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, 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 40% of our revenue, respectively, for the nine months ended September 30, 2009 and 55% and 33% of our revenue, respectively, for the nine months ended September 30, 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 493 diagnostic imaging and radiation oncology systems, including 288 MRI systems and 126 positron emission tomography ("PET") or PET/CT systems, and served over 1,000 clients in 45 states at September 30, 2009. We operated 110 fixed-site imaging centers (three in unconsolidated joint ventures) at September 30, 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 110 fixed-site imaging centers, 86 were MRI fixed-site imaging centers, 16 were PET or PET/CT fixed-site imaging centers, five were other modality fixed-site imaging centers and three were in unconsolidated joint ventures. We also operated 23 radiation oncology centers and stereotactic radiosurgery facilities (including two radiation oncology centers in unconsolidated joint ventures) at September 30, 2009.

Approximately 80% and 79% of our revenues for the nine months ended September 30, 2009 and 2008, respectively, 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% and 21% of our revenues for the nine months ended September 30, 2009 and 2008, respectively, 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. For 2010, the Centers for Medicare and Medicaid Services ("CMS") are projecting a rate reduction of 21.2% unless Congress intervenes again to avoid the payment reduction. Federal legislative proposals have been introduced to prevent the rate reduction.

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 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, PET/CT, CT, and nuclear medicine to be accredited by an accreditation organization designated by 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/CT 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 nine months of 2009 have been limited.

The DRA also codified the reduction in reimbursement for multiple images on contiguous body parts, which was previously announced by CMS. The DRA mandated payment at 100% of the technical component of the higher priced imaging procedure and 50% for the technical component of each additional imaging procedure for multiple images of contiguous body parts within a family of codes performed in the same session. Initially, CMS announced that it would phase in this reimbursement reduction over a two-year period, to include a 25% reduction for each additional imaging procedure on contiguous body parts in 2006 and an additional 25% reduction in 2007. To date, CMS has not yet implemented the additional 25% reduction scheduled for 2007. Federal legislative proposals have been introduced that would change the percentage reduction from 25% to 50%. It is unclear what impact this change would have on our business if the proposal is passed.

For payments under the Physician Fee Schedule for calendar year 2010, CMS changes the way it calculates components of the Medicare Physician Fee Schedule. First, CMS will reduce payment rates for certain diagnostic services using equipment costing more than $1 million through revisions to usage assumptions from the current 50% usage rate to a 90% usage rate. This change would apply to MRI and CT scans, but not for radiation therapy and other therapeutic equipment. Federal legislative proposals have been introduced that would result in lower usage assumptions and, if finalized, would supersede CMS's regulatory changes. Further with respect to its 2010 changes, CMS will also reduce payment for services primarily involving the technical component rather than the physician work component, including the services we provide, by adjusting downward malpractice payments for these services. The reductions primarily impact radiology and other diagnostic tests. All these changes to the Medicare Fee Schedule will be transitioned over a four year period such that beginning in 2013, CMS will fully implement the revised payment rates. CMS projects that the combined impact of these changes, when fully implemented will result in a 5% reduction in radiation oncology, 16% reduction in radiology, 23% reduction in nuclear medicine and 34% reduction for all suppliers providing diagnostic tests generally. For the 2010 transitioned payment, CMS estimates the impact of its changes will result in a 1% reduction in radiation oncology, 5% reduction in radiology, 18% reduction in nuclear medicine and 12% reduction for all suppliers providing the technical component of diagnostic tests generally. These impacts are calculated prior to any application of the projected negative update factor of 21.2% related to MIPPA and may impact our future revenues. If the CMS 2010 reimbursement rates had been in effect for full year 2009, we estimate that our annualized retail revenue related to MRI and radiation oncology would not have been materially impacted.

In addition, as indicated above, the HOPPS payments are the amounts received by our hospital clients for hospital outpatient services. For 2008, the national Medicare HOPPS 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. For 2009, the payment rate for nonmyocardial PET and PET/CT scans 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. On October 30, 2009, CMS released its 2010 national Medicare HOPPS payment rates. For nonmyocardial PET and PET/CT, the 2010 payment rate will be $1,037 per scan. For myocardial PET procedures, the 2010 payment rate will be $1,433 per scan. For stereotactic radiosurgery treatment delivery services, the 2010 payment rates range from $963 to $7,344, depending on the level of service. These rates will go into effect January 1, 2010.

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 nine months 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 total revenue and earnings for full year 2009. Also, in 2008 and in the first nine months 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. The new policies have not significantly impacted 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 these trends will continue throughout 2009. Further, a number of payment initiatives are being proposed in the imaging area. 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. In addition, healthcare reform under the current administration is a priority. If laws are passed, certain changes could become effective as early as next year. Currently, pending at the federal level are a number of proposals in both the Senate and House of Representatives that would substantially change the way health care is financed by both governmental and private insurers. A number of the bills from the Senate and House contain provisions that could impact negatively the payment rates for certain imaging services. At this time, we cannot predict which of the proposals, if any, will be adopted or if adopted, what effect, if any, these or any other proposals would 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. Our MRI revenues decreased during the nine months ended September 30, 2009 compared to the same period in 2008 due to a decrease in demand. We believe that MRI revenues will continue to 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 United States government financial assistance to certain companies and other federal government's interventions in the United States financial system has 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. We believe our MRI and PET/CT scan volumes have been impacted during the first nine months of 2009 by rising unemployment rates, the number of under-insured or uninsured patients and other conditions arising from the global economic conditions described above. At this time, it is unclear what impact this might have on our future revenues or business.

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 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 and nine months ended
September 30:

                                                    Quarter Ended       Nine Months Ended
                                                    September 30,         September 30,
                                                   2008      2009        2008        2009
Revenues                                            100.0 %   100.0 %      100.0 %    100.0 %
Costs and expenses:
Cost of revenues, excluding depreciation and
amortization                                         52.3      52.7         52.2       52.3
Selling, general and administrative expenses         12.4      12.7         12.7       13.2
Transaction costs                                       -       0.1            -        0.2
Severance and related costs                           0.1       0.4          0.1        0.2
Depreciation expense                                 17.1      19.4         17.5       18.5
Amortization expense                                  1.9       2.2          1.7        2.1
Interest expense and other, net                       8.4       9.0          9.1        8.7
Loss on extinguishment of debt                          -         -          0.1          -
Other (income) and expense, net                      (0.1 )    (0.2 )       (0.1 )     (0.2 )

Total costs and expenses                             92.1      96.3         93.3       95.0

Income before income taxes, earnings from
unconsolidated investees and noncontrolling
interest, net of tax                                  7.9       3.7          6.7        5.0
Income tax expense                                    3.3       1.7          3.0        2.2
Earnings from unconsolidated investees               (1.0 )    (1.0 )       (1.0 )     (0.7 )

Net income                                            5.6       3.0          4.7        3.5
Less: Net income attributable to noncontrolling
interest, net of tax                                 (0.7 )    (0.6 )       (0.7 )     (0.5 )

Net income attributable to Alliance HealthCare
Services, Inc.                                        4.9 %     2.4 %        4.0 %      3.0 %

The table below provides MRI statistical information for each of the quarters and nine months ended September 30:

                                                  Quarter Ended         Nine Months Ended
                                                  September 30,           September 30,
                                                2008        2009        2008        2009
MRI statistics
  Average number of total systems                 305.4       276.7       305.8       282.4
  Average number of scan-based systems            255.7       240.2       253.9       242.9
  Scans per system per day (scan-based
  systems)                                         9.23        8.74        9.21        9.01
  Total number of scan-based MRI scans          157,737     141,392     479,680     441,886
  Price per scan                              $  379.44   $  383.92   $  380.20   $  379.99

The table below provides PET and PET/CT statistical information for each of the quarters and nine months ended September 30:

                                                Quarter Ended        Nine Months Ended
                                                September 30,          September 30,
                                               2008       2009       2008        2009
    PET and PET/CT statistics
      Average number of scan-based systems       92.0      119.2        82.7       115.2
      Scans per system per day                   6.17       5.88        6.18        6.02
      Total number of PET and PET/CT scans     37,756     45,415     102,004     136,085
      Price per scan                         $  1,196   $  1,089   $   1,187   $   1,105

Following are the components of revenue (in millions) for each of the quarters and nine months ended September 30:

                                                   Quarter Ended       Nine Months Ended
                                                   September 30,         September 30,
                                                  2008      2009        2008        2009
Total MRI revenue                                $  67.6   $  58.8    $   204.6    $ 184.0
PET/CT revenue                                      45.4      50.0        121.8      152.7
Radiation oncology, other modalities and other
revenue                                             15.1      15.4         43.6       49.3

Total                                            $ 128.1   $ 124.2    $   370.0    $ 386.0

                                                   Quarter Ended       Nine Months Ended
                                                   September 30,         September 30,
                                                   2008      2009       2008        2009
Total fixed-site imaging center revenue (in

Quarter Ended September 30, 2009 Compared to Quarter Ended September 30, 2008

Revenue decreased $3.9 million, or 3.0%, to $124.2 million in the third quarter of 2009 compared to $128.1 million in the third quarter of 2008 due to a decrease in MRI revenues, partially offset by an increase in PET and PET/CT revenues and radiation oncology, other modalities and other revenue. MRI revenue decreased $8.8 million in the third quarter of 2009, or 13.1%. Scan-based MRI . . .