Recommendation: Speculative Buy

Basis for Recommendation

Mobile P.E.T. Systems, Inc. is the largest operator of mobile Positron Emission Tomography (PET) imaging systems in the United States and Europe. We believe PET scanning, given all of its benefits, will become a widespread diagnostic tool for hospitals and health centers. We are recommending purchase of the shares, due to its growth potential and leading position. We are qualifying our BUY recommendation with speculative due to the Company's present need for capital and operational need to increase yields per machine.

• MBPT has 15 mobile PET systems in operation in hospitals and other healthcare facilities in the U.S. and one fixed site in the U.K. The Company has 74 contracted healthcare providers located in 15 states.
  
  
• By 2007, it is forecast that annual PET units sold will total 643 units as compared to 160 units sold in 2000, underscoring the forecast demand for PET scans.
  
  
• There is one other national company providing mobile PET services, Alliance Imaging, Inc. MBPT has also secured a strong brand image and reputation that should provide it a unique competitive advantage as PET scanning becomes much higher volume.
  
  
• The Company has taken great strides to reduce operating expenses and increase revenues. We expect profitability as early as Q4 '02. If the Company can show profitability by then, it is likely that the market will reward it with a higher relative valuation, one in excess of our target.
  

Company Profile

California-based Mobile P.E.T. Systems, Inc. (OTCBB : MBPT) ("the Company" or "Mobile P.E.T."), founded in 1998, is a medical service provider operating mobile Positron Emission Tomography (PET) imaging systems in the United States and Europe. PET imaging systems produce images of the body that represent the metabolic characteristics of tissues. These images provide early detection of numerous abnormalities that are undetected with conventional methods such as x-ray, Computerized Axial Tomography (CT), and Magnetic Resonance Imaging (MRI) systems. By providing early detection of illnesses including cancer and neurological disorders, PET systems help eliminate the need for redundant testing, hospitalization, and non-beneficial treatment procedures.

Currently, the Company has 15 mobile PET systems in operation in hospitals and other healthcare facilities in the U.S. and one fixed site in the U.K. The systems are under capital leases with Finova Capital Corporation, Siemens Medical Systems, Inc., and General Electric. To date, the Company has 74 contracted healthcare providers located in 15 states. Mobile P.E.T. has successfully negotiated contracts with key clinical leaders in the field of nuclear medicine. As of June, the Company employed 63 people on a full-time basis and had a total of 67 employees.

The PET Scanner Market

The PET scan has emerged as an essential method of measuring body function and guiding disease treatment. PET is a non-invasive technology that can quantitatively measure metabolic, biochemical and functional activity in living tissue via electronic detection of short-lived positron emitting radiopharmaceuticals (compounds that are used in medicine as sources of radiation for radiotherapy and for diagnostic purposes). It identifies changes in the function, circulation and metabolism of body organs, for example, the increased utilization of glucose by cancerous tissues. Unlike MRI or CT scans, which primarily provide images of organ anatomy, PET measures chemical changes that occur before visible signs of disease are present on CT and MRI images.

Advantages over current diagnostic imaging procedures:

• Replaces the need for multiple, costly medical testing with a single imaging procedure, thus reducing costs for patients and third-party payers.
  
  
• Displays a three-dimensional image of all the organ systems of the body with one examination.
  
  
• Diagnoses and detects disease, in most instances, before detection by other tests.
  
  
• Monitors the path and progress of disease as well as how the body responds to treatment.
  
  
• Reduces or eliminates ineffective or unnecessary surgical/medical treatments and hospitalization.
  

According to several independent studies, PET imaging has displayed the following detection rates compared to CT scanning and mammography:

• 81% detection rate for lung cancer, compared to a 52% detection rate with CT.
  
  
• 95% detection rate for colon cancer, compared to 68% with CT.
  
  
• 85% detection rate for breast cancer, compared to a 67% detection rate for mammography.
  

The PET scanner market has several attractive investment characteristics. Even though the industry is already generating billions of dollars in revenues, the base of established customers remains low. Consequently, healthy growth rates are expected to continue for several years.

$50 Billion Industry: The diagnostic imaging industry generates annual revenues in excess of $50 billion in the United States, or approximately 5% to 6% of total healthcare spending. However, the mobile PET scanner market is in its early stage of development with high research and development costs and therefore not yet generating positive earnings or cash flow.

Strong Market Growth Expected to Continue: According to a report by Frost and Sullivan, dramatic sales in 2000 are only the beginning of what is likely to be a robust health market. The PET scanner market in 2000 generated $216.8 million in sales, which significantly beat all forecasts established 1998. This translated into year-over-year revenue growth of almost 175%. By 2007, it is forecast that annual units sold will total 643 units as compared to 160 units sold in 2000.

Growth Drivers:

1) Favorable reimbursement rates: Although a majority of private insurers and HMOs currently reimburse for PET, additional reimbursement from the public sector (Medicare) should stimulate consumer demand. Effective July 2001, Medicare patients have expanded coverage for PET procedures covering a variety of indications.

2) Increased physician awareness.

3) Unique and beneficial clinical utility: PET offers significant advantages over other diagnostic imaging techniques as it provides a direct measure of biochemistry and functional/metabolic activity. In most cases, the precursors to all disease are biochemical in nature and initially affect function, as opposed to structure. PET, which has the ability to create a diagnostic image of early metabolic changes, can significantly reduce the time to diagnosis, reduce costs and improve patient outcomes for numerous indications for oncology, cardiology and neurology.

4) The increased availability of radiopharmaceuticals.

Products and Services

The PET imaging system provides 2D and 3D volume measurement of metabolic and physiologic processes. The system is integrated into a mobile or stationary facility and consists of the PET imaging system, integrated workstations, advanced computational image acquisition and display system, and a patient couch.

Rather than solely providing a PET system itself, Mobile P.E.T. offers a comprehensive "total solutions" approach for clients. Depending on the facility's needs, this would include any or all of the following:

• Medical Advisory Board presentations and seminars that educate physicians on the benefits of the PET imaging system.
  
  
• Physician training programs and expert guidance to assure accurate PET exam interpretation.
  
  
• Electronic data transmission and archiving of all PET exams via the Company's Internet site and software package.
  
  
• Assistance with obtaining the licenses necessary to operate and evaluate PET scans.
  
  
• Site planning and support to accommodate each client location.
  
  
• Regional strategic marketing assistance to evaluate and educate referring physicians.
  
  
• Convenient access to radiotracers at negotiated discount rates.
  

Competition

By the end of 2000, there were only four manufacturers of dedicated PET scanners in the U.S. market. According to management, there is one other national company providing mobile PET services (Alliance Imaging, Inc.) as well as several regional competitors. The Company also competes with free-standing CT, MRI and PET imaging centers, healthcare providers that have their own diagnostic imaging systems, and equipment manufacturers that sell or lease imaging systems to healthcare providers for mobile or full-time use. Although the installed base of potential customers remains large relative to established accounts, price competition has remained intense and is likely to increase as a greater number of companies distribute or private label PET scanners. With the largest fleet of operating mobile PET systems in the U.S., Mobile P.E.T. has secured a strong brand image and reputation that should provide a unique competitive advantage. In addition, according to management, price competition has not increased in recent months.

Competitive Strategy

The Company's management team has developed and implemented a business strategy designed to enhance growth, maximize return on invested capital and increase revenues. Mobile P.E.T.'s goal is to maintain a leadership position in the industry as well as pursue significant growth opportunities based upon:

• Superior Customer Service. Mobile P.E.T. is positioning itself as both a provider of high quality patient services and an operator of equipment. The Company will differentiate itself from potential competitors by marketing its total solutions to healthcare professionals who determine which value-added services are beneficial for patients and cost-effective for the institution.
  
  
• Becoming a National Provider of Mobile PET Services. Mobile P.E.T. is currently licensed and operating mobile PET systems in California, Connecticut, Florida, Indiana, Iowa, Kentucky, Louisiana, Missouri, Nevada, New Jersey, New York, Ohio, Oklahoma, Oregon, , Pennsylvania, South Dakota, Texas, and Washington. With continued geographic expansion, we believe the Company will realize significant savings in equipment purchases, negotiate attractive service and maintenance contracts from suppliers, gain strong name recognition and a reputation for quality service, increase financial flexibility and access to lower-cost capital, and efficiently deploy systems in a manner which maximizes utilization and satisfies customer requirements.
  
  The Company currently has regional representatives to identify, qualify and educate new business prospects. Business development efforts to increase patient procedures include direct marketing to physicians, hospitals, and other members of the medical community. The primary sales and marketing focus has been directed at major metropolitan markets in Southern California, Florida, New York, Northern California, Texas, Eastern Pennsylvania, Chicago and Boston.
  
  
• Securing Exclusive, Long-Term Contracts with Key Hospitals. Mobile P.E.T. generates significant revenues from exclusive, long-term contracts with hospitals and other healthcare providers on a fee-for-service basis.
  
  
• Substantial Operating Leverage. Because of the significant amount of fixed costs associated with operating a PET system, Mobile P.E.T. can benefit from operating leverage, which with increased utilization rates will result in increased operating earnings and margins.
  
  
• Favorable Payment Terms. The Company receives payment for services directly from the hospitals, which in turn bill the patients, insurance carriers and third party payors. Accordingly, Mobile P.E.T.'s exposure to uncollectable patient receivables is minimized.
  
  
• Experienced Management Team. Senior management has considerable industry experience and has a proven track record of successfully developing and implementing educational, operating and financial strategies with previous healthcare companies.
  
  
• Increased Scan Volumes. We believe that the demand for PET procedures will continue to grow and gain increased acceptance as new applications are developed to replace and/or supplement other diagnostic imaging technologies.
  
  
• Maximizing Return on Invested Capital. The Company actively optimizes the utilization of its PET systems to maximize return on capital (i.e., the amount of cash flow generated by each system relative to the carrying value of such system).
  
  
• Identifying Attractive Strategic Acquisitions. Although management's initial operational focus is directed toward geographic expansion rather than acquisitions, Mobile P.E.T. may identify strategic alliances to increase revenues and/or reduce operating expense and overhead.
  

Financial Information

Mobile P.E.T. generates substantially all of its revenue from exclusive, long-term contracts with hospitals and other healthcare providers. The contract usually has a term of three to five years, is typically non-cancelable, and requires minimum monthly patient levels. Fees paid to the Company are billed on a per patient basis and initially paid by the healthcare provider. The insurance carriers later reimburse healthcare providers for these fees. Given that each PET system runs a tab of nearly $2 million, the ability to ramp up the volume of scans per imaging system becomes key to recovering initial capital investments. Consequently, the placement of PET imaging system in locations likely to generate the highest volume of scans is key to recovering initial capital investments.

Under this model, management believes it can contract for one additional mobile unit per month until December 2002, with increases of approximately 10% per month thereafter. On a unit basis, scans are forecasted to increase from the current 4.5 per day to an average of six per day through December 2001 and seven per day through 2004. To achieve these goals, Mobile P.E.T. plans to secure contracts with key hospitals with revenue minimums, provide additional imaging services when patient demand exceeds the hospital's in-house capability, and form partnerships with other scanning vendors.

A viability analysis by Vector Consulting, LLC has estimated that to reach positive cash flow will require approximately 18 mobile units scanning 4.5 per day. This assumes that operating expenses and fees will remain stable. We feel this is reasonable given the current industry trends, which forecast a healthy growth in units sold over the next few years.

Capital and Funding: The ability of Mobile P.E.T. to execute its business plan and meet its growth forecasts will initially rely on its ability to secure additional funding. So far this year, Mobile P.E.T. has raised $7.0 million in equity and convertible debt and structured a $10 million credit facility. We anticipate Mobile P.E.T. will need additional financing of approximately $60 million to expand its business to 40 mobile units and 60 stationary sites through internal development and acquisitions. The Company plans to raise these funds through public and private offerings.

Key Risk Factors / Concerns

1. Slow market acceptance: The utilization of mobile PET services has been slow in acceptance by physicians due to a lack of understanding of PET by doctors, hospitals and medical centers. Management believes this will change as the medical community becomes more aware of the substantial advantages of the P.E.T. solution over existing methods. This appears to be where the market is heading.

2. Price competition: Competition within the industry has been intense and has led to price-cutting in an attempt to gain market presence. In addition, the volume of scans per unit per day has not been high enough to cover variable costs. Unfortunately, this has resulted in an inability to turn a profit. There are several reasons to believe that this will change in the future:

a. Economies of scale: As scan volumes increase, fixed costs as a percentage of sales will fall and margins will increase.

b. Some of the incentives offered by Mobile P.E.T. in the past are beginning to expire. Management is currently attempting to bring price discipline to the contracts now being negotiated and is requiring finance and accounting to have input into the decision to approve/disapprove each prospective client.

c. Increased Medicare reimbursements should lead to greater volumes of scans and result in increased margins.

3. Need for cash resources: Historically, this has resulted from a negative contribution margin and has the potential to become an even greater problem should unit sales exceed forecasts without a change in margins.

4. Operational risk: Mobile P.E.T. is expecting very large increases in signed contracts over the next few years; effective execution of strategy and the ability to maintain a high level of customer service are critical to maintaining and strengthening brand image.

Valuation / Outlook

Arriving at a fair valuation and building a corresponding case for either under or over-valuation of the stock is not only difficult but also highly theoretical. Because financial results will be greatly affected by even a small change in the number of future contracts signed, actual revenue and earnings numbers are likely to significantly deviate from expected results -- both in terms of estimates being met or exceeded. In addition, strong visibility into our estimates is tenuous at best because we cannot establish direct relationship with end-market demand on the basis of customer commitments, contracts, etc. for 2002 and beyond. We are unable to compare our estimates for Mobile P.E.T. to its competitors because that information is unavailable to us. Consequently, a valuation based on future estimates is highly theoretical and subject to a high degree of subjective judgement, largely based on favorable industry trends and a projection of short-term Company results into the future. Several factors lessen the credibility of a valuation on the basis of expected future results:

1. Limited financial history: Mobile P.E.T. has only been generating revenues since 1999 and has no earnings; therefore a valuation relative to an established record of growth is difficult.

2. Small market-capitalization.

3. Lack of earnings and revenue visibility: A small change in the number of additional units contracted can have a very large percentage effect on the top and bottom line. We have little insight into the number of these contracts in the form of commitments, customer surveys, or specific purchase agreements to support future estimates.

Consequently, we prefer to emphasize how the stock can be expected to act assuming it maintains its one-year trailing price-to-sales (P/S) multiple of 1.42x under a variety of possible scenarios for revenues. Table 1, below, provides a projected stock price for three scenarios: revenues that meet our estimates, exceed them by 25%, or fall short by 25%. It should be noted that the Company's main competitor, Alliance Imaging (NYSE:AIQ), is selling at 1.26x trailing revenues. Therefore, considering Mobile P.E.T.'s rapid, top-line growth rate (compound growth of 16% over the past four quarters), we feel that maintenance of a multiple at or near 1.41x is reasonable..

It should be noted that sales are certainly not the only determinant factor for valuation. The Company has taken great strides to reduce operating expenses and we expect profitability as early as Q4 '02. If the Company can show profitability by then, it is likely that the market will reward it with a higher valuation. Other factors, such as market and industry effects, as well as Company-specific events such as new contracts, can also cause the stock price to rise. It is important to remember that we are initiating coverage during a market downturn, caused in large part by accounting concerns of several highly visible public companies and an overall negative change in investor sentiment. What this means is that most companies in Mobile P.E.T.'s space, including Alliance Imaging, have seen their valuations decrease somewhat in recent weeks. In short, though the stock appears to be roughly fairly valued on a sales-based valuation, many other factors can cause it to beat our short-term price target in the coming months.

Table 1. Price Target Scenarios

Mobile P.E.T. has strong growth prospects; we believe the Company is at an inflection point where strong growth in demand should lead to a ramp-up in revenues and positive earnings. As a leading service provider for mobile PET services in a growing industry, the Company has an opportunity to leverage its market position to achieve its targets for revenue growth and positive earnings results. We feel that this best done through contract with healthcare networks rather than individual facilities. Of course, while the individual facilities are the Company's bread-and-butter, healthcare networks, such as the Company's contract with Legacy Health Systems, will more rapidly expand Mobile P.E.T.'s customer base. We feel this is key.

Although there are several key factors that will drive the stock price (we have based our valuation on revenue growth alone), the ability to generate earnings will provide a clear sign to investors that the current business plan is viable. Once Mobile P.E.T. proves it can increase scan volumes and generate profits in the face of increasing competition and price pressure, the stock can be expected to appreciate significantly. All in all, we are initiating coverage of Mobile P.E.T. with a ëSpeculative Buy' rating and a 6-month price target range of $0.75 - $1.00.

Table 2. Mobile P.E.T. Systems, Inc.
Projected Statement of Operations & Earnings

Click here to view Table 2.

Analyst:
Randall D. Lewis, CFA

Mr. Lewis has more than ten years experience in security and portfolio analysis, and served as an equity analyst at SSI Investment Management, Inc., financial analyst for Griffin Financial Services, and research and market analyst for Eneric Financial Services. As part of his experience, Mr. Lewis has advised on strategic planning issues, facilitated comprehensive financial analyses, and developed and published financial reports, including business plans. Mr. Lewis has had several articles published, most recently in HFR Journal of Hedge Fund Research on the subject of merger arbitrage. Mr. Lewis received his Bachelors Degree with honors in Finance from California State University, Fullerton, and his MBA from the Anderson School of Business at UCLA.

Contact:
Mobile PET Systems, Inc. 2150 W. Washington Street, Suite 110, San Diego, CA 92110  (619) 226-6738 Mr. Leonard MacMillan, Dir. of Corporate Investor Relations.

American Financial Communications, Inc. 655 Redwood Highway, #255, Mill Valley, CA 94941 (415) 389-4670 Terry McGovern, Partner.

J.M.Dutton & Associates, LLC. John M. Dutton, President and Supervisory Analyst, 801 S. Figueroa, Suite 1120, Los Angeles, CA 90017 Phone (213) 929-2616, Fax (213) 896 0457 Email: [email protected] Web site: www.JMDutton.com

Information, opinions or recommendations contained in this research report are submitted solely for advisory and information purposes. The information used and statements of fact made have been obtained from sources considered reliable but we neither guarantee nor represent the completeness or accuracy. Such information and the opinions expressed are subject to change without notice. This research note is not intended as an offering or a solicitation of an offer to buy or sell the securities mentioned or discussed. Neither the Firm, its principals, nor the assigned analysts own or trade shares of any company covered. The Firm does not accept any equity compensation. Anyone may enroll a company for research coverage, which costs US $22,000 prepaid for one-year. Reports are performed on behalf of the public, and are not a service to any company. The analysts are responsible only to the public, and are paid in advance to eliminate pecuniary interests and insure independence. Please read full disclosure and other reports and notes on the Company at www.JMDutton.com.

© Copyright, 2002, by J.M. Dutton & Associates, LLC.