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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, 1998
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 21, 1998, 52,879,701 shares of Common Stock, 5,411 shares of
Class B Common Stock, 9,562,824 shares of Class C Common Stock and 7,836,287
shares of Class A Non-voting Preferred Stock of the registrant were outstanding.
The aggregate market value of the approximately 50,316,374 shares of Common
Stock held by non-affiliates as of such date (based on the closing price per
share on September 21, 1998 as reported on the NASDAQ System) was approximately
$66,015,082 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.
Health Management Corporation of America (formerly U.S. Health Management
Corporation and hereinafter sometimes referred to as "HMCA") was formed by the
Company in March 1997 as a wholly-owned subsidiary in order to enable the
Company to expand into the business of providing comprehensive management
services to medical providers, sometimes referred to as "physician practice
management" or "PPM." In connection with its entry into this new line of
business, HMCA has completed five acquisitions. HMCA provides management
services, administrative services, office space, equipment, repair and
maintenance service and clerical and other non-medical personnel to physicians
and other medical providers, including diagnostic imaging centers.
See Note 20 to the Financial Statements for separate financial information
respecting the Company's medical equipment and physician practice management
services segments.
FORWARD LOOKING STATEMENTS.
Certain statements made in this Annual Report on Form 10-K are
"forward-looking statements" (within the meaning of the Private Securities
Litigation Reform Act of 1995) regarding the plans and objectives of Management
for future operations. Such statements involve known and unknown risks,
uncertainties and other factors that may cause actual results, performance or
achievements of the Company to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. The forward-looking statements included herein are based on current
expectations that involve numerous risks and uncertainties. The Company's plans
and objectives are based, in part, on assumptions involving the expansion of
business. Assumptions relating to the foregoing involve judgments with respect
to, among other things, future economic, competitive and market conditions and
future business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that its assumptions underlying the forward-looking statements
are reasonable, any of the assumptions could prove inaccurate and, therefore,
there can be no assurance that the forward-looking statements included in this
Report will prove to be accurate. In light of the significant uncertainties
inherent in the forward-looking statement included herein, the inclusion of such
information should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be achieved.
RECENT DEVELOPMENTS AND OVERVIEW.
The Company's 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
at high field. 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.
The Company also produces the "QUAD(TM) 7000," a MR scanner which is
similar in design to the QUAD 12000 but utilizes a smaller 3,500 gauss
electromagnet. The less expensive QUAD 7000 offers an economical solution to the
rising cost of medicine.
In addition, the Company's current "works in progress" include a breast MRI
scanner and an operating room scanner (the OR 360). (See "Works in Progress".)
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 of New York. On July 2, 1997, following the trial
and appeal of the Company's claims against General Electric Company, General
Electric Company paid FONAR $128.7 million (inclusive of interest) for
infringement of FONAR's Multi-Angle Oblique (MAO) and original MRI (Cancer
Detection) patents. Previously, immediately prior to trial, in April, 1995, the
Company reached a settlement with Hitachi Ltd. and related defendants.
In March 1996, the Company commenced a patent infringement suit against
Toshiba Corporation, Toshiba America Medical Systems, Inc. and Toshiba America
MRI, Inc. Toshiba America MRI, Inc. in turn commenced an action against FONAR
alleging patent infringement. In May 1998 FONAR and the Toshiba companies
settled the pending litigation between them, neither party admitting liability.
FONAR and Toshiba cross-licensed each other on the patents in suit, and FONAR
received a monetary payment from Toshiba.
The Company is optimistic about sales of its new scanner products. To
further promote product recognition and sales, FONAR will attend the RSNA
(Radiological Society of North America) trade show in November 1998 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 attended the RSNA
trade shows previously in 1997, 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, Saudi Arabia,
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 Health Management Corporation of America
(formerly U.S. Health Management Corporation and hereinafter sometimes referred
to as "HMCA") as a wholly-owned subsidiary for the purpose of engaging in the
business of providing comprehensive management and administrative services,
office space, equipment, repair and maintenance service for equipment and
clerical and other personnel (other than physicians) to physicians' practices
and other medical providers, including diagnostic centers (sometimes referred to
as "physician practice management," "PPM" or "practice management.")
HMCA entered the PPM business through the consummation of two acquisitions,
effective June 30, 1997. As a result of these two acquisitions, three additional
acquisitions completed through August, 1998 and the opening of two new
facilities, HMCA currently is managing 38 facilities and offices located
principally in New York State and Florida.
PRODUCTS
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 at
high field. 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.
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.
Prior to the introduction of the QUAD scanners, the Ultimate(TM) 7000
scanner, introduced in 1990, was the Company's principal product. The Ultimate
scanner replaced the Company's traditional principal products, the Beta(TM) 3000
scanner (which utilized a permanent magnet) and the Beta(TM) 3000M scanner
(which utilized an iron core electromagnet). All of the Company's current and
earlier model scanners create cross-sectional images of the human body.
The Company's majority-owned subsidiary, Medical SNI, manufactures and
markets teleradiology equipment. Such equipment, through the use of computer
hardware and software, permits MRI images to be transmitted by telephone lines,
enabling a physician to view the results of an MRI scan (immediately, if
necessary) without the necessity of being present at the site of the scan or
receiving film.
During fiscal 1998, sales of the Company's QUAD scanners accounted for
approximately 15% of the Company's total revenues and 53% of its medical
equipment segment revenues, as compared to 27% of total revenues and 50% of
medical equipment revenues during fiscal 1997. There were no sales of Ultimate
or Beta scanners in fiscal 1997 or fiscal 1998.
The materials and components used in the manufacture of the Company's
products (circuit boards, computer hardware components, electrical components,
steel and plastic) are generally available at competitive prices. The Company
has not had difficulty acquiring such materials.
WORKS IN PROGRESS
The Company's current "works in progress" center around the development of
its breast MRI scanner and operating room scanner (the OR 360). Both seek to
bring to the public scanners that are expected to provide important advances
against serious disease.
MRI takes advantage of the nuclear resonance signal elicited from the
body's tissues and the exceptional sensitivity of this signal for detecting
disease. Much of the serious disease of the body occurs in soft tissue. The
principal diagnostic modality currently in use for detecting disease, as in the
case of x-ray mammography, are diagnostic x-rays. X-rays discriminate soft
tissues like healthy breast tissue and cancerous tissue poorly because the x-ray
particle traverses the tissues almost equally thereby rendering the target film
equally exposed by the two tissues and creating healthy and cancerous shadows on
the film that differ very little in brightness. The image contrast between
cancerous and healthy tissue is poor, making the detection of breast cancers by
the x-ray mammogram less than optimal. If microscopic stones
(microcalcifications) are not present to provide the missing contrast the breast
cancer goes undetected. They frequently are not present. The maximum contrast
available by x-ray with which to discriminate disease is 4%. Brain cancers
differ from surrounding healthy brain by only 1.6%.
On the other hand the soft tissue contrasts with which to distinguish
cancers on images by MRI are up to 180%. This is because the nuclear resonance
signals from the body's tissues differ so dramatically. Liver cancer and healthy
liver signals differ by 180%. Thus there is some urgency to bring to market an
MRI based breast scanner that can overcome the x-ray limitation and assure that
mammograms do not miss serious lesions. The added benefit of MRI mammography
relative to x-ray mammography is the elimination of the need for the patient to
disrobe and the painful compression of the breast typical of the x-ray
mammogram. The patient is scanned in her street clothes in MRI mammography.
Moreover MRI mammogram scans the entire chest wall including the axilla for the
presence of nodes which the x-ray mammogram cannot reach.
In addition there is a need for a treatment modality that can deal
effectively with the diseased tissue once it has been detected.
The OR 360 is Fonar's latest works-in-progress product. The OR 360 has an
enlarged room sized magnet in contrast to the small bore "tunnel" MRI magnet the
public is familiar with. Thus full-fledged surgical teams may walk into the
magnet and thereby perform conventional surgery on the patient inside the
magnet. Most importantly the exceptional quality of the MRI image and its
exceptional capacity to exhibit tissue detail on the image, by virtue of the
nuclear resonance signal's extraordinary capacity to create image contrast, can
then be obtained real time during surgery to guide the surgeon in his surgery.
Thus surgical instruments, needles, catheters, endoscopes and the like can be
introduced directly into the human body and guided to the malignant lesion by
means of the MRI image. The number of inoperable lesions should be greatly
reduced by the availability of this new capability. Most importantly treatment
can be carried directly to the target tissue.
With current cancer treatment methods, therapy must always be restricted in
the doses that can be applied to the malignant tissue because of the adverse
effects on the healthy tissues. Thus chemotherapies must be limited at the first
sign of toxic side effects. The same is the case with radiation therapy. The
Company expects that once its new OR 360 product is available treatment agents
may be administered directly to the malignant tissue through small catheters or
needles allowing much larger doses of chemotherapy, x-rays, laser ablation,
microwave, or rf to be applied directly and exclusively to the malignant tissue
with more effective results. Since the procedure of introducing a treatment
needle or catheter under image guidance will be minimally invasive the procedure
can be readily repeated should metastases occur elsewhere, with minimum impact
on the patient beyond a straightforward needle injection.
The presence of the MRI image during treatment will enable the operator to
judge during treatment if his treatment is being effective. The Company received
an enthusiastic reception for its new "works-in-progress" OR 360 scanner at the
annual International Radiology Congress held in Chicago's McCormick Place known
as the RSNA (Radiological Society of North America) and expects to be extremely
successful with this new product.
Most of the design work for the OR 360 has been completed and construction
of a prototype is approximately 90% complete.
The Company is negotiating with two universities to install and commence
clinical trials of its breast scanning equipment. The Company is working with
these universities to jointly secure research funding for the breast scanning
and treatment program.
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, 1996
and 1997 and plans to attend the RSNA trade shows in November 1998 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 $980,000 for the
QUAD 12000 and of $780,000 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.
During the fiscal year ended June 30, 1998, 5% of the Company's revenues
were generated by foreign sales, as compared to 4% and 17% for fiscal 1997 and
1996 respectively. 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 $6.1 million in fiscal 1996, $4.6 million in
fiscal 1997 and $3.7 million in fiscal 1998. The decreases in fiscal 1997 and
1998 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, 1998, the Company incurred
expenditures of $6,506,995 (none of which was capitalized) on research and
development, as compared to $3,928,035 ($108,809 of which was capitalized) and
$3,607,703 ($251,659) of which was capitalized) incurred during the fiscal years
ended June 30, 1997 and June 30, 1996, respectively.
Research and development activities have focused, in large part, on the
development of the Company's new OR 360 and the continued development and
enhancement of the Company's QUAD MR scanners. The OR 360 and QUAD scanners
involve significant software and hardware development as the new products
represented entirely new hardware design and architecture requiring a complete
new operating software system. The Company's research activity includes
developing a multitude of new features for the QUAD series scanners made
possible by the QUAD's high speed processing power.
BACKLOG
The Company's backlog of unfilled orders at September 1, 1998 was
approximately $2.8 million, as compared to $6.4 million at September 1, 1997. Of
these amounts, approximately $0.6 million and $1.2 million had been paid to the
Company as customer advances as at September 1, 1998 and September 1, 1997,
respectively. Of the backlog amounts at September 1, 1997, approximately
$800,000 represented orders from affiliates. None of the backlog existing at
September 1, 1998 represents orders from affiliates. It is expected that the
existing backlog of orders will be filled within the current fiscal year. The
Company's contracts generally provide that if a customer cancels an order, the
customer's initial down payment for the MRI scanner is nonrefundable.
PATENTS AND LICENSES
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). Following
appeals to the United States Court of Appeals for the Federal Circuit, General
Electric Company paid FONAR $128.7 million (inclusive of interest) on July 2,
1997. The Supreme Court denied General Electric Company's petition for a writ of
certiorari on October 6, 1997. The Company was 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
Corporation, Toshiba America MRI, Inc. and Toshiba America Medical Systems, Inc.
Toshiba America MRI, Inc. in turn commenced an action against FONAR alleging
patent infringement. In May 1998, FONAR settled with the Toshiba companies,
neither side admitting liability in the settlement agreement. The parties
cross-licensed each other on the patents-in-suit, and FONAR received a monetary
payment from Toshiba.
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. In 1997, however, sales of non-superconductive MRI's were almost
equal to sales of superconductive magnets. In 1997, the size of the MRI market
in the United States was approximately $565 million. The market share of
superconductive MRI's was approximately 53%. 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 at high field strength.
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. Superconductive 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 FONAR 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. Such competitors sell both superconductive and
non-superconductive products. FONAR's current market share of the market for MRI
scanners is less than 5%. FONAR introduced the first "Open MRI" in 1982. "Open
MRI" was made possible by FONAR's introduction of an MRI magnet built on an iron
frame. Thus the magnetic flux generating apparatus of the magnet (magnet coils
or permanent magnet bricks) was built into a frame of steel. The steel frame
provided a return path for the magnetic lines of force and thereby kept the
magnetic lines of force contained within the magnet. This enabled FONAR, from
1982 on, to show that the FONAR magnet was the only magnet that allowed the
patients to stretch out their arms, the only "open" MRI.
The iron frame, because it could control the magnetic lines of force and
place them where wanted and remove them from where not wanted (such as in the
operating room where surgeons are standing), provided a much more versatile
magnet design than was possible with superconductive magnets. Superconductive
magnets contain no iron but consist entirely of turns of current carrying wire.
They therefore lack the versatility of design that the iron frame provides the
"open" MRI magnet. Thus the superconductive magnets made by Fonar's large
competitors that have dominated the MRI market since 1983 have been of the
confining "tunnel" design that the public has generally resented.
For an 11 year period, 1983-1994, Fonar's large competitors (with one
exception) generally rejected Fonar's "open" design but in 1994 all (with one
exception) added an "open" magnet to their MRI product line. In 1997 the sale of
non-superconductive "open" magnets exceeded the sale of traditional
superconductive magnets for the first time. One principal reason for this market
shift, in addition to patient claustrophobia, is the growing awareness that the
"open" magnet designs permit access to the patient to perform surgical
procedures under MRI image guidance, a field which is now growing rapidly and is
called "interventional MRI."
Fonar's OR 360 explicitly addresses this growing market reception of MRI
guided surgical procedures but is not yet available as a product. Fonar's QUAD
series magnets do also. Although not enabling a full operating theater as the OR
360 does, the "Open" QUAD design permits ready access to the patient from four
sides and therefore enables a wide range of interventional surgical procedures
such as biopsies and needle or catheter delivered therapies to be performed
under MRI image guidance. The "tunnel" superconductive scanners do not permit
access to the patient while the patient is inside the scanner.
While Fonar's current market share of the domestic MRI market is under 5%
and its current market share of the domestic "Open MRI" market is only of the
order of 10% at present, FONAR expects to be a leader in this market for several
reasons. In MRI, scanning speed and image quality is controlled by the strength
of the magnetic field. Fonar's QUAD 12000 scanner operates at twice the field
strength of its closest market share "Open MRI" competitor, Hitachi (.6 Tesla
vs. .3 Tesla). High field MRI manufacturers convinced the marketplace for FONAR,
and the marketplace accepts, that higher field strength translates directly into
superior image quality and faster scanning speeds. This is the principal reason
GE's 1.5 Tesla superconductive scanner achieved market dominance in the MRI
market before the marketplace shifted and registered its preference for "Open
MRI." All of Fonar's other competitors in the "Open MRI" market are lower in
field strength than the Hitachi product other than Toshiba at .35 Tesla. No
companies possess the OR 360 and FONAR possesses the pioneer patents on "Open
MRI" technology.
OTHER IMAGING MODALITIES
FONAR's MRI scanners also compete with other diagnostic imaging systems,
all of which are based upon the ability of energy waves to penetrate human
tissue and to be detected by either photographic film or electronic devices for
presentation of an image on a television monitor. Three different kinds of
energy waves - X-ray, gamma and sound - are used in medical imaging techniques
which compete with MRI medical scanning, the first two of which involve exposing
the patient to potentially harmful radiation. These other imaging modalities
compete with MRI products on the basis of specific applications.
X-rays are the most common energy source used in imaging the body and are
employed in three imaging modalities:
1. Conventional X-ray systems, the oldest method of imaging, are typically
used to image bones and teeth. The image resolution of adjacent structures that
have high contrast, such as bone adjacent to soft tissue, is excellent, while
the discrimination between soft tissue organs is poor because of the nearly
equivalent penetration of x-rays.
2. Computerized Tomography ("CT") systems couple computers to x-ray
instruments to produce cross-sectional images of particular large organs or
areas of the body. The CT scanner addresses the need for images, not available
by conventional radiography, that display anatomic relationships spatially.
However, CT images are generally limited to the transverse plane and cannot
readily be obtained in the two other planes (sagittal and coronal). Improved
picture resolution is available at the expense of increased exposure to x-rays
from multiple projections. Furthermore, the pictures obtained by this method are
computer reconstructions of a series of projections and, once diseased tissue
has been detected, CT scanning cannot be focused for more detailed pictorial
analysis or obtain a chemical analysis.
3. Digital radiography systems add computer image processing capability to
conventional x-ray systems. Digital radiography can be used in a number of
diagnostic procedures which provide continuous imaging of a particular area with
enhanced image quality and reduced patient exposure to radiation.
Nuclear medicine systems, which are based upon the detection of gamma
radiation generated by radioactive pharmaceuticals introduced into the body, are
used to provide information concerning soft tissue and internal body organs and
particularly to examine organ function over time.
Ultrasound systems emit, detect and process high frequency sound waves
reflected from organ boundaries and tissue interfaces to generate images of soft
tissue and internal body organs. Although the images are substantially less
detailed than those obtainable with x-ray methods, ultrasound is generally
considered harmless and therefore has found particular use in imaging the
pregnant uterus.
X-ray machines, ultrasound machines, digital radiography systems and
nuclear medicine compete with the MRI scanners by offering significantly lower
price and space requirements. However, FONAR believes that the quality of the
images produced by its MRI scanners is generally superior to the quality of the
images produced by those other methodologies.
GOVERNMENT REGULATION
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 Company anticipates that it will need FDA
approvals for its OR 360 and breast scanners.
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. The Company is subject to these requirements and has received the
necessary approvals. In addition, the Company needs to obtain any necessary
approvals from the appropriate foreign governmental and other authorities in
connection with its export sales.
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.
The Company obtains approvals as necessary in connection with the sales of
its products in foreign countries. In some cases, U.S. Food and Drug
Administration approval has been sufficient for foreign sales as well. The
Company's standard practice has been to require either the distributor or the
customer to obtain any such foreign approvals or licenses which may be required.
Commencing in fiscal 1998, however, export sales to most European countries
and certain other countries require CE certification (essentially safety
requirements for electrical products). The Company is in the process of
complying with these requirements and obtaining this certification.
HEALTH MANAGEMENT CORPORATION OF AMERICA
(PHYSICIAN PRACTICE MANAGEMENT BUSINESS)
Health Management Corporation of America (formerly known as U.S. Health
Management Corporation and referred to as "HMCA") was organized by the Company
in March 1997 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 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."
Since its formation, HMCA has completed five acquisitions. HMCA became
actively engaged in the PPM business through its initial two acquisitions which
were consummated effective June 30, 1997. Following these two initial
acquisitions, HMCA completed two additional acquisitions in fiscal 1998 and one
additional acquisition in the first quarter of fiscal 1999 (August 1998).
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 HMCA (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 is being continued by HMCA,
consisted 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, HMCA 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,
on a mobile route in northern New Jersey and Rockland, Orange and Putnam
counties in New York.
The second completed acquisition was of Raymond V. Damadian, M.D. MR
Scanning Centers Management Company ("RVDC"). Pursuant to the terms of the
transaction, HMCA 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, which is being
continued by HMCA, 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, HMCA 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, HMCA
entered into new management agreements with the centers. Pursuant to the
management agreements, HMCA 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 9 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.
The third completed acquisition, consummated on January 20, 1998, was an
acquisition of the business and assets of Central Health management Co., LLC
(Central Health). Central Health is a management service organization (MSO)
managing a multi-specialty practice in Yonkers, New York. The assets acquired
include therapy and rehabilitation equipment, x-ray equipment, office equipment
and office furnishings.
The fourth completed acquisition, consummated effective March 20, 1998, was
the acquisition of A & A Services, Inc. ("A & A Services"), an MSO managing four
primary care practices in Queens County, New York. A & A Services provides the
practices with management services, office space, equipment, repair and
maintenance service for the equipment and clerical and other non medical
personnel. The office locations for the practices are located in Woodhaven,
Richmond Hill, Corona and Ridgewood in Queens County, New York and account for
over 52,000 primary care patient visits per year.
The fifth completed acquisition, consummated effective August 20, 1998, was
the acquisition of Dynamic Health Care Management, Inc. ("Dynamic"). Dynamic is
an MSO which manages three physician practices in Nassau and Suffolk Counties on
Long Island, New York. The office locations for these practices are in Bellmore
and Hempstead in Nassau County and Deer Park in Suffolk County and account for
approximately 85,000 patient visits per year.
HMCA GROWTH STRATEGY
In addition, HMCA may also pursue acquisitions pursuant to which HMCA would
purchase the assets of physicians' practices. Simultaneously with the
acquisition of the assets, HMCA would enter into agreements with the physicians
(or a professional corporation employing the physicians) pursuant to which HMCA
would lease the use of the assets and provide management services. The
professional corporation could be either affiliated with HMCA or owned by the
selling physicians.
HMCA 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 HMCA's clients include opening more
offices and expanding existing offices so as to enable practices to treat more
patients more efficiently.
HMCA is seeking to create a network of physicians to participate in managed
care and to promote an expansion of the medical services offered by its medical
practice clients.
HMCA 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.
HMCA'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, HMCA
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
HMCA's services to the facilities it manages encompass substantially all of
the facilities' operations. These services include:
(1) Offices and Equipment. HMCA provides office space and equipment to its
clients. This includes technologically sophisticated medical equipment. HMCA
also provides improvements to leaseholds, assistance in site selection and
advice on improving, updating, expanding and adapting to new technology.
(2) Personnel. HMCA staffs all the non-medical positions of its clients
with its own employees, eliminating the client's need to interview, train and
manage non-medical employees, as well as process the necessary tax, insurance
and other documentation relating to employees.
(3) Administrative. HMCA assists in the scheduling of patient appointments,
purchasing of medical supplies and equipment and handling of reporting,
accounting, processing and filing systems. It prepares and files the physician
portions of complex forms to ensure full and timely regulatory compliance and
appropriate cost reimbursement under no-fault insurance and workers'
compensation guidelines.
(4) Billing and Collections. HMCA is responsible for the billing and
collection of revenues from third-party payors including those governed by
no-fault and workers' compensation statutes.
(5) Cost Saving Programs. Based on available volume discounts, HMCA seeks
to obtain favorable pricing for medical supplies, equipment, pharmaceuticals and
other inventory for its clients.
(6) Diagnostic Imaging and Ancilliary Services. HMCA 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. HMCA is responsible for developing marketing
plans for its clients.
HMCA provides its services pursuant to negotiated contracts with its
clients. While HMCA believes it can provide the greatest value to its clients by
furnishing the full range of services appropriate to that client, HMCA would
also be willing to enter into contracts providing for a more limited spectrum of
management services.
HMCA MARKETING
HMCA's marketing strategy is to increase the size, number and locations of
medical practices and facilities which it manages. HMCA 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. HMCA 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 HMCA. HMCA will focus on
opportunities for expanding the services clients offer and expanding into new
geographic areas. HMCA will also seek to increase the patient volume of clients.
DIAGNOSTIC IMAGING CENTERS AND OTHER ANCILLIARY SERVICES
Diagnostic imaging centers managed by HMCA provide diagnostic imaging
services to patients referred by physicians who are either in private practice
or affiliated with managed care providers or other payor groups. The 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 HMCA personnel and
then delivered to the referring physician.
In addition, HMCA 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.
HMCA develops marketing programs in an effort to establish and maintain
profitable referring physician relationships and to maximize reimbursement
yields. These marketing approaches identify and target selected market segments
consisting of area physicians with certain desirable medical specialties and
reimbursement yields. Corporate and 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. HMCA 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, HMCA will seek to expand
the imaging modalities offered at its managed centers or to create networks with
other imaging centers.
COMPETITION (HMCA)
The medical practice management field is highly competitive. A number of
large hospitals have acquired medical practices and this trend may continue.
HMCA expects that more competition will develop. Many competitors have greater
financial and other resources than HMCA.
With respect to the diagnostic imaging centers managed by HMCA, the
outpatient diagnostic imaging industry is highly competitive. Competition
focuses primarily on attracting physician referrals at the local market level
and increasing referrals through relationships with managed care organizations.
HMCA believes that principal competitors for the diagnostic imaging centers are
hospitals and independent or management company-owned imaging centers.
Competitive factors include quality and timeliness of test results, ability to
develop and maintain relationships with managed care organizations and referring
physicians, type and quality of equipment, facility location, convenience of
scheduling and availability of patient appointment times.
GOVERNMENT REGULATION APPLICABLE TO HMCA
Various States prohibit business corporations from practicing medicine.
Consequently, HMCA leases space and equipment to clients and provides clients
with a range of non-medical administrative and managerial services. HMCA 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.
HMCA'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, HMCA could be required to modify its business
practices and services in ways that could be more costly to HMCA or in ways that
decrease the revenues which HMCA receives from its clients.
HMCA believes that it is in compliance with applicable Federal, State and
local laws. HMCA does not believe that such laws will have any material effect
on its business.
EMPLOYEES
As of July 1, 1998, the Company employed 444 persons on a full-time
basis. Of such employees, 10 were engaged in marketing and sales, 38 in
research and development, 94 in manufacturing, 48 in customer support services,
219 in administration (including 116 on site at facilities and offices managed
by HMCA and 57 performing billing, collection and transcription services for
those facilities) and 35 professional MRI technicians on site at diagnostic
imaging centers managed by HMCA.
ITEM 2. PROPERTIES
The Company leases approximately 135,240 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 annual rental rate of
approximately $913,800, 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 9 years on its principal
facilities. Management believes that these premises are adequate for its current
needs. In addition, HMCA maintains leased office premises for its clients at
approximately 34 site locations having an aggregate annual rental rate of
approximately $1.6 million.
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 March 4, 1996, the Company filed an action against Toshiba Corporation,
Toshiba America Medical Systems, Inc., Toshiba America 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). Thereafter, in February 1997, Toshiba
America MRI, Inc. commenced an action against FONAR in the U.S. District Court
for the Northern District of California (Toshiba America MRI, Inc. v. Fonar
Corporation, Case No.: C97-00664 SBA ENE) alleging infringement of certain of
its patents relating to magnetic resonance imaging technology. Both FONAR and
the Toshiba companies asserted counterclaims in the actions brought against
them. In May 1998 FONAR and Toshiba amicably resolved the litigation in both the
New York and California United States District Courts. Neither party admitted
liability in the settlement agreement. The parties cross-licensed each other on
the patents-in-suit, and FONAR received a monetary payment from Toshiba. Other
terms of the settlement are confidential.
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. Subsequently, judgments were entered on the
California judgment in New York, Pennsylvania, Michigan and Florida and
enforcement proceedings were commenced. The plaintiffs to date have not
collected any part of the judgment in these proceedings.
Thereafter, plaintiffs purportedly assigned the judgment to Phoenix General
& Health Services, Inc. ("Phoenix"). Phoenix commenced a new and separate action
in United States District Court for the Eastern District of New York seeking to
enforce the judgment against AMD and FONAR, as well. FONAR is defending this
claim on the ground, among others, that in the original California action it was
determined that FONAR was not liable, and both FONAR and AMD are defending on
the grounds that the assignment to Phoenix, a Nevada corporation, was made
solely for the purpose of seeking to bring this case within the diversity
jurisdiction of the Federal Courts. A motion to dismiss this case on various
grounds is now under consideration by the United States District Court for the
Eastern District of New York.
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 increased 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.
Subsequently, on December 17, 1997, the parties agreed to modification of
the settlement agreement, which was approved by the Court of Chancery on March
2, 1998. The modification provided that the Company issue 2,231,689.3 shares of
FONAR Common Stock in substitution for the Warrants which would have been issued
under the original terms of the settlement agreement. In addition, the
modification provides for a schedule to pay the special dividends on the
Company's Common Stock and Class A Non-voting Preferred Stock with respect to
awards and settlements already received by the Company in connection with its
patent litigations. These first installments (comprising one-half of the total)
was paid in May 1998 and the second installment (comprising one-sixth of the
total) was paid in September 1998. The remaining two installments (each
comprising one-sixth of the total) are required to be paid as follows: one prior
to December 31, 1998 and one prior to March 31, 1999.
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 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 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 1997 3.87 2.72 3.94 2.75
October - December 1997 4.03 2.63 4.06 2.66
January - March 1998 3.03 2.38 3.13 2.41
April - June 1998 2.72 1.94 2.75 2.00
July - September 21 1998 2.47 1.25 2.50 1.31
On September 21, 1998, the Company had approximately 5,476 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 4,621 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 paid cash dividends in fiscal 1998 and the first quarter of
fiscal 1999 on monies it received from the enforcement of its patents. Prior to
these dividends, the Company had not paid any cash dividends. The Company
anticipates paying additional dividends on monies it receives from the
enforcement of its patents. Except for these dividends, however, it is expected
that the Company will continue to retain earnings to finance the development and
expansion of its business.
Item 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data has been extracted
from the Company's consolidated financial statements for the five years ended
June 30, 1998. 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 1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- ------------
Revenues $27,554,357 $17,633,066 $13,915,725 $16,522,676 $15,387,000
Cost of $23,841,844 $13,828,574 $10,417,384 $10,192,542 $ 7,814,000
revenues
Research and $ 6,506,995 $ 3,928,035 $ 3,607,703 $ 3,356,120 $ 2,803,000
Development Expenses
Net Income (loss) $(5,653,086) $56,068,771 $(11,407,444) $(7,549,625) $ (335,000)
Net income (loss) $(.09) .95 (.22) (.17) (0.01)
per common share
Weighted average $61,175,986 $56,097,965 51,516,470 45,055,334 36,774,000
number of shares
outstanding *
BALANCE SHEET DATA
- ------------------
Working capital $54,426,483 $62,659,470 $(1,575,857) $(4,498,911) $ (7,749,000)
(deficit)
Total $108,447,780 $106,690,561 $28,057,384 $27,949,122 $48,418,000
assets
Long-term debt and $16,003,479 $ 4,626,269 $ 4,204,935 $ 4,274,420 $ 5,884,000
obligations under
capital leases
Stockholders' $72,572,486 $ 73,245,262 $11,412,629 $29,394,096 $28,333,000
equity
* Adjusted for stock dividend of Class A Non-voting Preferred Stock
declared in October, 1995.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION.
INTRODUCTION.
The Company was formed in 1978 to engage in the business of designing,
manufacturing and selling MRI scanners. In 1997, the Company formed a
wholly-owned subsidiary, Health Management Corporation of America ("HMCA"),
formerly known as U.S. Health Management Corporation, in order to expand into
the physician practice management business.
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, 1996 and 1997 and plans to do so again in November 1998. 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.
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.
HMCA 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. HMCA has completed five acquisitions since it was formed in March
1997.
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, which is being continued by
HMCA, was the management of MRI diagnostic imaging centers in New York, Florida,
Georgia and other locations. The third acquisition was the acquisition of the
business and assets of Central Health Management Co., LLC ("Central Health") a
multi-specialty management service organization (MSO) in Yonkers, New York. The
fourth acquisition was the acquisition of A & A Services, Inc. ("A & A"), an MSO
managing four primary care practices in Queens County, New York, and the fifth
acquisition was the acquisition of Dynamic Health Care Management, Inc.
("Dynamic"), an MSO managing three multi-specialty physician practices in Nassau
and Suffolk Counties in New York.
In addition, HMCA sponsored the opening of two new multi-specialty
facilities during fiscal 1998. These facilities are located in Albany County,
New York and in Melbourne, Florida.
HMCA 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, Central Health and A & A, have been consolidated effective as of the
dates of their respective acquisitions. The acquisition of Dynamic was
consummated on August 20, 1998, following the end of the 1998 fiscal year, and
consequently is not reflected in the financial statements for fiscal 1998.
The Company has assessed and continues to assess the impact of the Year
2000 Issue (Y2K) on its financial reporting systems and operations. The Year
2000 Issue is the result of computer programs being written using two digits
(rather than four) to define the applicable year. The Company is developing a
plan to meet this issue. The Company is reviewing all in-house computer based
systems. The MIS department is updating or replacing older systems that are not
Y2K compatible. The Company is also reviewing and has started to plan changes to
its existing customer base of MRI scanners. The Company expects that all
computer based systems will be Y2K compliant and in the final phase of testing
in the second quarter of 1999. Based on preliminary information, costs of
addressing these items are currently not expected to have a material adverse
impact on the Company's financial position.
RESULTS OF OPERATIONS. FISCAL 1998 COMPARED TO FISCAL 1997
In fiscal 1998, the Company experienced a net loss of $5.5 million on
revenues of $27.6 million as compared to net income of $56.1 million on revenues
of $17.6 million for fiscal 1997. As a result of HMCA's acquisitions, revenues
attributable to the Company's physician practice management services segment
(HMCA) increased dramatically, to $21.1 million in fiscal 1998 from $8.1 million
in fiscal 1997. Income of $2.7 million was recognized from the Company's
physician practice management services in fiscal 1998, as compared to a loss of
$71,769 in fiscal 1997. Revenues attributable to the Company's medical equipment
segment declined to $7.8 million in fiscal 1998 from $9.5 million, reflecting
lower sales volume in fiscal 1998. Results of operations for the medical
equipment segment improved, however, from a loss of $24.3 million in fiscal 1997
to a loss of $20.3 million in fiscal 1998. Other income of $8.7 million
(principally the net proceeds from the Company's patent enforcement lawsuits)
and interest income of $3.7 million were recognized by the Company in fiscal
1998 as compared to other income of $83.1 million (principally the net proceeds
from the Company's patent enforcement lawsuits) and interest income of $385,500
in fiscal 1997.
Costs of revenues and expenses increased from $42 million in fiscal 1997 to
$45.1 million in fiscal 1998, reflecting the expansion of the Company's
physician practice management services operations and an increase in research
and development in the medical equipment segment. Costs of revenue and expenses
for the Company's physician practice management services increased to $17.0
million in fiscal 1998 from $9.1 million in fiscal 1997. Research and
development expenses increased to $6.5 million in fiscal 1998 as compared to
$3.9 million in fiscal 1997.
Overall, costs of revenues and expenses for the Company's medical equipment
segment, however, declined to $28.1 million in fiscal 1998 from $34.4 million in
fiscal 1997 reflecting, most significantly, reductions in general and
administrative expenses ($7.3 million in fiscal 1998 as compared to $11.8
million in fiscal 1997) and costs of revenue ($11.6 million in fiscal 1998 as
compared to $12.3 million in fiscal 1997).
Net income for the Company for fiscal 1997 reflects the net income
attributable to the award received by the Company in its patent litigation.
Revenues generated by sales of QUAD MRI scanners were $1.4 million (10% of
total revenues) in fiscal 1996, $4.8 million (approximately 27% of total
revenues) in fiscal 1997 and $4.1 million (15% of total revenues) in fiscal
1998. Revenues attributable to sales of the Company's Ultimate scanners during
the same period were $94,000 (approximately 1% of total revenues) in fiscal 1996
and $0.00 in fiscal 1997 and fiscal 1998.
Sales of Beta scanners approximated $4.7 million in fiscal 1996
(approximately 35.9% of total revenues) as compared to $0.00 in fiscal 1997 and
1998. Of these revenues approximately 94.5% were attributable to sales to
affiliates in fiscal 1996.
Sales to affiliated parties represented approximately 0.3% ($0.1 million)
of the Company's revenues in fiscal 1998, as compared to approximately 4% ($0.7
million) in fiscal 1997 and 54.4% ($7.1 million) in fiscal 1996.
Gross profit margins on product sales to unrelated parties were negative
(133%) in fiscal 1996, negative (60%) in fiscal 1997 and negative (98%) in
fiscal 1998. This reflects the losses on sales of the Company's QUAD scanners.
The Company's strategy is to attempt to hold down the price of its QUAD scanners
and to increase profitability by reducing manufacturing costs and increasing
volume. The effectiveness of this strategy will not be discernible until higher
sales volume for the Company's QUAD scanners is achieved.
To reduce the cost of manufacturing its QUAD scanners, the Company expanded
its manufacturing capacity in fiscal 1998 by acquiring approximately $1.4
million worth of new capital equipment. In addition, the Company expanded its
operating capacity by hiring additional personnel.
Notwithstanding the Company's increased manufacturing activities, revenues
attributable to the Company's medical equipment segment declined to
approximately $7.8 million in fiscal 1998 from approximately $9.5 million in
fiscal 1997, but were the same as the revenues of $7.8 million in fiscal 1996.
The Company has not yet been able to achieve the sales volumes from its new QUAD
scanners necessary to become profitable because of intense competition and the
challenges of introducing a new product. These trends reflect a decline in
service revenue from $3.9 million in fiscal 1996 to $2.7 million in fiscal 1997
and $2.5 million in fiscal 1998 and a decrease in product sales in fiscal 1998
($4.0 million) from fiscal 1997 ($5.2 million), but an increase in product sales
from fiscal 1996 ($2.1 million). The decline in service revenue reflects the
retirement of old scanners by the Company's customers. The Company does not
expect the decline in revenue to continue. The Company is enthusiastic about the
future of its FONAR 360 product line (See Works in Progress) which will bring a
new plateau of "openness" to diagnostic MRI and a new frontier in surgery for
performing surgical treatments using MRI images to guide surgery.
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 1998 the
Company continued its investment in the development of its new MRI scanners,
together with software and upgrades, with an investment of $6,506,995 in
research and development (none of which was capitalized) as compared to
$3,928,035 ($108,809 of which was capitalized) in fiscal 1997. The research and
development expenditure was approximately 80.8% of revenues attributable to the
Company's medical equipment segment (and 22.9% of total revenues) in 1998 and
$41.2% of medical equipment segment revenues in 1997 (and 22.3% of total
revenues).
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, the percentage of
the Company's revenue derived from sources other than scanner sales was
approximately 85.7% for fiscal 1998 and 70.64% for fiscal 1997.
During the fiscal year ended June 30, 1998, the Company realized income of
approximately $8.7 million from the settlement of various legal disputes
(essentially its patent infringement actions) as compared to approximately $83.1
million in fiscal 1997.
FISCAL 1997 COMPARED TO FISCAL 1996
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
the Company's physician practice management services segment were $8.1 million
and ($1.1 million), respectively for fiscal 1997 and $6.2 million and ($3.4
million), respectively for fiscal 1996.
As the Company 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.
As at September 1, 1997, the Company's backlog of unfilled scanner orders
was approximately $6.4 million, as compared to $6.8 million at September 1,
1996.
In fiscal 1997 the Company invested $3,928,035 in research and development
($108,809 of which was capitalized) as compared to $3,607,703 in research and
development ($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.
During the fiscal year ended June 30, 1997, the Company realized income of
approximately $83.1 million from the settlement of various legal disputes
(essentially its patent infringement actions) as compared to $4.0 million in
fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company's liquidity and capital resources positions
changed from the June 30, 1997 position as follows:
June 30, June 30,
1998 1997 Change
____________ ____________ __________
Working capital
(deficiency) $54,426,483 $62,659,470 $(8,232,987)
The change in the Company's working capital position resulted primarily
from its investments in new equipment ($2.8 million), the cash portions of the
purchase prices for its acquisitions ($4.0 million) and its overall operating
losses, notwithstanding a decrease in its current liabilities ($22.1 million as
at June 30, 1998 as compared to $31 million as at June 30, 1997.
The increase in long-term debt from $1.8 million as at June 30, 1997 to
$13.7 million as at June 30, 1998 was attributable to notes issued in connection
with HMCA's acquisitions and new indebtedness for equipment and repayment of
existing debt.
As at June 30, 1998, the Company's past due obligations consisted of
approximately $1.1 million in past due taxes (various state taxes), and
approximately $100,000 in other past due indebtedness. The Company is seeking to
enter into payment plans with taxing authorities with respect to past due taxes
and to restructure its other past due indebtedness.
As of June 30, 1998, 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, Health Management Corporation of America, 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.
Advances and notes to affiliates and related parties decreased by
approximately $0.9 million from June 30, 1997 to June 30, 1998. As these are
long-term assets, they tend to reduce the Company's liquidity.
There were no past due receivables and lease payments from affiliates as at
June 30, 1998 and June 30, 1997.
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 1998 and 1997 approximated $3.6
million and $1.75 million, respectively, and substantially consisted of office
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 enhancing its revenue by entering into the PPM (physician
practice management) business through its new subsidiary, HMCA.
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 $2.7 million for the year ended June 30, 1997
and $2.5 million for the year ended June 30, 1998 (transactions between the
Company and its subsidiaries 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, 1998 approximates
$54.4 million, as compared to a working capital surplus of $62.7 million as of
June 30, 1997.
During fiscal 1998, cash provided by operating activities increased to
approximately $68 million from $(3.6) million in fiscal 1997 and cash used in
investing activities increased to approximately $27.1 million from approximately
$1.5 million in fiscal 1997. Cash used in financing activities increased to
approximately $5.6 million for fiscal 1998 from approximately $(7.1) million
provided by in fiscal 1997.
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.
STOCKHOLDER LITIGATION.
In June 1995, one of the Company's stockholders commenced an action in the
Delaware Court of Chancery against FONAR and its directors, alleging breaches of
fiduciary duties by the defendants for adopting the recapitalization plan
(Horace Rubenstein, Individually and on Behalf of All Others Similarly Situated
v. Raymond V. Damadian et al.) 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. FONAR and its directors 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
increased 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.
Subsequently, on December 17, 1997, the parties agreed to modification of
the settlement agreement, which was approved by the Court of Chancery on March
2, 1998. The modification provided that the Company issue 2,231,689.3 shares of
FONAR Common Stock in substitution for the Warrants which would have been issued
under the original terms of the settlement agreement. In addition, the
modification provides for a schedule to pay the special dividends on the
Company's Common Stock and Class A Non-voting Preferred Stock with respect to
awards and settlements already received by the Company in connection with its
patent litigations. These first installments (comprising one-half of the total)
was paid in May 1998 and the second installment (comprising one-sixth of the
total) was paid in September 1998. The remaining two installments (each
comprising one-sixth of the total) are required to be paid as follows: one prior
to December 31, 1998 and one prior to March 31, 1999.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to equity price risks on the marketable equity
securities included in its portfolio of investments. As at June 30, 1998, equity
securities and mutual funds composed of equity securities had a fair value of
$10,994,776.
The Company's investments in equity securities consist of common stock
traded in the major United States security markets. Approximately 97% of the
Company's investment in equity securities is composed of United States based
companies. The Company's portfolio of common stock is not concentrated in any
particular industry. Common stock prices are sensitive to changes in interest
rates and economic changes. The Company anticipates the future fair value of its
investment in common stock will closely follow the movement of the major United
States security markets.
The Company also invests in fixed rate instruments. None of the fixed rate
instruments in which the Company invests extend beyond June 30, 2000. Below is a
tabular presentation of the maturity profile of the fixed rate instruments held
by the Company at June 30, 1998.
INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT BY EXPECTED MATURITY
WEIGHTED AVERAGE INTEREST RATE
6/30/99 6/30/00 Total Fair Value
at 6/30/98
Investments in
Fixed Rate
Instruments $5,652,277 $3,750,000 $9,402,277 $9,257,055
Weighted Average
Interest Rate 5.4% 5.7%
All of the Company's revenue, expense and capital purchasing activities are
transacted in United States dollars.
See Note 12 to the Company's Financial Statements for information on long
term debt.
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 to F-5
At June 30, 1998 AND 1997
CONSOLIDATED STATEMENTS OF OPERATIONS F-6
For the Three Years Ended June 30, 1998, 1997 and 1996
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY F-7 to F-12
For the Three Years Ended June 30, 1998, 1997 and 1996
CONSOLIDATED STATEMENTS OF CASH FLOWS F-13; F-14
For the Three Years Ended June 30, 1998, 1997 and 1996
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-15 to F-58
SELECTED FINANCIAL DATA (*)
For the Five Years Ended June 30, 1998
(*) 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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the consolidated
results of their operations and cash flows for each of the years in the
three-year period ended June 30, 1998, in conformity with generally accepted
accounting principles.
During each of the years in the three-year period ended June 30, 1998, a
significant portion of the Company's revenues was from related parties (see
Notes 2, 3 and 19).
TABB, CONIGLIARO & McGANN, P.C.
s/s TABB, CONIGLIARO & McGANN, P.C.
New York, New York
September 25, 1998
F-2
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
------
June 30,
------------------------------
1998 1997
------------ ------------
CURRENT ASSETS
Cash and cash equivalents $ 41,751,704 $ 5,861,500
Marketable securities 20,251,832 -
Receivable from litigation award (received
July 1997) - 77,223,460
Accounts receivable, net 9,877,347 6,000,063
Costs and estimated earnings in excess of
billings on uncompleted contracts 833,615 818,865
Inventories 3,513,622 3,440,509
Prepaid expenses and other current assets 285,965 409,673
------------ ------------
TOTAL CURRENT ASSETS 76,514,085 93,754,070
RESTRICTED CASH 5,000,000 -
PROPERTY AND EQUIPMENT - Net 9,102,239 6,068,675
ADVANCES AND NOTES TO RELATED PARTIES, Net of
discounts and allowance for doubtful
accounts of $904,000 and $3,750,000 at
June 30, 1998 and 1997, respectively 1,350,114 1,928,625
LONG-TERM ACCOUNTS RECEIVABLE, Net of allowance
for doubtful accounts of $2,490,018 at June
30, 1997 - 253,534
NOTES RECEIVABLE, Net of allowance for doubtful
accounts of $477,456 and $865,964 at June 30,
1998 and 1997, respectively 65,751 107,384
EXCESS OF COST OVER NET ASSETS OF BUSINESSES
ACQUIRED, NET 14,745,555 2,796,197
OTHER INTANGIBLE ASSETS, Net 1,161,601 1,544,471
OTHER ASSETS 508,435 237,605
------------ ------------
TOTAL ASSETS $108,447,780 $106,690,561
============ ============
See accompanying notes to consolidated financial statements.
F-3
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
-------------------------------------
June 30,
--------------------------
1998 1997
------------ ------------
CURRENT LIABILITIES
Current portion of debt and capital leases $ 2,443,326 $ 2,802,508
Accounts payable 2,029,552 2,837,421
Other current liabilities 11,256,159 13,470,373
Dividends payable 3,909,366 7,855,067
Customer advances 669,731 764,402
Billings in excess of costs and estimated
earnings on uncompleted contracts 31,032 192,932
Income taxes payable