SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [Fee Required] For the fiscal year ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934 [No Fee Required] For the transition
period from _____________ to _____________
Commission File No. 0-10248
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FONAR CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 11-2464137
(State of incorporation) (IRS Employer Identification Number)
110 Marcus Drive, Melville, New York 11747
(Address of principal executive offices) (Zip Code)
(631) 694-2929
(Registrant's telephone number, including area code)
_____________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0001 per share
(Title of Class)
______________________________________________________________________
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 ___X___ No _______
Indicate by check mark if disclosure of delinquent filers, pursuant to Item 405
of Regulation S-K (ss.229.405 of this Chapter), is not contained herein, and
will not be contained, to the best of the registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
10-K or any amendment to the Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes ___X___ No _______
As of September 3, 2003, 85,890,712 shares of Common Stock, 4,153 shares of
Class B Common Stock, 9,562,824 shares of Class C Common Stock and 7,836,287
shares of Class A Non-voting Preferred Stock of the registrant were outstanding.
The aggregate market value of the approximately 83,301,869 shares of Common
Stock held by non-affiliates as of such date (based on the closing price per
share on September 3, 2003 as reported on the NASDAQ System) was approximately
$144,945,252 million. The other outstanding classes do not have a readily
determinable market value.
DOCUMENTS INCORPORATED BY REFERENCE
None
PART I
ITEM 1. BUSINESS
GENERAL
FONAR Corporation (the "Company" or "FONAR") is a Delaware corporation which was
incorporated on July 17, 1978. The Company's address is 110 Marcus Drive,
Melville, New York 11747 and its telephone number is (631) 694-2929. FONAR also
maintains a WEB site at www.fonar.com.
FONAR is engaged in the business of designing, manufacturing, selling and
servicing magnetic resonance imaging ("MRI" or "MR") scanners which utilize MRI
technology for the detection and diagnosis of human disease. FONAR's founders
built the first scanner in 1977 and FONAR introduced the first commercial MRI
scanner in 1980. FONAR is the originator of the iron-core non-superconductive
and permanent magnet technology.
FONAR's iron frame technology made FONAR the originator of "open" MRI scanners.
FONAR introduced the first "open" MRI in 1980. It has concentrated since on
further application of its "open" MRI, introducing the Stand-Up(TM) Brand MRI
scanner, the QUAD(TM) MRI, the Open Sky(TM) MRI and its works in progress MRI
operating room.
The product we are now most vigorously promoting is our Stand-Up(TM) MRI. The
Stand-Up(TM) MRI is unique in the industry in that it allows patients to be
scanned in a fully weight-bearing condition, such as standing, sitting or
bending in any position that causes symptoms. This means that an abnormality or
injury, such as a slipped disk can be visualized where it may not be visualized
with the patient lying down.
Health Management Corporation of America (formerly U.S. Health Management
Corporation and hereinafter sometimes referred to as "HMCA") was formed by the
Company in March 1997 as a wholly-owned subsidiary in order to enable the
Company to expand into the business of providing comprehensive management
services to medical providers. HMCA provides management services, administrative
services, office space, equipment, repair and maintenance service and clerical
and other non-medical personnel to physicians and other medical providers,
including diagnostic imaging centers.
See Note 20 to the Financial Statements for separate financial information
respecting the Company's medical equipment and physician and diagnostic
management services segments.
FORWARD LOOKING STATEMENTS.
Certain statements made in this Annual Report on Form 10-K are "forward-looking
statements" (within the meaning of the Private Securities Litigation Reform Act
of 1995) regarding the plans and objectives of Management for future operations.
Such statements involve known and unknown risks, uncertainties and other factors
that may cause actual results, performance or achievements of the Company to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. The forward-looking
statements included herein are based on current expectations that involve
numerous risks and uncertainties. The Company's plans and objectives are based,
in part, on assumptions involving the expansion of business. Assumptions
relating to the foregoing involve judgments with respect to, among other things,
future economic, competitive and market conditions and future business
decisions, all of which are difficult or impossible to predict accurately and
many of which are beyond the control of the Company. Although the Company
believes that its assumptions underlying the forward-looking statements are
reasonable, any of the assumptions could prove inaccurate and, therefore, there
can be no assurance that the forward-looking statements included in this Report
will prove to be accurate. In light of the significant uncertainties inherent in
the forward-looking statement included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.
RECENT DEVELOPMENTS AND OVERVIEW.
The Company's products and works-in-progress are intended to significantly
improve the Company's competitive position. The Company's products are the
Stand-Up(TM) MRI, the Fonar 360(TM), the QUAD(TM) MRI scanner and the Echo(TM)
MRI scanner.
The Stand-Up(TM) MRI permits, for the first time, MRI diagnoses to be made in
the weight-bearing state. The Stand-Up(TM) MRI is the only MRI scanner which
allows patients to be scanned while standing, sitting or reclining, either
horizontally or at an angle. This means that an abnormality or injury, such as a
slipped disk, will be able to be scanned under full weight-bearing conditions,
or, more often than not, in the position in which the patient experiences pain.
An elevator built into the floor brings the patient to the desired height in the
scanner. An adjustable bed allows the patients to stand, sit or lie on their
backs, sides or stomachs at any angle. In the future the Stand-Up(TM) MRI may
also be useful for MRI directed surgical procedures.
We are vigorously promoting sales of the Stand-Up(TM) MRI which we regard as our
most promising product. The market for the Stand-Up(TM) shows strong progress.
During the fiscal year ended June 30, 2003, we received orders for 22
Stand-Up(TM) MRI scanners as compared to 20 for the fiscal year ended June 30,
2002. Revenues recognized from the sale of Stand-Up(TM) MRI scanners increased
in fiscal 2003 by 119% over fiscal 2002 from approximately $11.1 million in
fiscal 2002 to approximately $24.3 million in fiscal 2003. The following chart
shows the revenues attributable to our different model scanners for the fiscal
years ended June 30, 2002 and June 30, 2003. Note that we recognize revenue on a
percentage of completion basis. Accordingly, revenue is recognized as each
sub-assembly of a scanner is manufactured. Consequently the revenues for a
fiscal period do not necessarily relate to orders placed in that period.
Model Revenues Recognized
2002 2003
Stand-Up(TM) $11,089,675 $24,298,460
Fonar 360(TM) 0 0
QUAD(TM) 0 0
Echo(TM) 0 0
Beta(TM)(used) $ 361,000 $ 100,000
The Fonar 360(TM), includes the Open Sky(TM) MRI. The magnet frame is
incorporated into the floor, ceiling and sidewalls of the scan room and is open.
Consequently, physicians and family members can walk inside the magnet to
approach the patient. The Open Sky(TM) version of the Fonar 360(TM) is
decoratively designed so that it is incorporated into the panoramic landscape
that decorates the walls of the scan room. The ability of the Fonar 360(TM) to
give physicians direct 360 access to patients and the availability of MRI
compatible surgical instruments will also enable the Fonar 360(TM), in its
future OR-360(TM) version, to be used for image guided surgery.
The QUAD(TM) MR scanner utilizes a electromagnet and is accessible from four
sides. The QUAD(TM) was the first "open" MRI scanner at high field. The greater
field strength of the QUAD(TM)'s magnet, when enhanced by the electronics
already utilized by the Company's scanners, produces images of a quality and
clarity competitive with high field superconductive magnets. The QUAD(TM)
scanner magnet is among the highest field "open MRI" scanners in the industry.
In addition, the Company offers a low cost, low-field strength open MRI scanner,
the Echo(TM).
The Company's current "works in progress" include the QUAD-S(TM) which combines
many of the features of the QUAD(TM) scanners with a superconducting magnet.
(See "Works in Progress".)
The Company's "works in progress" also include an in-office, weight-bearing
extremities scanner designed for examining the knee, foot, elbow, hand and wrist
under both weight-bearing and non-weight bearing conditions.
Fonar has an internal sales force of approximately 17 persons, concentrating on
domestic sales. Fonar continues to use manufacturer's representatives and
distributors for its foreign sales efforts. Fonar has also expanded its website
to a full-scale interactive product information desk for reaching new customers
and assisting existing customers. Fonar has been experiencing increasing scanner
sales activity originating from its website.
In March 1997, FONAR formed Health Management Corporation of America (formerly
U.S. Health Management Corporation and hereinafter sometimes referred to as
"HMCA") as a wholly-owned subsidiary for the purpose of engaging in the business
of providing comprehensive management and administrative services, office space,
equipment, repair and maintenance service for equipment and clerical and other
personnel (other than physicians) to physicians' practices and other medical
providers, including diagnostic centers.
HMCA currently is managing 11 diagnostic imaging centers, and six physical
therapy and rehabilitation practices located principally in New York State and
Florida. HMCA discontinued management of primary care offices, selling that
portion of its business in April, 2003.
PRODUCTS
The Company's principal products are its Stand-Up(TM) MRI, the Fonar 360(TM),
the QUAD(TM) scanner series and the Echo(TM).
The Stand-Up(TM) MRI is a whole-body open MRI system that enables positional MRI
(pMRI(TM)) applications, such as weight-bearing MRI studies. Operating at a
magnetic field strength of 0.6 Tesla, the scanner is a powerful, diagnostically
versatile and cost-effective Open MRI that provides a broad range of clinical
capabilities and a complete set of imaging protocols.
Patients can be scanned standing, bending, sitting, upright at an intermediate
angle or in any of the conventional recumbent positions. This multi-positional
MRI system accommodates an unrestricted range of motion for flexion, extension,
lateral bending, and rotation studies of the cervical (upper)and lumbar (lower)
spine. Previously difficult patient scanning positions can be achieved using the
system's MRI-compatible, three-dimensional, motorized patient handling system.
Patients, lying horizontally, are placed into the magnet in the conventional
manner. The system's lift and tilt functions then deliver the targeted
anatomical region to the center of the magnet. The ceiling and floor are
recessed to accommodate the full vertical travel of the table. True image
orientation is assured, regardless of the rotation angle, via computer read-back
of the table's position. Spines and extremities can be scanned in weight-bearing
states; brains can be scanned with patients either standing or sitting.
The Stand-Up(TM) MRI is exceptionally open, making it the most
non-claustrophobic whole-body MRI scanner. Patients can walk into the magnet,
stand or sit for their scans and then walk out. From the patient's point of
view, the magnet's front-open and top-open design provides an unprecedented
degree of comfort because the scanner allows the patient an unobstructed view of
the scanner room from inside the magnet, and there is nothing in front of one's
face or over one's head. The only thing in front of the patient's face during
the scan is a very large (42") panoramic TV (included with the scanner) mounted
on the wall. The bed is tilted back five degrees to stabilize a standing
patient. Special coil fixtures, a patient seat, Velcro straps, and transpolar
stabilizing bars are available to keep the patient comfortable and motionless
throughout the scanning process.
Full-range-of-motion studies of the joints in virtually any direction will be
possible, an especially promising feature for sports injuries. Full range of
motion cines, or movies, of the lumbar spine will be achieved under full body
weight.
The Stand-Up(TM) MRI will also be useful for MR-directed surgical procedures as
the surgeon would have unhindered access to the patient with no restrictions in
the vertical direction.
This easy-entry, mid-field-strength scanner should be ideal for trauma centers
where a quick MRI-screening within the first critical hour of treatment will
greatly improve patients' chances for survival and optimize the extent of
recovery.
The Fonar 360(TM) is an enlarged room sized magnet in which the floor, ceiling
and walls of the scan room are part of the magnet frame. This is made possible
by Fonar's patented Iron-Frame(TM) technology which allows the Company's
engineers to control, contour and direct the magnet's lines of flux in the
patient gap where wanted and almost none outside of the steel of the magnet
where not wanted. Consequently, this scanner allows 360 degree access to the
patient and physicians and family members are able to enter the scanner and
approach the patient.
The Fonar 360(TM) is presently marketed as a diagnostic scanner and is sometimes
referred to as the Open Sky(TM) MRI. In its Open Sky(TM) version, the Fonar
360(TM) serves as an open patient-friendly scanner which allows 360 access to
the patient on the scanner bed.
To optimize the patient-friendly character of the Open Sky(TM) MRI, the walls,
floor, ceiling and magnet poles are decorated with landscape murals. The patient
gap is twenty inches and the magnetic field strength, like that of FONAR's
QUAD(TM) MRI scanner, is 0.6 Tesla.
In the future, we may also develop the Fonar 360(TM) to function as an operating
room. We sometimes refer to this contemplated version of the Fonar 360(TM) as
the OR-360(TM). In its OR-360(TM) version, which is in the planning stages, the
enlarged room sized magnet and 360 access to the patient afforded by the Fonar
360(TM) would permit full-fledged surgical teams to walk into the magnet and
perform surgery on the patient inside the magnet. Most importantly the
exceptional quality of the MRI image and its exceptional capacity to exhibit
tissue detail on the image, by virtue of the nuclear resonance signal's
extraordinary capacity to create image contrast, can then be obtained real time
during surgery to guide the surgeon in the surgery. Thus surgical instruments,
needles, catheters, endoscopes and the like can be introduced directly into the
human body and guided to the malignant lesion by means of the MRI image. The
number of inoperable lesions should be greatly reduced by the availability of
this new capability. Most importantly treatment can be carried directly to the
target tissue.
A Neurosurgeon, for example, has direct access to the patient's head while the
patient is lying in the scanner and can perform image guided neurosurgery in
this magnet. The unimpeded access in the space above the patient is also useful
for surgical access, positioning of life support devises, neuro-surgical
microscopes and anaesthetic gases. It should be noted that these procedures have
not yet been performed in the scanner, although they are promising
possibilities.
With current treatment methods, therapy must always be restricted in the doses
that can be applied to the malignant tissue because of the adverse effects on
the healthy tissues. Thus chemotherapies must be limited at the first sign of
toxic side effects. The same is the case with radiation therapy. The Company
expects that with the OR-360(TM) treatment agents may be administrated directly
to the malignant tissue through small catheters or needles allowing much larger
doses of chemotherapy, x-rays, laser ablation, microwave, or if to be applied
directly and exclusively to the malignant tissue with more effective results.
Since the procedure of introducing a treatment needle or catheter under image
guidance will be minimally invasive the procedure can be readily repeated should
metastases occur elsewhere, with minimum impact on the patient beyond a
straightforward needle injection.
The presence of the MRI image during treatment will enable the operator to make
assessments during treatment if his treatment is being effective.
The interventional OR-360(TM) version of the Fonar 360(TM) is still in the
planning stages. There is not a prototype. A separate FDA submission for the
interventional 360 has not been made as yet and might not be necessary in that
it was not required of other MRI manufacturers in similar situations. We note
that other manufacturers have incorporated the use of their imaging machine for
use in interventional procedures without separate FDA submissions.
The QUAD(TM) MRI scanner utilizes a 6000 gauss (0.6 Tesla) iron core
electromagnet and is accessible from four sides. The QUAD(TM) was the first
"open" MRI scanner at high field.
In addition to the patient comfort, increased throughput and new applications
(such as MRI directed surgery and MRI breast imaging) made possible by the
QUAD(TM) scanner's open design, the QUAD(TM) is designed to maximize image
quality through an optimal combination of signal-to-noise (S/N) and
contrast-to-noise (C/N) ratios. The technical improvements realized in the
QUAD(TM)'s design over its predecessors also include increased image-processing
speed and diagnostic flexibility.
MRI directed surgery (laproscopic surgical procedures) is possible by the
QUAD(TM)'s ability to supply images to a monitor positioned next to the patient,
enabling a surgeon to view in process surgical procedure from an unlimited
number of vantage points. The openness of FONAR's QUAD(TM) scanner enables
surgeons to perform a wide range of surgical procedures inside the magnet.
Four sides are open on the QUAD(TM), thus allowing access to the scanning area
from four vantage points. In the case of breast imaging the access by a
physician permits image guided biopsy to be performed easily which is essential
once suspicious lesions are spotted. In addition to being far superior to x-ray
in detecting breast lesions because of the MRI's ability to create the soft
tissue contrast needed to see them, where x-ray is deficient in its ability to
generate the needed contrast between cancer and normal tissue, there is not the
painful compression of the breast characteristic of X-ray mammography.
The Stand-Up(TM) MRI, Fonar 360(TM) and QUAD(TM) scanners share much of the same
fundamental technology and offer the same speed, precision and image quality.
These scanners initiated the new market segment of high-field open MRI in which
the Fonar Stand-Up(TM) MRI is one of the market leaders. High-field open MRIs
operate at significantly higher magnetic field strengths and, therefore, produce
more of the MRI image-producing signal needed to make high-quality MRI images
(measured by signal-to-noise ratios, S/N).
The Stand-Up(TM) MRI, Fonar 360(TM) and QUAD(TM) scanners utilize a 6000 gauss
(0.6 Tesla field strength) iron core electromagnet. The greater field strength
of the 6000 gauss magnet, as compared to lower field open MRI scanners that
operate at 3,000 gauss (0.3 Tesla) when enhanced by the electronics already
utilized by the Company's scanners, produces images of higher quality and
clarity. Fonar's 0.6 Tesla open scanner magnets are among the highest field
"open MRI" magnets in the industry. One competitor's open scanner was recently
introduced at 0.7 Tesla field strength and differs negligibly from Fonar's 0.6
Tesla scanners.
The Stand-Up(TM) MRI, Fonar 360(TM) and QUAD(TM) scanners are designed to
maximize image quality through an optimal combination of signal-to-noise (S/N)
and contrast-to-noise (C/N) ratios. The technical improvements realized in the
scanners' design over their lower field predecessors also include increased
image-processing speed and diagnostic flexibility.
Several technological advances have been engineered into the Stand-Up(TM) MRI,
Fonar 360(TM) and QUAD(TM) scanners for extra improvements in S/N, including:
new high-S/N Organ Specific(TM) receiver coils\; new advanced front-end
electronics featuring high-speed, wide-dynamic-range analog-to-digital
conversion and a miniaturized ultra-low-noise pre-amplifier\; high-speed
automatic tuning, bandwidth-optimized pulse sequences, multi-bandwidth
sequences, and off-center FOV imaging capability.
In addition to the signal-to-noise ratio, however, the factor that must be
considered when it comes to image quality is contrast, the quality that enables
reading physicians to clearly distinguish adjacent, and sometimes minute,
anatomical structures. This quality is measured by contrast-to-noise ratios
(C/N). Unlike S/N, which increases with increasing field strength, relaxometry
studies have shown that C/N peaks in the mid-field range and actually falls off
precipitously at higher field strengths. The Stand-Up(TM) MRI, Fonar 360(TM) and
QUAD(TM) scanners operate squarely in the optimum C/N range.
The Stand-Up(TM) MRI, Fonar 360(TM) and QUAD(TM) provide various features
allowing for versatile diagnostic capability. For example, SMART(TM) scanning
allows for same-scan customization of up to 63 slices, each slice with its own
thickness, resolution, angle and position. This is an important feature for
scanning parts of the body that include small-structure sub-regions requiring
finer slice parameters. There is also Multi-Angle Oblique (MAO)(TM) imaging, and
oblique imaging.
The console for these scanners includes a mouse-driven, multi-window interface
for easy operation and a 19-inch, 1280 x 1024-pixel, 20-up, high-resolution
image monitor with features such as electronic magnifying glass and real-time,
continuous zoom and pan.
The Company also offers a low cost open scanner, the Echo(TM), which operates at
a .3 Tesla field strength. The Echo(TM) is an open upgraded version of the
Company's former principal product, the Beta(TM) MRI scanner, but open on four
sides to provide four directions for patient access instead of two.
Prior to the introduction of the Stand-Up(TM) MRI, Fonar 360(TM) and QUAD(TM)
scanners, the Ultimate(TM) 7000 scanner, introduced in 1990, was the Company's
principal product. The Ultimate(TM) scanner replaced the Company's traditional
principal products, the Beta(TM) 3000 scanner (which utilized a permanent
magnet) and the Beta(TM) 3000M scanner (which utilized an iron core
electromagnet). All of the Company's current and earlier model scanners create
cross-sectional images of the human body.
During fiscal 2003, sales of the Company's Stand-Up(TM) MRI scanners accounted
for approximately 45.9% of total revenues and 81.1% of medical equipment
revenues, as compared to 25.7% of total revenues and 68.7% of medical equipment
revenues in fiscal 2002. This dramatic increase shows the market penetration
being achieved by the Stand-Up(TM) MRI scanner and the successful reemphasis of
the Company on new product development and scanner sales.
During fiscal 2003, less than 1% of both total revenues and of medical equipment
revenues were derived from the sale of a refurbished Beta(TM) scanner and during
fiscal 2002, 1% of total revenues and 2.1% of medical equipment revenues were
derived from the sale of two refurbished Beta(TM) scanners. The Beta(TM) is an
older model scanner which the Company does not manufacture any longer.
Nevertheless, the Company can refurbish and sell used Beta(TM) scanners where
there is a demand for it.
During fiscal 2003 and fiscal 2002, sales of the Company's QUAD(TM), Fonar
360(TM) and Echo(TM) scanners accounted for none of the Company's revenues. The
Company's principal selling, marketing and advertising efforts have in the past
two years focused on the Stand-Up(TM) MRI, which it believes is a particularly
unique product, being the only MRI scanner which is both open and allows for
weight bearing imaging. Since the Company perceives that the Stand-Up(TM) MRI is
successfully penetrating the market and the Company's objective is to achieve
profitability as soon as possible, primarily through product sales, we expect to
continue our focus on the Stand-Up(TM) MRI in the immediate future. Further in
the future, the Company is optimistic that its other products and works in
progress, including the interventional or "operating room" version of the Fonar
360 (which is not yet available) and in office weight bearing extremities
scanner (one of our works in progress) will also contribute materially to
increased product sales.
The materials and components used in the manufacture of the Company's products
(circuit boards, computer hardware components, electrical components, steel and
plastic) are generally available at competitive prices. The Company has not had
difficulty acquiring such materials.
WORKS-IN-PROGRESS
All of the Company's products and works-in-progress seek to bring to the public
MRI products that are expected to provide important advances against serious
disease.
MRI takes advantage of the nuclear resonance signal elicited from the body's
tissues and the exceptional sensitivity of this signal for detecting disease.
Much of the serious disease of the body occurs in soft tissue. The principal
diagnostic modality currently in use for detecting disease, as in the case of
x-ray mammography, are diagnostic x-rays. X-rays discriminate soft tissues like
healthy breast tissue and cancerous tissue poorly because the x-ray particle
traverses the tissues almost equally thereby rendering the target film equally
exposed by the two tissues and creating healthy and cancerous shadows on the
film that differ very little in brightness. The image contrast between cancerous
and healthy tissue is poor, making the detection of breast cancers by the x-ray
mammogram less than optimal. If microscopic stones (microcalcifications) are not
present to provide the missing contrast the breast cancer goes undetected. They
frequently are not present. The maximum contrast available by x-ray with which
to discriminate disease is 4%. Brain cancers differ from surrounding healthy
brain by only 1.6% while the contrast by MRI is 25 times greater at 40%. X-ray
contrasts among the body's soft tissues are maximally 4%. Their contrast by MRI
is 32.5 times greater (130%).
On the other hand the soft tissue contrasts with which to distinguish cancers on
images by MRI are up to 180%. In the case of cancer these contrasts can be even
more marked making cancers readily visible and detectable anywhere in the body.
This is because the nuclear resonance signals from the body's tissues differ so
dramatically. Liver cancer and healthy liver signals differ by 180% for example.
Thus there is some urgency to bring to market an MRI based breast scanner that
can overcome the x-ray limitation and assure that mammograms do not miss serious
lesions. The added benefit of MRI mammography relative to x-ray mammography is
the elimination of the need for the patient to disrobe and the painful
compression of the breast typical of the x-ray mammogram. The patient is scanned
in her street clothes in MRI mammography. Moreover MRI mammogram scans the
entire chest wall including the axilla for the presence of nodes which the x-ray
mammogram cannot reach.
The Company views its Stand-Up(TM) MRI as having the potential for being the
ideal mammography machine as it permits the patient to be seated for the
examination, which would allow easy access for an MR guided breast biopsy when
needed.
The Company is developing a superconductive version of its open magnets. This
MRI scanner will combine the benefits of openess with the high field strength of
a superconducting magnet. The Company received FDA approval for its QUAD-S(TM)
product in June, 2001.
In addition, the Company's works in progress include an in-office weight bearing
extremities scanner which will be able to be used to examine the knee, foot,
elbow, hand and wrist. This scanner will allow scans to be performed in under
both weight- bearing and non-weight-bearing conditions.
PRODUCT MARKETING
The principal markets for the Company's scanners are hospitals and private
scanning centers.
Fonar's internal sales force is approximately 17 persons. Our internal sales
force handles the domestic market while we continue to use independent
manufacturer's representatives and distributors for foreign markets. In addition
to its internal domestic sales force, Fonar and General Electric Medical
Systems, a division of General Electric Company, have entered into an
arrangement pursuant to which General Electric Medical Systems acts as
independent manufacturer's representative for Fonar's Stand-Up(TM) MRI scanner.
In addition, the Company has expanded its website to include an interactive
product information desk for reaching customers. The Company plans to commence a
program for providing demonstrations of its products to potential customers on
an international basis. FONAR has been experiencing increasing scanner sales
activity originating from its website.
The Company has exhibited its new products at the annual meeting of the
Radiological Society of North America ("RSNA") in Chicago since November 1995
and plans to attend the RSNA meeting in November 2003 and future years. The RSNA
meeting is attended by radiologists from all over the world. Most manufacturers
of MRI scanners regularly exhibit at this meeting.
In 2003, the Company exhibited for the first time at the annual meeting of the
American Academy of Orthopedic Surgeons (AAOS). The Company has targeted
orthopedic surgeons as an important market for its Stand-Up(TM) MRI, and plans
to attend future AAOS meetings.
The Company is directing its marketing efforts to meet the demand for high field
open MRI scanners. Fonar plans to devote its principal efforts to marketing the
Stand-Up(TM) MRI, which is the only scanner in the industry that has the unique
capability of scanning patients under weight-bearing conditions and in various
positions of pain or other symptoms. In addition the Company will continue to
market its Fonar 360(TM), QUAD(TM) and Echo(TM) MRI scanners. Utilizing a 6000
gauss (0.6 Tesla field strength) iron core electromagnet, the Stand-Up(TM) MRI,
Fonar 360(TM) and QUAD(TM) scanner magnets are among the highest field "open
MRI" scanners in the industry.
The Company also will seek to introduce new MRI applications for its scanners
such as MRI-directed surgery, head-to-toe MRI preventive screening and an
in-office, weight-bearing, extremity MRI scanner.
The Company's areas of operations are principally in the United States. During
the fiscal year ended June 30, 2003, 3.0% of the Company's revenues were
generated by foreign sales, as compared to 5.0% and 1.7% for fiscal 2002 and
2001, respectively.
The Company is seeking to promote foreign sales and has sold scanners in various
foreign countries. Foreign sales, however, have not yet proved to be a
significant source of revenue.
SERVICE AND UPGRADES FOR MRI SCANNERS
The Company's customer base of installed scanners has been and will continue to
be an additional source of income, independent of direct sales.
Income is generated from the installed base in two principal areas namely,
service and upgrades. Service and maintenance revenues from the Company's
external installed base were approximately $2.0 million in fiscal 2001, $2.2
million in fiscal 2002 and $2.5 million in fiscal 2003.
The Company anticipates that its new line of scanners will result in upgrades
income in future fiscal years. The potential for upgrades income originates in
the versatility and productivity of the MRI technology. New medical uses for the
technology are constantly being discovered and are anticipated for the Upright
Imaging(TM) technology as well. New features can often be added to the scanner
by the implementation of little more than versatile new software packages. For
example, software can be added to existing MRI angiography applications to
synchronize angiograms with the cardiac cycle. By doing so the dynamics of blood
vessel filling and emptying can be visualized with movies. Such enhancements are
attractive to end users because they extend the useful life of the equipment and
enable the user to avoid obsolescence and the expense of having to purchase new
equipment. At the present time, however, upgrade revenue is not significant.
Upgrade revenues were approximately $386,898 in fiscal 2002 and $205,893 in
fiscal 2003.
Service and upgrade revenues are expected to increase as sales of scanners and
the size of the customer base increases.
RESEARCH AND DEVELOPMENT
During the fiscal year ended June 30, 2003, the Company incurred expenditures of
$5,955,667($791,216 of which was capitalized) on research and development, as
compared to $5,955,394 ($855,612 of which was capitalized) and
$6,621,225($754,804 of which was capitalized) incurred during the fiscal years
ended June 30, 2002 and June 30, 2001, respectively.
Research and development activities have focused principally, on the development
and enhancement of the new Stand-Up(TM) and Fonar 360(TM) MRI scanners and its
new extremities scanner. The Stand-Up(TM) MRI and Fonar 360(TM) involve
significant software and hardware development as the new products represent
entirely new hardware designs and architecture requiring a new operating
software. The Company's research activity includes developing a multitude of new
features for the upright scanning made possible by the high speed processing
power of its scanners. In addition, the Company's research and development
efforts include the development of new software, such as its "Sympulse"(TM)
software and hardware upgrade and the designing of new receiver surface coils
for the Stand-Up(TM) MRI.
BACKLOG
The Company's backlog of unfilled orders at July 1, 2003 was approximately $26.8
million, as compared to $25.5 million at July 1, 2002. Of these amounts,
approximately $4.9 million and $7.7 million had been paid to the Company as
customer advances as at July 1, 2003 and July 1, 2002, respectively. Of the
backlog amounts at July 1, 2003 and July 1, 2002, $2.5 and $6.9 million
respectively represented orders from affiliates. It is expected that the
existing backlog of orders will be filled within the current fiscal year. The
Company's contracts generally provide that if a customer cancels an order, the
customer's initial down payment for the MRI scanner is nonrefundable.
PATENTS AND LICENSES
The Company currently has numerous patents in effect which relate to the
technology and components of the MRI scanners. The Company believes that these
patents, and the know-how it developed, are material to its business.
Dr. Damadian granted an exclusive world-wide license to the Company to make, use
and sell apparatus covered by certain domestic and foreign patents in his name
relating to MRI technology. No patents covered by this license are in effect any
longer.
One of the patents, issued in the name of Dr. Damadian and covered by said
license, was United States patent No. 3,789,832, Apparatus and Method for
Detecting Cancer in Tissue (the "1974 Patent"). The development of the Beta(TM)
3000 was based upon the 1974 Patent, and Management believes that the 1974
Patent was the first of its kind to utilize MR to scan the human body and to
detect cancer. The 1974 Patent was extended beyond its original 17-year term and
expired in February, 1992. None of the recoveries with respect to the
enforcement of this patent were received by Dr. Damadian.
Historically, the patent for multiple angle oblique imaging generated
significant revenues in connection with the enforcement and settlement of our
patent litigations. As a result of these litigations and settlements, our
competitors are now entitled to use this technology as well. This patent will
expire in 2006.
The Company has significantly enhanced its patent position within the industry
and now possesses a substantial patent portfolio which provides the Company,
under the aegis of United States patent law, "the exclusive right to make, use
and sell" many of the scanner features which FONAR pioneered and which are now
incorporated in most MRI scanners sold by the industry. The Company has 84
patents issued and approximately 50 patents pending. A substantial number of
FONAR's existing patents specifically relate to protecting FONAR's position in
the high-field iron frame open MRI market. The patents further enhance Dr.
Damadian's pioneer patent (the 1974 Patent), that initiated the MRI industry and
provided the original invention of MRI scanning. The 84 issued patents expire at
various times between 2004 and 2021.
The Company has entered into a cross-licensing agreement (utilizing other than
FONAR's MRI technology) with another entity to use prior art developed for
nuclear magnetic resonance technology and has entered into a license to utilize
the MRI technology covered by the existing patent portfolio of a patent holding
company. The Company also has patent cross-licensing agreements with other MRI
manufacturers.
PRODUCT COMPETITION
MRI SCANNERS
A majority of the MRI scanners in use in hospitals and outpatient facilities and
at mobile sites in the United States are based on high field air core magnet
technology while the balance are based on open iron frame magnet technology. In
2000, the size of the MRI market in the United States was approximately $1.041
billion. In 2001, the size of the MRI market in the United States was
approximately $1.202 billion. For the first half of 2002, the size of the MRI
market in the United States was approximately $682.4 million ($1.365 annualized)
FONAR's open iron frame MRI scanners are competing principally with high-field
air core scanners. FONAR's open MRI scanners, however, utilizing a 6,000 gauss
(0.6 Tesla field strength) iron core electromagnet, were the first "open" MR
scanners at high field strength. In addition FONAR's works-in-progress include a
superconductive version of its open magnets.
FONAR believes that its MRI scanners have significant advantages as compared to
the high-field air core scanners of its competitors. These advantages include:
1. There is no expansive fringe magnetic field. High field air core scanners
require a more expensive shielded room than is required for the iron frame
scanners. The shielded room required for the iron frame scanners is intended to
prevent interference from external radio frequencies.
2. They are more open, quiet and in the case of the QUAD(TM) scanners allow for
faster throughput of patients.
3. Their annual operating costs are lower.
4. They can scan the trauma victim, the cardiac arrest patient, the
respirator-supported patient, and premature and newborn babies. This is not
possible with high- field air core scanners because their magnetic field
interferes with conventional life-support equipment.
The principal competitive disadvantage of the Company's products is that they
are not "high field strength" (1.0 Tesla +) magnets. As a general principle, the
higher field strength can produce a faster scan. In some parts of the body a
faster scan can be traded for a clearer picture. Although the Company believes
that the lower cost of its systems plus the benefits of "openness" provided by
its scanners compensate for the lower field strength, certain customers will
still prefer the higher field strength.
FONAR faces competition within the MRI industry from such firms as General
Electric Company, Philips N.V., Toshiba Corporation, Hitachi Corporation and
Siemens A.G. Most competitors have marketing and financial resources more
substantial than those available to the Company. They have in the past, and may
in the future, heavily discount the sales price of their scanners. Such
competitors sell both high field air core and iron frame products. FONAR's
current market share of the United States market for MRI scanners is under 2.0%.
FONAR introduced the first "Open MRI" in 1980. "Open MRI" was made possible by
FONAR's introduction of an MRI magnet built on an iron frame. Thus the magnetic
flux generating apparatus of the magnet (magnet coils or permanent magnet
bricks) was built into a frame of steel. The steel frame provided a return path
for the magnetic lines of force and thereby kept the magnetic lines of force
contained within the magnet. This enabled FONAR, from 1980 on, to show that the
FONAR magnet was the only magnet that allowed the patients to stretch out their
arms, the only "open" MRI.
The iron frame, because it could control the magnetic lines of force and place
them where wanted and remove them from where not wanted (such as in the
operating room where surgeons are standing), provided a much more versatile
magnet design than was possible with air core magnets. Air core magnets contain
no iron but consist entirely of turns of current carrying wire. FONAR's patented
work-in-progress superconductive iron frame magnet, however, combines the high
field capability of the air core superconductive magnets with the control and
versatility of the open iron frame magnets, thereby joining the best features of
both designs into a single magnet. Thus the air core superconductive magnets
made by Fonar's large competitors that have dominated the MRI market since 1983
remain the confining "tunnel" design that the public has generally resented.
For an 11 year period from 1983-1994, Fonar's large competitors (with one
exception) generally rejected Fonar's "open" design but by now all have added
the iron frame "open" magnet to their MRI product lines. One principal reason
for this market shift, in addition to patient claustrophobia, is the awareness
that the "open" magnet designs permit access to the patient to perform surgical
procedures under MRI image guidance, a field which is now growing rapidly and is
called "interventional MRI."
Fonar's future OR-360(TM) version of the Fonar 360(TM) explicitly addresses this
growing market reception of MRI guided surgical procedures but is not yet
available as a product. Fonar's Stand-Up(TM) and QUAD(TM) magnets do also.
Although not enabling a full operating theater as the OR-360(TM) does, the iron
frame "Open" QUAD(TM) and Indomitable designs permit ready access to the patient
from four sides and therefore enables a wide range of interventional surgical
procedures such as biopsies and needle or catheter delivered therapies to be
performed under MRI image guidance. The "tunnel" air core superconductive
scanners do not permit access to the patient while the patient is inside the
scanner.
While Fonar's current market share of the domestic MRI market is under 2.0%,
FONAR expects to be a leader in domestic open MRI market for several reasons. In
MRI, scanning speed and image quality is controlled by the strength of the
magnetic field. Fonar's Stand-Up(TM), Fonar 360(TM) and QUAD(TM) scanners
operate at 0.6 Tesla, which make them among the highest field strength open MRI
scanners. Furthermore, the Stand-Up(TM) MRI is the only MRI which allows
patients to be scanned under weight-bearing conditions. High field MRI
manufacturers convinced the marketplace for FONAR, and the marketplace accepts,
that higher field strength translates directly into superior image quality and
faster scanning speeds. No companies possess the Stand-Up(TM) MRI or Fonar
360(TM) scanners, and FONAR possesses the pioneer patents on "Open MRI"
technology.
OTHER IMAGING MODALITIES
FONAR's MRI scanners also compete with other diagnostic imaging systems, all of
which are based upon the ability of energy waves to penetrate human tissue and
to be detected by either photographic film or electronic devices for
presentation of an image on a television monitor. Three different kinds of
energy waves - X-ray, gamma and sound - are used in medical imaging techniques
which compete with MRI medical scanning, the first two of which involve exposing
the patient to potentially harmful radiation. These other imaging modalities
compete with MRI products on the basis of specific applications.
X-rays are the most common energy source used in imaging the body and are
employed in three imaging modalities:
1. Conventional X-ray systems, the oldest method of imaging, are typically used
to image bones and teeth. The image resolution of adjacent structures that have
high contrast, such as bone adjacent to soft tissue, is excellent, while the
discrimination between soft tissue organs is poor because of the nearly
equivalent penetration of x-rays.
2. Computerized Tomography ("CT") systems couple computers to x-ray instruments
to produce cross-sectional images of particular large organs or areas of the
body. The CT scanner addresses the need for images, not available by
conventional radiography, that display anatomic relationships spatially.
However, CT images are generally limited to the transverse plane and cannot
readily be obtained in the two other planes (sagittal and coronal). Improved
picture resolution is available at the expense of increased exposure to x-rays
from multiple projections. Furthermore, the pictures obtained by this method are
computer reconstructions of a series of projections and, once diseased tissue
has been detected, CT scanning cannot be focused for more detailed pictorial
analysis or obtain a chemical analysis.
3. Digital radiography systems add computer image processing capability to
conventional x-ray systems. Digital radiography can be used in a number of
diagnostic procedures which provide continuous imaging of a particular area with
enhanced image quality and reduced patient exposure to radiation.
Nuclear medicine systems, which are based upon the detection of gamma radiation
generated by radioactive pharmaceuticals introduced into the body, are used to
provide information concerning soft tissue and internal body organs and
particularly to examine organ function over time.
Ultrasound systems emit, detect and process high frequency sound waves reflected
from organ boundaries and tissue interfaces to generate images of soft tissue
and internal body organs. Although the images are substantially less detailed
than those obtainable with x-ray methods, ultrasound is generally considered
harmless and therefore has found particular use in imaging the pregnant uterus.
X-ray machines, ultrasound machines, digital radiography systems and nuclear
medicine compete with the MRI scanners by offering significantly lower price and
space requirements. However, FONAR believes that the quality of the images
produced by its MRI scanners is generally superior to the quality of the images
produced by those other methodologies.
GOVERNMENT REGULATION
FDA Regulation
The Food and Drug Administration in accordance with Title 21 of the Code of
Federal Regulations regulates the manufacturing and marketing of FONAR's MRI
scanners. The regulations can be classified as either pre-market or post-market.
The pre-market requirements include obtaining marketing clearance, proper device
labeling, establishment registration and device listing. Once the products are
on the market, FONAR must comply with post-market surveillance controls. These
requirements include the Quality Systems (QS) regulation, also known as Good
Manufacturing Practices or GMPs, and Medical Device Reporting (MDR) regulations.
The QS regulation is a quality assurance requirement that covers the design,
packaging, labeling and manufacturing of a medical device. The MDR regulation is
an adverse event-reporting program.
Classes of Products
Under the Medical Device Amendments of 1976 to the Federal Food, Drug and
Cosmetic Act, all medical devices are classified by the FDA into one of three
classes. A Class I device is subject only to certain controls, such as labeling
requirements and manufacturing practices; a Class II device must comply with
certain performance standards established by the FDA; and a Class III device
must obtain pre-market approval from the FDA prior to commercial marketing.
FONAR's products are Class II devices. Class I devices are subject to the least
regulatory control. They present minimal potential for harm to the user and are
often simpler in design than Class II or Class III devices. Class I devices are
subject to "General Controls" as are Class II and Class III devices. General
Controls include:
1.Establishment registration of companies which are required to register under
21 CFR Part 807.20, such as manufacturers, distributors, re-packagers and
re-labelers. 2.Medical device listing with FDA of devices to be marketed.
3.Manufacturing devices in accordance with the Good Manufacturing Practices
(GMP) regulation in 21 CFR Part 820. 4.Labeling devices in accordance with
labeling regulations in 21 CFR Part 801 or 809. 5.Submission of a Premarket
Notification [510(k)] before marketing a device.
Class II devices are those for which general controls alone are insufficient to
assure safety and effectiveness, and existing methods are available to provide
such assurances. In addition to complying with general controls, Class II
devices are also subject to special controls. Special controls may include
special labeling requirements, guidance documents, mandatory performance
standards and post-market surveillance.
The Company received approval to market its Beta(TM) 3000 and Beta(TM) 3000M
scanners as Class III devices on September 26, 1984 and November 12, 1985. On
July 28, 1988, the Magnetic Resonance Diagnostic Device which includes MR
Imaging and MR Spectroscopy was reclassified by the FDA to Class II status.
Consequently, Fonar's products are now classified as Class II products. On June
25, 1992, Fonar received FDA clearance to market the Ultimate(TM) Magnetic
Resonance Imaging Scanner as a Class II device. Fonar received FDA clearance to
market the QUAD(TM) 7000 in April 1995 and the QUAD(TM) 12000 in November 1995.
On March 16, 2000, Fonar received FDA clearance to market the Fonar 360(TM) for
diagnostic imaging (the Open Sky(TM) version)and on October 3, 2000 received FDA
clearance for the Stand-Up(TM) MRI. The Company received FDA clearance for the
QUAD-S(TM) on June 6, 2001 . The Company anticipates that it may need FDA
clearance for the OR-360(TM) version of the Fonar 360(TM).
Premarketing Submission
Each person who wants to market Class I, II and some III devices intended for
human use in the U.S. must submit a 510(k) to FDA at least 90 days before
marketing unless the device is exempt from 510(k) requirements. A 510(k) is a
pre-marketing submission made to FDA to demonstrate that the device to be
marketed is as safe and effective, that is, substantially equivalent (SE), to a
legally marketed device that is not subject to pre-market approval (PMA).
Applicants must compare their 510(k) device to one or more similar devices
currently on the U.S. market and make and support their substantial equivalency
claims.
The FDA is committed to a 90-day clearance after submission of a 510(k),
provided the 510(k) is complete and there is no need to submit additional
information or data.
The 510(k) is essentially a brief statement and description of the product. As
Fonar's scanner products are Class II products, there are no pre-market data
requirements and the process is neither lengthy nor expensive.
An investigational device exemption (IDE) allows the investigational device to
be used in a clinical study pending FDA clearance in order to collect safety and
effectiveness data required to support the Premarket Approval (PMA) application
or a Premarket Notification [510(k)] submission to the FDA. Clinical studies are
most often conducted to support a PMA.
For the most part, however, Fonar has not found it necessary to utilize IDE's.
The standard 90 day clearance for our new MRI scanner products classified as
Class II products makes the IDE unnecessary, particularly in view of the time
and effort involved in compiling the information necessary to support an IDE.
Quality System Regulation
The Quality Management System is applicable to the design, manufacture,
administration of installation and servicing of magnetic resonance imaging
scanner systems. The FDA has authority to conduct detailed inspections of
manufacturing plants, to establish Good Manufacturing Practices which must be
followed in the manufacture of medical devices, to require periodic reporting of
product defects and to prohibit the exportation of medical devices that do not
comply with the law.
Medical Device Reporting Regulation
Manufacturers must report all MDR reportable events to the FDA. Each
manufacturer must review and evaluate all complaints to determine whether the
complaint represents an event which is required to be reported to FDA. Section
820.3(b) of the Quality Systems regulation defines a complaint as, "any written,
electronic or oral communication that alleges deficiencies related to the
identity, quality, durability, reliability, safety, effectiveness, or
performance of a device after it is released for distribution."
A report is required when a manufacturer becomes aware of information that
reasonably suggests that one of their marketed devices has or may have caused or
contributed to a death, serious injury, or has malfunctioned and that the device
or a similar device marketed by the manufacturer would be likely to cause or
contribute to a death or serious injury if the malfunction were to recur.
Malfunctions are not reportable if they are not likely to result in a death,
serious injury or other significant adverse event experience.
A malfunction which is or can be corrected during routine service or device
maintenance still must be reported if the recurrence of the malfunction is
likely to cause or contribute to a death or serious injury if it were to recur.
Fonar has established and maintains written procedures for implementation of the
MDR regulation. These procedures include internal systems that:
provide for timely and effective identification, communication and evaluation of
adverse events;
provide a standardized review process and procedures for determining
whether or not an event is reportable; and
provide procedures to insure the timely transmission of complete reports.
These procedures also include documentation and record keeping requirements for:
information that was evaluated to determine if an event was reportable;
all medical device reports and information submitted to the FDA;
any information that was evaluated during preparation of annual
certification report(s); and
systems that ensure access to information that facilitates timely follow up
and inspection by FDA.
FDA Enforcement
FDA may take the following actions to enforce the MDR regulation:
FDA-Initiated or Voluntary Recalls
Recalls are regulatory actions that remove a hazardous, potentially hazardous,
or a misbranded product from the marketplace. Recalls are also used to convey
additional information to the user concerning the safe use of the product.
Either FDA or the manufacturer can initiate recalls.
There are three classifications, i.e., I, II, or III, assigned by the Food and
Drug Administration to a particular product recall to indicate the relative
degree of health hazard presented by the product being recalled.
Class I
Is a situation in which there is a reasonable probability that the use of, or
exposure to, a violative product will cause serious adverse health consequences
or death.
Class II
Is a situation in which use of, or exposure to, a violative product may cause
temporary or medically reversible adverse health consequences or where the
probability of serious adverse health consequences is remote.
Class III
Is a situation in which use of, or exposure to, a violative product is not
likely to cause adverse health consequences.
FONAR has initiated four Class II recalls. The recalls involved making minor
corrections to the product in the field. Frequently, corrections which are made
at the site of the device are called field corrections as opposed to recalls.
Civil Money Penalties
The FDA, after an appropriate hearing, may impose civil money penalties for
violations of the FD&C Act that relate to medical devices. In determining the
amount of a civil penalty, FDA will take into account the nature, circumstances,
extent, and gravity of the violations, the violator's ability to pay, the effect
on the violator's ability to continue to do business, and any history of prior
violations. The civil money penalty may not exceed $15,000 for each violation
and may not exceed $1,000,000 for all violations adjudicated in a single
proceeding, per person.
Warning Letters
FDA issues written communications to a firm, indicating that the firm may incur
more severe sanctions if the violations described in the letter are not
corrected. Warning letters are issued to cause prompt correction of violations
that pose a hazard to health or that involve economic deception. The FDA
generally issues the letters before pursuing more severe sanctions.
Seizure
A seizure is a civil court action against a specific quantity of goods which
enables the FDA to remove these goods from commercial channels. After seizure,
no one may tamper with the goods except by permission of the court. The court
usually gives the owner or claimant of the seized merchandise approximately 30
days to decide a course of action. If they take no action, the court will
recommend disposal of the goods. If the owner decides to contest the
government's charges, the court will schedule the case for trial. A third option
allows the owner of the goods to request permission of the court to bring the
goods into compliance with the law. The owner of the goods is required to
provide a bond (security deposit) to assure that they will perform the orders of
the court, and the owner must pay for FDA supervision of any activities by the
company to bring the goods into compliance.
Citation
A citation is a formal warning to a firm of intent to prosecute the firm if
violations of the FD&C Act are not corrected. It provides the firm an
opportunity to convince FDA not to prosecute.
Injunction
An injunction is a civil action filed by FDA against an individual or company.
Usually, FDA files an injunction to stop a company from continuing to
manufacture, package or distribute products that are in violation of the law.
Prosecution
Prosecution is a criminal action filed by FDA against a company or individual
charging violation of the law for past practices.
Foreign and Export Regulation
The Company obtains approvals as necessary in connection with the sales of its
products in foreign countries. In some cases, FDA approval has been sufficient
for foreign sales as well. The Company's standard practice has been to require
either the distributor or the customer to obtain any such foreign approvals or
licenses which may be required.
Legally marketed devices that comply with the requirements of the Food Drug &
Cosmetic Act require a Certificate to Foreign Government issued by the FDA for
export. Other devices that do not meet the requirements of the FD&C Act but
comply with the laws of a foreign government require a Certificate of
Exportability issued by the FDA. All products which Fonar sells have FDA
clearance and would fall into the first category.
Foreign governments have differing requirements concerning the import of medical
devices into their respective jurisdictions. The European Union (EU), made up of
15 individual countries, has some essential requirements described in the EU's
Medical Device Directive (MDD). In order to export to one of these countries,
FONAR must meet the essential requirements of the MDD and any additional
requirements of the importing country. The essential requirements are similar to
some of the requirements mandated by the FDA. In addition the MDD requires that
FONAR enlist a Notified Body to examine and assess our documentation (Technical
Construction File) and verify that the product has been manufactured in
conformity with the documentation. The notified body must carry out or arrange
for the inspections and tests necessary to verify that the product complies with
the essential requirements of the MDD, including safety performance and
Electromagnetic Compatibility (EMC). Also required is a Quality System
(ISO-9001) assessment by the Notified Body. Fonar was approved for ISO 9001
certification for its Quality Management System in April, 1999.
Fonar received clearance to sell the QUAD(TM) scanners in the EU in May, 1999.
Clearances for the Fonar 360(TM) and Stand-Up(TM) MRI scanners were obtained in
May, 2002.
Other countries such as China and Russia require that their own testing
laboratories perform an evaluation of our devices. This requires that we must
bring the foreign agency's personnel to the USA to perform the evaluation at
Fonar's expense before exporting.
Some countries, including many in Latin America and Africa, have very few
regulatory requirements.
Because Fonar's export sales are not material at this point, foreign regulation
does not have a material effect on Fonar. In any case, Fonar does not believe
that foreign regulation will deter its efforts to penetrate foreign markets.
Reimbursement to Medical Providers for MRI Scans
Effective November 22, 1985, the Department of Health and Human Services
authorized reimbursement of MRI scans under the Federal Medicare program. In
addition, most private insurance companies have authorized reimbursement for MRI
scans.
Anti-Kickback and Self-Referral Legislation
Proposed and enacted legislation at the State and Federal levels has restricted
referrals by physicians to medical and diagnostic centers in which they or their
family members have an interest. In addition, regulations have been adopted by
the Secretary of Health and Human Services which provide limited "safe harbors"
under the Medicare Anti-Kickback Statute. These safe harbors describe payments
and transactions which are permitted between an entity receiving reimbursement
under the Medicare program and those having an interest in or dealings with the
entity. Although the Company cannot predict the overall effect of the adoption
of these regulations on the medical equipment industry, the use and continuation
of limited partnerships (where investors may be referring physicians) to own and
operate MRI scanners could be greatly diminished.
HEALTH MANAGEMENT CORPORATION OF AMERICA (PHYSICIAN AND DIAGNOSTIC SERVICES
MANAGEMENT BUSINESS)
Health Management Corporation of America (formerly known as U.S. Health
Management Corporation and referred to as "HMCA") was organized by the Company
in March 1997. HMCA is a wholly-owned subsidiary which engages in the business
of providing comprehensive management services to physicians' practices and
other medical providers, in particular diagnostic imaging centers. The services
provided by the Company include development, administration, leasing of office
space, facilities and medical equipment, provision of supplies, staffing and
supervision of non-medical personnel, legal services, accounting, billing and
collection and the development and implementation of practice growth and
marketing strategies.
HMCA currently manages 11 MRI facilities and six physical therapy and
rehabilitation practices. In April, 2003, HMCA sold its subsidiary A&A Services,
Inc. which managed four primary care medical practices. For the 2003 fiscal
year, the revenues HMCA recognized from the MRI facilities were $13,497,837 and
the revenues recognized from the physical therapy and rehabilitation practices
were $9,435,000. The revenues recognized from the primary care medical practices
were $1,179,095 through April 9, 2003, when this part of the Company's business
was sold. These revenues have been reclassified as part of discontinued
operations in the financial statements.
HMCA GROWTH STRATEGY
HMCA's growth strategy focuses on upgrading and expanding the existing
facilities it manages and expanding the number of facilities it manages for its
clients. Our most important effort in this regard is to promote and facilitate
the replacement of existing MRI scanners with new Fonar Stand-Up(TM) MRI
scanners at the most promising locations. To date, we have installed new
Stand-Up(TM) MRI scanners at the MRI facilities we manage in Islandia, New York,
Staten Island, New York and Bensonhurst, New York. We also plan to install
Stand-Up(TM) MRI scanners at other MRI facilities we manage. The first
additional location at which we plan to install a Stand-Up(TM) MRI scanner is in
Boca Raton, Florida which will be a new site to replace the one currently
located in Deerfield Beach, Florida.
HMCA's longer range plans involve opening new MRI facilities clustered in
selected television and radio media areas in New York, Florida, Houston, Boston,
Los Angeles and Chicago, although at the present time our efforts are focused
only in the New York and Florida markets. Marketing efforts in targeted areas
include television, radio and billboard advertising.
In addition, HMCA has promoted the opening of new physical therapy and
rehabilitation offices by existing clients, expanding the number of such offices
from the initial three offices we managed in August, 1998 to the six offices we
currently manage. HMCA no longer manages any primary care offices and has no
present plans to do so. In April, 2003, HMCA sold A&A Services, Inc., a company
which it had acquired in 1998. This subsidiary managed four primary care
offices.
PHYSICIAN AND DIAGNOSTIC MANAGEMENT SERVICES
HMCA's services to the facilities and practices it manages encompass
substantially all of their business operations. The facilities and practices are
controlled, however, by the physician owners, not HMCA, and all medical services
are performed by the physicians and other medical personnel under their
supervision. HMCA is the management company and performs services of a
non-professional nature. These services include:
(1) Offices and Equipment. HMCA identifies, negotiates leases for and/or
provides office space and equipment to its clients. This includes
technologically sophisticated medical equipment. HMCA also provides improvements
to leaseholds, assistance in site selection and advice on improving, updating,
expanding and adapting to new technology.
(2) Personnel. HMCA staffs all the non-medical positions of its clients with its
own employees, eliminating the client's need to interview, train and manage
non-medical employees. HMCA processes the necessary tax, insurance and other
documentation relating to employees.
(3) Administrative. HMCA assists in the scheduling of patient appointments,
purchasing of medical supplies and equipment and handling of reporting,
accounting, processing and filing systems. It prepares and files the physician
portions of complex forms to enable its clients to participate in managed care
programs and to qualify for insurance reimbursement. We assist the clients to
implement programs and procedures to ensure full and timely regulatory
compliance and appropriate cost reimbursement under no-fault insurance and
workers' compensation guidelines, as well as compliance with other applicable
governmental requirements and regulations, including HIPAA and other privacy
requirements.
(4) Billing and Collections. HMCA is responsible for the billing and collection
of revenues from third-party payors including those governed by no-fault and
workers' compensation statutes.
(5) Cost Saving Programs. Based on available volume discounts, HMCA seeks to
obtain favorable pricing for medical supplies, equipment, contrast agents (such
as gadolinuim) and other inventory for its clients.
(6) Diagnostic Imaging and Ancillary Services. HMCA can offer access to
diagnostic imaging equipment through diagnostic imaging facilities it manages.
The Company is expanding the ancillary services offered in its network to
include CT-scans, x-rays, ultrasound, and other ancillary services useful to its
clients.
(7) Marketing Strategies. HMCA is responsible for developing marketing plans for
its clients.
(8) Expansion Plans. HMCA assists the clients in developing expansion plans.
Additional physicians, physical therapists and technologists have been added
where needed.
HMCA advises clients on all aspects of their businesses, including expansion
where it is a reasonable objective, on a continuous basis. HMCA's objective is
to free physicians from as many non-medical duties as is practicable. Practices
can treat patients more efficiently if the physicians can spend less time on
business and administrative matters and more time practicing medicine.
HMCA provides its services pursuant to negotiated contracts with its clients.
While HMCA believes it can provide the greatest value to its clients by
furnishing the full range of services appropriate to that client, HMCA would
also be willing to enter into contracts providing for a more limited spectrum of
management services.
In the case of contracts with the MRI facilities, fees are charged by HMCA based
on the number of procedures performed. In the case of the physical
rehabilitation and medical practices, flat fees are charged on a monthly basis.
Fees are subject to adjustment on an annual basis, but must be based on mutual
agreement. The per procedure charges to the MRI facilities range from $325 to
$1,060 per MRI scan. The monthly fees charged to the physical rehabilitation
practices range from approximately $75,000 to $285,000. No MRI facilities or
physical and rehabilitation facilities are owned by HMCA. Only one chiropractic
practice managed by HMCA, providing HMCA with management fees of approximately
$22,500 in fiscal 2003 and $180,000 in fiscal 2002, was owned by a seller in an
acquisition. HMCA discontinued management of this practice in the beginning of
the second quarter of fiscal 2003.
The practices and the facilities enter into contracts with third party payors,
including managed care companies. With the exception of some capitated health
plans in which the medical practices previously managed by HMCA up to April,
2003, participated, neither HMCA's clients nor HMCA participate in any risk
sharing arrangements. Capitated plans are those HMO programs where the provider
is paid a flat monthly fee per patient. All of the fees from capitated health
plans were attributable to medical professional corporations managed by A & A
Services, Inc., representing 48%, and 46% of their revenues in fiscal 2003 and
fiscal 2002, respectively. Since divesting itself of the A&A Services, Inc. as
of April 8, 2003, none of HMCA's clients nor HMCA have participated in any
capitated or other risk sharing arrangements.
HMCA MARKETING
HMCA's marketing strategy is to expand the business and improve the facilities
and practices which it manages. HMCA will also seek to increase the number of
locations of those facilities and practices where market conditions are
promising. HMCA will seek to promote growth of its clients' patient volume and
revenue through installing new Stand-Up(TM) MRI scanners at MRI facilities and
advertising in television, radio and other media.
HMCA's lack of capital resources has prevented HMCA from increasing the number
of clients it manages through acquisitions since it made its most recent
acquisition in August, 1998.
DIAGNOSTIC IMAGING FACILITIES AND OTHER ANCILLIARY SERVICES
Diagnostic imaging facilities managed by HMCA provide diagnostic imaging
services to patients referred by physicians who are either in private practice
or affiliated with managed care providers or other payor groups. The facilities
are operated in a manner which eliminates the admission and other administrative
inconveniences of in-hospital diagnostic imaging services. Imaging services are
performed in an outpatient setting by trained medical technologists under the
direction of physicians. Following diagnostic procedures, the images are
reviewed by the interpreting physicians who prepare a report of these tests and
their findings. These reports are transcribed by HMCA personnel and then
delivered to the referring physician.
HMCA develops marketing programs in an effort to establish and maintain
profitable referring physician relationships and to maximize reimbursement
yields. These marketing approaches identify and target selected market segments
consisting of area physicians with certain desirable medical specialties and
reimbursement yields. Corporate and facility managers determine these market
segments based upon an analysis of competition, imaging demand, medical
specialty and payor mix of each referral from the local market. HMCA also
directs marketing efforts at managed care providers.
Managed care providers have become an important factor in the diagnostic imaging
industry. To further its position, HMCA will seek to expand the imaging
modalities offered at its managed diagnostic imaging facilities.
COMPETITION (HMCA)
The physician and diagnostic management services field is highly competitive. A
number of large hospitals have acquired medical practices and this trend may
continue. HMCA expects that more competition will develop. Many competitors have
greater financial and other resources than HMCA.
With respect to the diagnostic imaging facilities managed by HMCA, the
outpatient diagnostic imaging industry is highly competitive. Competition
focuses primarily on attracting physician referrals at the local market level
and increasing referrals through relationships with managed care organizations.
HMCA believes that principal competitors for the diagnostic imaging centers are
hospitals and independent or management company-owned imaging centers.
Competitive factors include quality and timeliness of test results, ability to
develop and maintain relationships with managed care organizations and referring
physicians, type and quality of equipment, facility location, convenience of
scheduling and availability of patient appointment times. HMCA believes that it
will be able to effectively meet the competition in the outpatient diagnostic
imaging industry by installing the new Fonar Stand-Up(TM) MRI scanners at its
most promising facilities.
GOVERNMENT REGULATION APPLICABLE TO HMCA
FEDERAL REGULATION
Stark Law
Under the federal Self-Referral Law (the "Stark Law") (which is applicable to
Medicare and Medicaid patients) and the self-referral laws of various States,
certain health practitioners (including physicians, chiropractors and
podiatrists) are prohibited from referring their patients for the provision of
designated health services (including diagnostic imaging and physical therapy
services) to any entity with which they or their immediate family members have a
financial relationship, unless the referral fits within one of the specific
exceptions in the statutes or regulations. Statutory exceptions under the Stark
Law include, among others, direct physician services, in-office ancillary
services rendered within a group practice, space and equipment rental and
services rendered to enrollees of certain prepaid health plans. Some of these
exceptions are also available under the State self-referral laws.
Anti-kickback Regulation
Under the federal Anti-kickback statute, which is applicable to Medicare and
Medicaid, it is illegal, among other things, for a provider of MRI services to
pay or offer money or other consideration to induce the referral of MRI scans.
Neither HMCA nor its clients engage in this practice.
In fiscal 2003, approximately 11.8% of the revenues of HMCA's clients were
attributable to Medicare and .5% were attributable to Medicaid. In fiscal 2002,
approximately 8.8% of the revenues of HMCA's clients were attributable to
Medicare and 0.17% were attributable to Medicaid.
State Regulation
In addition to the federal self-referral law and federal Anti-kickback statute,
many States, including those in which HMCA and its clients operate, have their
own versions of self-referral and anti-kickback laws. These laws are not limited
in their applicability, as are the federal laws, to specific programs. HMCA
believes that it and its clients are in compliance with these laws.
Various States prohibit business corporations from practicing medicine. Various
States also prohibit the sharing of professional fees or fee splitting.
Consequently, HMCA leases space and equipment to clients and provides clients
with a range of non-medical administrative and managerial services for agreed
upon fees. HMCA does not engage in the practice of medicine or establish
standards of medical practice or policies for its clients in any State even
where permitted.
HMCA's clients generate revenue from patients covered by no-fault insurance and
workers' compensation programs. For the fiscal year ended June 30, 2003
approximately 57.7% of our clients' receipts were from patients covered by
no-fault insurance and approximately 11.1% of our client's receipts were from
patients covered by worker's compensation programs. For the fiscal year ended
June 30, 2002, approximately 43.2% of our clients' receipts were from patients
covered by no-fault insurance and approximately 8.7% of our clients' receipts
were from patients covered by workers compensation programs. In the event that
changes in these laws alter the fee structures or methods of providing service,
or impose additional or different requirements, HMCA could be required to modify
its business practices and services in ways that could be more costly to HMCA or
in ways that decrease the revenues which HMCA receives from its clients.
HMCA believes that it and its clients are in compliance with applicable Federal,
State and local laws. HMCA does not believe that such laws will have any
material effect on its business.
EMPLOYEES
As of July 1, 2003, the Company employed 477 persons on a full-time and
part-time basis. Of such employees, 32 were engaged in marketing and sales, 46
in research and development, 76 in prodution, 41 in customer support services,
282 in administration (including 168 on site at facilities and offices managed
by HMCA and 62 performing billing, collection and transcription services for
those facilities) and 18 professional MRI technicians on site at diagnostic
imaging centers managed by HMCA.
ITEM 2. PROPERTIES
Fonar leases approximately 135,240 square feet of office and plant space at its
principal offices in Melville, New York and at two other locations in Melville
and Farmingdale, New York at a current aggregate annual rental rate of $955,985,
excluding utilities, taxes and other related expenses. The term of one of the
leases includes options to renew up through 2008 and the terms of the other
leases extend to the beginning of 2009. Management believes that these premises
are adequate for its current needs. HMCA leases approximately 16,850 square feet
for its headquarters in Melville, New York at a current annual rental rate of
$411,805. The term of the lease extends through September, 2009. In addition,
HMCA maintains leased office premises for its clients at approximately 17 site
locations having an aggregate annual rental rate of approximately $1.6 million
under leases having various terms.
ITEM 3. LEGAL PROCEEDINGS
There is no material litigation pending, or to its knowledge, threatened against
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On June 9, 2003, we held our annual meeting of stockholders. The matters before
the meeting were (1) the election of directors, (2) an increase in the number of
shares of common stock the Company is authorized to issue, (3) the ratification
of certain stock bonus and stock option plans and (4) the ratification of the
selection of auditors for fiscal 2003. All nominees for directors were elected
and all other proposals were approved, including the selection of Marcum &
Kliegman LLP as the Company's auditors for fiscal 2003. All of the directors
elected, Raymond V. Damadian, Claudette J.V. Chan, Robert Janoff, Charles N.
O'Data and Robert Djerejian were sitting directors. The proposal to increase the
number of authorized shares of common stock of the Company approved by the
stockholders allows the Board of Director to increase the number of authorized
shares of common stock at any time or in increments from time to time, up to a
maximum of 150 million shares. The plans ratified by the stockholders were the
2002 and 2003 Stock Bonus Plans and the 2002 Incentive Stock Option Plan. The
table below lists the votes cast for, against or withheld, as well as
abstentions and broker non-votes.
(1) Election of Directors:
FOR WITHHELD
--- --------
Raymond V. Damadian 310,775,628 2,512,091
Claudette J.V. Chan 310,778,455 2,509,313
Robert J. Janoff 310,777,455 2,510,313
Charles N. O'Data 310,198,112 3,089,657
Robert Djerejian 310,140,572 3,147,196
(2) Proposal to Increase Number of Authorized Shares of Common
Stock:
FOR AGAINST ABSTAIN BROKER NON-VOTES
----------- --------- ------- ----------------
304,500,914 8,522,782 264,073 0
(3) Ratification of Stock Bonus and Option Plans
FOR AGAINST ABSTAIN BROKER NON-VOTES
----------- --------- ------- ----------------
252,914,571 7,488,051 429,532 52,455,615
(4) Ratification of Auditors Marcum & Kliegman LLP
FOR AGAINST ABSTAIN BROKER NON-VOTES
----------- --------- ------- -----------------
311,593,011 1,307,281 387,476 0
Part II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded in the Nasdaq SmallCap market under the
National Association of Securities Dealers Automated Quotation System ("NASDAQ")
symbol FONR. The following table sets forth the high and low trades reported in
NASDAQ System for the periods shown.
Fiscal Quarter
--------------
High Low
---- ----
July - September 2001 2.49 1.20
October - December 2001 1.48 1.15
January - March 2002 1.24 0.96
April - June 2002 2.15 0.95
July - September 2002 1.99 0.99
October - December 2002 1.30 0.96
January - March 2003 1.12 0.80
April - June 2003 1.45 0.81
July - September 2003 2.10 1.19
On September 3, 2003, the Company had approximately 4,728 stockholders of record
of its Common Stock, 11 stockholders of record of its Class B Common Stock, 4
stockholders of record of its Class C Common Stock and 4,032 stockholders of
record of its Class A Non-voting Preferred Stock.
At the present time, the only class of the Company's securities for which there
is a market is the Common Stock.
The Company paid cash dividends in fiscal 1998 and the first three quarters of
fiscal 1999 on monies it received from the enforcement of its patents. Except
for these dividends, the Company had not paid any cash dividends. The Company
anticipates paying one additional dividend on monies received from the
enforcement of its patents. Except for these dividends, however, it is expected
that the Company will continue to retain earnings to finance the development and
expansion of its business.
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data has been extracted from the
Company's consolidated financial statements for the five years ended June 30,
2003. This consolidated selected financial data should be read in conjunction
with the consolidated financial statements of the Company and the related notes
included in Item 8 of this form. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" for a discussion of the Company's
business plan.
STATEMENT OF OPERATIONS
As of and For the Periods Ended June 30,
2003 2002 2001 2000 1999
----------- ------------ ------------ ------------ ------------
Revenues (1)$52,892,000 $ 43,161,000 $ 40,274,038 $ 33,560,000 $30,208,150
Cost of (1)$32,477,000 $ 24,682,000 $ 25,959,000 $ 25,054,000 $24,804,000
revenues
Research & $ 5,164,000 $ 5,100,000 $ 5,866,000 $ 5,532,000 $ 6,648,000
Development
Expenses
Net Loss $(15,201,000) $(16,956,000) $(14,538,000) $(11,054,000)$(14,677,000)
from
continued
operations
Net Gain $ 194,000 $ (5,926,000) $ (646,000) $ 98,000 $ 461,000
(Loss) from
discontinued
operations
Basic and $(.20) $(.27) $(.25) $(.20) $(.27)
Diluted Net
Loss per
common share-
continuing
operations
Basic and $ --- $(.09) $(.01) $--- $.01
Diluted Net
Gain (Loss)
per common
share-
discontinued
operations
Weighted 75,816,973 63,511,814 57,388,050 55,096,212 52,862,647
average
number of
shares
outstanding
BALANCE SHEET DATA
Working
capital (1)$13,053,000 $14,107,000 $ 17,206,000 $24,857,000 $38,472,000
Total $58,749,000 $73,129,000 $84,900,000 $84,599,000 $97,648,000
assets
Long- (1)$1,930,000 $ 9,624,000 $17,760,000 $15,443,000 $18,138,000
term debt
and
obligations
under
capital
leases
Stock- $32,380,000 $35,695,000 $41,830,000 $51,285,000 $59,304,000
holder's
equity
(1) Amounts as of and for the years ended June 30, 1999 to June 30, 2002 have
been adjusted for the reclassification of discontinued operations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
INTRODUCTION.
The Company was formed in 1978 to engage in the business of designing,
manufacturing and selling MRI scanners. In 1997, the Company formed a
wholly-owned subsidiary, Health Management Corporation of America ("HMCA"),
formerly known as U.S. Health Management Corporation, in order to expand into
the physician and diagnostic management services business.
FONAR's principal MRI products are its Stand-Up(TM) MRI, Fonar 360(TM), QUAD(TM)
and Echo(TM) MRI scanners. The Stand-Up(TM) MRI allows patients to be scanned
for the first time under weight-bearing conditions. The Company has been
aggressively seeking new sales and during fiscal 2003 and 2002, respectively
received orders for 22 and 20 Stand-Up(TM) MRI scanners. The Stand-Up(TM) MRI is
the only MRI capable of producing images in the weight bearing state.
At 0.6 Tesla field strength, the Stand-Up(TM) MRI, Fonar 360(TM) and QUAD(TM)
magnets are among the highest field "Open MRI" scanners in the industry,
offering non-claustrophobic MRI together with high-field image quality. Fonar's
open MRI scanners were the first high field strength MRI scanners in the
industry. Fonar also offers the Echo(TM), a low cost open MRI scanner. Fonar's
works in progress include an in-office extremities scanner. (See "Description of
Business - Products, Works-in-Progress and Product Marketing.")
HMCA commenced operations in July, 1997 and generates revenues from providing
comprehensive management services (including development, administration,
accounting and billing and collection services) together with office space,
medical equipment, supplies and non-medical personnel to its clients. Revenues
are in the form of management and leasing fees, which have been earned under
contracts with MRI facilities, medical practices and physical rehabilitation
practices. Since April 2003, HMCA no longer engages in the management of primary
care medical practices.
Approximately 99% of HMCA's revenues for the fiscal years ended June 30, 2003,
June 30, 2002 and June 30, 2001 were derived from contracts with facilities and
practices owned by Dr. Raymond V. Damadian, the President of FONAR and HMCA and
principal stockholder of FONAR. The agreements with the MRI facilities are for
one-year terms which renew automatically on an annual basis, unless terminated.
The fees are based on the number of procedures performed and currently range
from $325 to $1,060 per MRI scan. The fees are reviewed and if appropriate,
adjusted on an annual basis by mutual agreement.
The agreements with the physical rehabilitation practices are for a term of 20
years. The fees are fixed monthly fees adjusted annually. Historically,
adjustments have been on the basis of changes in HMCA's costs, plus a percentage
of costs. Currently, the monthly fees under these contracts with the physical
rehabilitation practices range from approximately $75,000 to $285,000. Prior to
HMCA's diversiture of A&A Services, Inc., which managed the medical practices,
the monthly fees under the contracts with the medical practices were $110,000
during fiscal 2003.
Critical Accounting Policies
- ----------------------------
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to investments, intangible assets, income taxes, contingencies and
litigation. We base our estimates on historical experience and on various
assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. We recognize revenue and related costs of revenue from
sales contracts for our MRI scanner products, under the percentage-of-completion
method. Under this method, we recognize revenue and related costs of revenue, as
each sub-assembly is completed. Amounts received in advance of our commencement
of production are recorded as customer advances.
We recognize revenue from license agreements for our intellectual property over
the shorter of the contractual life of the license or the estimated economic
life. For our current license agreement, we are recognizing revenue ratably over
5 years.
We record a valuation allowance to reduce our deferred tax assets to the amount
that is more likely than not to be realized. As of June 30, 2003, we recorded a
valuation allowance which reduced our deferred tax assets to equal our deferred
tax liability.
We amortize our intangible assets, including patents, purchased management
agreements and capitalized software development costs, over the shorter of the
contractual/legal life or the estimated economic life. Our amortization life for
patents, purchased management agreements and capitalized software development
costs is 15 to 17 years, 20 years and 5 years, respectively.
We periodically assesses the recoverability of long-lived assets, including
property and equipment, intangibles and management agreements, when there are
indications of potential impairment, based on estimates of undiscounted future
cash flows. The amount of impairment is calculated by comparing anticipated
discounted future cash flows with the carrying value of the related asset. In
performing this analysis, management considers such factors as current results,
trends, and future prospects, in addition to other economic factors. During the
year ended June 30, 2002, we recorded an impairment loss of $4,700,000 related
to the management contracts in our physician's management services segment with
the primary care medical practices. In April, 2003, we sold A&A Services, Inc.,
the subsidiary which held those contracts, back to the original sellers for a
purchase price of $4.0 million. In addition, the buyers released HMCA from the
balance of its indebtedness remaining due on the original purchase, in the
amount of $913,495. As depreciated assets attributed to these contracts was
$3,298,443. We recognized a gain of $509,814 on the transaction. These amounts
have been reflected as discontinued operations in the accompanying consolidated
financial statements.
RESULTS OF OPERATIONS. (FISCAL 2003 COMPARED TO FISCAL 2002)
In fiscal 2003, the Company experienced a net loss of $15.0 million on revenues
of $52.9 million, as compared to a net loss of $22.9 million on revenues of
$43.2 million for fiscal 2002. This represents a decrease in the net loss of
34.5% and an increase in revenues of 22.5%. This was due in part to the fact
that while revenues increased by 22.5%, total costs and expenses increased by
only 18.2%. The Company's consolidated operating loss increased by 5.3% to $15.1
million for fiscal 2003 as compared to an operating loss of $14.4 million for
fiscal 2002.
Discussion of Operating Results of Medical Equipment Segment
(Fiscal 2003 Compared to Fiscal 2002)
- ------------------------------------------------------------
Revenues attributable to the Company's medical equipment segment increased by
85.2% to $30.0 million in fiscal 2003 from $16.2 million in fiscal 2002,
reflecting an increase in product sales of 115%, from $11.6 million in fiscal
2002 to $24.9 million in fiscal 2002 and an increase in service revenue of
13.6%, from $2.2 million in fiscal 2002 to $2.5 million in fiscal 2003. This
improvement in revenues was attributable to the Company's increase in scanner
sales, particularly its Stand-Up(TM) MRI, which is unique in that it permits MRI
scans to be performed on patients upright in the weight-bearing state and in
multiple positions that correlate with symptoms. During the fiscal years ended
June 30, 2003 and June 30, 2002, respectively, the Company received orders for
22 and 20 Stand-Up(TM) MRI scanners.
Confirming the Company's expectation of increased demand for its MRI scanners,
product sales to unrelated parties increased by 228% in fiscal 2003 from $5.4
million in fiscal 2002 to $17.7 million in fiscal 2003. Product sales to related
parties increased by 17.7% in fiscal 2003 from $6.2 million in fiscal 2002 to
$7.3 million in fiscal 2003. The Company believes that its principal challenges
in achieving greater market penetration are primarily attributable to the better
name recognition and larger sales forces of its larger competitors such as
General Electric, Siemens, Hitachi, Philips and Toshiba and the ability of some
of its competitors to offer attractive financing terms through affiliates, such
as G.E. Capital. Nevertheless, no other competitor offers a whole body weight
bearing MRI scanner such as the Stand-Up(TM) MRI, and General Electric Medical
Systems division acts as a manufacturer's representative for the Stand-Up(TM)
MRI.
The operating loss for the medical equipment segment improved by 26.6% from a
loss of $15.4 million in fiscal 2002 to a loss of $11.3 million in fiscal 2003.
This improvement is attributable to our continuing increase in gross margins on
our scanner sales.
The Company recognized revenues of $24.3 million from the sale of its new
Stand-Up(TM) MRI scanners and of $100,000 from the sale of one refurbished
(used) Beta(TM) scanner (the Company no longer manufactures Beta(TM) scanners)
in fiscal 2003. In fiscal 2002, the Company recognized revenues of $11.1 million
from the sale of Stand-Up(TM) MRI scanners, and $361,000 from the sale of two
refurbished (used) Beta(TM) scanners.
Product sales revenues for fiscal 2003 included revenues from the sale of 17
scanners. Product sales revenues for fiscal 2002 included revenues from the
sales of 11 scanners and for fiscal 2001, seven scanners.
Sales of MRI scanners to affiliated parties, consisting of professional
corporations and other entities in which Dr. Damadian or members of his family
have an interest represented approximately 13.8% ($7.3 million) of the Company's
revenues in fiscal 2003, as compared to 13.9% ($6.2 million) of the Company's
revenues in fiscal 2002.
License and royalty revenue increased by 6.1% to approximately $2.6 million in
fiscal 2003 from approximately $2.4 million in fiscal 2002.
Gross profit margins on product sales improved significantly during fiscal 2003
from a 28% in fiscal 2002 to 35.6% in fiscal 2003. Such improvement was
principally attributable to the medical equipment segment operating at a higher
level of capacity resulting from the increased sales volume.
Research and development expenses, net of capitalized costs, increased by 2% to
$5.2 million in fiscal 2003 as compared to $5.1 million in fiscal 2002. Our
expenses for fiscal 2003 represented continued research and development of
Fonar's scanners, its new hardware and software product, "Sympulse (TM)" and new
surface coils to be used with the Stand-Up(TM) MRI scanner.
Discussion of Operating Results of Physician and Diagnostic Services Management
Segment (Fiscal 2003 Compared to Fiscal 2002)
- --------------------------------------------------------------------------------
Revenues attributable to the Company's physician and diagnostic services
management segment (HMCA) decreased by 15.1% to $22.9 million in fiscal 2003
from $27.0 million in fiscal 2002. The decrease in revenues reflected a decline
in MRI scan volume prior to upgrading older scanners, the closing of certain MRI
facilities and other facilities managed by HMCA. The $1.2, $1.5 and $2.0 million
in revenues from the medical primary care practices in fiscal 2003, 2002 and
2001 are not included in HMCA's revenues; this part of its business has been
sold and results of operations are shown separately under discontinued
operations.
Cost of revenues as a percentage of the related revenues for the Company's
physician and diagnostic services management segment increased from $13.7
million or 50.7% of related revenues for the year ended June 30, 2002 to $13.3
million, or 57.9% of related revenue for the year ended June 30, 2003.
Operating results of this segment declined from operating income of $1.1 million
in fiscal 2002 to an operating loss of $3.8 in fiscal 2003. In the fourth
quarter of fiscal 2003, HMCA recognized an impairment loss of $795,237, on
certain management agreements with a physical rehabilitation and therapy
facility which was closed in the beginning of the second quarter of fiscal 2003.
HMCA believes that focusing its efforts on more profitable facilities, including
the introduction of Stand-Up(TM) MRI scanners, will in the long term improve
HMCA's profitability.
Discontinued Operations - (Fiscal 2003 Compared to Fiscal 2002)
- ----------------------------------------------------------------
The net gain from discontinued operations for fiscal 2003 was $0.2 million as
compared to a loss from discontinued operations of $5.9 million in fiscal 2002.
The net gain from discontinued operations in fiscal 2003 consists of a loss from
discontinued operations of $0.3 million offset by a gain from the sale of
discontinued operations of $0.5 million. The loss from discontinued operations
for fiscal 2002 was attributable primarily to an impairment loss of $4.7 million
due to the reduction of the value of the management contracts with the medical
primary care practices reflected on the Company's balance sheet because of past
and anticipated performance. This portion of HMCA's business has now been sold
and accordingly all results for the current and prior fiscal years have been
reclassified as discontinued operations. In addition, included in the loss from
discontinued operations in fiscal 2002, we recorded a debt conversion expense of
$545,000 in connection with a premium associated with the repayment of
approximately $2.5 million in long-term debt incurred in connection with the
initial acquisition of A&A by HMCA.
The gain on the sale of discontinued operations in fiscal 2003 was $509,814, and
represented the excess of the consideration received over the depreciated value
of the contracts and other assets of the sold subsidiary.
Discussion of Consolidated Results of Operations (Fiscal 2003 Compared to Fiscal
2002)
- --------------------------------------------------------------------------------
Interest income of $670,678 was recognized by the Company in 2003 as compared to
$973,862 in fiscal 2002, representing a decrease of 31.1%. The decrease was
attributable primarily to a decrease in interest on the Company's investments in
marketable securities.
Interest expense of $626,450 was recognized in fiscal 2003 decreasing from
$691,126 in fiscal 2002 and representing a decrease of 9.4%. The decrease was
attributable primarily to the repayment of long-term debt and capital lease
obligations in fiscal 2002.
In fiscal 2002, the Company recorded non-cash financing costs of $2.4 million in
connection with the payment of its convertible debentures to The Tailwind Fund
in common stock and the issuance of related warrants. This expense represented
the discount from the market price on the stock issued to The Tailwind Fund and
the value of the purchase warrants granted to the investor.
Selling, general and administrative expenses increased by 9.3% to $23.4 million
in fiscal 2003 from $21.4 million in fiscal 2002. The increase in selling,
general and administrative expenses was attributable primarily to the expansion
of Fonar's increased manufacturing, advertising, marketing and sales activity.
Commencing in fiscal 2002, the Company engaged the services of an advertising
agency and introduced television and radio advertising.
The increase in compensatory element of stock issuances from approximately $4.7
million in fiscal 2002 to $4.8 million in fiscal 2003 reflected the continued
use of Fonar's stock bonus plan to pay certain highly compensated employees and
others in stock rather than in cash.
The lower provision for bad debt of $702,000 in fiscal 2003 as compared to
$972,000 in fiscal 2002, reflected a decrease in reserves and write-offs of
certain indebtedness. This represented primarily a reduction in the reserves for
fees due to HMCA from $729,000 in fiscal 2002 to $335,000 in fiscal 2003 offset
by an increase in Fonar's bad debt from $243,000 in fiscal 2002 to $367,000 in
fiscal 2003.
The amortization expense in fiscal 2003 and 2002 of approximately $696,000 for
both fiscal years, reflects the amortization of management agreements
attributable to HMCA's acquisitions. The loss on impairment of management
agreements was attributable to the closure of the primary care practices managed
by HMCA's subsidiary, Central Health Care Services, Inc. because of a
significant decline in overall patient volume.
The Company is enthusiastic about the future of its Stand-Up(TM) MRI and FONAR
360(TM) product line scanners which bring a new plateau of "openness" to
diagnostic MRI and are expected to bring a new frontier in surgery for
performing surgical treatments using MRI images to guide surgery. The Company
believes its new products are beginning to successfully penetrate the market, as
reflected in the dramatic increase in product sales from approximately $3.4
million in fiscal 2000 to $6.1 million in fiscal 2001, to $11.6 million in
fiscal 2002 and to $24.9 million in fiscal 2003. In addition to increased
product sales, the decline in service and repair fees has been reversed, as
reflected by the increase in service and repair fees from $1.7 million in fiscal
2000 to $2.0 million in fiscal 2001 to $2.2 million in fiscal 2002 and $2.5
million in fiscal 2003.
Continuing its tradition as the originator of MRI, the Company remained
committed to maintaining its position as the leading innovator of the industry
through aggressive investing in research and development. In fiscal 2003 the
Company continued its investment in the development of its new MRI scanners,
together with software and upgrades, with an investment of $5,955,667 in
research and development ($791,216 of which was capitalized) as compared to
$5,955,394 ($855,612 of which was capitalized) in fiscal 2002. The research and
development expenditures were approximately 18% of revenues attributable to the
Company's medical equipment segment (and 10.8% of total revenues) in 2003 and
34.6% of medical equipment segment revenues (and 13.8% of total revenues)in
fiscal 2002. This represented an essentially constant amount in research and
development expenditures in fiscal 2002 and fiscal 2003 and also reflects the
Company's greater emphasis on marketing and selling the products it has
developed.
In summary, Fonar continued the trend of steadily increasing MRI scanner sales,
most dramatically the increase in Stand-Up(TM) MRI scanner sales from fiscal
2001 through fiscal 2003. The physician and diagnostic services management
segment (HMCA) revenues continued to decline slightly in the same period, from
$28.5 in fiscal 2001 to $27.0 million in fiscal 2002 and to $22.9 in fiscal
2003.
Fonar anticipates that the increase in scanner sales will continue due to the
unique capability of the Stand-Up(TM) MRI scanner to scan patients in
weight-bearing positions and future sales of the Fonar 360(TM) for image guided
interventional procedures and treatments and the high field strength of its
other open MRI scanners, the Fonar 360(TM) and QUAD(TM) scanners. Service
revenues have also increased over the past four fiscal years, from $1.7 million
in fiscal 2000 to $2.0 million in fiscal 2001 to $2.2 million in fiscal 2002 and
to $2.5 in fiscal 2003, which increases are attributable primarily to the
increased number of scanners being placed in service. Most of the revenues on
the Stand-Up(TM) MRI scanners sold in the last quarter of fiscal 2003, were not
recognized as of June 30, 2003, and as of June 30, 2003, the Company's balance
sheet reflects $4.9 million in customer advances, as compared to $7.7 million in
customer advances as at June 30, 2002.
The Company has taken steps to reverse the decline in HMCA revenues by closing
unprofitable facilities and continuing its program of replacing the MRI scanners
at the MRI facilities it manages with Stand-Up(TM) MRI scanners. Stand-Up(TM)
MRI scanners are now installed in the Islandia, New York site, Bensonhurst, New
York and Staten Island, New York sites and additional Stand-Up(TM) MRI's are
planned for other MRI facilities managed by HMCA.
Expenditures for advertising and marketing are likely to continue to increase,
as the Company believes the increased advertising is helpful to promote sales.
RESULTS OF OPERATIONS. (FISCAL 2002 COMPARED TO FISCAL 2001)
In fiscal 2002, the Company experienced a net loss of $22.9 million and a net
loss from continuing operations of $17.0 million on revenues of $43.2 million as
compared to a net loss of $15.2 million and a net loss from continuing
operations of $14.5 million on revenues of $40.3 million for fiscal 2001. This
represented an increase in the net loss of 51%, an increase in the net loss from
continuing operations of 16.6% and an increase in revenues of 7.1%.
Discussion of Operating Results of Medical Equipment Segment
(Fiscal 2002 Compared to Fiscal 2001)
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Revenues attributable to the Company's medical equipment segment increased by
54.3% to $16.2 million in fiscal 2002 from $10.5 million in fiscal 2001,
reflecting an increase in scanner sales of 90.0%, from $6.1 million in fiscal
2001 to $11.6 million in fiscal 2002 and an increase in service revenue of 10%
from $2.0 million in fiscal 2001 to $2.2 million in fiscal 2002. The Company
attributed the increase in scanner sales to the growing market penetration of
its products, particularly the Stand-Up(TM) MRI. Product sales to unrelated
parties increased by 59% in fiscal 2002 from $3.4 million in fiscal 2001 to $5.4
million in fiscal 2002.
Sales to affiliated parties, consisting of professional corporations and other
entities in which Dr. Damadian or members of his family have an interest
represented approximately 14% ($6.2 million) of the Company's revenues in fiscal
2002, as compared to 6.0% ($2.7 million) of the Company's revenues in fiscal
2001.
Research and development expenses net of capitalized costs decreased by 14% to
$5.1 million in fiscal 2002 as compared to $5.9 million in fiscal 2001. Our
expenses for fiscal 2002 represented continued research and development of
Fonar's scanners and its new hardware and software product, "Sympulse(TM) and
new surface coils to be used within the Stand-Up(TM) MRI scanner".
Gross profit margins on product sales improved significantly during fiscal 2002
from a negative 2% in fiscal 2001 to 28% in fiscal 2002. Such improvement was
principally attributable to the medical equipment segment operating at a higher
level of capacity resulting from increased sales volume.
Results of operations for the medical equipment segment improved by 10% from a
loss of $17.2 million in fiscal 2001 to a loss of $15.4 million in fiscal 2002.
This improvement is attributable to our increase in gross margins on our scanner
sales.
The Company recognized revenues of $11.1 million from the sale of its new
Stand-Up(TM) MRI scanners and of $361,000 from sale of two refurbished (used)
Beta(TM) scanners in fiscal 2002. In fiscal 2001 the Company recognized revenues
of $1.6 million from the sale of Stand-Up(TM) MRI scanners, $1.1 million from
the sale of Echo(TM) scanners and $3.0 million from the sale of QUAD(TM) MRI
scanners. Sales of Beta(TM) scanners were $0 in fiscal 2001.
Product sales revenues for fiscal 2002 included revenues from the sale of 11
scanners. Product sales revenues for fiscal 2001 included revenues from the
sales of seven scanners.
Discussion of Operating Results of Physician Management Services Segment
(Fiscal 2002 Compared to Fiscal 2001)
- ------------------------------------------------------------------------
Revenues attributable to the Company's physician and diagnostic services
management segment (HMCA) decreased by 9.3% to $27.0 million in fiscal 2002 from
$29.8 million in fiscal 2001. The decrease in revenues reflected the closing of
certain facilities managed by HMCA.
Cost of revenue for the Company's physician and diagnostic services management
segment decreased from $16.7 million, or 56.0%, of related revenues for the year
ended June 30, 2001 to $14.0 million, or 52.0%, of related revenues for the year
ended June 30, 2002.
Discussion of Discontinued Operations (Fiscal 2002 Compared to Fiscal 2001)
- ---------------------------------------------------------------------------
The loss from discontinued operations increased from $5.9 million for fiscal
2002 as compared to $0.6 million for fiscal 2001 for increase in the loss of
$5.3 million or 818%. The increase in the loss was due primarily to the loss on
impairment of the management contract of $4.7 million. In addition, in fiscal
2002, we recorded a debt conversion expense of $545,000 in connection with a
premium associated with the repayment of approximately $2.5 in long-term debt
incurred in connection with an HMCA acquisition.
Discussion of Consolidated Results of Operations
(Fiscal 2002 Compared to Fiscal 2001)
- ------------------------------------------------
Other expenses of $69,133 were recognized by the Company in fiscal 2002 as
compared to other income of $1.0 million (principally the sale of a partnership
interest) in fiscal 2001, and investment income of $973,862 was recognized by
the Company in 2002 as compared to $1.8 million in fiscal 2001. This represented
a decrease of 69% in other income. In addition, the Company recorded non-cash
financing costs of $2.4 million in fiscal 2002 in connection with the payment of
its convertible debentures to the Tailwind Fund in common stock and the issuance
of related warrants. This expense represented the discount from the market price
on the stock issued to the Tailwind Fund and the value of the purchase warrants
granted to the investor.
Selling, general and administrative expenses increased by 11.8% to $21.4 million
in fiscal 2002 from $19.1 million in fiscal 2001. The increase was attributed
prim