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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [Fee Required] For the fiscal year ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from
_____________ to _____________
Commission File No. 0-10248
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FONAR CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 11-2464137
(State of incorporation) (IRS Employer Identification Number)
110 Marcus Drive, Melville, New York 11747
(Address of principal executive offices) (Zip Code)
(516) 694-2929
(Registrant's telephone number, including area code)
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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)
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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 10, 1999, 54,804,957 shares of Common Stock, 5,211 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 52,238,644 shares
of Common Stock held by non-affiliates as of such date (based on the closing
price per share on September 10, 1999 as reported on the NASDAQ System) was
approximately $57 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 also maintains a WEB site at www.fonar.com.
FONAR is engaged in the business of designing, manufacturing, selling and
servicing magnetic resonance imaging ("MRI" or "MR") scanners which utilize
MRI technology for the detection and diagnosis of human disease. FONAR
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. 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 and
diagnostic management services segments.
FORWARD LOOKING STATEMENTS.
Certain statements made in this Annual Report on Form 10-K are
"forward-looking statements" (within the meaning of the Private Securities
Litigation Reform Act of 1995) regarding the plans and objectives of
Management for future operations. Such statements involve known and unknown
risks, uncertainties and other factors that may cause actual results,
performance or achievements of the Company to be materially different from any
future results, performance or achievements expressed or implied by such
forward-looking statements. The forward-looking statements included herein are
based on current expectations that involve numerous risks and uncertainties.
The Company's plans and objectives are based, in part, on assumptions
involving the expansion of business. Assumptions relating to the foregoing
involve judgments with respect to, among other things, future economic,
competitive and market conditions and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
the control of the Company. Although the Company believes that its assumptions
underlying the forward-looking statements are reasonable, any of the
assumptions could prove inaccurate and, therefore, there can be no assurance
that the forward-looking statements included in this Report will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statement included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives and plans of the Company will be achieved.
RECENT DEVELOPMENTS AND OVERVIEW.
The Company's 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 the "OR
360"(TM) (an operating room scanner), the "Open Sky MRI"(TM), with its breast
scanning capabilities (similar to the OR 360, the scanner room is inside the
magnet) and the "Stand-Up MRI"(TM), a scanner which will allow patients to be
scanned while standing or sitting. (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.
Following two and a half years of intense research and development
activity to develop and consolidate the features on its new QUAD scanners the
Company has begun to turn its attentions from predominately research and
development to predominantly sales.
The Company intends to increase its sales force and is seeking
experienced medical equipment salesmen and distributors worldwide. Among other
things the Company also intends to expand its WEB site to a full-scale
interactive sales desk for reaching new customers and assisting existing
customers.
The Company will also continue to actively seek to promote foreign sales.
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.
HMCA entered the physician and diagnostic management services business
through the consummation of two acquisitions, effective June 30, 1997. As a
result of these two acquisitions, three additional acquisitions and the
opening of new facilities, HMCA currently is managing 25 diagnostic imaging
centers and 12 primary care and specialty medical practices located
principally in New York State and Florida.
PRODUCTS
The Company's principal products are its new "QUAD(TM)" 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.
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 12000, 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 12,000 is used to describe the S/N
equivalency of the QUAD 12000 to 12,000-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. In addition,
the Company's works-in-progress, the OR 360, Open Sky MRI and Stand-Up MRI are
also designed to operate with said 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 1999, sales of the Company's QUAD scanners accounted for
approximately 7% of the Company's total revenues and 40% of its medical
equipment segment revenues, as compared to 15% of total revenues and 53% of
medical equipment revenues during fiscal 1998. There were no sales of Ultimate
or Beta scanners in fiscal 1998 and only one sale of a Beta scanner (1% of
total revenues and 6.6% of medical equipment segment revenues) in fiscal 1999.
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 the OR 360(TM) scanner, the Open Sky MRI(TM) scanner, with its breast
scanning capabilities and the Stand-Up MRI(TM) scanner. All of these products
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.
Among its other uses, the Company envisions that its Open Sky MRI(TM)
scanner will meet the public need for an MRI breast scanner.
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(TM) 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 Open Sky MRI(TM), similar in design to the OR 360, includes the
floor, ceiling and sidewalls of the scanning room as part of the iron frame of
the magnet. This is made possible by FONAR's patented Iron-Frame(TM)
technology which allows the Company's engineers to control, contour and direct
the magnet's lines of flux in the patient gap where wanted and almost none
away from the magnet where not wanted. Unlike the OR 360, the Open Sky MRI is
strictly a diagnostic scanner, and does not include the software and features
that make the OR 360 suitable as an operating room.
To increase the number of patients who can be scanned, patients are
rolled into the scanner room on a special high-throughput gurney. Once the bed
is anchored in position, it allows for full horizontal, vertical and
rotational positioning for scanning any region of the body. To optimize the
patient-friendly character of the Open Sky MRI, the walls, floor, ceiling and
magnet poles are decorated with landscape murals. The patient gap is twenty
inches and the magnetic field strength, like that of FONAR's QUAD 12000 is 0.6
Tesla. The Open Sky MRI shares the fundamental technology of the QUAD 12000
and offers the same speed, precision and image quality.
The Company's Stand-Up MRI(TM) will allow patients to be scanned while
standing, sitting, bending or reclining. This will allow all parts of the
body, particularly the spine and joints, to be imaged in the weight-bearing
state. As a result, for the first time, MRI will be able to be used to show
abnormalities and injuries under full weight-bearing conditions.
A floor-recessed elevator brings the patient to the height appropriate
for the targeted image region. A custom-built adjustable bed will allow
patients to sit or lie on their backs, sides or stomachs at any angle. The
beds could even be rotated into the Trendelenburg position for MR angiography.
Full-range-of-motion studies of the joints in virtually any direction
will be possible, an especially promising feature for sports injuries. Maximal
flexion cines of the lumbar spine can be achieved under full body weight.
The Stand-Up MRI will also be useful for MR-directed surgical procedures
as the surgeon would have unhindered access to the patient with no
restrictions in the vertical direction.
This easy-entry, mid-field-strength scanner should be ideal for trauma
centers where a quick MRI-screening within the first critical hour of
treatment will greatly improve patients' chances for survival and optimize the
extent of recovery.
Most of the design work for the OR 360 and Open Sky MRI and the
construction of prototypes have been completed. Most of the design work for
the Stand-Up MRI is complete.
Additionally the Company has completed construction of a prototype of its
0.6 Tesla superconductive magnet to provide its customers with FONAR's
patented superconducting version of its open iron frame magnets. The Company's
design of its superconductive magnet anticipated the need to convert all of
its products to superconducting magnets. Therefore, all of its products, the
OR 360, the Open Sky MRI and the Stand-Up MRI, will be available to FONAR's
customers as either iron-frame resistive models or iron-frame superconductive
magnets depending on customer preference and pricing.
The Company is negotiating with several universities to install and
commence clinical trials of its OR 360, Open Sky MRI and Stand-Up MRI. The
Company is working with these universities to jointly secure research funding
for these products.
PRODUCT MARKETING
The principal markets for the Company's scanners are hospitals and
private scanning centers.
Following two and a half years of intense research and development
activity to develop and consolidate the features of its QUAD scanners, the
Company has begun to turn its attention from predominantly research and
development to predominantly sales.
The Company intends to increase its sales force and is seeking
experienced medical equipment sales personnel and distributors. The Company
will conduct domestic sales through its own sales personnel and independent
sales representatives and distributors. In foreign markets, the Company plans
to expand its existing network of independent distributors.
In addition, the Company plans to expand its WEB site to include an
interactive "sales desk" for reaching customers and to commence a program for
providing demonstrations of its products to potential customers on an
international basis.
The Company has exhibited its new products at the annual trade show held
by the Radiological Society of North America ("RSNA") in Chicago since
November 1995 and plans to attend the RSNA trade show in November 1999 and
future years. 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 (0.6
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 competitive prices for the QUAD
12000 and QUAD 7000 scanners. 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 and 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, 1999, 3.4% of the Company's
revenues were generated by foreign sales, as compared to 4.6% and 3.7% for
fiscal 1998 and 1997 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's customer base of installed scanners has been and will
continue to be an additional source of income, independent of direct sales.
Income is generated from the installed base in two principal areas
namely, service and upgrades. Service and maintenance revenues from the
Company's installed base were approximately $4.6 million in fiscal 1997, $3.7
million in fiscal 1998 and $3.1 million in fiscal 1999. The decreases in
fiscal 1998 and 1999 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.
Service and upgrade revenues are expected to increase as sales of QUAD
scanners and the size of the customer base increases.
RESEARCH AND DEVELOPMENT
During the fiscal year ended June 30, 1999, the Company incurred
expenditures of $6,647,555 (none of which was capitalized) on research and
development, as compared to $6,506,995 (none of which was capitalized) and
$3,928,035 ($108,809) of which was capitalized) incurred during the fiscal
years ended June 30, 1998 and June 30, 1997, respectively.
Research and development activities have focused, in large part, on the
development of the Company's new OR 360(TM), Open Sky MRI(TM) and Stand-Up
MRI(TM) scanners and the continued development and enhancement of the
Company's QUAD MR scanners. The OR 360, Open Sky MRI, Stand-Up MRI 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, 1999 was
approximately $1.4 million, as compared to $2.8 million at September 1, 1998.
Of these amounts, approximately $0.35 million and $0.6 million had been paid
to the Company as customer advances as at September 1, 1999 and September 1,
1998, respectively. Of the backlog amounts at September 1, 1998 and September
1, 1999, none represented orders from affiliates. It is expected that the
existing backlog of orders will be filled within the current fiscal year. The
Company's contracts generally provide that if a customer cancels an order, the
customer's initial down payment for the MRI scanner is nonrefundable.
PATENTS AND LICENSES
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 2016, 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
Company has 42 patents issued and 34 patents pending. A substantial number of
FONAR's existing patents specifically relate to protecting FONAR's position in
the high field iron frame open MRI market. The patents further enhance Dr.
Damadian's pioneer patent (the 1974 Patent), that initiated the MRI industry
and provided the original invention of MRI scanning.
The 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.
PRODUCT COMPETITION
MRI SCANNERS
A majority of the MRI scanners in use in hospitals and outpatient
facilities and at mobile sites in the United States are based on high field
air core magnet technology while the balance are based on open iron frame
magnet technology. In 1998 the size of the MRI market in the United States was
approximately $957 million. The market share of high field air core MRI's was
approximately 57%. FONAR's open iron frame MRI scanners are competing
principally with high field air core scanners. The QUAD 12000 scanner,
however, utilizing a 6,000 gauss (0.6 Tesla field strength) iron core
electromagnet, is the first "open" MR scanner at high field strength. In
addition FONAR's works-in-progress include a superconductive version of its
open iron frame magnets.
FONAR believes that its MRI scanners have significant advantages as
compared to the high field air core scanners of its competitors. These
advantages include:
1. There is no fringe magnetic field. High field air core scanners
require a more expensive shielded room than is required for the iron frame
scanners. The shielded room required for the iron frame scanners is intended
to prevent interference from external radio frequencies.
2. They are more open, quiet and in the case of the QUAD scanners allow
for faster throughput of patients.
3. They require smaller space to install.
4. Their annual operating costs are lower.
5. They can scan the trauma victim, the cardiac arrest patient, the
respirator-supported patient, and premature and newborn babies. This is not
possible with high field air core scanners because their magnetic field
interferes with conventional life-support equipment.
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; 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 high field air core
and iron frame 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 air core magnets. Air core magnets
contain no iron but consist entirely of turns of current carrying wire.
FONAR's patented work-in-progress superconductive iron frame magnet, however,
combines the high field capability of the air core superconductive magnets
with the control and versatility of the open iron frame magnets, thereby
joining the best features of both designs into a single magnet. Thus the air
core superconductive magnets made by Fonar's large competitors that have
dominated the MRI market since 1983 remain the confining "tunnel" design that
the public has generally resented.
For an 11 year period, 1983-1994, Fonar's large competitors (with one
exception) generally rejected Fonar's "open" design but by 1994 all (with one
exception) added the iron frame "open" magnet to their MRI product line. In
1997 the sale of iron frame "open" magnets exceeded the sale of traditional
air core superconductive magnets. One principal reason for this market shift,
in addition to patient claustrophobia, is the awareness that the "open" magnet
designs permit access to the patient to perform surgical procedures under MRI
image guidance, a field which is now growing rapidly and is called
"interventional MRI."
Fonar's OR 360 explicitly addresses this growing market reception of MRI
guided surgical procedures but is not yet available as a product. Fonar's
Stand-Up MRI and QUAD series magnets do also. Although not enabling a full
operating theater as the OR 360 does, the iron frame "Open" QUAD and Stand-Up
MRI designs permit ready access to the patient from four sides and therefore
enables a wide range of interventional surgical procedures such as biopsies
and needle or catheter delivered therapies to be performed under MRI image
guidance. The "tunnel" air core superconductive scanners do not permit access
to the patient while the patient is inside the scanner.
While Fonar's current market share of the domestic MRI market is under
5%, FONAR expects to be a leader in domestic open 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 almost twice the field
strength of the next highest field strength open magnet, manufactured by
Toshiba (0.6 Tesla vs. 0.35 Tesla). The Company's OR 360, Open Sky MRI and
Stand-Up MRI scanners will also operate at this field strength. 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 air core superconductive scanner achieved market dominance in the MRI
market before the marketplace shifted and registered an increased demand for
the iron frame "Open MRI." No companies possess the OR 360 or Open Sky MRI 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 clearance to market the Ultimate Magnetic Resonance Imaging
Scanner as a Class II device. The Company received FDA clearance 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 or clearances for its OR 360, Open
Sky MRI and Stand-Up MRI 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 export sales to most European countries and
certain other countries have required CE certification (essentially safety
requirements for electrical products). On May 25, 1999, the Company obtained
CE certification. Previously, on April 9, 1999, the Company was approved for
ISO 9001 Certification for its Quality Management System. The Quality
Management System is applicable to the design, manufacture, administration of
installation and servicing of magnetic resonance imaging scanner systems.
HEALTH MANAGEMENT CORPORATION OF AMERICA
(PHYSICIAN AND DIAGNOSTIC MANAGEMENT SERVICES 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.
Since its formation, HMCA has completed five acquisitions. HMCA became
actively engaged in the physician and diagnostic management services 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 fiscal 1999.
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
consummated the acquisition of an additional MRI scanner pursuant to a
contract entered into prior to the acquisition. The scanner is a mobile unit
which being provided to a number of hospitals on a shared basis, as needed, on
a mobile route in 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 19 MRI scanning centers. Sixteen of the scanning
centers are managed pursuant to management agreements, and 3 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 Care Services
Management Company, 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 40,000 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 to the physicians or their professional corporations. 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.
PHYSICIAN AND DIAGNOSTIC 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 physician and diagnostic management services field is highly
competitive. A number of large hospitals have acquired medical practices and
this trend may continue. HMCA expects that more competition will develop. Many
competitors have greater financial and other resources than HMCA.
With respect to the diagnostic imaging 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 in any such State.
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, 1999, the Company employed 528 persons on a full-time and
part-time basis. Of such employees, 10 were engaged in marketing and sales, 39
in research and development, 84 in manufacturing, 48 in customer support
services, 304 in administration (including 164 on site at facilities and
offices managed by HMCA and 83 performing billing, collection and
transcription services for those facilities) and 43 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 $967,000, excluding utilities, taxes and other related expenses.
The term of one of the leases extends through 2002 with options to renew up
through 2008 and the term of the other lease extends to the beginning of 2009.
Management believes that these premises are adequate for its current needs. In
addition, HMCA maintains leased office premises for its clients at
approximately 38 site locations having an aggregate annual rental rate of
approximately $1.9 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). 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 for
infringement of two of FONAR's 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."
Following the post trial applications and appeals, the District Court
entered a judgment against General Electric and 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 October 1997, the
Supreme Court denied General Electric's petition.
On June 16, 1995, the Company filed an action against Siemens Medical
Systems, Inc., Philips Electronics North America Corporation, Philips
Electronics, N.V. and other defendants for patent infringement in the United
States District Court for the Eastern District of New York. (FONAR Corporation
and Dr. Raymond V. Damadian v. Siemens Medical Systems, Inc. et al. Civil
Action No. CV 95-2469 (LJW). FONAR alleged that four of its patents were
infringed, including U.S. Patent Nos. 3,789,832 (Apparatus and Method for
Detecting Cancer in Tissue) and 4,871,966 (Apparatus and Method for Multiple
Angle Oblique Magnetic Resonance Imaging).
Previously, in May 1995, Siemens Medical Systems, Inc. had filed a
complaint against FONAR in the United States District Court for the District
of Delaware seeking a declaratory judgment that the four patents were invalid
and unenforceable, as well as an adjudication that Siemens was not infringing
the four patents. The complaint was further amended on December 14, 1995 to
allege infringement of two additional patents.
Thereafter, on June 30, 1995, Philips Electronics North America
Corporation and Philips Electronics, N.V. filed a complaint against FONAR in
the United States District Court for the District of Delaware seeking a
declaratory judgment that FONAR's U.S. Patents Nos. 3,789,832 and 4,871,966
were invalid, unenforceable and not infringed (Philips Electronics North
America Corporation and Philips Electronics, N.V. v. FONAR Corporation, Case
No. 95-431). Separately, U.S. Philips Corporation, an affiliate of Philips
Electronics North America Corporation and Philips Electronics, N.V., commenced
an action in the United States Court for the District of Delaware alleging
infringement by FONAR of two of its patents. (U.S. Philips Corporation v.
Fonar Corporation and Raymond V. Damadian, M.D. MR Scanning Centers Management
Company, Civil Action No. 95-448.)
In April 1996, FONAR entered into an agreement with Philips Electronics
N.V., Philips Electronics North America Corporation, Philips Medical Systems
North America and U.S. Philips Corporation setting the lawsuits and claims
between them. The settlement involved a monetary payment to FONAR.
In September 1996, FONAR entered into an agreement with Siemens Medical
Systems, Inc. and its affiliates settling the lawsuits and claims between
them. The settlement agreement, which does not admit liability by either
party, includes a cross-license by Siemens and FONAR of certain patents
relating to MRI technology. FONAR received a monetary payment from Siemens and
an agreement by Siemens to pay FONAR royalties.
On March 4, 1996, the Company filed an action against Toshiba
Corporation, Toshiba America Medical Systems, Inc., Toshiba 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.
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 February 2, 1999, the Company filed an action against Elscint Inc.,
Elscint MR Inc., Elscint Ltd. and others in the United States District Court
for the Eastern District of New York (Civil Action No. 98-CV-0681) alleging
infringement of the Company's Multi-Angle Oblique Imaging Patent (U.S. Patent
No. 4,871,966). In February 1999 these claims and counterclaims were amicably
resolved. The settlement involved a monetary payment to the Company.
On February 2, 1999, the Company filed an action against Shimadzu
Corporation in the United States District Court for the Eastern District of
New York (Civil Action No. 98-0680) alleging infringement of the Company's
Multi-Angle Oblique Imaging Patent (U.S. Patent No. 4,871,966). In November
1998, the litigation was resolved by the parties. Shimadzu Corporation agreed
to pay royalties to the Company in exchange for Shimadzu Corporation being
granted a license under the patent.
In January 1998, the Company filed an action against Health South, Inc.,
an end-user of MRI scanners in the United States District Court for the
Eastern District of New York (Civil Action No. CV-98-0679) alleging
infringement of the Company's Multi-Angle Oblique Imaging Patent (U.S. Patent
No. 4,871,966). Health South, Inc. filed a declaratory judgment counterclaim
for non-infringement and invalidity. The case is in discovery. In addition,
Health South, Inc. filed a third party claim against a manufacturer of the
scanners seeking indemnification and contribution. The manufacturer has also
asserted non-infringement and invaliditiy claims respecting the patent.
There are certain other minor litigations to which the Company is a
party. There is no material litigation pending, or to its knowledge,
threatened against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
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 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 1998 2.47 1.25 2.50 1.31
October - December 1998 1.97 0.97 2.00 1.00
January - March 1999 1.72 1.19 1.78 1.22
April - June 1999 1.41 1.03 1.50 1.09
July - September 10 1999 1.16 0.97 1.16 0.94
On September 10, 1999, the Company had approximately 5,514 stockholders
of record of the Company's Common Stock, 13 stockholders of record of the
Company's Class B Common Stock, 4 stockholders of record of the Company's
Class C Common Stock and 4,698 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 three
quarters 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, 1999. 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 1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ -----------
Revenues $ 36,945,044 $ 27,554,357 $ 17,633,066 $ 13,915,725 $16,552,676
Cost of $ 29,391,682 $ 23,841,844 $ 18,428,574 $ 14,417,384 $10,192,542
revenues
Research and $ 6,647,555 $ 6,506,995 $ 3,928,035 $ 3,607,703 $ 3,356,120
Development Expenses
Net Income (loss) $(14,215,763) $ (5,653,086) $ 56,068,771 $(11,407,444) $(7,549,625)
Net income (loss) $(.22) $(.09) 1.00 (.22) (.17)
per common share
Weighted average 64,071,151 61,175,986 56,097,965 51,516,470 45,055,334
number of shares
outstanding *
BALANCE SHEET DATA
Working capital $ 37,863,029 $ 54,426,483 $ 62,659,470 $ (1,575,857) $(4,498,911)
(deficit)
Total $ 97,648,168 $108,447,780 $106,690,561 $ 28,057,384 $27,949,122
assets
Long-term debt and $ 24,821,834 $ 16,003,479 $ 4,626,269 $ 4,204,935 $ 4,274,420
obligations under
capital leases
Stockholders' $ 59,303,773 $ 72,572,486 $ 73,245,262 $ 11,412,629 $29,394,096
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 and diagnostic management services 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 0.6 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. Among the Company's works-in-progress are the OR
360(TM), Open Sky MRI(TM) and Stand-Up MRI(TM), which share the fundamental
technology of the QUAD scanners and also have a field strength of 0.6 Tesla.
The Company expects vigorous sales from its new products. (See "Description of
Business - Products, Works-in-Progress and Product Marketing.")
As part of its scanner marketing program, the Company has attended the
industry's annual trade show, RSNA (Radiological Society of North America)
since 1995 and plans to do so again in November 1999. 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 its products 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.
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 and manages two
multi-specialty facilities. These facilities are located in Orlando, Florida
and Elmhurst, New York.
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, A & A and Dynamic, have been
consolidated effective as of the dates of their respective acquisitions (June
30, 1997, January 23, 1998, March 20, 1998 and August 20, 1998, respectively).
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 has developed a
plan to meet this issue. The Company has reviewed all in-house computer based
systems. The MIS department is on schedule for updating or replacing older
systems that are not Y2K compatible. The Company has also reviewed, tested and
has started to change its existing customer base of MRI scanners. The Company
expects that all computer based systems will be Y2K compliant in the last
quarter of 1999. Based upon 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 1999 COMPARED TO FISCAL 1998
In fiscal 1999, the Company experienced a net loss of $14.2 million on
revenues of $36.9 million as compared to net loss of $5.7 million on revenues
of $27.6 million for fiscal 1998.
Revenues attributable to the Company's physician and diagnostic
management services segment (HMCA) increased to $31.3 million in fiscal 1999
from $21.1 million in fiscal 1998. Operating income of $3.1 million was
recognized from the Company's physician and diagnostic management services in
fiscal 1999, as compared to an operating income of $2.7 million in fiscal
1998.
Revenues attributable to the Company's medical equipment segment declined
to $6.5 million in fiscal 1999 from $7.8 million in fiscal 1998, reflecting
lower sales volume in fiscal 1999. Results of operations for the medical
equipment segment improved, however, from a loss of $20.3 million in fiscal
1998 to a loss of $18.7 million in fiscal 1999.
As a result, the Company's consolidated operating loss improved to a loss
of $15.6 million for fiscal 1999 from a loss of $17.6 million for fiscal 1998,
a further improvement from the operating loss of $24.4 million for fiscal
1997.
Other income of $8.6 million (principally the net proceeds from the
Company's patent enforcement lawsuits) and investment income of $3.7 million
were recognized by the Company in fiscal 1998 as compared to other income of
approximately $1.0 million (principally the net proceeds from the Company's
patent enforcement lawsuits) and investment income of $2.1 million in fiscal
1999.
Costs of revenues and expenses increased from $45.1 million in fiscal
1998 to $52.6 million in fiscal 1999, reflecting principally the expansion of
the Company's physician and diagnostic management services operations. Costs
of revenue and expenses for the Company's physician and diagnostic management
services increased to $21.8 million in fiscal 1999 from $13.7 million in
fiscal 1998. Research and development expenses increased to $6.6 million in
fiscal 1999 as compared to $6.5 million in fiscal 1998.
Overall, costs of revenues and expenses for the Company's medical
equipment segment, however, declined to $25.1 million in fiscal 1999 from
$28.1 million in fiscal 1998 reflecting, most significantly, reductions in
costs of product sales ($4.9 million in fiscal 1999 as compared to $7.8
million in fiscal 1998) and in general and administrative expenses ($7.7
million in fiscal 1999 as compared to $7.5 million in fiscal 1998) and costs
of revenue ($8.5 million in fiscal 1999 as compared to $11.4 million in fiscal
1998).
Revenues generated by sales of QUAD MRI scanners were $4.1 million (15%
of total revenues) in fiscal 1998 and $2.6 million (7% of total revenues) in
fiscal 1999. Revenues attributable to sales of the Company's Ultimate scanners
during the same period were $0.00.
Sales of Beta scanners were $0.00 in fiscal 1998 and $430,000
(approximately 1% of total revenues) in fiscal 1999.
Sales to affiliated parties represented approximately 0.4% ($150,000) of
the Company's revenues in fiscal 1999, as compared to 0.3% ($100,000) of the
Company's revenues in fiscal 1998.
Gross profit margins on product sales to unrelated parties were negative
(98%) in fiscal 1998 and negative (49%) in fiscal 1999. This reflected 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 1999 and 1998 by acquiring
approximately $3.8 million and $1.4 million, respectively, 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 $6.5 million in fiscal 1999 from approximately $7.8 million in
fiscal 1998. These trends reflected a decline in service revenue from $2.5
million in fiscal 1998 to $2.3 million in fiscal 1999 and a decrease in
product sales in fiscal 1999 ($3.4 million) from fiscal 1998 ($3.9 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 and Stand-Up MRI scanners (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 1999 the
Company continued its investment in the development of its new MRI scanners,
together with software and upgrades, with an investment of $6,647,555 in
research and development (none of which was capitalized) as compared to
$6,506,995 (none of which was capitalized) in fiscal 1998. The research and
development expenditure was approximately 102% of revenues attributable to the
Company's medical equipment segment (and 18% of total revenues) in 1999 and
$83.3% of medical equipment segment revenues in 1998 (and 23.6% 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 and diagnostic
management services, 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 90.9% for fiscal 1999 and 85.7% for
fiscal 1998.
During the fiscal year ended June 30, 1999, the Company realized income
of approximately $1.0 million from the settlement of various legal disputes
(essentially its patent infringement actions) as compared to approximately
$8.6 million in fiscal 1998.
RESULTS OF OPERATIONS. FISCAL 1998 COMPARED TO FISCAL 1997
In fiscal 1998, the Company experienced a net loss of $5.7 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 and diagnostic management
services segment (HMCA) increased dramatically, to $21.1 million in fiscal
1998 from $9.8 million in fiscal 1997. Operating income of $2.7 million was
recognized from the Company's physician and diagnostic 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 $8.6 million (principally the net
proceeds from the Company's patent enforcement lawsuits) and investment 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 investment 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 and diagnostic 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 and diagnostic 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 ($7.5 million in fiscal 1998 as compared
to $11.8 million in fiscal 1997) and costs of revenue ($11.4 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 $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 $0.00.
Sales of Beta scanners were $0.00 in fiscal 1997 and 1998.
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.
Gross profit margins on product sales to unrelated parties were negative
(60%) in fiscal 1997 and negative (98%) in fiscal 1998. This reflected the
losses on sales of the Company's QUAD scanners.
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. These trends reflected a decline in service revenue from $2.7
million in fiscal 1997 to $2.5 million in fiscal 1998 and a decrease in
product sales in fiscal 1998 ($3.9 million) from fiscal 1997 ($5.2 million).
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 83.3% of revenues
attributable to the Company's medical equipment segment (and 23.6% of total
revenues) in 1998 and $41.2% of medical equipment segment revenues in 1997
(and 22.3% of total revenues).
During the fiscal year ended June 30, 1998, the Company realized income
of approximately $8.6 million from the settlement of various legal disputes
(essentially its patent infringement actions) as compared to approximately
$83.1 million in fiscal 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents declined from $41.8 million at June 30, 1998 to
$15.2 million at June 30, 1999. Principal uses of cash during fiscal 1999
included acquisitions in the amount of $2.7 million, capital expenditures of
$4.8 million, payment of special dividends to shareholders of $3.9 million,
repayment of indebtedness and capital lease obligations in the amount of $2.1
million, purchase of treasury stock of $197,000 and $12.4 million to fund the
losses for the fiscal year.
Marketable securities approximated $20.2 million as of June 30, 1999 as
compared to $20.3 million as of June 30, 1998. During fiscal 1999, the Company
realized a loss of approximately $153,930 on sales of equity securities. From
June 30, 1998 to June 30, 1999 the Company reduced its investments in equity
securities from approximately $11 million to $100,000 and increased its
investments in U.S. government obligations from approximately $6.7 million to
$11.0 million and in corporate and government agency bonds from approximately
$2.6 million to $9.3 million. This has had the intended effect of reducing the
volatility of the Company's investment portfolio.
Cash used in operating activities for fiscal 1999 approximated
$12,421,000. Cash used in operating activities was attributable substantially
to the funding of the net loss for fiscal 1999.
Cash used in investing activities for fiscal 1999 approximated
$7,553,000. The principal uses of cash in investing activities during fiscal
1999 consisted of cash used in connection with the acquisitions by HMCA of
Dynamic Health Care Services Management, Inc. and Central Health Care Services
Management Company, LLC of approximately $2,652,000 and expenditures for
property and equipment of approximately $4,775,000.
Cash used in financing activities for fiscal 1999 approximated
$6,603,000. The principal uses of cash in financing activities during fiscal
1999 consisted of dividend distributions to stockholders and holders of
minority interests approximating $4,308,000 and repayment of principal on
long-term debt of approximately $2,098,000.
Total liabilities increased since June 30, 1998 by approximately $2.5
million to approximately $38.3 million at June 30, 1999. The increase in
liabilities from June 30, 1998 was attributable to approximately $9.4 million
in new long-term debt incurred in connection with the acquisition of Dynamic
Health Care Management, Inc. and Central Health Care Services Management
Company, LLC, reduced by approximately $2.1 million of payments of principal
on long-term debt and a net reduction of other liabilities of approximately
$4.8 million.
As at June 30, 1999, the Company's past due obligations consisted of
approximately $1.4 million in past due taxes (various state taxes), and
approximately $6,000 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, 1999, 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 physician and diagnostic management services) 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 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 increased by
approximately $100,000 from June 30, 1998 to June 30, 1999. 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, 1999 and June 30, 1998.
Capital expenditures for each of fiscal 1999 and 1998 approximated $5.5
million and $4.2 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 and is reemphasizing MRI Scanner sales. In addition, the Company
is enhancing its revenue by entering into the physician and diagnostic
management services 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 and the expansion of HMCA's physician and
diagnostic management services business. 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 $2.5 million for the year ended June
30, 1998 and $2.3 million for the year ended June 30, 1999 (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, 1999 approximates
$37.9 million, as compared to a working capital surplus of $54.4 million as of
June 30, 1998.
The change in the Company's working capital position resulted primarily
from its investments in new equipment ($5.5 million), the cash portions of the
purchase prices for its acquisitions ($2.7 million) and its overall operating
losses, notwithstanding a decrease in its current liabilities of $4.3 million
($17.8 million as at June 30, 1999 as compared to $22.1 million as at June 30,
1998.
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 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. The settlement was revised and approved
by the Court on March 2, 1998. 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 issued 2,231,689.6 shares of Fonar Common Stock
to holders of record of its Common Stock as of 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.
The dividends were paid according to a schedule of installments set forth
in the settlement agreement, as revised. These first installments (comprising
one-half of the total) were paid in May 1998 and the second, third and fourth
installments (each comprising one-sixth of the total) were paid in September
1998, December 1998 and March 1999, respectively.
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, 1999,
equity securities and mutual funds composed of equity securities had a fair
value of $99,500.
The Company's investments in equity securities consist of common stock
traded in the major United States security markets. Approximately 100% 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, 2005.
Below is a tabular presentation of the maturity profile of the fixed rate
instruments held by the Company at June 30, 1999.
INTEREST RATE SENSITIVITY
PRINCIPAL AMOUNT BY EXPECTED MATURITY
WEIGHTED AVERAGE INTEREST RATE
Date Investments in Fixed Rate Weighted Average
Instruments Interest Rate
6/30/00 $8,198,935 5.0%
6/30/01 5,100,000 5.1%
6/30/02 2,320,000 5.1%
6/30/03 3,207,000 6.0%
6/30/04 1,547,000 5.9%
6/30/05 100,000 6.6%
Total: $20,472,935
Fair Value
at 6/30/99: $20,098,198
All of the Company's revenue, expense and capital purchasing activities
are transacted in United States dollars.
See Note 11 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 - F-5
At June 30, 1999 AND 1998
CONSOLIDATED STATEMENTS OF OPERATIONS F-6
For the Three Years Ended June 30, 1999, 1998 and 1997
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY F-7 - F-12
For the Three Years Ended June 30, 1999, 1998 and 1997
CONSOLIDATED STATEMENTS OF CASH FLOWS F-13 - F-14
For the Three Years Ended June 30, 1999, 1998 and 1997
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-15 - F-59
SELECTED FINANCIAL DATA (*)
For the Five Years Ended June 30, 1999
(*) 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, 1999 and 1998, 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, 1999. 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, 1999 and 1998, and the
consolidated results of their operations and cash flows for each of the years
in the three-year period ended June 30, 1999, in conformity with generally
accepted accounting principles.
During each of the years in the three-year period ended June 30, 1999, a
significant portion of the Company's revenues was from related parties (see
Notes 2, 3, 5 and 19).
TABB, CONIGLIARO & McGANN, P.C.
New York, New York
September 24, 1999
F-2
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
--------
June 30,
-----------------------------
1999 1998
Current Assets ------------ ------------
Cash and cash equivalents $ 15,175,804 $ 41,751,704
Marketable securities 20,197,698 20,251,832
Accounts receivable, net 13,936,734 9,877,347
Costs and estimated earnings in
excess of billings on
uncompleted contracts 1,463,450 833,615
Inventories 4,237,778 3,513,622
Prepaid expenses and other current assets 701,433 285,965
------------ ------------
Total Current Assets 55,712,897 76,514,085
Restricted Cash 5,000,000 5,000,000
Property and Equipment - Net 11,442,493 9,102,239
Advances and Notes to Related Parties,
Net of discounts and allowance for
doubtful accounts of $904,000 at June 30,
1999 and 1998 1,434,689 1,350,114
Notes Receivable, Net of allowance for
doubtful accounts of $477,456 at June
30, 1999 and 1998 24,796 65,751
Excess of Cost Over Net Assets of
Businesses acquired, Net of accumulated
amortization of $1,498,166 and $272,224 at
June 30, 1999 and 1998, respectively 22,875,683 14,745,555
Other Intangible Assets, Net 888,992 1,161,601
Other Assets 268,618 508,435
------------ ------------
Total Assets $ 97,648,168 $108,447,780
============ ============
See accompanying notes to consolidated financial statements.
F-3
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
June 30,
-----------------------------
1999 1998
------------ ------------
CURRENT LIABILITIES
Current portion of debt and capital leases $4,474,293 $2,443,326
Accounts payable 2,401,926 2,029,552
Other current liabilities 9,920,991 11,256,159
Dividends payable - 3,909,366
Customer advances 95,518 669,731
Billings in excess of costs and estimated
earnings on uncompleted contracts - 31,032
Income taxes payable 957,140 954,642
Deferred income taxes - 793,794
------------ ------------
TOTAL CURRENT LIABILITIES 17,849,868 22,087,602
------------ ------------
LONG-TERM DEBT AND CAPITAL LEASES, Less
current maturities 20,347,541 13,560,153
OTHER LIABILITIES 131,629 113,663
------------ ------------
20,479,170 13,673,816
------------ ------------
MINORITY INTEREST 15,357 113,876
------------ ------------
COMMITMENTS, CONTINGENCIES AND OTHER
MATTERS (Notes 1, 2, 3, 5, 10, 11,
12, 14, 17 and 19)
See accompanying notes to consolidated financial statements.
F-4
FONAR CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
(Continued)
June 30,
-----------------------------
1999 1998
------------