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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_____________________
FORM 10-K
_____________________
[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, 1997
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
___________________________
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)
(516) 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 _______
As of September 22, 1997, 49,908,447 shares of Common Stock, 5,411 shares of
Class B Common Stock, 9,562,824 shares of Class C Common Stock and 7,855,627
shares of Class A Non-voting Preferred Stock of the registrant were
outstanding. The aggregate market value of the approximately 47,450,300
shares of Common Stock held by non-affiliates as of such date (based on the
closing price per share on September 22, 1997 as reported on the NASDAQ
System) was approximately $146.8 million. The other outstanding classes do
not have a readily determinable market value.
DOCUMENTS INCORPORATED BY REFERENCE
None
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
(516) 694-2929.
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 introduced the first MRI scanner in 1980 and 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 and maintained its
"open" design ever since.
U.S. Health Management Corporation ("HMC") 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, sometimes referred to as "physician practice management"
or "PPM." In connection with its entry into this new line of business, HMC
has completed two acquisitions and is pursuing others. HMC will provide
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.
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 principal products are its new "QUAD" series of MRI
scanners. The "QUAD(TM) 12000" MR scanner utilizes a 6000 gauss iron core
electromagnet and is accessible from four sides. The QUAD 12000 is the
first "open" MR scanner above low field (above 600 gauss). The "QUAD(TM)
7000" is similar in design to the QUAD 12000 but utilizes a smaller 3,500
gauss electromagnet.
In 1990 the Company introduced the Ultimate(TM) 7000 scanner, which
was its principal product prior to the introduction of the QUAD scanners.
The QUAD and Ultimate(TM) scanners are revolutionary new MR scanning
products representing the culmination of years of total company wide effort
to design and construct the "Ultimate MR" scanner product line. These
products replaced the Company's traditional principal products, the Beta(TM)
3000 scanner (which utilizes a permanent magnet) and the Beta(TM) 3000M
scanner (which utilizes an iron core electromagnet). All of the Company's
scanners create cross-sectional images of the human body.
The QUAD 7000, utilizing a 3500 gauss iron core electromagnet, is
envisioned by the Company as an economical solution to the rising cost of
medicine. Priced at $695,000, the Company expects the QUAD 7000 to be a
success in the market, not only with first time buyers but with users who
must now replace their obsolete MRI equipment.
The QUAD 12000 scanner utilizes a 6000 gauss (.6 Tesla field
strength) iron core electromagnet. The greater field strength of the 6000
gauss 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 12000 scanner magnet is
the highest field "open MRI" in the industry.
As a result of these new products and other research and
development, the Company is positioning itself to dramatically increase
sales and improve its competitive position in the marketplace.
In tandem with new product and software developments, the Company
has been strengthening and continues to strengthen its legal position for
the purpose of protecting its proprietary technology as well as other
interests. The Company does not intend to permit its competitors and
would-be competitors to capitalize, to the detriment of the Company, on its
inventions and exhaustive research and development efforts, as the Company
believes has happened in the past.
On September 2, 1992, the Company filed a patent infringement suit
against Hitachi Ltd., General Electric Company and others in the United
States District Court for the Eastern District. In April, 1995, the Company
reached a settlement with Hitachi Ltd. and related defendants. Following
the trial and appeal of the Company's claims against General Electric
Company, the decision of the United States Court of Appeals for the Federal
Circuit awarded FONAR $62 million against General Electric Company for
infringement of FONAR's Multi-Angle Oblique (MAO) patent and $35 million for
infringement of FONAR's original MRI patent (the Cancer Detection Patent).
In May 1997 General Electric Company's petition for a rehearing was denied
and in July 1997 General Electric Company paid FONAR $128.7 million
(inclusive of interest) without, however, prejudicing its right to appeal.
In August 1997, General Electric Company filed its petition for a writ of
certiorari asking the Supreme Court to hear the case. The Supreme Court
denied General Electric Company's petition in October, 1997.
In June 1995, FONAR filed patent infringement suits against Siemens
Medical Systems, Inc., Siemens, AG, Philips Electronics, NV, Philips Medical
Systems, Inc. and Philips Electronics North America Corporation. The
patents sought to be enforced by the Company against both defendants
included the Multi-Angle Oblique improvement patent (U.S. Patent No.
4,871,966 entitled "Apparatus and Method for Multiple Angle Oblique Magnetic
Resonance Imaging"). FONAR settled with the Philips companies in April 1996
and the Siemens companies in September, 1996.
In March 1996, the Company commenced a patent infringement suit
against Toshiba America Medical Systems, Inc. and Toshiba
American MRI, Inc.
The Company is optimistic about sales of its new scanner products.
At September 1, 1997, the Company's backlog of unfilled orders was $6.4
million as compared to $6.8 million at September 1, 1996. In November of
1996 the Company entered into an agreement with National Imaging Resources,
Inc., a network of medical distributors having a large national sales force,
to promote the Company's new products. To further promote product
recognition and sales, FONAR will attend the RSNA (Radiological Society of
North America) trade show in November 1997 to exhibit its products. The
RSNA is the leading trade show in the MRI industry. Approximately 25,000
radiologists, who are among the principal groups to whom the Company directs
its marketing efforts, are expected to attend to view MRI industry's most
current product developments. The Company previously attended the RSNA
trade shows in 1996 and 1995.
The Company is actively seeking to promote foreign sales, thus
enhancing America's competitive position as well as its own. Since
commencing its current foreign sales program, the Company has sold scanners
in Korea, Mexico and Poland. Based on numerous indications of interest,
meetings, sales trips abroad and negotiations, the Company is cautiously
optimistic that foreign sales will produce significant revenues.
The Company believes there are and will be significant market
opportunities abroad, particularly in Asia and Eastern Europe.
In March 1997, FONAR formed U.S. Health Management Corporation
("HMC") 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
(sometimes referred to as "physician practice management," "PPM" or
"practice management.")
HMC entered the PPM business through the consummation of two
acquisitions, effective June 30, 1997. As a result of these two
acquisitions, HMC is managing 21 facilities located principally in New York
State and Florida. HMC is presently considering other potential
acquisitions.
PRODUCTS OFFERED
The Company's principal products are its new "QUAD" series of MRI
scanners. The QUAD(TM) 12000 MR scanner utilizes a 6000 gauss iron core
electromagnet and is accessible from four sides. The QUAD 12000 is the
first "open" MR scanner above low field (above 600 gauss). The QUAD(TM)
7000 is similar in design to the QUAD 12000 but utilizes a smaller 3,500
gauss electromagnet. The Ultimate 7000 utilizes a 3500 gauss iron core
electromagnet.
FONAR received FDA approval to market the QUAD 7000 in April, 1995
and for the QUAD 12000 in November 1995.
In addition to the patient comfort, increased throughput and new
applications (such as MRI directed surgery and MRI mammography) made
possible by the QUAD scanners' open design, the QUAD 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 QUAD's design over its predecessors also include increased
image-processing speed and diagnostic flexibility.
The increased patient space in the QUAD permits the utilization of
the Company's software for the taking of "moving scans." Those "moving
scans" or "CINE," enable the physician to observe the scanned body part
(e.g., knee, neck and elbow) in motion. The QUAD enables a full range of
motion studies that cannot be completely performed in the claustrophobic
cylindrical tubes of today's superconductive magnets.
FONAR's works-in-progress include CINE-FLEX(TM), which is a set of
specialized coils and matching fixtures that enable full-range CINEs of the
knee, shoulder, C-spine, L-spine and TMJ - an impossibility with supercon
MRIs.
MRI directed surgery (laproscopic surgical procedures) is made
possible by the QUAD'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 marked openness of FONAR's
QUAD scanners enables surgeons to perform a wide range of surgical
procedures inside the magnet.
The "QUAD" scanners are unique MR scanners in that four sides are
open, thus allowing access to the scanning area from four vantage points.
Equipped with up to four beds, the user is able to prep one or more "on
deck" patients while another patient is being scanned, thereby increasing
throughput and reducing scan prices. The starshaped open design of the QUAD
will also make possible a host of new applications, particularly MRI
mammography and MRI directed surgery (Interventional MRI).
With the QUAD's multi-bed patient handling system, many more short
scan procedures such as those used in breast imaging can be done in a day,
allowing the price of MRI mammography to drop without reducing the scanner's
revenue-generating capacity. At the same time, there is not the painful
compression of the breast characteristic of X-ray mammography.
The principal difference between the QUAD scanners and other open
MRI scanners is in field strength. Other open MRIs operate at significantly
lower magnetic field strengths and, therefore, are unable to produce the
amount of MRI image-producing signal necessary to make high-quality MRI
images (measured by signal-to-noise ratios, S/N).
The QUAD 12000 scanner utilizes a 6000 gauss (.6 Tesla field
strength) iron core electromagnet. The greater field strength of the 6000
gauss magnet, when enhanced by the electronics already utilized by the
Company's scanners, produces images of a higher quality and clarity than
other open MRI scanners. The QUAD 12000 scanner magnet is the highest field
"open MRI" in the industry and operates at a field strength that is almost
two times its closest competitor (.6 Tesla field strength versus .35 Tesla
field strength).
The QUAD 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
QUAD's design over its predecessors also include increased image-processing
speed and diagnostic flexibility.
Maximal S/N is achieved when the direction of the magnetic field
and the direction of the receiving coil axis are perpendicular to one
another, as is the case with the QUAD scanners. The orientation of the
magnetic field is vertical and when combined with any one of FONAR's array
of solenoidal (wrap-around) surface coils, the QUAD 7000, for example,
produces as much S/N as a supercon MRI at twice the field strength. So that
prospective buyers can make an accurate comparison, the number 7000 is used
to describe the S/N equivalency of the QUAD 7000 to 7000-gauss
superconductive machines.
Several technological advances have been engineered into the QUAD
scanners for extra improvements in S/N, including: new high-S/N Organ
Specific(TM) receiver coils; new ceramic magnet poles that provide advanced
eddy-current control; 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 QUAD 7000 and QUAD 12000 scanners operate squarely in the
optimum C/N range.
The QUAD's state-of-the-art electronics package features five
computer processors performing parallel processing. Its speed is
demonstrated by its ability to scan and reconstruct images simultaneously
and its ability to reconstruct a 256x256 image in 0.7 seconds, the fastest
of any MRI scanner on the market.
The QUAD provides 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 extremely important feature for
scanning parts of the body that include small-structure sub-regions
requiring finer slice parameters. There's also Evolving Images(TM),
Multi-Angle Oblique (MAO)(TM) imaging, and oblique imaging.
The QUAD console includes a mouse-driven, multi-window interface
for easy operation and a 19-inch, 1280x1280-pixel, 20-up, high-resolution
image monitor with features such as electronic magnifying glass and
real-time, continuous zoom and pan.
Because of the openness of the QUAD 7000 and FONAR's coil
development and CINE, QUAD 7000 users can plan on adding the
works-in-progress CINE-FLEX(TM) option to their scanners. CINE-FLEX(TM) is
a set of specialized coils and matching fixtures that enable full-range
CINEs of the knee, shoulder, C-spine, L-spine and TMJ - an impossibility
with supercon MRIs.
The Beta 3000 initiated the Company's product line and resulted in
over 150 worldwide FONAR installations to date. The effort to achieve the
QUAD and the Ultimate product line represented a company-wide aspiration to
seize the opportunity to incorporate into the Company's product line all of
the desirable features FONAR had learned since it opened the industry in
1980. The facility of these features have been achieved in FONAR's "QUAD"
and "Ultimate" MR machines.
PRODUCT MARKETING
The principal markets for the Company's scanners are hospitals and
private scanning centers. The Company is conducting its marketing through a
national network of independent distributors represented by National Imaging
Resources, Inc. The Company's network of independent sales representatives
and distributors operates on a commission basis in the domestic market.
The Company exhibited its new products at the trade show held by
the Radiological Society of North America ("RSNA") in Chicago in November
1995 and 1996 and plans to attend the RSNA trade shows in November 1997 and
future years as well. The RSNA trade show is held annually and is attended
by most manufacturers of MRI scanners.
The Company is directing its marketing efforts to meet the demand
for both "open" and high field strength MRI scanners. Utilizing a 6000
gauss (.6 Tesla field strength) iron core electromagnet, the QUAD 12000
scanner magnet is the highest field "open MRI" in the industry.
The Company also plans to direct its marketing efforts to meeting
the increasing demand for low price MRI. To date, the increased pressure
for lower scanning prices has come largely from preferred provider
organizations, health maintenance organizations and other private sector
group plans and stricter insurance requirements, but government mandated
health care reform is also under consideration.
To meet this demand, the Company has set a base price of $895,000
for the QUAD 12000 and of $695,000 for the QUAD 7000 scanner. In addition
to reducing the health care provider's equipment cost, the QUAD scanners'
improved image processing speed and extra-bed(s) option (allowing patients
to be prepped while another patent is being scanned) would enable the
provider to increase patient volume and further reduce per scan costs.
The reduced per scan costs will enable the Company to promote the
QUAD 7000 in particular for short scan procedures such as MRI mammograms.
MRI mammograms have the advantage over traditional x-rays of involving no
radiation, and an MRI breast scan can be taken in most cases through
ordinary street clothes without any painful compression.
The Company also will seek to introduce new MRI applications for
the QUAD scanners such as MRI-directed surgery and head-to-toe MRI
preventive screening.
The Company is actively seeking to promote foreign sales. Since
commencing its current foreign sales program, the Company has sold scanners
in various foreign countries. Based on indications of interest, meetings,
sales trips abroad and negotiations, the Company is optimistic that foreign
sales will continue to be an important source of revenue.
The Company believes there are and will be significant market
opportunities abroad, particularly in Asia and Eastern Europe.
See "Note 9 to Notes to Consolidated Financial Statements" for the
percentage of foreign sales as in relation to the Company's total revenues.
SERVICE AND UPGRADES FOR MRI SCANNERS
The Company regards its customer base of approximately 100 scanners
installed or in the process of being installed as a major asset. It has
been and will continue to be a significant 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 installed base were approximately $6.6 million in fiscal 1995,
$6.1 million in fiscal 1996 and $4.6 million in fiscal 1997. The decreases
in fiscal 1996 and 1997 were principally the result of the retirement of old
scanners.
The Company anticipates that its new line of QUAD scanners will
result in significant upgrades income in future fiscal years. The potential
for upgrades income originates in the exceptional versatility and
productivity of the MRI technology. New medical uses for the technology are
constantly being discovered. Dramatic new features can often be added to
the scanner by the implementation of little more than versatile new software
packages. Such enhancements are attractive to the 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.
RESEARCH AND DEVELOPMENT
During the fiscal year ended June 30, 1997, the Company incurred
expenditures of $3,928,035 ($108,809 of which was capitalized) on research
and development, as compared to $3,607,703 ($251,659 of which was
capitalized) and $3,356,120 ($281,052) of which was capitalized) incurred
during the fiscal years ended June 30, 1996 and June 30, 1995, respectively.
Research and development activities have focused, in large part, on
the development and enhancement of the Company's QUAD MR scanners and on the
continued enhancement of the Ultimate and Beta 3000 and Beta 3000M products.
The QUAD and Ultimate scanners involved significant software and hardware
development as the new products represented entirely new hardware design and
architecture requiring a complete new operating software system. Most
recently, the Company's research activity has centered on developing a
multitude of new features for the QUAD series scanners made possible by the
QUAD's high speed processing power. The Company is also investing in
developing its QUAD scanners for surgical MRI.
BACKLOG
The Company's backlog of unfilled orders at September 1, 1997 was
approximately $6.4 million, as compared to $6.8 million at September 1,
1996. Of these amounts, approximately $1.2 million and $1.3 million had
been paid to the Company as customer advances as at September 1, 1997 and
September 1, 1996, respectively. 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
There are currently numerous patents in effect which relate to the
technology and components of the MRI scanners, some of which are registered
in the name of the Company and others which are registered in the name of
Dr. Raymond V. Damadian, the President and principal stockholder of the
Company. The Company believes that these patents, which expire at various
times from 1999 to 2014, and the know-how it developed, are material to its
business.
Dr. Damadian has granted an exclusive world-wide license to the
Company to make, use and sell apparatus covered by certain domestic and
foreign patents relating to his MRI technology. The license continues until
the expiration of the last patent included within the licensed patent
rights, but is terminable earlier, at the option of Dr. Damadian, if he is
removed from his position as Chairman of the Board or President of the
Company without his consent, or if any stockholder or group of stockholders
acting in concert becomes the beneficial owner of Company securities having
voting power equal to or greater than the voting power of the securities
held directly by him, his executors, administrators, successors or heirs.
The agreement can also be terminated by Dr. Damadian upon the commission of
an act of bankruptcy by the Company. If Dr. Damadian is unable to serve the
Company by reason of his death or disability, the license agreement will
remain in effect.
One of the patents, issued in the name of Dr. Damadian and covered
by said license, is United States patent No. 3,789,832, Apparatus and Method
for Detecting Cancer in Tissue (the "1974 Patent"). The development of the
Beta 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.
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 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 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.
ENFORCEMENT OF PATENTS
On September 2, 1992, the Company commenced legal action to enforce
its patent rights, filing suit against Hitachi Ltd., General Electric
Company and others in the United States District Court for the Eastern
District of New York. Prior to trial in April 1995, FONAR settled with
Hitachi. On May 26, 1995 the jury rendered a verdict against General
Electric Company awarding FONAR $110,575,000 for infringement of its
multi-angle oblique patent (Apparatus and Method for Multiple Angle Oblique
MRI, 10/3/89, U.S. Patent No. 4,871,966) and Dr. Damadian's pioneer cancer
detection patent (Apparatus and Method for Detecting Cancer in Tissue,
2/5/74, U.S. Patent No. 3,789,832). On September 30, 1995, the Court
decided the parties' respective post-trial motions, awarding FONAR
$61,950,000 and an injunction (stayed pending appeal) on the multi-angle
oblique patent (U.S. Patent No. 4,871,966). Although finding that the
cancer detection patent was valid (U.S. Patent No. 3,789,832), the Court
overturned the jury's determination that General Electric Company's MRI
scanners infringed the patent. Both the Company and General Electric
Company appealed. In February 1997, the United States Court of Appeals for
the Federal Circuit affirmed the judgment against General Electric Company
for infringement of the multi-angle oblique patent. In addition, the Court
of Appeals reversed the District Court on the original MRI patent and
reinstated the jury verdict awarding FONAR $35 million. Following the Court
of Appeals' denial of its petition for a rehearing and both the Court of
Appeals' and Chief Justice Rehnquist's denial of its application for a stay,
General Electric Company paid FONAR $128.7 million (inclusive of interest)
on July 2, 1997. In August 1997 General Electric filed a petition for a
writ of certiorari to the Supreme Court. The Supreme Court denied General
Electric Company's petition on October 6, 1997. The Company is represented
by Robins, Kaplan, Miller and Ciresi, the Minneapolis based national law
firm that represented Honeywell in its lawsuit against Minolta for
infringement of Honeywell's autofocus patents.
In June 1995, the Company filed suits against Siemens Medical
Systems, Inc., Philips Electronics North America Corporation and related
parties for infringement of FONAR's multi-angle oblique patent, Dr.
Damadian's pioneer cancer detection patent and, in the case of Siemens
Medical Systems, Inc., two additional MRI patents. FONAR settled with the
Philips companies in April, 1996 and the Siemens companies in September,
1996.
In March 1996, FONAR commenced a patent infringement suit against
Toshiba American MRI, Inc. and Toshiba American Medical Systems, Inc.
The Company believes that it has achieved a significant milestone
in protecting and enforcing its proprietary rights in its lawsuit against
General Electric Company, and having pioneered the establishment and
development of the medical MRI scanning industry, the Company intends to
take the steps necessary to enforce its rights and protect its proprietary
technology against other infringers as well. (See "Litigation.")
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
superconductive magnet technology while the balance are based on
non-superconductive magnet technology. FONAR's non-superconductive MRI
scanners are competing principally with superconductive scanners. The QUAD
12000 scanner, however, utilizing a 6,000 gauss (.6 Tesla field strength)
iron core electromagnet, is the first "open" MR scanner above low field
strength (above 600 gauss).
FONAR believes that its MRI scanners have significant advantages as
compared to the superconductive scanners. These advantages include:
1. There is no fringe magnetic field. Super conductive scanners
require a more expensive shielded room than is required for the
non-superconductive scanners. The shielded room required for the
non-superconductive scanners is intended to prevent interference from
external radio frequencies.
2. They do not require costly coolants (liquid nitrogen and liquid
helium) or highly complex technology to handle them.
3. They are more open, quiet and in the case of the QUAD scanners
allow for faster throughput of patients.
4. They require smaller space to install.
5. Their annual operating costs are lower.
6. Their set-up and disconnect time for a Mobile
Scanner is shorter than for a mobile superconductive
scanner.
7. They can scan the trauma victim, the cardiac arrest patient,
the respirator-supported patient, and premature and newborn babies. This is
not possible with superconductive scanners because their magnetic field
interferes with conventional life-support equipment.
FONAR faces competition within the MRI industry from such firms as
General Electric Company; Picker International, which is a Division of
General Electric Company PLC, of England; Elscint Ltd; Philips N.V.; Toshiba
Corporation, Hitachi Corporation, Shimadzu Corporation and Siemens A.G.
Most competitors have marketing and financial resources more substantial
than those available to the Company and have in the past, and may in the
future, heavily discount the sales price of their scanners.
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.
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. These systems have
comprised one of the most rapidly growing modalities during recent years due
to an increasing number of procedures for established applications, as well
as the expansion of ultrasound into new applications. 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
Under the Medical Device Amendments of 1976 to the Federal Food,
Drug and Cosmetic Act, all medical devices are classified by the Food and
Drug Administration (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. The
Company received approval to market its Beta 3000 and Beta 3000M scanners as
Class III devices on September 26, 1984. 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. On June 25, 1992, the
Company received FDA approval to market the Ultimate Magnetic Resonance
Imaging Scanner as a Class II device. The Company received FDA approval to
market the QUAD 7000 in April 1995 and for the QUAD 12000 in November 1995.
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.
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.
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.
U.S. HEALTH MANAGEMENT CORPORATION
(PHYSICIAN PRACTICE MANAGEMENT BUSINESS)
U.S. Health Management Corporation ("HMC") was organized by the
Company in March 1997 as a wholly-owned subsidiary for the purpose of
engaging in the business of providing comprehensive management services to
physicians' practices and other medical providers, including diagnostic
imaging centers and ancilliary services. The services to be 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. This business is sometimes referred to as "physician
practice management," "PPM" or "practice management." Revenues are earned
not from the performance of medical services, but through providing
management, administrative, equipment, personnel and other resources
required by the medical provider.
HMC became actively engaged in the PPM business through two
acquisitions which were consummated effective June 30, 1997. The acquired
companies in both cases were actively engaged in the business of managing
medical providers. With the exception of one multi-specialty practice, all
of the medical providers are diagnostic imaging centers, principally MRI
scanning centers.
The first acquisition was of a group of several interrelated
corporations, limited liability companies and a partnership engaged in the
business of managing three diagnostic imaging centers and one
multi-speciality practice in New York State. The transaction was effected
through a merger between a wholly-owned subsidiary of HMC (formed for the
purpose of effecting the transaction) and Affordable Diagnostics, Inc., one
of the acquired companies which immediately prior to the merger had acquired
the assets and assumed the liabilities of the other acquired companies
(together, the "Affordable Companies").
The business of the Affordable Companies, which will be continued
by HMC, consists of providing management, space, equipment, personnel and
other resources to the four managed facilities. The services provided at
the facilities include MRI scans, CAT scans, x-rays, physical
rehabilitation, and in connection with physical rehabilitation, ultra-sound
and SSEP/EMG electromygographic diagnostics. The four managed facilities
are located in Brewster, New York (MRI), Yonkers, New York (MRI and x-ray),
Bronx, New York (MRI and CT) and Riverdale, New York (multi-specialty
practice, ultra-sound and SSEP/EMG electromygographic diagnostics). The
assets acquired through the acquisition include three MRI scanners, one CT
scanner, one x-ray machine, rehabilitation equipment and ultra-sound and
electromygographic machines. The equipment is leased to and used at the
managed facilities. In addition, HMC is consummating the purchase of an
additional MRI scanner pursuant to a contract entered into prior to the
acquisition. The scanner is a mobile unit which is intended to be provided
to a number of hospitals on a shared basis, as needed, in northern New
Jersey.
The second completed acquisition was of Raymond V. Damadian, M.D.
MR Scanning Centers Management Company ("RVDC"). Pursuant to the terms of
the transaction, HMC purchased all of the issued and outstanding shares of
stock of RVDC from Raymond V. Damadian in exchange for 10,000 shares of the
Common Stock of FONAR. Raymond V. Damadian, the principal stockholder,
President and Chairman of the Board of FONAR, was the sole stockholder,
director and President of RVDC immediately prior to the acquisitions. The
business of RVDC, to be continued by HMC, was the management of MRI
diagnostic imaging centers in New York, Florida, Georgia and other
locations.
As a result of these transactions with Dr. Damadian, HMC has
acquired the business of managing 21 MRI scanning centers. Seventeen of the
scanning centers are managed pursuant to management agreements, and 4 of the
centers are partnerships with RVDC as the general partner. Effective July
1, 1997, HMC entered into new management agreements with the centers.
Pursuant to the management agreements, HMC is providing comprehensive
management services, including administrative services, office facilities,
office equipment, supplies and personnel (except for physicians) to the
centers. Service for the centers' MRI scanning equipment is provided under
the management agreements in these cases. MRI scanning systems are provided
to 8 of the centers pursuant to scanner leases entered into effective July
1, 1997. All of the facilities previously managed by RVDC are MRI scanning
centers.
HMC GROWTH STRATEGY
In addition to acquiring existing management companies (i.e. RVDC
and the Affordable Companies), HMC is also pursuing acquisitions pursuant to
which HMC would purchase the assets of physicians' practices.
Simultaneously with the acquisition of the assets, HMC would enter into
agreements with the physicians (or a professional corporation employing the
physicians) pursuant to which HMC would lease the use of the assets and
provide management services. The professional corporation could be either
affiliated with HMC or owned by the selling physicians.
HMC intends to pursue such transactions with primary care practices
and specialists to whom primary care doctors typically refer patients. HMC
believes that there are numerous existing medical practices that could
benefit from improved management techniques which would allow the physicians
to spend more time treating patients (thereby increasing their revenue) and
less time being concerned with the day to day tasks of managing the
business.
In addition, expansion plans for HMC's clients will include opening
more offices and expanding existing offices so as to enable practices to
treat more patients more efficiently.
HMC will seek to create a network of physicians to participate in
managed care. HMC believes that the creation of this network will be
particularly helpful to its clients where capitated fee agreements are
negotiated with insurers since its clients will be able to offer more
services from more locations and thereby obtain a higher capitation rate
than they might otherwise have been able to obtain.
HMC's growth strategy is intended to enable its medical practice
clients to retain and enhance revenues and to offer patients cost-effective
medical care within an integrated practice offering a broad range of
evaluation, testing, diagnostic, treatment and therapeutic services. In the
longer term, as the network of offices to which it provides its management
services grows, HMC believes that it will be in an excellent position to
attract managed care contracts for its clients from employers and insurance
carriers.
MEDICAL PRACTICE MANAGEMENT SERVICES
HMC's services to the facilities it manages encompass substantially
all of the facilities' operations. These services include:
(1) Offices and Equipment. HMC provides office space and
equipment to its clients. This includes technologically sophisticated
medical equipment. HMC also provides improvements to leaseholds, assistance
in site selection and advice on improving, updating, expanding and adapting
to new technology.
(2) Personnel. HMC 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, as well as process the
necessary tax, insurance and other documentation relating to employees.
(3) Administrative. HMC 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 ensure full and timely regulatory
compliance and appropriate cost reimbursement under no-fault insurance and
workers' compensation guidelines.
(4) Billing and Collections. HMC 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, HMC seeks to obtain favorable pricing for medical supplies,
equipment, pharmaceuticals and other inventory for its clients.
(6) Diagnostic Imaging and Ancilliary Services. With the
acquisition of RVDC, HMC can offer access to diagnostic imaging equipment
through diagnostic imaging facilities managed by it. The Company is
expanding the ancilliary services offered in its network to include
CT-scans, x-rays, ultrasound, and other ancilliary services useful to its
clients.
(7) Marketing Strategies. HMC is responsible for developing
marketing plans for its clients.
HMC provides its services pursuant to negotiated contracts with its
clients. While HMC believes it can provide the greatest value to its
clients by furnishing the full range of services appropriate to that client,
HMC would also be willing to enter into contracts providing for a more
limited spectrum of management services.
HMC MARKETING
HMC's marketing strategy is to increase the size, number and
locations of medical practices and facilities which it manages. HMC will
also seek to broaden the types of medical practices which it services and to
develop a client base of primary care and speciality practices as well as
diagnostic imaging facilities and other ancilliary services. HMC will seek
to promote growth of its clients' patient and revenue bases by developing a
network of medical providers and assisting its clients in the development of
multi-specialty medical practices.
Marketing activities include locating medical practices which meet
the size, quality and operating parameters set by HMC. HMC will focus on
opportunities for expanding the services clients offer and expanding into
new geographic areas. HMC will also seek to increase the patient volume of
clients.
DIAGNOSTIC IMAGING CENTERS AND OTHER ANCILLIARY SERVICES
Diagnostic imaging centers managed by HMC 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 centers 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 interpreting
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 HMC personnel and then delivered
to the referring physician.
In addition, HMC is expanding the ancilliary services offered in
its network to include CT scans, x-rays, ultrasound and other modalities as
may be appropriate for the physician practice mix.
HMC 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
center 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. HMC also directs marketing efforts at
managed care providers.
Managed care providers are becoming an increasingly important
factor in the diagnostic imaging industry. To further its position, HMC
will seek to expand the imaging modalities offered at its managed centers or
to create networks with other imaging centers.
COMPETITION (HMC)
The medical practice management field is highly competitive. A
number of large hospitals have acquired medical practices and this trend may
continue. HMC expects that more competition will develop. Many competitors
have greater financial and other resources than HMC.
With respect to the diagnostic imaging centers managed by HMC, the
outpatient diagnostic imaging industry is highly competitive. Competition
focuses primarily on attracting physician referrals at the local market
level and , increasingly, referrals through relationships with managed care
organizations. HMC 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.
GOVERNMENT REGULATION APPLICABLE TO HMC
Various States prohibit business corporations from practicing
medicine. Consequently, HMC leases space and equipment to clients and
provides clients with a range of non-medical administrative and managerial
services. HMC does not engage in the practice of medicine or establish
standards of medical practice or policies for its clients.
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.
HMC's clients generate revenue from patients covered by
no-fault insurance and 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, HMC could be
required to modify its business practices and services in ways that could be
more costly to HMC or in ways that decrease the revenues which HMC receives
from its clients.
HMC believes that it is in compliance with applicable Federal,
State and local laws. HMC does not believe that such laws will have any
material effect on its business.
EMPLOYEES
As of July 1, 1997, the Company employed 346 persons on a full-time
basis. Of such employees, 10 were engaged in marketing and sales, 36 in
research and development, 87 in manufacturing, 46 in customer support
services, 137 in administration (including 75 on site at facilities managed
by HMC and 32 performing billing, collection and transcription services for
those facilities) and 30 professional MRI technicians on site at diagnostic
imaging centers managed by HMC.
ITEM 2. PROPERTIES
The Company leases approximately 122,240 square feet of office and
plant space at its principal offices in Melville, New York and at one other
location in Farmingdale, New York at a current aggregate rental rate of
approximately $735,321, excluding utilities, taxes and other related
expenses. The terms of the various leases extend through 1998 and the
beginning of 1999, with options to renew ranging from 17 months to 10 years
on its principal facilities. Management believes that these premises are
adequate for its current needs.
ITEM 3. LEGAL PROCEEDINGS
On September 2, 1992, the Company filed an action against General
Electric Company, ("General Electric"), Hitachi Ltd. ("Hitachi") and other
defendants for patent infringement in the United States District Court for
the Eastern District of New York seeking injunctive relief and damages.
(FONAR Corporation and Dr. Raymond V. Damadian v. Hitachi Ltd. et. al. Civil
Action No. 92-4196). The defendants contested the Company's claims, and
Hitachi counterclaimed, alleging infringement by the Company of two of its
patents. In April, 1995, after the opening statements by counsel at the
commencement of trial, FONAR and Hitachi reached a settlement. On May 26,
1995, the jury rendered a verdict against General Electric Company awarding
FONAR $110,575,000 for infringement of two of its patents: United States
Patent Number 3,789,832 entitled "Apparatus and Method for Detecting Cancer
in Tissue" and United States Patent Number 4,871,966 entitled "Apparatus and
Method for Multiple Angle Oblique Magnetic Resonance Imaging." Subsequent
to the verdict General Electric made motions to the Court to enter judgment
as a matter of law in its favor and against FONAR with respect to both
patents notwithstanding the jury's verdict. FONAR made a motion to the
Court for an injunction restraining General Electric Company from using the
multi-angle oblique imaging technology covered by U.S. Patent No. 4,871,966.
On September 30, 1995 the Court announced its decision. In its decision,
the Court awarded FONAR $61,950,000 in damages against General Electric for
direct infringement of U.S. Patent No. 4,871,966 (Multiple Angle Oblique
Magnetic Resonance Imaging) and granted an injunction against General
Electric prohibiting future violations of the patent. (An additional
$6,471,726 in pre-judgment interest was awarded to FONAR on November 17,
1995.) The injunction was stayed pending appeal, however, upon the posting
of a bond by General Electric. With respect to U.S. Patent No. 3,789,832
(Cancer Detection Patent), the judge agreed with the jury's finding that the
patent was valid, but disagreed with the jury finding of infringement and
determined that General Electric's MRI scanners did not infringe the patent.
The Court also rejected the jury's finding that General Electric had induced
others to infringe U.S. Patent No. 4,871,966. General Electric has appealed
the portion of the judgment upholding the jury's award of damages to FONAR
for direct infringement of U.S. Patent No. 4,871,966 and the issuance of the
injunction. FONAR has appealed the portion of the judgment overturning the
jury's findings of infringement on U.S. Patent No. 3,789,832 and
contributory infringement in respect of U.S. Patent No. 4,871,966.
In February 1997, the Court of Appeals for the Federal Circuit
affirmed the District Court's judgment against General Electric for
infringement of the Company's Multi-Angle Oblique imaging patent (U.S.
Patent No. 4,871,966) but left standing the District Court's determination
that General Electric was not liable for inducing others to infringe the
patent. With respect to the Cancer Detection Patent (U.S. Patent No.
3,789,832), the Court of Appeals reversed the District Court and reinstated
the jury verdict against General Electric awarding the Company $35 million
for infringement.
General Electric subsequently petitioned the Court of Appeals for a
rehearing, with the suggestion that the rehearing be held in banc (by all
the Circuit judges). On May 8, 1997, the Court of Appeals denied the
petition. General Electric then applied for a stay pending an appeal to the
United States Supreme Court. The application was denied by the Court of
Appeals in the first instance and then by Chief Justice Rehnquist of the
Supreme Court.
Following the denial of General Electric's petition and application
for a stay, the District Court entered a judgment based on the Court of
Appeals' decision. On July 2, 1997, General Electric paid $128.7 million
(inclusive of interest) without, however, prejudicing its right to appeal to
the Supreme Court. In August, 1997, General Electric filed a petition for a
writ of certiorari requesting the Supreme Court to hear the case. In
October 1997, the Supreme Court denied General Electric's petition.
On June 16, 1995, the Company filed an action against Siemens
Medical Systems, Inc., Philips Electronics North America Corporation,
Philips Electronics, N.V. and other defendants for patent infringement in
the United States District Court for the Eastern District of New York.
FONAR sought injunctive relief and damages (FONAR Corporation and Dr.
Raymond V. Damadian V. Siemens Medical Systems, Inc. et al. Civil Action No.
CV 95-2469 (LJW). In its suit, FONAR alleged that four of its patents were
infringed, including U.S. Patent Nos. 3,789,832 (Apparatus and Method for
Detecting Cancer in Tissue) and 4,871,966 (Apparatus and Method for Multiple
Angle Oblique Magnetic Resonance Imaging). (Subsequently, the action was
transferred to the United States District Court for the District of
Delaware.)
Previously, in May 1995, Siemens Medical Systems, Inc. had filed a
complaint against FONAR in the United States District Court for the District
of Delaware seeking a declaratory judgment that the four patents were
invalid and unenforceable, as well as an adjudication that Siemens was not
infringing the four patents. On June 14, 1995, Siemens Medical Systems,
Inc. amended the Complaint to add Siemens AG as a plaintiff, to add Raymond
V. Damadian, M.D. MR Scanning Centers Management Company as a defendant and
to include a claim against FONAR for infringement of one of Siemens' MRI
patents. The complaint was further amended on December 14, 1995 to allege
infringement of two additional patents. (Siemens Medical Systems, Inc. and
Siemens AG, v. FONAR Corporation and Raymond V. Damadian, M.D. MR Scanning
Centers Management Company, Civil Action No. 95-261.
Thereafter, on June 30, 1995, Philips Electronics North America
Corporation and Philips Electronics, N.V. filed a complaint against FONAR in
the United States District Court for the District of Delaware seeking a
declaratory judgment that FONAR's U.S. Patents Nos. 3,789,832 and 4,871,966
were invalid, unenforceable and not infringed (Philips Electronics North
America Corporation and Philips Electronics, N.V. v. FONAR Corporation, Case
No. 95-431).
Separately, U.S. Philips Corporation, an affiliate of Philips
Electronics North America Corporation and Philips Electronics, N.V.,
commenced an action in the United States Court for the District of Delaware
alleging infringement by FONAR of two of its patents. (U.S. Philips
Corporation v. Fonar Corporation and Raymond V. Damadian, M.D. MR Scanning
Centers Management Company, Civil Action No. 95-448.)
In April 1996, FONAR entered into an agreement with Philips
Electronics N.V., Philips Electronics North America Corporation, Philips
Medical Systems North America and U.S. Philips Corporation setting the
lawsuits and claims between them. The settlement involved a monetary
payment to FONAR.
In September 1996, FONAR entered into an agreement with Siemens
Medical Systems, Inc. and its affiliates settling the lawsuits and claims
between them. The settlement agreement, which does not admit liability by
either party, includes a cross-license by Siemens and FONAR of certain
patents relating to MRI technology. FONAR received a monetary payment from
Siemens and an agreement by Siemens to pay FONAR royalties.
On March 4, 1996, the Company filed an action against Toshiba
Corporation, Toshiba America Medical Systems, Inc., Toshiba American MRI,
Inc. and others alleging infringement of four of its MRI patents. FONAR
Corporation and Dr. Raymond V. Damadian v. Toshiba Corporation, Toshiba
America Medical Systems, Inc., Toshiba America MRI, Inc. et al. (U.S.
District Court, Eastern District of New York, Civil Action No. 96-0963.)
On March 4, 1987, Philip B. Kivitz, M.D. and Rad-Sonic Diagnostic
Medical Clinics, Inc., filed a complaint against AMD, FONAR, Raymond V.
Damadian and others in the San Francisco County Superior Court (Case Action
No. 870407) seeking $10,000,000 in compensatory damages and $10,000,000 in
punitive damages. In January 1993, the case went to trial and the jury
returned a verdict of $880,000 against AMD and $120,000 against FONAR. On
June 17, 1993, the Court granted FONAR's and AMD's motion for judgment
notwithstanding the verdict, thereby vacating the entire award against both
FONAR and AMD. The plaintiffs appealed the Court's granting of judgment
notwithstanding the verdict. On February 27, 1995, the appellate court
affirmed the lower court's judgment notwithstanding the verdict as to FONAR,
but reversed the judgment as to AMD. As a result, the trial court's
determination that the plaintiffs could not recover against FONAR was
upheld, but the jury verdict against AMD was reinstated. AMD filed a
petition for review with the California Supreme Court. AMD's petition was
denied on May 17, 1995.
On April 3, 1990, Summit, Rovins and Feldesman commenced an action
in the Supreme Court of the State of New York, County of New York against
the Company and its President, Raymond V. Damadian. The complaint alleged
unpaid fees for legal services and disbursements in the amount of
$664,371.65. The Company contested the plaintiff's claims as excessive and
improper charges for legal services, and has asserted various defenses and a
counterclaim of $100,000 for a refund of fees. The plaintiff made a motion
for summary judgment which was granted as to the existence of liability but
denied as to the amount. Dr. Damadian's cross-motion to dismiss the action
against him personally was granted. Both parties appealed the court's
decisions. On March 9, 1995, the appellate court reversed the granting of
summary judgment against FONAR. The appellate court also upheld the
dismissal of the action against Dr. Damadian personally. Immediately prior
to trial, on June 25, 1997, the parties entered into a settlement pursuant
to which the Company will pay Summit, Rovins and Feldesman $415,000.
In June 1995, a FONAR stockholder commenced an action in the
Delaware Court of Chancery against FONAR and its directors, alleging
breaches of fiduciary duties by the defendants in connection with a
recapitalization plan adopted by the stockholders of the Company on April 3,
1995 (Horace Rubenstein, Individually and on Behalf of All Others Similarly
Situated v. Raymond V. Damadian et al., C.A. No. 14378). The action was
brought derivatively, on behalf of FONAR and as a class action on behalf of
the public holders of FONAR's Common Stock. The defendants answered the
complaint and vigorously denied any wrongdoing or liability. The parties
reached a settlement agreement which was approved by the Court of Chancery
on April 29, 1997. As approved by the Court, the settlement increases the
dividends payable on the Company's Common Stock and Class A Non-voting
Preferred Stock from the proceeds of its patent litigation. The three
percent (3%) dividend originally payable on the Common Stock of any awards
collected by the Company on its Cancer Detection Patent (U.S. Patent No.
3,789,832) was increased to 3 1/4% of the first $10 million collected, 4
1/2% of the next $20 million collected and 5 1/2% of any additional amounts
collected of any such cash award. The 3% dividend originally payable on the
Class A Non-voting Preferred Stock of any awards on the other four patents
asserted in the litigation against General Electric Company and Hitachi
Ltd., including the Company's Multi-Angle Oblique Imaging Patent, was
similarly increased and extended to any patent litigation seeking to enforce
those patents commenced prior to November 29, 1997. In addition, the
Company agreed to issue Warrants to purchase Common Stock to holders of
record of its Common Stock on October 20, 1995 (the record date for
determining the stockholders entitled to receive the Class A Non-voting
Preferred Stock). The settlement agreement further provided that there
would be no further recapitalizations increasing Dr. Damadian's voting
control for a period of 5 years without the consent of a majority of the
holders of the Company's Common Stock, and Dr. Damadian agreed to share with
the holders of the Common Stock any "control premium" he might receive in
connection with the sale by him of Class B or Class C Common Stock during a
five year period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Part II
ITEM 5. MARKET FOR REGISTRANT's COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded in the over-the-counter market
under the National Association of Securities Dealers Automated Quotation
System ("NASDAQ") symbol FONR. The following table sets forth the high and
low bid and asked prices reported in NASDAQ System for the periods shown.
The prices represent quotations between dealers and do not include certain
mark-ups, mark-downs or commissions, and do not necessarily represent actual
transactions.
Fiscal Quarter
Bid Ask
High Low High Low
July - September 1994 1.91 1.22 2.00 1.25
October - December 1994 2.50 1.28 2.53 1.31
January - March 1995 2.50 1.53 2.53 1.63
April - June 1995 4.50 2.38 4.56 2.41
July - September 1995 3.84 2.56 4.00 2.63
October - December 1995 3.91 2.50 3.97 2.56
January - March 1996 2.78 2.09 2.81 2.13
April - June 1996 3.00 2.19 3.03 2.25
July - September 3 1996 2.63 2.13 2.72 2.19
October - December 1996 3.06 2.22 3.13 2.25
January - March 1997 4.44 2.09 4.50 2.13
April - June 1997 3.16 2.28 3.19 2.34
July - September 22 1997 3.44 2.72 3.50 2.75
On September 22, 1997, the Company had approximately 4,479
stockholders of record of the Company's Common Stock, 14 stockholders of
record of the Company's Class B Common Stock, 4 stockholders of record of
the Company's Class C Common Stock and 4,639 stockholders of record of the
Company's 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 has paid no dividends to date. The Company
anticipates, however, paying certain dividends on monies it receives from
the enforcement of its patents. Except for these dividends, 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, 1997. The selected financial data for 1997, 1996 and 1995 reflects the
results of operations, assets and liabilities of RVDC and the assets and
liabilities of the Affordable Companies. The selected financial data for 1994 and
1993 is not consolidated with these entities. 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.
As of, or For the Period Ended June 30,
STATEMENT OF OPERATIONS 1997 1996 1995 1994** 1993**
----------- ----------- ----------- ------------ -----------
Revenues $17,633,066 $13,915,725 $16,522,676 $15,387,000 $16,802,000
Cost of $13,828,574 $10,417,384 $ 6,360,134 $ 7,814,000 $ 9,608,000
revenues
Research and $ 3,928,035 $ 3,607,703 $ 3,356,120 $ 2,803,000 $ 2,181,000
Development Expenses
Net Income (loss) $56,068,771 $(11,407,444) $(7,549,625) $ (335,000) $ 238,000
Net income (loss) .95 -.22 -.17 -0.01 0.01
per common share
Weighted average 59,097,965 51,516,470 45,055,334 36,774,000 30,870,000
number of shares
outstanding *
BALANCE SHEET DATA
Working capital $64,837,573 $(1,575,857) $(4,498,911) $ (7,749,000) $(12,239,000)
(deficit)
Total $106,690,561 $28,057,384 $27,949,122 $48,418,000 $42,811,000
assets
Long-term debt and $ 4,211,269 $ 4,204,935 $ 4,274,420 $ 5,884,000 $ 9,483,000
obligations under
capital leases
Stockholders' $ 73,245,262 $11,412,629 $29,394,096 $28,333,000 $18,022,000
equity
* Adjusted for stock dividend of Class A Non-voting Preferred Stock declared in October, 1995.
** Does not reflect consolidation with RVDC or the Affordable Companies.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITIONS AND RESULTS OF OPERATIONS.
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, U.S. Health Management Corporation ("HMC")
in order to expand into the physician practice management business. In
connection with its entry into this new line of business, HMC completed two
acquisitions.
The first acquisition was of a group of companies engaged
in the business of managing three diagnostic imaging centers and one
multi-specialty practice in New York State (the "Affordable Companies").
The second acquisition was of Raymond V. Damadian, M.D. MR Scanning Centers
Management Company ("RVDC"), a company owned by FONAR's principal
stockholder, President and Chairman of the Board, Raymond V. Damadian. The
business of RVDC, to be continued by HMC, was the management of MRI
diagnostic imaging centers in New York, Florida, Georgia and other
locations.
FONAR's principal MRI products are its QUAD 7000 and QUAD
12000 MRI scanners. Having received the necessary FDA approvals for its
QUAD scanners, the Company believes it is in a position to aggressively seek
new sales. The QUAD scanners are highly competitive and totally new
non-claustrophobic scanners not previously available in the MRI market. At
.6 Tesla field strength, the QUAD 12000 magnet is the highest field "Open
MRI" in the industry, offering non-claustrophobic MRI together with
high-field image quality for the first time. The Company expects vigorous
sales from its new products.
As part of its scanner marketing program, the Company attended
the industry's annual trade show, RSNA (Radiological Society of North
America) in November 1995 and 1996, and plans to do so again in November
1997. The Company believes that it is uniquely positioned to take advantage
of the rapidly expanding "Open MRI" market, as the manufacturer of the only
high-field "Open MRI" in the industry. The Company expects marked demand
for this product since image quality increases as a direct proportion to
magnetic field strength. In addition, the Company's new scanners provide
improved image quality and high speed imaging at costs that are
significantly less than the competition and more in keeping with the medical
cost reduction demands being made by our national leaders on behalf of the
public.
As at September 1, 1997, the Company's backlog of unfilled orders
was approximately $6.4 million, as compared to approximately $6.8 million at
September 1, 1996.
HMC 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.
HMC did not actively engage in business until after June 30, 1997,
which was the effective date of its acquisitions of the Affordable Companies
and RVDC. As separate businesses, the Affordable Companies had been engaged
in business since 1994 and RVDC had been engaged in business since 1990.
For financial statement presentation the results of operations, assets and
liabilities of the Company and RVDC have been consolidated for prior
periods. The Affordable Companies have been consolidated for balance sheet
purposes, but not for results of operations for prior periods. In
connection with the acquisition of the Affordable Companies and related
transactions, the Company has issued 2,164,000 shares of its Common Stock
and will release from escrow an additional 576,000 shares provided certain
financial performance goals are met. The acquisition of RVDC was
consummated by the purchase of all of the outstanding shares of RVDC for
10,000 shares of the Company's Common Stock.
The Company's efforts to reduce infringement of its intellectual
property rights by competitors have produced material benefits, as reflected
in the $128.7 million recovered from General Electric Company. After
deduction of attorney's fees, the net amount of $77.2 million was collected
by the Company on July 2, 1997. The full amount of the award was recognized
for financial statement purposes in fiscal 1997 (See Financial Statements).
The Company also has commenced and settled similar patent infringement suits
against other major competitors (See "Litigation").
RESULTS OF OPERATIONS.
FISCAL 1997 COMPARED TO FISCAL 1996
Except where otherwise indicated, the results of operations reflect
the consolidation of the Company and RVDC, but not of the Affordable
Companies.
In fiscal 1997, the Company experienced net income of $56.0 million
on revenues of $17.6 million as compared to a net loss of $11.4 million on
revenues of $13.9 million for fiscal 1996. Revenues and income (losses)
attributable to RVDC were approximately $8.1 million and ($2.0 million)
respectively for fiscal 1997 and $5.7 million and ($4.8 million)
respectively for fiscal 1996. As noted above, net income for fiscal
1997 reflects the net income attributable to the award received by the
Company in its patent litigation.
As the Company has expanded its operations and productive capacity,
costs and expenses increased in fiscal 1997. Cost of revenues increased
from $10.4 million in fiscal 1996 to $13.8 million in fiscal 1997. Research
and development, selling, general and administrative expenses increased to
approximately $24.2 million for fiscal 1997 from approximately $17.2 million
for fiscal 1996. Costs of revenues and selling general and administrative
expenses attributable to RVDC were $1.9 million and $7.2 million respectively
for fiscal 1997 and $2.1 million and $6.8 million, respectively for fiscal 1996.
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 1997 the Company continued its investment in the development of its
new MRI scanners, together with software and upgrades, with an investment of
$3,928,035 in research and development ($108,809 of which was capitalized)
as compared to $3,607,703 ($251,659 of which was capitalized) in fiscal
1996. The research and development expenditure was approximately 22.3% of
revenues in 1997 and $25.9% of revenues in 1996.
The Company has continued its efforts to increase scanner sales in
foreign countries as well as domestically. Based on sales to date, further
indications of interest, meetings, sales trips abroad and negotiations, the
Company is optimistic that foreign sales will continue to prove a
significant source of revenue.
The Company continued to benefit as a result of programs set in
motion in fiscal 1989; namely strict cost containment initiatives and
expanding the corporate business into a greater number of profitable
enterprises within and related to the MRI and medical industries (e.g.,
physician practice management, customer service, upgrades). As a result of
this expansion, including the acquisition of RVDC, the percentage of the
Company's revenue derived from sources other than scanner sales was
approximately 70.64% for fiscal 1997 and 85.2% for fiscal 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
In fiscal 1996, the Company experienced a net loss of $3.4 million
on revenues of $13.1 million as compared to a net loss of $1.8 million on
revenues of $14.1 million for fiscal 1995. Revenues and income (losses)
attributable to RVDC were $5.7 million and ($4.8 million), respectively for
fiscal 1996 and $7.8 million and ($2.0 million), respectively for fiscal 1995.
Lower revenues experienced in fiscal 1996 were the principal reason
for the operating losses experienced in fiscal 1996 (operating losses of
$15.3 million in fiscal 1996 as compared to $10.1 million in fiscal 1995).
Lower revenues reflected strong competition in the markets for both MRI
products and diagnostic imaging services, and a continued weak domestic
demand for MRI scanners in a marketplace eager to see new products that
would address both the heightened cost pressures on MRI and the patient
demand for non-claustrophobic scanners.
As at September 1, 1996, the Company's backlog of unfilled scanner
orders was approximately $6.8 million, as compared to $4.0 million at
September 1, 1995.
As the Company has expanded its operations and productive capacity
to meet and anticipate new orders, costs and expenses increased in fiscal
1996. Although cost of revenues remained relatively constant at
approximately $10.4 million in 1996 as compared to $10.2 million in fiscal
1995, research and development, selling, general and administrative expenses
increased to approximately $17.2 million for fiscal 1996 from approximately
$15.0 million for fiscal 1995. Costs of revenues and selling, general and
administrative expenses attributable to RVDC were $2.1 million and $6.8
million respectively for fiscal 1996 and $1.8 million and $6.0 million
for fiscal 1995.
In fiscal 1996 the Company invested $3,607,703 in research and
development ($251,659 of which was capitalized) as compared to $3,356,120 in
research and development ($281,052 of which was capitalized) in fiscal 1995.
The research and development expenditure was approximately 25.9% of revenues
in 1996 and 20.3% of revenues in 1995.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1997, the Company's liquidity and capital
resources positions changed from the June 30, 1996 position as follows:
June 30, June 30,
1997 1996 Change
____________ ____________ __________
Working capital
(deficiency) $64,837,573 ($1,575,857) $66,413,430
The improvement in the Company's working capital position
resulted primarily from the award in its patent litigation ($77.2 million),
but cash and accounts receivable increased from fiscal 1996 to fiscal 1997
as well (to $11.9 million at June 30, 1997 from $8.5 million at June 30,
1996). The increase in current liabilities from $14.9 million to $28.5
million at June 30, 1997 was attributable principally to dividends payable
on the awards and settlements in the Company's patent litigation, accrued
compensation, taxes and legal fees.
Since June 1989, a principal objective of the Company has been
to reduce and ultimately eliminate its debt. Since the inception of the
plan, interest bearing debt was reduced from $23.1 million in fiscal 1989
(which does not include any indebtedness of RVDC) to $4.6 million on a
consolidated basis with RVDC at June 30, 1997 ($3.9 million without
consolidating RVDC). From June 30 1996 to June 30, 1997, interest-bearing
debt increased slightly, from $4.3 million to $4.6 million, reflecting
principally the financing of new equipment in connection with the expansion
of the Company's productive capacity.
As of June 30, 1997, the Company had no unused credit
facilities with banks or financial institutions.
The Company's business plan currently includes an aggressive
program for manufacturing and selling its new line of QUAD scanners which
are achieving success in the marketplace. In addition the Company plans,
through its subsidiary, U.S. Health Management Corporation, to develop and
expand its PPM (physician practice management) business (See "Description of
Business").
The Company believes its present financial resources are
sufficient to achieve the sales, service and production levels necessary to
support its operations.
The Company offers its products for sale or lease to customers.
Cash flows from leasing transactions are derived under the terms of the
underlying agreements. Over the long term, the Company expects enhanced
cash flows and increased revenues from such transactions while in the short
term, such transactions impair cash flow. In order to mitigate the short
term effect on cash flow, the Company previously had borrowed money secured
by the leases and the underlying equipment. Such debt comprises
substantially all of the remaining long-term debt in the accompanying
financial statements.
In addition to leasing products to customers, the Company has developed
and begun to implement a new program to finance a portion of the purchase
price of its scanners through a newly formed subsidiary, Fonar Acceptance
Corporation, and to assist the customer in obtaining the remaining portion of
its financing through an independent source or sources. The new program is
intended to increase the overall profitability of the Company by assisting in
the sale of scanners and participating in the profits derived from financing
those sales.
Since 1990 the Company has restructured various long-term loans and
notes. The significant changes included extended maturity dates, and the
addition of unpaid interest to the note and loan balances.
Capital expenditures for each of fiscal 1997 and 1996 approximated
$1.75 million and $1.76 million, respectively, and substantially consisted
of capitalized computer software costs in connection with the development of
scanner products, patent costs, copyright costs and production equipment.
The Company's business plan initiated in September 1989, had as its
objective the enhancement and stabilization of revenue streams through the
generation of additional income from its installed base of scanners and
leasing programs. In addition, the Company instituted strict cost
containment programs. While continuing to focus on new sources of income,
the Company now has commenced aggressive sales and manufacturing of its new
generation of Open MRI scanners, the QUAD scanners and is reemphasizing MRI
Scanner sales. In addition, the Company is seeking to enhance revenue by
entering into the PPM (physician practice management) business through its
new subsidiary, U.S. Health Management Corporation ("HMC").
Cost containment programs continue in force notwithstanding an
increase in costs and expenses resulting from increased manufacturing
activity and marketing of its MRI scanners. These programs, which include
increasing the portion of manufacturing conducted on the Company's premises,
have enabled the Company to achieve significantly lower manufacturing costs
than would have otherwise been experienced in the production of its QUAD
scanners. This has enabled the Company to pass on to customers a much
needed reduction in the sales price of MRI scanners.
The Company's plan calls for a continuing emphasis on providing its
customers with enhanced equipment service and maintenance capabilities and
delivering state-of-the-art, innovative and high quality equipment upgrades
at competitive prices. Fees for on-going service and maintenance from the
Company's installed base of scanners were $3.7 million for the year ended
June 30, 1996 and $2.5 million for the year ended June 30, 1997
(transactions between the Company and RVDC are eliminated in the
consolidation). The Company will continue to aggressively develop and
market upgrades and enhancements for previously installed scanners.
The Company's working capital surplus as of June 30, 1997
approximates $64.8 million, as compared to a working capital deficiency of
$1.6 million as of June 30, 1996.
The Company believes that the above mentioned financial resources
will provide the cash flows needed to achieve the sales, service and
production levels necessary to support its operations. In addition, the
Company is exploring other more permanent financing alternatives which may
become available as the success of the previously described programs
accelerates.
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FONAR CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Page No.
INDEPENDENT AUDITORS' REPORT F-2
CONSOLIDATED BALANCE SHEETS F-3; F-4
At June 30, 1997 AND 1996
CONSOLIDATED STATEMENTS OF OPERATIONS F-5
For the Three Years Ended June 30,
1997, 1996 and 1995
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'
EQUITY For the Three Years F-6 to F-14
Ended June 30, 1997, 1996 and 1995
CONSOLIDATED STATEMENTS OF CASH FLOWS F-15; F-16
For the Three Years Ended June 30, 1997,
1996 and 1995
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-17 to F-70
SELECTED FINANCIAL DATA (*)
For the Five Years Ended June 30, 1997
(*) Included in Part II, Item 6
of the Form.
Information required by other schedules called for under Regulation S-X is
either not applicable or is included in the consolidated financial statements or
notes thereto.
F-1
INDEPENDENT AUDITORS' REPORT
----------------------------
To the Board of Directors
FONAR Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of FONAR
Corporation and Subsidiaries as at June 30, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the years in the three-year period ended June 30, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of FONAR
Corporation and Subsidiaries at June 30, 1997 and 1996, and the consolidated
results of their operations and cash flows for each of the years in the
three-year period ended June 30, 1997, in conformity with generally accepted
accounting principles.
During each of the years in the three-year period ended June 30, 1997, a
significant portion of the Company's revenues was from related parties (see Note
18).
/S/ TABB, CONIGLIARO & McGANN, P.C.
TABB, CONIGLIARO & McGANN, P.C.
New York, New York
October 13, 1997
F-2
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
------
June 30,
---------------------------
1997 1996
------------ -----------
CURRENT ASSETS
Cash and cash equivalents $ 5,861,500 $ 3,861,167
Receivable from litigation award 77,223,460 -
Accounts receivable, net 6,000,063 4,599,576
Costs and estimated earnings in
excess of billings on uncompleted
contracts 818,865 336,455
Inventories 3,440,509 3,629,244
Prepaid expenses and other current
assets 409,673 905,271
------------ -----------
TOTAL CURRENT ASSETS 93,754,070 13,331,713
ASSET HELD FOR RESALE - 450,000
PROPERTY AND EQUIPMENT - Net 6,068,675 3,720,090
ADVANCES AND NOTES TO AFFILIATES AND
RELATED PARTIES, Net of discounts
and allowance for doubtful accounts
of $3,750,000 and $1,250,000 at June 30,
1997 and 1996, respectively 1,928,625 5,109,857
LONG-TERM ACCOUNTS RECEIVABLE, Net of
allowance for doubtful accounts of
$2,490,018 and $1,990,018 at June
30, 1997 and 1996, respectively 253,534 624,174
NOTES RECEIVABLE, Net of allowance for
doubtful accounts of $865,964 and
$708,411 at June 30, 1997 and 1996,
respectively 107,384 157,553
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
Net of accumulated amortization of
$7,465,409 and $6,872,193 at June 30,
1997 and 1996, respectively 771,517 1,255,924
OTHER INTANGIBLE ASSETS, Net 3,569,151 3,204,155
OTHER ASSETS 237,605 203,918
------------ -----------
TOTAL ASSETS $106,690,561 $28,057,384
============ ===========
See accompanying notes to consolidated financial statements.
F-3
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
June 30,
---------------------------
1997 1996
------------ -----------
CURRENT LIABILITIES
Notes payable $ 415,000 $ 100,000
Current maturities of long-term debt
and capital lease obligations 2,387,508 2,958,064
Accounts payable 2,837,421 2,148,160
Other current liabilities 13,687,599 8,305,508
Dividends payable 7,637,841 217,226
Customer advances 764,402 933,604
Billings in excess of costs and
estimated earnings on uncompleted
contracts 192,932 170,008
Income taxes payable 100,000 75,000
Deferred income taxes 3,071,897 -
------------ -----------
TOTAL CURRENT LIABILITIES 31,094,600 14,907,570
------------ -----------
DEFERRED INCOME TAXES - NON-CURRENT 221,897 -
LONG-TERM DEBT AND CAPITAL LEASE
OBLIGATIONS, Less current maturities
(Notes 2, 11 and 15) 1,823,761 1,246,871
OTHER LIABILITIES 100,941 59,023
------------ -----------
2,146,599 1,305,894
------------ -----------
MINORITY INTEREST 204,100 431,291
------------ -----------
COMMITMENTS AND CONTINGENCIES (Notes 3,
9, 11 and 15)
STOCKHOLDERS' EQUITY
Common stock - $.0001 par value;
issued - 49,133,422 and 42,871,751
shares at June 30, 1997 and 1996 4,913 4,287
Class B common stock (10 votes per
share) - $.0001 par value; issued
and outstanding - 5,411 shares at
June 30, 1997 and 1996 - -
Class C common stock (25 votes per
share) - $.0001 par value;
9,562,824 issued and
outstanding at June 30, 1997 and
1996 956 956
Class A non-voting preferred stock -
$.0001 par value; issued and
outstanding - 7,855,627 shares at
June 30, 1997 and 1996 785 785
Preferred stock - $.001 par value;
issued and outstanding - none - -
Paid-in capital in excess of par
value 90,640,637 75,985,245
Accumulated deficit (13,991,988) (62,422,918)
Notes receivable from stockholders (1,918,596) (1,760,281)
Unearned compensation (1,096,000) -
Treasury stock - 108,864 shares of
common stock at June 30, 1997 and
1996 (395,445) (395,445)
------------ -----------
TOTAL STOCKHOLDERS' EQUITY 73,245,262 11,412,629
------------ -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $106,690,561 $28,057,384
============ ===========
See accompanying notes to consolidated financial statements.
F-4
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended June 30,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
REVENUES
Product sales - net $ 5,177,346 $ 2,060,888 $ 2,383,309
Service and repair fees
- net 2,686,048 3,927,383 4,533,653
Related parties -
service and repair
fees - net 1,828,086 1,972,304 1,831,258
Related parties -
scanning and
management fees - net 7,941,586 5,955,150 7,804,456
----------- ----------- -----------
TOTAL REVENUES - Net 17,633,066 13,915,725 16,552,676
----------- ----------- -----------
COST OF REVENUES
Product sales 8,277,945 4,818,952 5,509,147
Service and repair fees 2,202,120 2,451,708 2,256,036
Related parties - service
and repair fees 1,535,981 1,054,652 759,771
Related parties -
scanning and management
fees - net 1,812,528 2,092,072 1,667,588
----------- ----------- -----------
TOTAL COST OF REVENUES 13,828,574 10,417,384 10,192,542
----------- ----------- -----------
GROSS PROFIT 3,804,492 3,498,341 6,360,134
----------- ----------- -----------
EXPENSES
Research and development
expenses 3,928,035 3,607,703 3,356,120
Selling and marketing
expenses 2,369,652 2,069,045 1,497,825
General and
administrative expenses 17,873,396 11,517,538 10,166,435
Provision for bad debt 3,608,062 1,226,014 116,514
Compensatory element of
stock issuances 407.052 355,327 1,363,194
----------- ----------- -----------
28,186,197 18,775,627 16,500,088
----------- ----------- -----------
LOSS FROM OPERATIONS (24,381,705) (15,277,286) (10,139,954)
INTEREST EXPENSE (311,900) (609,071) (1,226,777)
INTEREST INCOME 385,500 310,489 293,137
OTHER INCOME, principally
gain on litigation awards 83,099,685 4,007,576 3,322,201
----------- ------------ -----------
INCOME (LOSS) BEFORE
PROVISION FOR TAXES AND
MINORITY INTEREST 58,791,580 (11,568,292) (7,751,393)
PROVISION FOR INCOME TAXES 2,950,000 19,965 145,558
----------- ------------ -----------
INCOME (LOSS) BEFORE
MINORITY INTEREST 55,841,580 (11,588,257) (7,896,951)
MINORITY INTEREST IN NET
LOSS OF SUBSIDIARY AND
PARTNERSHIP 227,191 180,813 347,326
----------- ------------ -----------
NET INCOME (LOSS) $56,068,771 $(11,407,444) $(7,549,625)
=========== ============ ===========
NET INCOME (LOSS) PER SHARE $0.95 $(0.22) $(0.17)
===== ====== ======
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING 59,097,965 51,516,470 45,055,334
=========== =========== ===========
See accompanying notes to consolidated financial statements.
F-5
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED JUNE 30, 1997
Class A
Common Stock
Per Share -----------------------
Amount Shares Amount
--------- ----------- ---------
Balance - June 30, 1996 $ - 42,871,751 $ 4,287
Shares issued as follows:
Stock bonus to employees (measured at
the average quoted market price on
the award dates) 2.56 159,025 16
Under incentive stock option plan 2.09 259,375 26
Shares issued under non-statutory plans 2.46 2,100,000 210
Issuance of stock in settlememt
of liabilities 2.49 579,271 58
Issuance of stock under stock bonus
plans 2.38 1,000,000 100
Issuance of stock under consulting
contracts 2.74 400,000 40
Issuance of stock for acquisition of
Affordable Dioagnostics, Inc. 2.06 1,764,000 176
Net Change in notes receivable from
stockholders - -
Stock divident adjustment - -
Dividend - preferred stock - -
NET INCOME - -
---------- --------
Balance - JUNE 30, 1997 49,133,422 $ 4,913
========== ========
Class B
Common Stock
----------------------
Shares Amount
----------- --------
Balance - June 30, 1996 5,411 -
Shares issued as follows:
Stock bonus to employees (measured at
the average quoted market price on
the award dates) - -
Under incentive stock option plan - -
Shares issued under non-statutory plans - -
Issuance of stock in settlememt
of liabilities - -
Issuance of stock under stock bonus
plans - -
Issuance of stock under consulting
contracts - -
Issuance of stock for acquisition of
Affordable Dioagnostics, Inc. - -
Net Change in notes receivable from
stockholders - -
Stock divident adjustment - -
Dividend - preferred stock - -
NET INCOME - -
---------- --------
Balance - JUNE 30, 1997 5,411 -
========== ========
F-6
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED JUNE 30, 1997
(continued) Class C Common Stock
---------------------
Shares Amount
--------- --------
Balance - June 30, 1996 9,562,824 956
Shares issued as follows:
Stock bonus to employees (measured at
the average quoted market price on
the award dates) - -
Under incentive stock option plan - -
Shares issued under non-statutory plans - -
Issuance of stock in settlememt
of liabilities - -
Issuance of stock under stock bonus
plans - -
Issuance of stock under consulting
contracts - -
Issuance of stock for acquisition of
Affordable Dioagnostics, Inc. - -
Net Change in notes receivable from
stockholders - -
Stock divident adjustment - -
Dividend - preferred stock - -
NET INCOME - -
---------- --------
Balance - JUNE 30, 1997 9,562,824 956
========== ========
Class A Non-Voting Paid-in
Preferred Stock Capital in
------------------- Excess of
Shares Amount Par Value
--------- ------ -----------
Balance - June 30, 1996 7,855,627 785 $75,985,245
Shares issued as follows:
Stock bonus to employees (measured at
the average quoted market price on
the award dates) - - 407,036
Under incentive stock option plan - - 543,334
Shares issued under non-statutory plans - - 5,159,166
Issuance of stock in settlememt
of liabilities - - 1,444,464
Issuance of stock under stock bonus
plans - - 2,375,296
Issuance of stock under consulting
contracts - - 1,095,960
Issuance of stock for acquisition of
Affordable Dioagnostics, Inc. - - 3,630,136
Net Change in notes receivable from
stockholders - - -
Stock divident adjustment - - -
Dividend - preferred stock - - -
NET INCOME - - -
---------- ------- -----------
Balance - JUNE 30, 1997 7,855,627 785 $90,640,637
========== ======= ===========
See accompanying notes to consolidated financial statements
F-7
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED JUNE 30, 1997
(Continued) Treasury Stock
Unearned ---------------------
Compensation Shares Amount
------------ --------- ----------
Balance - June 30, 1996 - 108,864 $(395,445)
Shares issued as follows:
Stock bonus to employees (measured at
the average quoted market price on
the award dates) - - -
Under incentive stock option plan - - -
Shares issued under non-statutory plans - - -
Issuance of stock in settlememt
of liabilities - - -
Issuance of stock under stock bonus
plans - - -
Issuance of stock under consulting
contracts (1,096,000) - -
Issuance of stock for acquisition of
Affordable Dioagnostics, Inc. - - -
Net Change in notes receivable from
stockholders - - -
Stock divident adjustment - - -
Dividend - preferred stock - - -
NET INCOME - - -
----------- ---------- ----------
Balance - JUNE 30, 1997 (1,096,000) 108,864 $(395,445)
=========== ========== ==========
Notes
Receivable
from Accumulated
Stockholders Deficit
------------ -------------
Balance - June 30, 1996 $(1,760,281) 62,422,918
Shares issued as follows:
Stock bonus to employees (measured at
the average quoted market price on
the award dates) - -
Under incentive stock option plan - -
Shares issued under non-statutory plans - -
Issuance of stock in settlememt
of liabilities - -
Issuance of stock under stock bonus
plans - -
Issuance of stock under consulting
contracts - -
Issuance of stock for acquisition of
Affordable Dioagnostics, Inc. - -
Net Change in notes receivable from
stockholders (158,315) -
Stock divident adjustment - -
Dividend - preferred stock - (7,637,841)
NET INCOME - 56,068,771
------------ -------------
Balance - JUNE 30, 1997 $(1,918,596) $(13,991,988)
============ =============
See accompanying notes to consolidated financial statements
F-8
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED JUNE 30, 1996
Class A
Common Stock
Per Share ----------------------
Amount Shares Amount
--------- ---------- --------
Balance - June 30, 1995 $ - 38,229,448 $ 3,822
Shares issued as follows:
Stock bonus to employees (measured at
the average quoted market price on
the award dates) 2.67 157,341 16
Under incentive stock option plan 2.66 82,125 8
Shares issued under non-statutory plans 2.69 3,100,000 310
Issuance of stock in settlememt
of liabilities 2.73 802,400 80
Issuance of stock 2.08 500,000 50
Conversion from class B to class C - - -
Conversion from class B to class A 437 1
Net charge in notes receivable
from stockholders - - -
Stock dividend adjustment -
Class A non-voting preferred - - -
Dividend - preferred stock - - -
NET LOSS - - -