Overview

We are a leading national provider of outpatient diagnostic imaging services, based upon annual revenue and number of diagnostic imaging systems deployed, and are a provider of radiation oncology services. Our principal sources of revenue are derived from magnetic resonance imaging ("MRI") and positron emission tomography/computed tomography ("PET/CT"). We provide imaging and therapeutic services primarily to hospitals and other healthcare providers on a shared-service and full-time service basis. We also provide services through a growing number of fixed-site imaging centers, primarily to hospitals or health systems. Our services normally include the use of our imaging systems, technologists to operate the systems, equipment maintenance and upgrades and management of day-to-day shared-service and fixed-site diagnostic imaging operations. We also provide non scan-based services, which include only the use of our imaging systems under a short-term contract. We are also leveraging our leadership in MRI and PET/CT to expand into radiation oncology. Our radiation oncology business is operated through our wholly-owned subsidiary, Alliance Oncology, LLC, and includes a wide range of services for cancer patients covering initial consultation, preparation for treatment, simulation of treatment, actual radiation oncology delivery, therapy management and follow-up care. Our services include the use of our linear accelerators, therapists to operate such systems, administrative staff, equipment maintenance and upgrades, and management of day-to-day operations. We also provide stereotactic radiation oncology services through our wholly-owned subsidiary, Alliance Radiosurgery, LLC.

MRI and PET/CT services generated 48% and 39% of our revenue, respectively, for the quarter ended March 31, 2009 and 57% and 31% of our revenue, respectively, for the quarter ended March 31, 2008. The remaining revenue was comprised of radiation oncology revenue and other modality diagnostic imaging services revenue, primarily computed tomography ("CT") and management contract revenue. We had 501 diagnostic imaging and radiation oncology systems, including 294 MRI systems and 119 positron emission tomography ("PET") or PET/CT systems, and served over 1,000 clients in 46 states at March 31, 2009. We operated 106 fixed-site imaging centers (four in unconsolidated joint ventures) at March 31, 2009, which consists of systems installed in hospitals or other medical buildings on or near hospital campuses, including modular buildings, systems installed inside medical groups' offices, and free-standing fixed-site imaging centers, and include systems installed in medical office buildings, ambulatory surgical centers, or other retail space. Of the 106 fixed-site imaging centers, 82 were MRI fixed-site imaging centers, 14 were PET or PET/CT fixed-site imaging centers, six were other modality fixed-site imaging centers and four were in unconsolidated joint ventures. We also operated 22 radiation oncology centers and stereotactic radiosurgery facilities (including two radiation oncology centers in unconsolidated joint ventures) at March 31, 2009.

Approximately 80% of our revenues for each of the quarters ended March 31, 2009 and 2008 were generated by providing services to hospitals and other healthcare providers, which we refer to as wholesale revenues. Our wholesale revenues are typically generated from contracts that require our clients to pay us based on the number of scans we perform on patients on our clients' behalf, although some pay us a flat fee for a period of time regardless of the number of scans we perform. Wholesale payments are due to us independent of our clients' receipt of retail reimbursement from third-party payors. We typically deliver our services for a set number of days per week through exclusive, long-term contracts with hospitals and other healthcare providers. The initial terms of these contracts average approximately three years in length for mobile services and approximately five to ten years in length for fixed-site arrangements. These contracts often contain automatic renewal provisions and certain contracts have cancellation clauses if the hospital or other healthcare provider purchases their own system. We price our contracts based on the type of system used, the scan volume, and the number of ancillary services provided. Pricing is also affected by competitive pressures.

Approximately 20% of our revenues for each of the quarters ended March 31, 2009 and 2008 were generated by providing services directly to patients from our sites located at or near hospitals or other healthcare provider facilities, which we refer to as retail revenue. Our revenue from these sites is generated from direct billings to patients or their third-party payors, including Medicare, which are recorded net of contractual discounts and other arrangements for providing services at discounted prices. We typically charge a higher price per scan under retail billing than we do under wholesale billing.

Fixed-site imaging centers and radiation oncology centers can be structured as either wholesale or retail arrangements. Revenues from these centers are included in either our wholesale or retail revenues, respectively.

For services for which we bill Medicare directly, we are paid under the Medicare Physician Fee Schedule, which is updated on an annual basis. Under the Medicare statutory formula, payments under the Physician Fee Schedule would have decreased for the past several years if Congress failed to intervene. For example, for 2008, the fee schedule rates were to be reduced by approximately 10.1%. The Medicare, Medicaid and SCHIP Extension Act of 2007 eliminated the 10.1% reduction for 2008 and increased the annual payment rate update by 0.5%. This increase to the annual Medicare Physician Fee Schedule payment update was effective only for Medicare claims with dates of service between January 1, 2008 and June 30, 2008. Beginning July 1, 2008, under the Medicare Improvement for Patients and Providers Act of 2008 ("MIPPA"), the 0.5% increase was continued for the rest of 2008.

In addition, MIPPA established a 1.1% increase to the Medicare Physician Fee Schedule payment update for 2009. MIPPA also modified the methodology by which the budget neutrality formula was applied to the 2009 physician fee schedule payment rates, however, resulting in an overall reduction in payment rates for services performed by many specialties, including an estimated 3% reduction for radiation oncology and 1% reduction for nuclear medicine. The impact of the payment rates on specific companies depends on their service mix. At this time, we estimate slight decreases in rates for our radiation oncology business, but cannot predict the full impact the rate reductions will have on our future revenues or business. Also with respect to MIPPA, the legislation requires all suppliers that provide the technical component of diagnostic MRI, CT, PET and nuclear medicine to be accredited by an accreditation organization designated by the Centers for Medicare and Medicaid Services ("CMS") by January 1, 2012. Though CMS has not yet designated the accreditation organizations, all our facilities are accredited by The Joint Commission.

A number of other legislative changes impact our retail business. For example, the Deficit Reduction Act of 2005 ("DRA") imposed caps on Medicare payment rates for certain imaging services furnished in physician's offices and other non-hospital based settings. The caps impact MRI, PET and certain imaging services performed in conjunction with radiation therapy, including certain image guided radiation therapy ("IGRT") services and diagnostic imaging services used to plan intensity modulated radiation therapy ("IMRT"). Under the cap, payments for specified imaging services cannot exceed the hospital outpatient payment rates for those services. This change applies to services furnished on or after January 1, 2007. The limitation is applicable to the technical components of the diagnostic imaging services only, which is the payment we receive for the services for which we bill directly under the Medicare Physician Fee Schedule. CMS issues on an annual basis the hospital outpatient prospective payment ("HOPPS") rates, which are used to develop the caps. The reimbursement for the technical component under the Physician Fee Schedule generally allows for higher reimbursement than under HOPPS. The implementation of this reimbursement reduction contained in the DRA had a significant effect on our financial condition and results of operations in 2007, whereas the changes in 2008 through the first quarter of 2009 have been limited.

In addition, as indicated above, the HOPPS payments are the amounts received by our hospital clients for hospital outpatient services. On November 1, 2007, CMS released its final determination of

Medicare Part B HOPPS reimbursement rates for PET and PET/CT imaging procedures, effective January 1, 2008. For 2008, the national payment rate for nonmyocardial PET and PET/CT scans was $1,057 per scan and the national payment rate for myocardial PET scans was $1,400 per scan. In its final 2008 HOPPS reimbursement rates, CMS also bundled the PET and PET/CT payment for radiopharmaceuticals with the payment for the PET and PET/CT scan. In addition, CMS reduced the 2008 national Medicare HOPPS rate for MRI scans by approximately 3%. The 2008 national Medicare HOPPS payment rates for stereotactic radiosurgery treatment delivery services ranged from $1,057 to $8,055, depending on the level of service. On October 30, 2008, CMS released its 2009 national Medicare HOPPS payment rates, effective January 1, 2009. For nonmyocardial PET and PET/CT, the 2009 payment rate is $1,037 per scan. For myocardial PET procedures, the 2009 payment rate is $1,157 per scan. For stereotactic radiosurgery treatment delivery services, the 2009 payment rates range from $952 to $7,642, depending on the level of service.

For full year 2006, we estimate that approximately 5.6% of our revenue was billed directly to the Medicare program. If the DRA had been in effect for full year 2006, we estimate the reduction in Medicare revenue due to the DRA reimbursement rate decrease would have reduced revenue by approximately $9.7 million and the PET and PET/CT Medicare HOPPS reduction would have reduced revenue by approximately $2.8 million. Combined, the DRA and PET and PET/CT Medicare HOPPS rate reductions would have negatively impacted our 2006 revenue and did impact our 2007 revenue by a total of approximately $12.5 million and $14.0 million, respectively. For 2008 and the first quarter of 2009, however, the DRA and the net Medicare rate reductions in HOPPS did not have a material negative effect on revenue and earnings, and we do not believe that such changes will have a material negative effect on revenue and earnings for 2009. Also, in 2008 and in the first quarter of 2009, we did not face an increase in pressure in wholesale pricing for PET and PET/CT as a result of the reductions in Medicare reimbursement rates from the implementation of the DRA and revised PET and PET/CT reimbursements under HOPPS. At this time, however, we cannot predict the impact the rate reductions will have on our future revenues or business.

Furthermore, with respect to the final Medicare Physician Fee Schedule Rule for calendar year 2009, CMS announced additional performance standards for suppliers of mobile diagnostic services. The final rule requires suppliers of mobile diagnostic services under certain circumstances to enroll in Medicare and bill directly for these services, regardless of where they are performed. An exception was made for services provided to hospital patients under arrangement with that hospital. In those circumstances, the mobile diagnostic facility would be required to enroll in Medicare, but the hospital would bill for the services. On December 15, 2008, CMS issued additional guidance that companies that lease or contract with a Medicare-enrolled provider or supplier to provide only diagnostic testing equipment and/or non-physician personnel are not required to enroll in Medicare. The agency nonetheless indicated that it is continuing to evaluate such arrangements. At this time, we do not expect that the new policies will significantly impact our business.

Over the past few years, the growth rate of MRI industry wide scan volumes has slowed in part due to weak hospital volumes as reported by several investor-owned hospital companies, a growing number of medical groups adding imaging capacity within their practice setting, the increasing trend of third-party payors intensifying their utilization management efforts to control MRI scan volume growth rate and additional patient-related cost-sharing programs. We expect that this trend will continue throughout 2009. Further, President Barack Obama's budget for fiscal year 2010 includes provisions that may require the use of radiology benefit managers to preauthorize certain imaging services for Medicare enrollees. At this time, it is unclear what impact this might have on our future revenues or business.

We have experienced and continue to experience an increase in the competitive climate in the MRI industry, resulting in an increase in activity by original equipment manufacturers, or OEMs, selling systems directly to certain of our clients. Typically, OEMs target our higher scan volume clients.

This increase in activity by OEMs has resulted in overcapacity of systems in the marketplace. This has caused an increase in the number of our higher scan volume clients deciding not to renew their contracts. We replace these higher volume clients typically with lower volume clients. During the first quarter of 2009, our MRI revenues decreased compared to the first quarter of 2008 due to a decrease in demand. We believe that MRI revenues will modestly decline in future years.

Recent global market and economic conditions have been unprecedented and challenging with tighter credit conditions and recession in most major economies continuing into 2009. Continued concerns about the systemic impact of potential long-term and wide-spread recession, inflation, energy costs, geopolitical issues, the availability and cost of credit, the United States mortgage market and a declining real estate market in the United States have contributed to increased market volatility and diminished expectations for the United States economy. Added concerns fueled by the federal government conservatorship of the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, the declared bankruptcy of Lehman Brothers Holdings Inc., the United States government financial assistance to certain companies and other federal government interventions in the United States financial system led to increased market uncertainty and instability in both United States and international capital and credit markets. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have contributed to volatility of unprecedented levels.

As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. Continued turbulence in the United States and international markets and economies may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability to timely and access the capital markets to meet liquidity needs, resulting in adverse effects on our financial condition and results of operations.

The principal components of our cost of revenues are compensation paid to technologists and drivers, system maintenance costs, medical supplies, system transportation and technologists' travel costs. Because a majority of these expenses are fixed, increased revenues as a result of higher scan volumes per system significantly improves our margins while lower scan volumes result in lower margins.

The principal components of selling, general and administrative expenses are sales and marketing costs, corporate overhead costs, provision for doubtful accounts, and share-based payment.

We record noncontrolling interest and earnings from unconsolidated investees related to our consolidated and unconsolidated subsidiaries, respectively. These subsidiaries primarily provide shared-service and fixed-site diagnostic imaging and therapeutic services.

Seasonality

We experience seasonality in the revenues and margins generated for our services. First and fourth quarter revenues are typically lower than those from the second and third quarters. First quarter revenue is affected primarily by fewer calendar days and inclement weather, typically resulting in fewer patients being scanned during the period. Fourth quarter revenues are affected by holiday and client and patient vacation schedules, resulting in fewer scans during the period. The variability in margins is higher than the variability in revenues due to the fixed nature of our costs.

Results of Operations

    The following table shows our consolidated statements of operations as a
percentage of revenues for each of the quarters ended March 31:

                                                       2008      2009
             Revenues                                   100.0 %   100.0 %
             Costs and expenses:
             Cost of revenues, excluding
             depreciation and amortization               52.7      52.3
             Selling, general and administrative
             expenses                                    13.2      13.7
             Transaction costs                              -       0.3
             Severance and related costs                  0.1       0.1
             Depreciation expense                        18.0      17.9
             Amortization expense                         1.6       2.1
             Interest expense and other, net              9.9       8.1
             Other (income) and expense, net             (0.1 )    (0.2 )

             Total costs and expenses                    95.4      94.3

             Income before income taxes, earnings
             from unconsolidated investees and
             noncontrolling interest, net of tax          4.6       5.7
             Income tax expense                           2.2       2.4
             Earnings from unconsolidated investees      (1.0 )    (0.4 )

             Net income                                   3.4       3.7
             Less: Net income attributable to
             noncontrolling interest, net of tax         (0.5 )    (0.5 )

             Net income attributable to Alliance
             HealthCare Services, Inc.                    2.9 %     3.2 %

The table below provides MRI statistical information for each of the quarters ended March 31:

                                                           2008        2009
       MRI statistics
         Average number of total systems                     307.0       285.4
         Average number of scan-based systems                249.9       242.2
         Scans per system per day (scan-based systems)        9.06        9.13
         Total number of scan-based MRI scans              158,708     147,656
         Price per scan                                  $  382.55   $  380.99

The table below provides PET and PET/CT statistical information for each of the quarters ended March 31:

                                                        2008       2009
             PET and PET/CT statistics
               Average number of systems                  76.9      110.5
               Scans per system per day                   6.12       6.15
               Total number of PET and PET/CT scans     31,000     45,113
               Price per scan                         $  1,199   $  1,116

Following are the components of revenue (in millions) for each of the quarters ended March 31:

                                                               2008      2009
     Total MRI revenue                                        $  68.2   $  62.6
     PET/CT revenue                                              37.3      51.0
     Radiation oncology, other modalities and other revenue      13.6      18.2

     Total                                                    $ 119.1   $ 131.8

2008 2009 Total fixed-site imaging center revenue (in millions) for each of the quarters ended March 31: $ 24.3 $ 29.1

Quarter Ended March 31, 2009 Compared to Quarter Ended March 31, 2008

Revenue increased $12.7 million, or 10.6%, to $131.8 million in the first quarter of 2009 compared to $119.1 million in the first quarter of 2008 due to an increase in PET and PET/CT revenues and radiation oncology, other modalities and other revenue, partially offset by a decrease in MRI revenues. PET and PET/CT revenue in the first quarter of 2009 increased $13.7 million, or 36.5%, compared to the first quarter of 2008. Total PET and PET/CT scan volumes increased 45.5% to 45,113 scans in the first quarter of 2009 from 31,000 scans in the first quarter of 2008, primarily as a result of the acquisition of Shared PET Imaging, LLC ("SPI") in the fourth quarter of 2008, the acquisition of Medical Outsourcing Services, LLC ("MOS") in the third quarter of 2008, and growth in our core PET business. The average number of PET and PET/CT systems in service increased to 110.5 systems in the first quarter of 2009 from 76.9 systems in the first quarter of 2008. Scans per system per day also increased 0.5%, to 6.15 scans per system per day in the first quarter of 2009 from 6.12 scans per system per day in the first quarter of 2008. These PET and PET/CT increases were partially offset by a 6.9% decline in the average price per PET and PET/CT scan, to $1,116 per scan in the first quarter of 2009 compared to $1,199 per scan in the first quarter of 2008. Radiation oncology, other modalities and other revenue increased $4.6 million, or 34.4%, to $18.2 million in the first quarter of 2009 compared to $13.6 million in the first quarter of 2008, primarily due to an increase in radiation oncology revenue. MRI revenue decreased $5.6 million in the first quarter of 2009, or 8.2%. Scan-based MRI revenue decreased $4.4 million in the first quarter of 2009, or 7.3%, compared to the first quarter of 2008, to $56.3 million in the first quarter of 2009 from $60.7 million in the first quarter of 2008. Scan-based MRI scan volume decreased 7.0% to 147,656 scans in the first quarter of 2009 from 158,708 scans in the first quarter of 2008, primarily due to a decrease in client demand. Scan-based systems in service decreased to 242.2 systems in the first quarter of 2009 from 249.9 systems in the first quarter of 2008. The average price per MRI scan also decreased to $380.99 per scan in the first quarter of 2009 from $382.55 per scan in the first quarter of 2008. Average scans per system per day increased by 0.8% to 9.13 in first quarter of 2009 from 9.06 in first quarter of 2008. Non scan-based MRI revenue decreased $1.2 million in the first quarter of 2009 over the same period in 2008. Included in the revenue totals above is fixed-site imaging center revenues, which increased $4.8 million, or 19.8%, to $29.1 million in the first quarter of 2009 from $24.3 million in the first quarter of 2008.

We had 294 MRI systems at March 31, 2009, compared to 314 MRI systems at March 31, 2008. We had 119 PET and PET/CT systems at March 31, 2009, compared to 81 PET and PET/CT systems at March 31, 2008. We operated 106 fixed-site imaging centers (including four in unconsolidated investees) at March 31, 2009, compared to 88 fixed-site imaging centers (including five in unconsolidated investees) at March 31, 2008. We operated 22 radiation oncology centers (including two in unconsolidated investees) at March 31, 2009, compared to 18 radiation oncology centers (including two in unconsolidated investees) at March 31, 2008.

Cost of revenues, excluding depreciation and amortization, increased $6.1 million, or 9.7%, to $68.9 million in the first quarter of 2009 compared to $62.8 million in the first quarter of 2008. Compensation and related employee expenses increased $2.3 million, or 7.6%, primarily as a result of an increase in average headcount related to acquisitions completed in the second half of 2008. Medical supplies increased $2.1 million, or 39.3%, primarily as a result of an increase in the number of PET and PET/CT scans, which use a radiopharmaceutical as a component of the PET and PET/CT scan. Maintenance and related costs increased $1.3 million, or 11.0%, due to an increase in service costs related to an increase in the number of PET/CT systems in operation and the addition of radiation oncology systems. Site fees increased $0.4 million, or 25.6%, primarily as a result of an increase in the average number of retail fixed-site imaging centers in operation. Fuel expenses decreased $0.7 million, or 39.0%, primarily due to a decrease in the average price per gallon of diesel fuel. All other cost of revenues, excluding depreciation and amortization, increased $0.7 million, or 6.5%. Cost of revenues, as a percentage of revenue, decreased to 52.3% in the first quarter of 2009 from 52.7% in the first quarter of 2008 as a result of the factors described above.

Selling, general and administrative expenses increased $2.2 million, or 13.9%, to $17.9 million in the first quarter of 2009 compared to $15.7 million in the first quarter of 2008. Compensation and related employee expenses increased $1.9 million, or 21.2%, as a result of investments in the infrastructure of the oncology division and an increase in average headcount related to acquisitions completed in the second half of 2008. Professional services increased $0.6 million, or 41.3%, due to an increase in consulting services and legal costs. Share-based payments increased $0.1 million in the first quarter of 2009 from the first quarter of 2008 due to new equity awards granted in the first quarter of 2009. The provision for doubtful accounts decreased $1.0 million, or 69.1%, primarily due to the collection of aged accounts receivable during the first quarter of 2009. The provision for doubtful accounts as a percentage of revenue was 0.4% in the first quarter of 2009 compared to 1.3% of revenue in the first quarter of 2008. All other selling, general and administrative expenses increased $0.6 million, or 25.8%. Selling, general and administrative expenses as a percentage of revenue were 13.7% and 13.2% in the first quarter of 2009 and 2008, respectively.

Transaction costs increased $0.4 million due to acquisition-related costs, which are now required to be expensed as incurred in accordance with Statement of Financial Accounting Standards No. 141(R) (Revised 2007), "Business Combinations" ("SFAS 141(R)").

We recorded severance and related costs of $0.2 million in the first quarter . . .