
that as of the date of that evaluation our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be noted that the design of any systems of
controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. There
have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out this evaluation.



PART II. OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



From time to time,
the Company is involved in various claims and disputes arising in the ordinary course of business. These may be claims in which third parties are seeking monetary damages and other relief from the Company, or in which the Company may seek to collect
money for services rendered or enforce the provisions of its service agreements. The amount of the liability, if any, from such claims cannot be determined with certainty. The Company is not currently a party to any pending legal proceeding, and is
not aware of any threatened proceeding that may have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows.



ITEM 2. CHANGES IN SECURITIES



Changes in
Securities.



On October 12, 2004 in connection with Mr. Fredericks
employment agreement the Company issued Mr. Frederick 900,000 warrants to purchase Company common stock. These warrants vest monthly over a period of 12 months and have an exercise price of (i) $.08 per share for the purchase of shares 1 to 300,000
vested and purchased; (ii) $0.16 per share for the purchase of shares 300,001 to 599,999 vested and purchased; and (iii) $0.24 per share for the purchase of shares 600,00 to 900,000 vested and purchased. The warrants expire on October 12, 2014. On
October 20, 2004, in connection with Mr. Fredericks three months of service on the Board and a committee of the Board before becoming our Chief Executive Officer, the Company issued Mr. Frederick 18,750 warrants to purchase Company common
Stock. These warrants also vest monthly over a period of 12 months and have an exercise price of $.09 per share. The warrants expire on October 20, 2014. These warrants were issued in reliance upon Section 4(2) of the Act.



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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



(a)
Exhibits



Exhibit 31.1Certification of Kenneth C. Frederick, Chief
Executive Officer



Exhibit 31.2Certification of Dennis M. Mulroy, Chief
Financial Officer



Exhibit 32Certifications of Chief Executive Officer
and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



(b) Reports on Form 8-K



Form 8-K was filed with the SEC on September
13, 2004 regarding the resignation of Paul J. Crowe.



Form 8-K was filed with
the SEC on October 5, 2004 regarding the lease restructuring with GE Medical Systems, Inc.



SIGNATURES



In accordance with the requirements
of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



MOLECULAR IMAGING CORPORATION a Delaware
corporationBy:

/s/ DENNIS M. MULROYDennis M. Mulroy, Chief Financial Officer




Date: November 22, 2004



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