AMERICAN SHARED HOSPITAL SERVICES - Annual Report: 2002 (Form 10-K)

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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 1-8789

American Shared Hospital Services

Four Embarcadero Center, Suite 3700, San Francisco, California 94111-4107

Registrant’s telephone number, including area code:

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes o          No þ

      As of June 28, 2002, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $11,044,000.

      Number of shares of common stock of the registrant outstanding as of March 14, 2003: 3,783,203.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the registrant’s definitive Proxy Statement for the 2003 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.

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PART I

General

      American Shared Hospital Services (“ASHS” and, together with its subsidiaries, the “Company”) provides Gamma Knife stereotactic radiosurgery services to fourteen medical centers in thirteen states. The Company provides these services through its 81% indirect interest in GK Financing, LLC, a California limited liability company (“GKF”). The remaining 19% of GKF is owned by GKV Investments, Inc., a wholly owned U.S. subsidiary of Elekta AG, a Swedish company (“Elekta”). Elekta is the manufacturer of the Leksell Gamma Knife® (the “Gamma Knife”). GKF is a non-exclusive provider of alternative financing services for Elekta. Gamma Knife services accounted for 100% of the Company’s revenue in 2002.

      At present, the Company is developing its business model for “The Operating Room for the 21st Century”® (“OR21”®). OR21 is not expected to generate significant revenue within the next twelve months.

      In November 1998, the Company sold its diagnostic imaging business to affiliates of Alliance Imaging, Inc. (the “Purchaser”) for $13,552,000 in cash and the assumption by the Purchaser of substantially all of the liabilities of the diagnostic imaging business, including approximately $27.1 million in debt. Prior to that sale, the Company provided Magnetic Resonance Imaging, Computed Axial Tomography, Ultrasound, Nuclear Medicine and Cardiac Catheterization Laboratory services to approximately 190 customers in 22 states.

      The Company was incorporated in the state of California in 1983 and its predecessor, Ernest A. Bates, M.D., Ltd. (d/b/a American Shared Hospital Services), a California limited partnership, was formed in June 1980.

Gamma Knife Operations

      Gamma Knife stereotactic radiosurgery, a non-invasive procedure, is an alternative to conventional brain surgery or can be an adjunct to conventional brain surgery. Compared to conventional surgery, Gamma Knife surgery usually involves shorter patient hospitalization, lower risk of complications and can be provided at a lower cost. Typically, Gamma Knife patients resume their normal activities one or two days after treatment. The Gamma Knife treats the patient with 201 single doses of gamma rays that are focused with great precision on small and medium, well circumscribed and critically located structures in the brain. The Gamma Knife delivers the concentrated dose of gamma rays from 201 sources of Cobalt 60 housed in the Gamma Knife. The 201 Cobalt 60 sources converge at the target area and deliver a dose that is high enough to destroy the diseased tissue without damaging surrounding healthy tissue.

      The Gamma Knife treats selected malignant tumors (i.e., solitary and multiple metastatic tumors, gliomas, nasopharyngeal carcinomas and ocular meningiomas), benign brain tumors (i.e., meningiomas, pituitary and acoustic neuromas, craniopharyngiomas), arteriovenous malformations and trigeminal neuralgia (facial pain). Research is being conducted at select Gamma Knife centers to determine whether the Gamma Knife can be effective in the treatment of epilepsy, Parkinson’s Disease and other functional disorders.

      There are currently 74 Gamma Knife sites in the United States and approximately 173 units in operation worldwide. As of December 31, 2002, in excess of 200,000 procedures had been performed worldwide. An estimated percentage breakdown of these Gamma Knife procedures performed in the U.S. by indications treated are as follows: malignant (44%) and benign (30%) brain tumors, vascular disorders (12%) and functional disorders (14%).

      The Company, as of March 14, 2003, has fourteen (14) Gamma Knife units operating at fourteen (14) sites in the United States. In addition, the Company has three (3) more hospitals that are currently under development. The Company’s first Gamma Knife commenced operation in September 1991. The Company’s Gamma Knife units performed approximately 1,700 procedures in 2002 for a cumulative total of approximately 7,400 procedures through December 31, 2002.

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      Gamma Knife revenue for the Company during the five (5) years ended December 31, and the percentage of total revenue of the Company represented by the Gamma Knife for each of the last five years, are set forth below:

      The Company conducts its Gamma Knife business through its 81% indirect interest in GKF. The remaining 19% interest is indirectly owned by Elekta. GKF, formed in October 1995, is managed by its policy committee. The policy committee is composed of one representative from the Company, Ernest A. Bates, M.D., the Company’s Chairman and CEO, and one representative from Elekta. The policy committee sets the operating policy for GKF. The policy committee may act only with the unanimous approval of both of its members. The policy committee selects a manager to handle GKF’s daily operations. Craig K. Tagawa, Chief Executive Officer of GKF and Chief Operating and Financial Officer of the Company, serves as GKF’s manager.

      GKF’s profits and/or losses and any cash distributions are allocated based on membership interests. GKF’s Operating Agreement requires that it have a cash reserve of at least $50,000 before cash distributions are made to its members. From inception to December 31, 2002, GKF distributed $8,667,000 to the Company.

Risks of Gamma Knife Business

      There are significant risks involved in the Company’s Gamma Knife business, including the following:

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Customers

      The Company’s current business is the outsourcing of Gamma Knife stereotactic radiosurgery services. The Company typically provides the Gamma Knife equipment, as well as planning, installation, reimbursement and marketing support services. Customers usually pay the Company on a fee per use basis. The market for these services primarily consists of major urban medical centers. The Gamma Knife business is capital intensive. The total cost of a Gamma Knife facility usually ranges from $3.25 million to $4 million, including equipment, site construction and installation. The Company’s historical cost for a Gamma Knife (exclusive of

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      The Company’s second Gamma Knife contract, with the University of Southern California, ended in the third quarter of 1999. The customer exercised its option to purchase the equipment for its net book value, approximately $1.2 million. Currently, two of the Company’s sites now under development are projected to become operational by mid 2003. A third site under development is scheduled for the latter part of 2003.

      The Company’s fee per use agreement is typically for a ten-year term. The fixed fee per use reimbursement amount that the Company receives from the customer is based on the Company’s cost to provide the service and the anticipated volume of the customer. The contracts signed by the Company

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      The Company’s revenue sharing agreements (“retail”) are for a period of eight to fifteen years. Instead of receiving a fixed fee, the Company receives all or a percentage of the reimbursement (exclusive of physician fees) received by the customer less the operating expenses of the Gamma Knife. The Company is at risk for any reimbursement rate changes for Gamma Knife services by the government or other third party payors. The Company is also at risk if it inefficiently operates the Gamma Knife. There are no minimum volume guarantees required of the customer.

      Two customers (Yale and UAMS) each accounted for more than 10% of the Company’s revenue in 2002, and four customers (Hoag, STMH, Yale and UAMS) each accounted for more than 10% of the Company’s revenue in 2001 and 2000.

Marketing

      The Company markets its services through its preferred provider status with Elekta and a direct sales effort. The direct sales effort is executed by the Company’s Vice President of Sales, who joined the Company in April 2001. The major advantages to a health care provider in contracting with the Company for Gamma Knife services include:

Financing

      The Company’s Gamma Knife business is operated through GKF. GKF has funded its existing Gamma Knife units with loans from a single lender for 100% of the cost of each Gamma Knife, plus any sales tax, customs and duties. The loans are fully amortized over an 84-month period. The loans are collateralized by the Gamma Knife, customer contracts, and accounts receivable and are without recourse to the Company and Elekta.

      GKF currently has loan commitments on all three of its Gamma Knife sites under development and has received progress payments from its primary lender for two of those projects. The loan commitments require that GKF have a debt to equity plus subordinated debt ratio of 6 to 1. GKF currently meets the ratio requirement to be eligible for funding of the approximately $5,400,000 remaining cash requirements for the three projects under development.

Competition

      Conventional neurosurgery is the primary competitor of Gamma Knife radiosurgery. Gamma Knife surgery is gaining acceptance as an alternative and/or adjunct to conventional surgery due to its more

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      The Company’s ability to contract with additional customers for Gamma Knife services is dependent on its ability to compete against (i) Elekta, the manufacturer of the Gamma Knife, (ii) manufacturers of competing radiosurgery devices (primarily modified linear accelerators), and (iii) other companies that outsource Gamma Knife services. The Company does not have an exclusive relationship with Elekta and has previously lost sales to customers that choose to purchase a Gamma Knife directly from Elekta. The Company may continue to lose future sales to such customers and may also lose sales to the Company’s competitors.

Government Regulation

      The Company’s Gamma Knife customers receive payments for patient care from federal government and private insurer reimbursement programs. Currently in the United States, the majority of Gamma Knife services are performed on an in-patient basis, although a significant number are performed on an out-patient basis. Gamma Knife patients, with Medicare as their primary insurer and treated on either an in-patient or out-patient basis, comprise an estimated 20% to 30% of the total Gamma Knife patients treated.

      A Prospective Payment System (“PPS”) is utilized to reimburse hospitals for care given to hospital in-patients covered by federally funded reimbursement programs. Patients are classified into a Diagnosis Related Group (“DRG”) in accordance with the patient’s diagnosis, necessary medical procedures and other factors. Patient reimbursement is limited to a predetermined amount for each DRG. The reimbursement payment may not necessarily cover the cost of all medical services actually provided because the payment is predetermined. Effective October 1, 1997, Gamma Knife services for Medicare hospital in-patients were reclassified from DRG 1 to either DRG 7 or DRG 8. This reclassification is estimated to have reduced medical center revenue from the Medicare DRG program by approximately 30%.

      In 1986 and again in 1990, Congress enacted legislation requiring the Department of Health and Human Services (“DHHS”) to develop proposals for a PPS for Medicare out-patient services. DHHS proposed a new payment system, Ambulatory Product Classifications (“APC”), which affects all out-patient services performed in a hospital based facility. APC implementation took place in the third quarter of 2000.

      The APC consists of 346 clinically, homogenous classifications or groupings of codes that are typically used in out-patient billing. Out-patient services are bundled with fixed rates of payment determined according to specific regional and national factors, similar to that of the in-patient PPS.

      The reimbursement for Medicare patients receiving Gamma Knife services on an out-patient basis is estimated to have decreased approximately 40% under the APC system. The Gamma Knife APC rate was modified effective April 1, 2002 and the total reimbursement amount remains similar to the amount reimbursed by Medicare prior to that date. The Company has two contracts from which revenue are directly affected by changes in payment rates under the APC system. During 2002, these two contracted hospitals primarily treated Medicare Gamma Knife patients on an in-patient basis and therefore the Company believes that adoption of APC’s has not had a significant impact on the revenue of the Company. In 2003, one of the two contracts will start treating its patients on an outpatient basis and it is estimated that revenue will decrease by approximately $50,000 to $150,000. Some of the Company’s fee per use customers treat patients on an out-patient basis and may also have experienced a reduction in Medicare payment. There can be no assurance that the adoption of APC’s will not have a negative impact directly or indirectly on the Company’s revenue in the future.

      The payment of remuneration to induce the referral of health care business has been a subject of increasing governmental and regulatory focus in recent years. Section 1128B(b) of the Social Security Act (sometimes referred to as the “federal anti-kickback statute”) provides criminal penalties for individuals or entities that knowingly and willfully offer, pay, solicit or receive remuneration in order to induce referrals for

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      A range of federal civil and criminal laws target false claims and fraudulent billing activities. One of the most significant is the Federal False Claims Act, which prohibits the submission of a false claim or the making of a false record or statement in order to secure a reimbursement from a government-sponsored program. In recent years, the federal government has launched several initiatives aimed at uncovering practices which violate false claims or fraudulent billing laws. Claims under these laws may be brought either by the government or by private individuals on behalf of the government, through a “whistleblower” or “qui tam” action. The Company believes that it is in compliance with the Federal False Claims Act; however, because such actions are filed under seal and may remain secret for years, there can be no assurance that the Company or one of its affiliates is not named in a material qui tam action.

      Legislation in various jurisdictions requires that health facilities obtain a Certificate of Need (“CON”) prior to making expenditures for medical technology in excess of specified amounts. Four of the Company’s existing customers were required to obtain a CON or its equivalent. The CON procedure can be expensive and time consuming and may impact the length of time before Gamma Knife services commence. CON requirements vary from state to state in their application to the operations of both the Company and its customers. In some jurisdictions the Company is required to comply with CON procedures to provide its services and in other jurisdictions customers must comply with CON procedures before using the Company’s services.

      The Company’s Gamma Knife units contain Cobalt 60 radioactive sources. The medical centers that house the Company’s Gamma Knife units are responsible for obtaining possession and user’s licenses for the Cobalt 60 source.

      The Company believes it is in substantial compliance with the various rules and regulations that affect its businesses.

Insurance and Indemnification

      The Company’s contracts with equipment vendors generally do not contain indemnification provisions. The Company maintains a comprehensive insurance program covering the value of its property and equipment, subject to deductibles, which the Company believes are reasonable.

      The Company’s customer contracts generally contain mutual indemnification provisions. The Company maintains general and professional liability insurance. The Company is not involved in the practice of medicine and therefore believes its present insurance coverage and indemnification agreements are adequate for its business.

Employees

      At December 31, 2002, the Company employed eight (8) people on a full-time basis. None of these employees is subject to a collective bargaining agreement and there is no union representation within the Company. The Company maintains various employee benefit plans and believes that its employee relations are good.

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Executive Officers of the Company

      The following table provides current information concerning those persons who serve as executive officers of the Company. The executive officers were appointed by the Board of Directors and serve at the discretion of the Board of Directors.

      Ernest A. Bates, M.D., founder of the Company, has served in the positions listed above since the incorporation of the Company. He is currently a member of the Board of Trustees of The Johns Hopkins University and a Senior Trustee at the University of Rochester, a member of the Board of Overseers of the University of California at San Francisco School of Nursing, a member of the State of California High Speed Rail Authority, and a member of the Board of Directors of Salzburg Seminar. Dr. Bates is a graduate of The Johns Hopkins University and the University of Rochester School of Medicine.

      Craig K. Tagawa has served as Chief Operating Officer since February 1999 in addition to serving as Chief Financial Officer since May 1996. Mr. Tagawa also served as Chief Financial Officer from January 1992 through October 1995. Previously a Vice President in such capacity, Mr. Tagawa became a Senior Vice President on February 28, 1993. He is also the Chief Executive Officer of GK Financing, LLC. From September 1988 through January 1992, Mr. Tagawa served in various positions with the Company. He is currently a Chair of the Industrial Policy Advisory Committee of the Engineering Research Center for Computer-Integrated Surgical Systems and Technology at The Johns Hopkins University. He received his Undergraduate degree from the University of California at Berkeley and his M.B.A. from Cornell University.

Available Information

      Our Internet address is www.ashs.com. We make available free of charge through our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.

      The Company’s corporate offices are located at Four Embarcadero Center, Suite 3700, San Francisco, California, where it subleases approximately 4,100 square feet for $24,258 per month. This sublease runs through May 2006. A portion of the office space is subleased to two third parties for approximately $2,000 per month. These sub-sublease agreements run through November 2003 and May 2006.

      The Company leased 2,550 square feet of office space at Two Embarcadero Center, Suite 2370, San Francisco, CA for $11,054 per month through September 2002. This office space was subleased for $7,442 per month through the end of the lease term.

      For the year ended December 31, 2002 the Company’s aggregate net rental expenses for all properties and equipment were approximately $350,000.

      There are no material pending legal proceedings involving the Company or any of its property. The Company knows of no legal or administrative proceedings against the Company contemplated by governmental authorities.

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      None.

      The Company’s common shares, no par value (the “Common Shares”), are currently traded on the American Stock Exchange and the Pacific Exchange. The table below sets forth the high and low closing sale prices of the Common Shares of the Company on the American Stock Exchange Consolidated Reporting System for each full quarter for the last two fiscal years.

      The Company estimates that there were approximately 1,200 beneficial holders of its Common Shares at December 31, 2002.

      The Board of Directors authorized in March 1999 the repurchase of up to 500,000 shares of the Company’s Common Stock in the open market from time to time at prevailing prices. Approximately 484,000 shares were repurchased in the open market pursuant to that authorization, through December 31, 2002, at a cost of approximately $1,213,000. The Board of Directors on February 2, 2001 authorized the repurchase of up to another 500,000 shares of the Company’s common stock in the open market from time to time at prevailing prices. No shares have been repurchased under this additional authorization.

      During 2002 holders of options to acquire the Company’s common stock exercised their respective rights pursuant to such securities, resulting in the Company issuing approximately 300,000 new shares of common stock for approximately $68,000.

      On March 22, 1999 the Company adopted a Shareholder Rights Plan (“Plan”). Under the Plan, the Company made a dividend distribution of one Right for each outstanding share of the Company’s common stock as of the close of business on April 1, 1999. The Rights become exercisable only if any person or group, with certain exceptions, becomes an “acquiring person” (acquires 15 percent or more of the Company’s outstanding common stock) or announces a tender or exchange offer to acquire 15 percent or more of the Company’s outstanding common stock. The Company’s Board of Directors adopted the Plan to protect shareholders against a coercive or inadequate takeover offer. The Board of Directors is not aware that any person or group intends to make a takeover offer for the Company.

      At December 31, 2002 the Company had 3,783,203 issued and outstanding common shares, 1,753,873 common shares reserved for options, and 5,206 shares reserved pursuant to the Company’s Shareholder Rights Plan.

      The Board of Directors has declared a dividend of $.12 per common share to shareholders of record on March 15, 2003 to be paid on April 4, 2003. Shareholders of record on March 15, 2002 were paid a dividend of $0.12 per common share on April 2, 2002. The Board of Directors anticipates declaring and paying annual

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See accompanying note

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See accompanying note

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General

      During the years ended December 31, 2002, 2001 and 2000, 100% of the Company’s revenue were derived from its Gamma Knife business.

Total Revenues

      Medical services revenue increased 13.7% in 2002 compared to 2001, and increased 25.9% in 2001 compared to 2000. The increase in 2002 compared to 2001 is primarily attributable to an increase in the number of Gamma Knife units in operation as well as increased revenue at Gamma Knife locations in operation for more than one year. The increase in 2001 compared to 2000 is primarily attributable to an increase in the number of Gamma Knife units in operation.

      Gamma Knife revenue increased $1,608,000 and $2,422,000 in 2002 and 2001, respectively, compared to the prior years. The 2002 increase was primarily due to the full year inclusion of two Gamma Knife units that began operation during 2001, two new Gamma Knife units that began operation during 2002, and a 3% increase in revenue for Gamma Knife units in operation more than one year. The 2001 increase was primarily due to three new Gamma Knife units that started at various times during 2001 and the full year inclusion of one new Gamma Knife unit that commenced operation in April 2000. The Company had fourteen, twelve and nine Gamma Knife units in operation at December 31, 2002, 2001 and 2000, respectively.

      The number of Gamma Knife procedures increased 241 in 2002 compared to 2001 because of the increase in the number of Gamma Knife units in operation as well as a 7% increase in procedures for Gamma Knife units in operation more than one year. The increase of 281 procedures in 2001 compared to 2000 was primarily due to the increase in the number of Gamma Knife units in operation and a 3% increase in procedures for Gamma Knife units in operation more than one year.

      Gamma Knife revenue per procedure decreased by $200 in 2002 compared to 2001 primarily because there was an increase in the number of procedures performed at certain Gamma Knife locations that have a lower per procedure rate. The Company’s contracts generally have different procedure rates because their investment basis varies. Per procedure revenue increased by $129 in 2001 compared to 2000 primarily because of the three new contracts that started during 2001.

Costs of Operations

      The Company’s costs of operations, consisting of maintenance and supplies, depreciation and amortization, and other operating expenses (such as insurance, property taxes, sales taxes, marketing costs and other fees) increased $1,114,000 in 2002 compared to 2001, and increased $850,000 in 2001 compared to 2000.

      The Company’s maintenance and supplies costs were 3%, 3% and 2% of medical service revenue in 2002, 2001 and 2000, respectively. Maintenance and supplies costs increased $106,000 in 2002 compared to 2001, and increased $152,000 in 2001 compared to 2000. The increase in 2002 compared to 2001 was primarily due to the expiration of the warranty period on two Gamma Knife units and the full year inclusion of one Gamma Knife unit whose warranty period expired during 2001. The increase in 2001 compared to 2000 was primarily

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      Depreciation and amortization increased $541,000 in 2002 compared to 2001, and increased $663,000 in 2001 compared to 2000. The increase in 2002 was due to the addition of two new Gamma Knife units that commenced operation during second and third quarters of 2002, as well as a full year’s depreciation on two Gamma Knife units that started in second quarter 2001. The increase in 2001 was due to the addition of three new Gamma Knife units that commenced operation at various times during 2001 and a full year of depreciation of a new Gamma Knife unit that started operation during 2000.

      Other costs of operations as a percentage of medical services revenue were 11%, 9% and 10% in 2002, 2001 and 2000, respectively. The increase of $467,000 in 2002 compared to 2001 was primarily due to increased spending for marketing, and increased insurance expense because of additional Gamma Knife units and higher insurance rates. These increases were partially offset by a use tax credit of $70,000 and lower property tax expense. The increase of $35,000 in 2001 compared to 2000 was primarily due to increased sales and use tax, as well as increased insurance expense because of additional Gamma Knife units and higher insurance rates. The increase was partially offset by an $80,000 credit to property tax expense in third quarter 2001.

Selling and Administrative

      The Company’s selling and administrative costs increased $68,000 in 2002 compared to 2001, and increased $590,000 in 2001 compared to 2000. The increase in 2002 was primarily due to increased building rent of approximately $100,000 and increased legal fees of approximately $96,000. These increases were partially offset by reduced business development costs of approximately $87,000 and reduced investor relations costs of approximately $45,000. The increase in 2001 was primarily due to increased investor relations costs of approximately $64,000, increased building rent of approximately $67,000, increased insurance expense of $66,000 and increased business development costs of approximately $278,000. The increase in business development costs was primarily due to the addition of a sales person in second quarter and the implementation of a broad based marketing program throughout the year.

Interest Expense

      The Company’s interest expense decreased $19,000 in 2002 compared to 2001, and increased $338,000 in 2001 compared to 2000. The decrease in 2002 was primarily due to lower interest expense on the Company’s more mature Gamma Knife units, which offset the additional interest expense on the financing of the Company’s two new Gamma Knife units in 2002. The increase in 2001 was primarily due to the addition of three new Gamma Knife units at various times during the year, all of which were financed. All of the Company’s operating Gamma Knife units are financed by means of interest bearing debt. Eight of the Company’s fourteen Gamma Knife units have been in operation for more than three years, and have lower interest expense than newer units because interest expense decreases with each principal payment.

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Other Income and Expense

      Interest and other income decreased $309,000 in 2002 compared to 2001 and decreased $349,000 in 2001 compared to 2000. The decrease in 2002 was primarily due to reduced return on cash investments due to the market decline in interest rates that started during 2001 and continued through 2002, as well as lower invested cash balances. The decrease in 2001 was primarily due to reduced return on cash investments due to the market decline in interest rates that began during 2001.

      Minority interest increased $80,000 in 2002 and $106,000 in 2001 compared to prior years. Minority interest represents the pre-tax income earned by the minority member’s 19% interest in GKF. The increase in minority interest reflects the increased profitability of GKF.

Income Taxes

      Income tax expense increased $22,000 in 2002 compared to 2001, and increased $433,000 in 2001 compared to 2000. The Company’s 40% income tax provision for all of 2002 was reduced by a $168,000 income tax benefit from the exercise of options to purchase 260,000 common shares in the first and second quarters. The income tax benefit is a result of compensation expense that was recognized when these options for common shares were granted in 1995. The Company began recording a federal and state income tax provision in 2001 as the Company’s deferred tax liability began to exceed its deferred tax assets. The valuation allowance that had been provided for the deferred tax asset in excess of the deferred tax liability was eliminated in second quarter 2001. In 2000 the Company recorded no income tax expense or benefit because a valuation allowance was provided for the entire deferred tax asset in excess of the deferred tax liability.

      The Company anticipates that it will continue to record income tax expense if it operates profitably in the future. Currently there are minimal actual tax payments required due to net operating loss carryforwards and other deferred tax assets available for tax purposes.

      The Company had a net operating loss carryforward for federal income tax return purposes at December 31, 2002 of approximately $10,000,000.

Net Income

      The Company had net income of $1,102,000 in 2002 compared to $1,068,000 in 2001 and $1,312,000 in 2000. Net income for 2002 included increased income from operations of $445,000 compared to 2001, which was offset by reduced interest and other income of $309,000. Net income for 2001 included a provision for federal and state income taxes of $433,000, startup costs for OR21 and MedLeader of $200,000 and an

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Liquidity and Capital Resources

      The Company had cash and cash equivalents of $9,924,000 at December 31, 2002 compared to $11,580,000 at December 31, 2001. Our expected primary cash needs on both a short and long-term basis are for capital expenditures, business expansion, working capital and other general corporate purposes.

      Restricted cash of $50,000 at December 31, 2002 reflects cash that may only be used for the operations of GKF.

      Operating activities provided cash of $4,188,000 in 2002. Net income of $1,102,000, depreciation of $3,529,000 and an increase in the deferred tax liability of $207,000 were offset by a decrease in accounts payable and other accrued liabilities of $376,000, and increases in prepaid expenses and other assets of $75,000 and receivables of $202,000. The Company’s trade accounts receivable decreased slightly to $2,089,000 at December 31, 2002 from $2,160,000 at December 31, 2001. This decrease was primarily due to a reduction in the number of days’ revenue outstanding in accounts receivable (“DSO”) for some of the Gamma Knife contracts, which offset additional accounts receivable due to two new Gamma Knife contracts in 2002. The DSO was 55 and 70 days as of December 31, 2002 and December 31, 2001, respectively. We expect DSO to fluctuate in the future depending on timing of customer payments received and the mix of fee per use vs. retail customers. Other receivables increased by $273,000, primarily due to a credit on over payment of use taxes.

      Investing activities used $1,063,000 of cash in 2002. The Company used $1,346,000 of its cash towards the purchase of equipment, primarily deposits on future Gamma Knife units. This was offset by an increase in minority interest of $283,000.

      Financing activities used $4,781,000 of cash during 2002, primarily due to principal payments on long-term debt of $4,434,000 and the payment of dividends of $438,000. Proceeds received from the exercise of stock options of $226,000 was partially offset by the repurchase of common stock for $135,000.

      Working capital decreased $2,176,000 to $7,175,000 at December 31, 2002 from $9,351,000 at December 31, 2001 due to the decrease in cash, as well as an increase in the current portion of long-term debt. The increase in debt was primarily due to the financing of two additional Gamma Knife units during 2002.

      The Company invests its cash in money market funds to minimize the potential for principal erosion. Cash is invested in these short-term funds pending use in the Company’s operations. The Company believes its cash position combined with its working capital is adequate to service the Company’s cash requirements in 2003. The Company finances all of its Gamma Knife units, and anticipates that it will continue to do so with future contracts, but there can be no assurance that financing will continue to be available on acceptable terms.

Impact of Inflation and Changing Prices

      The Company does not believe that inflation has had a significant impact on operations because a substantial majority of the costs that it incurs under its customer contracts are fixed through the term of the contract.

Contractual Obligations

      The following table presents, as of December 31, 2002, the Corporation’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts, hedge basis

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      Further discussion of the long-term debt commitment is included in Note 4, and operating leases in Note 8 of the consolidated financial statements.

      The Company has no significant off-balance sheet arrangements.

Application of Critical Accounting Policies

      The Company’s consolidated financial statements are prepared in accordance with generally accepted accounting principles and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.

      The most significant accounting policies followed by the Company are presented in Note 2 to the consolidated financial statements. These policies along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions and estimates underlying those amounts, management has identified the determination of the allowance for doubtful accounts and revenue recognition to be two areas that required the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available. The following are our critical accounting

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      Revenue is recognized when services have been rendered and collectibility is reasonably assured, on either a fee per use or revenue sharing basis. The Company has twelve fee per use customers and two revenue sharing customers.

      The fee per use agreements provide for a fixed fee per procedure, and are typically for a ten year term. Revenue is recognized at the time the procedures are performed.

      The Company receives a percentage of the reimbursement received by the medical center less the operating expenses of the Gamma Knife under the revenue sharing agreements. Revenue is recognized at the time the procedures are performed, based on an estimate of the per procedure net revenue that is being collected at the medical center. The estimates are reviewed quarterly to ensure that the estimates represent the amounts that will be realized.

      Accounts receivable are recorded at net realizable value. The allowance for doubtful accounts is estimated based on historical collections plus an allowance for probable losses. For the revenue sharing customers, the Company receives reimbursement from the customer based on the customer’s collections from individuals and third-party payors such as insurance companies and Medicare. For the fee per use customers, the Company receives a fixed fee from the hospital or medical center for use of the Gamma Knife unit. Receivables are charged against the allowance in the period that they are deemed uncollectable.

      See the Index to Consolidated Financial Statements and Financial Statement Schedules included at page A-1 of this report.

      None.

PART III

      Information regarding directors is incorporated herein by reference from the Company’s definitive Proxy Statement for the 2003 Annual Meeting of Shareholders (the “2003 Proxy Statement”). Information regarding executive officers of the Company, included herein under the caption “Executive Officers of the Registrant” in Part I, Item 1 above, is incorporated herein by reference.

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      Incorporated herein by reference from the 2003 Proxy Statement.

Item 12.     

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

      Incorporated herein by reference from the 2003 Proxy Statement.

      Incorporated herein by reference from the 2003 Proxy Statement.

(a) Evaluation of disclosure controls and procedures

      Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) as of a date (the “Evaluation Date”) within 90 days of the filing date of this annual report, have concluded that as of the Evaluation Date, our disclosure controls and procedures were adequate and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities.

(b) Changes in internal controls

      There were no significant changes in our internal controls or in other factors that could significantly affect our internal controls subsequent to the Evaluation Date.

PART IV

      (a) Financial Statements and Schedules

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      (b) Exhibits

      The following Exhibits are filed with this Report.

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      (c) Reports on Form 8-K

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SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

March 31, 2003

      Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.

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CERTIFICATION

I, Ernest A. Bates, M.D., certify that:

      1. I have reviewed this annual report on Form 10-K of American Shared Hospital Services;

      2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

      3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

      4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

      5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

      6. The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

March 31, 2003

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CERTIFICATION

I, Craig K. Tagawa, certify that:

      1. I have reviewed this annual report on Form 10-K of American Shared Hospital Services;

      2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

      3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

      4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

      5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

      6. The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

March 31, 2003

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AMERICAN SHARED HOSPITAL SERVICES

INDEPENDENT AUDITOR’S REPORT

and

CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2002, 2001 and 2000

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CONTENTS

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INDEPENDENT AUDITOR’S REPORT

To the Board of Directors and Shareholders

      We have audited the accompanying consolidated balance sheets of American Shared Hospital Services as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Shared Hospital Services at December 31, 2002 and 2001, and the consolidated results of their operations and consolidated cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

Stockton, California

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AMERICAN SHARED HOSPITAL SERVICES

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AMERICAN SHARED HOSPITAL SERVICES

CONSOLIDATED BALANCE SHEETS