-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, I0wifBI361CFdc6no1/Cu/km6ZkegBbO0YeyUaBTg8JImBbjieC0ZxZ+ebES6/Oy aa5BcjlfG6Swj/lqffGesg== 0000355019-98-000017.txt : 19980930 0000355019-98-000017.hdr.sgml : 19980930 ACCESSION NUMBER: 0000355019-98-000017 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980929 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FONAR CORP CENTRAL INDEX KEY: 0000355019 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 112464137 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-10248 FILM NUMBER: 98717237 BUSINESS ADDRESS: STREET 1: 110 MARCUS DR CITY: MELVILLE STATE: NY ZIP: 11747 BUSINESS PHONE: 5166942929 MAIL ADDRESS: STREET 1: 110 MARCUS DRIVE CITY: MELVILLE STATE: NY ZIP: 11747 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _____________________ FORM 10-K _____________________ [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [Fee Required] For the fiscal year ended June 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 [No Fee Required] For the transition period from _____________ to _____________ Commission File No. 0-10248 ___________________________ FONAR CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 11-2464137 (State of incorporation) (IRS Employer Identification Number) 110 Marcus Drive, Melville, New York 11747 (Address of principal executive offices) (Zip Code) (516) 694-2929 (Registrant's telephone number, including area code) ____________________________________________________ Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.0001 per share (Title of Class) ________________________________________________________________________ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ___X___ No _______ As of September 21, 1998, 52,879,701 shares of Common Stock, 5,411 shares of Class B Common Stock, 9,562,824 shares of Class C Common Stock and 7,836,287 shares of Class A Non-voting Preferred Stock of the registrant were outstanding. The aggregate market value of the approximately 50,316,374 shares of Common Stock held by non-affiliates as of such date (based on the closing price per share on September 21, 1998 as reported on the NASDAQ System) was approximately $66,015,082 million. The other outstanding classes do not have a readily determinable market value. DOCUMENTS INCORPORATED BY REFERENCE None ITEM 1. BUSINESS. GENERAL FONAR Corporation (the "Company" or "FONAR") is a Delaware corporation which was incorporated on July 17, 1978. The Company's address is 110 Marcus Drive, Melville, New York 11747 and its telephone number is (516) 694-2929. FONAR is engaged in the business of designing, manufacturing, selling and servicing magnetic resonance imaging ("MRI" or "MR") scanners which utilize MRI technology for the detection and diagnosis of human disease. FONAR introduced the first MRI scanner in 1980 and is the originator of the iron-core non-superconductive and permanent magnet technology. FONAR's iron frame technology made FONAR the originator of "open" MRI scanners. FONAR introduced the first "open" MRI in 1980 and maintained its "open" design ever since. Health Management Corporation of America (formerly U.S. Health Management Corporation and hereinafter sometimes referred to as "HMCA") was formed by the Company in March 1997 as a wholly-owned subsidiary in order to enable the Company to expand into the business of providing comprehensive management services to medical providers, sometimes referred to as "physician practice management" or "PPM." In connection with its entry into this new line of business, HMCA has completed five acquisitions. HMCA provides management services, administrative services, office space, equipment, repair and maintenance service and clerical and other non-medical personnel to physicians and other medical providers, including diagnostic imaging centers. See Note 20 to the Financial Statements for separate financial information respecting the Company's medical equipment and physician practice management services segments. FORWARD LOOKING STATEMENTS. Certain statements made in this Annual Report on Form 10-K are "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995) regarding the plans and objectives of Management for future operations. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. The Company's plans and objectives are based, in part, on assumptions involving the expansion of business. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes that its assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statement included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. RECENT DEVELOPMENTS AND OVERVIEW. The Company's principal products are its new "QUAD" series of MRI scanners. The "QUAD(TM) 12000" MR scanner utilizes a 6000 gauss iron core electromagnet and is accessible from four sides. The QUAD 12000 is the first "open" MR scanner at high field. The greater field strength of the 6000 gauss magnet, when enhanced by the electronics already utilized by the Company's scanners, produces images of a quality and clarity competitive with high field superconductive magnets. The QUAD 12000 scanner magnet is the highest field "open MRI" in the industry. The Company also produces the "QUAD(TM) 7000," a MR scanner which is similar in design to the QUAD 12000 but utilizes a smaller 3,500 gauss electromagnet. The less expensive QUAD 7000 offers an economical solution to the rising cost of medicine. In addition, the Company's current "works in progress" include a breast MRI scanner and an operating room scanner (the OR 360). (See "Works in Progress".) As a result of these new products and other research and development, the Company is positioning itself to dramatically increase sales and improve its competitive position in the marketplace. In tandem with new product and software developments, the Company has been strengthening and continues to strengthen its legal position for the purpose of protecting its proprietary technology as well as other interests. The Company does not intend to permit its competitors and would-be competitors to capitalize, to the detriment of the Company, on its inventions and exhaustive research and development efforts, as the Company believes has happened in the past. On September 2, 1992, the Company filed a patent infringement suit against Hitachi Ltd., General Electric Company and others in the United States District Court for the Eastern District of New York. On July 2, 1997, following the trial and appeal of the Company's claims against General Electric Company, General Electric Company paid FONAR $128.7 million (inclusive of interest) for infringement of FONAR's Multi-Angle Oblique (MAO) and original MRI (Cancer Detection) patents. Previously, immediately prior to trial, in April, 1995, the Company reached a settlement with Hitachi Ltd. and related defendants. In March 1996, the Company commenced a patent infringement suit against Toshiba Corporation, Toshiba America Medical Systems, Inc. and Toshiba America MRI, Inc. Toshiba America MRI, Inc. in turn commenced an action against FONAR alleging patent infringement. In May 1998 FONAR and the Toshiba companies settled the pending litigation between them, neither party admitting liability. FONAR and Toshiba cross-licensed each other on the patents in suit, and FONAR received a monetary payment from Toshiba. The Company is optimistic about sales of its new scanner products. To further promote product recognition and sales, FONAR will attend the RSNA (Radiological Society of North America) trade show in November 1998 to exhibit its products. The RSNA is the leading trade show in the MRI industry. Approximately 25,000 radiologists, who are among the principal groups to whom the Company directs its marketing efforts, are expected to attend to view MRI industry's most current product developments. The Company attended the RSNA trade shows previously in 1997, 1996 and 1995. The Company is actively seeking to promote foreign sales, thus enhancing America's competitive position as well as its own. Since commencing its current foreign sales program, the Company has sold scanners in Korea, Saudi Arabia, Mexico and Poland. Based on numerous indications of interest, meetings, sales trips abroad and negotiations, the Company is cautiously optimistic that foreign sales will produce significant revenues. The Company believes there are and will be significant market opportunities abroad, particularly in Asia and Eastern Europe. In March 1997, FONAR formed Health Management Corporation of America (formerly U.S. Health Management Corporation and hereinafter sometimes referred to as "HMCA") as a wholly-owned subsidiary for the purpose of engaging in the business of providing comprehensive management and administrative services, office space, equipment, repair and maintenance service for equipment and clerical and other personnel (other than physicians) to physicians' practices and other medical providers, including diagnostic centers (sometimes referred to as "physician practice management," "PPM" or "practice management.") HMCA entered the PPM business through the consummation of two acquisitions, effective June 30, 1997. As a result of these two acquisitions, three additional acquisitions completed through August, 1998 and the opening of two new facilities, HMCA currently is managing 38 facilities and offices located principally in New York State and Florida. PRODUCTS The Company's principal products are its new "QUAD" series of MRI scanners. The QUAD(TM) 12000 MR scanner utilizes a 6000 gauss iron core electromagnet and is accessible from four sides. The QUAD 12000 is the first "open" MR scanner at high field. The QUAD(TM) 7000 is similar in design to the QUAD 12000 but utilizes a smaller 3,500 gauss electromagnet. The Ultimate 7000 utilizes a 3500 gauss iron core electromagnet. FONAR received FDA approval to market the QUAD 7000 in April, 1995 and for the QUAD 12000 in November 1995. In addition to the patient comfort, increased throughput and new applications (such as MRI directed surgery and MRI mammography) made possible by the QUAD scanners' open design, the QUAD scanners are designed to maximize image quality through an optimal combination of signal-to-noise (S/N) and contrast-to-noise (C/N) ratios. The technical improvements realized in the QUAD's design over its predecessors also include increased image-processing speed and diagnostic flexibility. MRI directed surgery (laproscopic surgical procedures) is made possible by the QUAD's ability to supply images to a monitor positioned next to the patient, enabling a surgeon to view in process surgical procedure from an unlimited number of vantage points. The marked openness of FONAR's QUAD scanners enables surgeons to perform a wide range of surgical procedures inside the magnet. The "QUAD" scanners are unique MR scanners in that four sides are open, thus allowing access to the scanning area from four vantage points. Equipped with up to four beds, the user is able to prep one or more "on deck" patients while another patient is being scanned, thereby increasing throughput and reducing scan prices. The starshaped open design of the QUAD will also make possible a host of new applications, particularly MRI mammography and MRI directed surgery (Interventional MRI). With the QUAD's multi-bed patient handling system, many more short scan procedures such as those used in breast imaging can be done in a day, allowing the price of MRI mammography to drop without reducing the scanner's revenue-generating capacity. At the same time, there is not the painful compression of the breast characteristic of X-ray mammography. The principal difference between the QUAD scanners and other open MRI scanners is in field strength. Other open MRIs operate at significantly lower magnetic field strengths and, therefore, are unable to produce the amount of MRI image-producing signal necessary to make high-quality MRI images (measured by signal-to-noise ratios, S/N). The QUAD 12000 scanner utilizes a 6000 gauss (.6 Tesla field strength) iron core electromagnet. The greater field strength of the 6000 gauss magnet, when enhanced by the electronics already utilized by the Company's scanners, produces images of a higher quality and clarity than other open MRI scanners. The QUAD 12000 scanner magnet is the highest field "open MRI" in the industry and operates at a field strength that is almost two times its closest competitor (.6 Tesla field strength versus .35 Tesla field strength). The QUAD scanners are designed to maximize image quality through an optimal combination of signal-to-noise (S/N) and contrast-to-noise (C/N) ratios. The technical improvements realized in the QUAD's design over its predecessors also include increased image-processing speed and diagnostic flexibility. Maximal S/N is achieved when the direction of the magnetic field and the direction of the receiving coil axis are perpendicular to one another, as is the case with the QUAD scanners. The orientation of the magnetic field is vertical and when combined with any one of FONAR's array of solenoidal (wrap-around) surface coils, the QUAD 7000, for example, produces as much S/N as a supercon MRI at twice the field strength. So that prospective buyers can make an accurate comparison, the number 7000 is used to describe the S/N equivalency of the QUAD 7000 to 7000-gauss superconductive machines. Several technological advances have been engineered into the QUAD scanners for extra improvements in S/N, including: new high-S/N Organ Specific(TM) receiver coils; new ceramic magnet poles that provide advanced eddy-current control; new advanced front-end electronics featuring high-speed, wide-dynamic-range analog-to-digital conversion and a miniaturized ultra-low-noise pre-amplifier; high-speed automatic tuning, bandwidth-optimized pulse sequences, multi-bandwidth sequences, and off-center FOV imaging capability. In addition to the signal-to-noise ratio, however, the factor that must be considered when it comes to image quality is contrast, the quality that enables reading physicians to clearly distinguish adjacent, and sometimes minute, anatomical structures. This quality is measured by contrast-to-noise ratios (C/N). Unlike S/N, which increases with increasing field strength, relaxometry studies have shown that C/N peaks in the mid-field range and actually falls off precipitously at higher field strengths. The QUAD 7000 and QUAD 12000 scanners operate squarely in the optimum C/N range. The QUAD's state-of-the-art electronics package features five computer processors performing parallel processing. Its speed is demonstrated by its ability to scan and reconstruct images simultaneously and its ability to reconstruct a 256x256 image in 0.7 seconds, the fastest of any MRI scanner on the market. The QUAD provides various features allowing for versatile diagnostic capability. For example, SMART(TM) scanning allows for same-scan customization of up to 63 slices, each slice with its own thickness, resolution, angle and position. This is an extremely important feature for scanning parts of the body that include small-structure sub-regions requiring finer slice parameters. There's also Evolving Images(TM), Multi-Angle Oblique (MAO)(TM) imaging, and oblique imaging. The QUAD console includes a mouse-driven, multi-window interface for easy operation and a 19-inch, 1280x1280-pixel, 20-up, high-resolution image monitor with features such as electronic magnifying glass and real-time, continuous zoom and pan. Prior to the introduction of the QUAD scanners, the Ultimate(TM) 7000 scanner, introduced in 1990, was the Company's principal product. The Ultimate scanner replaced the Company's traditional principal products, the Beta(TM) 3000 scanner (which utilized a permanent magnet) and the Beta(TM) 3000M scanner (which utilized an iron core electromagnet). All of the Company's current and earlier model scanners create cross-sectional images of the human body. The Company's majority-owned subsidiary, Medical SNI, manufactures and markets teleradiology equipment. Such equipment, through the use of computer hardware and software, permits MRI images to be transmitted by telephone lines, enabling a physician to view the results of an MRI scan (immediately, if necessary) without the necessity of being present at the site of the scan or receiving film. During fiscal 1998, sales of the Company's QUAD scanners accounted for approximately 15% of the Company's total revenues and 53% of its medical equipment segment revenues, as compared to 27% of total revenues and 50% of medical equipment revenues during fiscal 1997. There were no sales of Ultimate or Beta scanners in fiscal 1997 or fiscal 1998. The materials and components used in the manufacture of the Company's products (circuit boards, computer hardware components, electrical components, steel and plastic) are generally available at competitive prices. The Company has not had difficulty acquiring such materials. WORKS IN PROGRESS The Company's current "works in progress" center around the development of its breast MRI scanner and operating room scanner (the OR 360). Both seek to bring to the public scanners that are expected to provide important advances against serious disease. MRI takes advantage of the nuclear resonance signal elicited from the body's tissues and the exceptional sensitivity of this signal for detecting disease. Much of the serious disease of the body occurs in soft tissue. The principal diagnostic modality currently in use for detecting disease, as in the case of x-ray mammography, are diagnostic x-rays. X-rays discriminate soft tissues like healthy breast tissue and cancerous tissue poorly because the x-ray particle traverses the tissues almost equally thereby rendering the target film equally exposed by the two tissues and creating healthy and cancerous shadows on the film that differ very little in brightness. The image contrast between cancerous and healthy tissue is poor, making the detection of breast cancers by the x-ray mammogram less than optimal. If microscopic stones (microcalcifications) are not present to provide the missing contrast the breast cancer goes undetected. They frequently are not present. The maximum contrast available by x-ray with which to discriminate disease is 4%. Brain cancers differ from surrounding healthy brain by only 1.6%. On the other hand the soft tissue contrasts with which to distinguish cancers on images by MRI are up to 180%. This is because the nuclear resonance signals from the body's tissues differ so dramatically. Liver cancer and healthy liver signals differ by 180%. Thus there is some urgency to bring to market an MRI based breast scanner that can overcome the x-ray limitation and assure that mammograms do not miss serious lesions. The added benefit of MRI mammography relative to x-ray mammography is the elimination of the need for the patient to disrobe and the painful compression of the breast typical of the x-ray mammogram. The patient is scanned in her street clothes in MRI mammography. Moreover MRI mammogram scans the entire chest wall including the axilla for the presence of nodes which the x-ray mammogram cannot reach. In addition there is a need for a treatment modality that can deal effectively with the diseased tissue once it has been detected. The OR 360 is Fonar's latest works-in-progress product. The OR 360 has an enlarged room sized magnet in contrast to the small bore "tunnel" MRI magnet the public is familiar with. Thus full-fledged surgical teams may walk into the magnet and thereby perform conventional surgery on the patient inside the magnet. Most importantly the exceptional quality of the MRI image and its exceptional capacity to exhibit tissue detail on the image, by virtue of the nuclear resonance signal's extraordinary capacity to create image contrast, can then be obtained real time during surgery to guide the surgeon in his surgery. Thus surgical instruments, needles, catheters, endoscopes and the like can be introduced directly into the human body and guided to the malignant lesion by means of the MRI image. The number of inoperable lesions should be greatly reduced by the availability of this new capability. Most importantly treatment can be carried directly to the target tissue. With current cancer treatment methods, therapy must always be restricted in the doses that can be applied to the malignant tissue because of the adverse effects on the healthy tissues. Thus chemotherapies must be limited at the first sign of toxic side effects. The same is the case with radiation therapy. The Company expects that once its new OR 360 product is available treatment agents may be administered directly to the malignant tissue through small catheters or needles allowing much larger doses of chemotherapy, x-rays, laser ablation, microwave, or rf to be applied directly and exclusively to the malignant tissue with more effective results. Since the procedure of introducing a treatment needle or catheter under image guidance will be minimally invasive the procedure can be readily repeated should metastases occur elsewhere, with minimum impact on the patient beyond a straightforward needle injection. The presence of the MRI image during treatment will enable the operator to judge during treatment if his treatment is being effective. The Company received an enthusiastic reception for its new "works-in-progress" OR 360 scanner at the annual International Radiology Congress held in Chicago's McCormick Place known as the RSNA (Radiological Society of North America) and expects to be extremely successful with this new product. Most of the design work for the OR 360 has been completed and construction of a prototype is approximately 90% complete. The Company is negotiating with two universities to install and commence clinical trials of its breast scanning equipment. The Company is working with these universities to jointly secure research funding for the breast scanning and treatment program. PRODUCT MARKETING The principal markets for the Company's scanners are hospitals and private scanning centers. The Company is conducting its marketing through a national network of independent distributors represented by National Imaging Resources, Inc. The Company's network of independent sales representatives and distributors operates on a commission basis in the domestic market. The Company exhibited its new products at the trade show held by the Radiological Society of North America ("RSNA") in Chicago in November 1995, 1996 and 1997 and plans to attend the RSNA trade shows in November 1998 and future years as well. The RSNA trade show is held annually and is attended by most manufacturers of MRI scanners. The Company is directing its marketing efforts to meet the demand for both "open" and high field strength MRI scanners. Utilizing a 6000 gauss (.6 Tesla field strength) iron core electromagnet, the QUAD 12000 scanner magnet is the highest field "open MRI" in the industry. The Company also plans to direct its marketing efforts to meeting the increasing demand for low price MRI. To date, the increased pressure for lower scanning prices has come largely from preferred provider organizations, health maintenance organizations and other private sector group plans and stricter insurance requirements, but government mandated health care reform is also under consideration. To meet this demand, the Company has set a base price of $980,000 for the QUAD 12000 and of $780,000 for the QUAD 7000 scanner. In addition to reducing the health care provider's equipment cost, the QUAD scanners' improved image processing speed and extra-bed(s) option (allowing patients to be prepped while another patent is being scanned) would enable the provider to increase patient volume and further reduce per scan costs. The reduced per scan costs will enable the Company to promote the QUAD 7000 in particular for short scan procedures such as MRI mammograms. MRI mammograms have the advantage over traditional x-rays of involving no radiation, and an MRI breast scan can be taken in most cases through ordinary street clothes without any painful compression. The Company also will seek to introduce new MRI applications for the QUAD scanners such as MRI-directed surgery and head-to-toe MRI preventive screening. The Company is actively seeking to promote foreign sales. Since commencing its current foreign sales program, the Company has sold scanners in various foreign countries. Based on indications of interest, meetings, sales trips abroad and negotiations, the Company is optimistic that foreign sales will continue to be an important source of revenue. The Company believes there are and will be significant market opportunities abroad, particularly in Asia and Eastern Europe. During the fiscal year ended June 30, 1998, 5% of the Company's revenues were generated by foreign sales, as compared to 4% and 17% for fiscal 1997 and 1996 respectively. See "Note 9 to Notes to Consolidated Financial Statements" for the percentage of foreign sales as in relation to the Company's total revenues. SERVICE AND UPGRADES FOR MRI SCANNERS The Company regards its customer base of approximately 100 scanners installed or in the process of being installed as a major asset. It has been and will continue to be a significant source of income, independent of direct sales. Income is generated from the installed base in two principal areas namely, service and upgrades. Service and maintenance revenues from the Company's installed base were approximately $6.1 million in fiscal 1996, $4.6 million in fiscal 1997 and $3.7 million in fiscal 1998. The decreases in fiscal 1997 and 1998 were principally the result of the retirement of old scanners. The Company anticipates that its new line of QUAD scanners will result in significant upgrades income in future fiscal years. The potential for upgrades income originates in the exceptional versatility and productivity of the MRI technology. New medical uses for the technology are constantly being discovered. Dramatic new features can often be added to the scanner by the implementation of little more than versatile new software packages. Such enhancements are attractive to the end users because they extend the useful life of the equipment and enable the user to avoid obsolescence and the expense of having to purchase new equipment. RESEARCH AND DEVELOPMENT During the fiscal year ended June 30, 1998, the Company incurred expenditures of $6,506,995 (none of which was capitalized) on research and development, as compared to $3,928,035 ($108,809 of which was capitalized) and $3,607,703 ($251,659) of which was capitalized) incurred during the fiscal years ended June 30, 1997 and June 30, 1996, respectively. Research and development activities have focused, in large part, on the development of the Company's new OR 360 and the continued development and enhancement of the Company's QUAD MR scanners. The OR 360 and QUAD scanners involve significant software and hardware development as the new products represented entirely new hardware design and architecture requiring a complete new operating software system. The Company's research activity includes developing a multitude of new features for the QUAD series scanners made possible by the QUAD's high speed processing power. BACKLOG The Company's backlog of unfilled orders at September 1, 1998 was approximately $2.8 million, as compared to $6.4 million at September 1, 1997. Of these amounts, approximately $0.6 million and $1.2 million had been paid to the Company as customer advances as at September 1, 1998 and September 1, 1997, respectively. Of the backlog amounts at September 1, 1997, approximately $800,000 represented orders from affiliates. None of the backlog existing at September 1, 1998 represents orders from affiliates. It is expected that the existing backlog of orders will be filled within the current fiscal year. The Company's contracts generally provide that if a customer cancels an order, the customer's initial down payment for the MRI scanner is nonrefundable. PATENTS AND LICENSES There are currently numerous patents in effect which relate to the technology and components of the MRI scanners, some of which are registered in the name of the Company and others which are registered in the name of Dr. Raymond V. Damadian, the President and principal stockholder of the Company. The Company believes that these patents, which expire at various times from 1999 to 2014, and the know-how it developed, are material to its business. Dr. Damadian has granted an exclusive world-wide license to the Company to make, use and sell apparatus covered by certain domestic and foreign patents relating to his MRI technology. The license continues until the expiration of the last patent included within the licensed patent rights, but is terminable earlier, at the option of Dr. Damadian, if he is removed from his position as Chairman of the Board or President of the Company without his consent, or if any stockholder or group of stockholders acting in concert becomes the beneficial owner of Company securities having voting power equal to or greater than the voting power of the securities held directly by him, his executors, administrators, successors or heirs. The agreement can also be terminated by Dr. Damadian upon the commission of an act of bankruptcy by the Company. If Dr. Damadian is unable to serve the Company by reason of his death or disability, the license agreement will remain in effect. One of the patents, issued in the name of Dr. Damadian and covered by said license, is United States patent No. 3,789,832, Apparatus and Method for Detecting Cancer in Tissue (the "1974 Patent"). The development of the Beta 3000 was based upon the 1974 Patent, and Management believes that the 1974 Patent was the first of its kind to utilize MR to scan the human body and to detect cancer. The 1974 Patent was extended beyond its original 17-year term and expired in February, 1992. The Company has significantly enhanced its patent position within the industry and now possesses a substantial patent portfolio which provides the Company, under the aegis of United States patent law, "the exclusive right to make, use and sell" many of the scanner features which FONAR pioneered and which are now incorporated in most MRI scanners sold by the industry. The patents further enhance Dr. Damadian's pioneer patent (the 1974 Patent), that initiated the MRI industry and provided the original invention of MRI scanning. The Company has entered into a cross-licensing agreement (utilizing other than FONAR's MRI technology) with another entity to use prior art developed for nuclear magnetic resonance technology and has entered into a license to utilize the MRI technology covered by the existing patent portfolio of a patent holding company. ENFORCEMENT OF PATENTS On September 2, 1992, the Company commenced legal action to enforce its patent rights, filing suit against Hitachi Ltd., General Electric Company and others in the United States District Court for the Eastern District of New York. Prior to trial in April 1995, FONAR settled with Hitachi. On May 26, 1995 the jury rendered a verdict against General Electric Company awarding FONAR $110,575,000 for infringement of its multi-angle oblique patent (Apparatus and Method for Multiple Angle Oblique MRI, 10/3/89, U.S. Patent No. 4,871,966) and Dr. Damadian's pioneer cancer detection patent (Apparatus and Method for Detecting Cancer in Tissue, 2/5/74, U.S. Patent No. 3,789,832). Following appeals to the United States Court of Appeals for the Federal Circuit, General Electric Company paid FONAR $128.7 million (inclusive of interest) on July 2, 1997. The Supreme Court denied General Electric Company's petition for a writ of certiorari on October 6, 1997. The Company was represented by Robins, Kaplan, Miller and Ciresi, the Minneapolis based national law firm that represented Honeywell in its lawsuit against Minolta for infringement of Honeywell's autofocus patents. In June 1995, the Company filed suits against Siemens Medical Systems, Inc., Philips Electronics North America Corporation and related parties for infringement of FONAR's multi-angle oblique patent, Dr. Damadian's pioneer cancer detection patent and, in the case of Siemens Medical Systems, Inc., two additional MRI patents. FONAR settled with the Philips companies in April, 1996 and the Siemens companies in September, 1996. In March 1996, FONAR commenced a patent infringement suit against Toshiba Corporation, Toshiba America MRI, Inc. and Toshiba America Medical Systems, Inc. Toshiba America MRI, Inc. in turn commenced an action against FONAR alleging patent infringement. In May 1998, FONAR settled with the Toshiba companies, neither side admitting liability in the settlement agreement. The parties cross-licensed each other on the patents-in-suit, and FONAR received a monetary payment from Toshiba. The Company believes that it has achieved a significant milestone in protecting and enforcing its proprietary rights in its lawsuit against General Electric Company, and having pioneered the establishment and development of the medical MRI scanning industry, the Company intends to take the steps necessary to enforce its rights and protect its proprietary technology against other infringers as well. (See "Litigation.") PRODUCT COMPETITION MRI SCANNERS A majority of the MRI scanners in use in hospitals and outpatient facilities and at mobile sites in the United States are based on superconductive magnet technology while the balance are based on non-superconductive magnet technology. In 1997, however, sales of non-superconductive MRI's were almost equal to sales of superconductive magnets. In 1997, the size of the MRI market in the United States was approximately $565 million. The market share of superconductive MRI's was approximately 53%. FONAR's non-superconductive MRI scanners are competing principally with superconductive scanners. The QUAD 12000 scanner, however, utilizing a 6,000 gauss (.6 Tesla field strength) iron core electromagnet, is the first "open" MR scanner at high field strength. FONAR believes that its MRI scanners have significant advantages as compared to the superconductive scanners. These advantages include: 1. There is no fringe magnetic field. Superconductive scanners require a more expensive shielded room than is required for the non-superconductive scanners. The shielded room required for the non-superconductive scanners is intended to prevent interference from external radio frequencies. 2. They do not require costly coolants (liquid nitrogen and liquid helium) or highly complex technology to handle them. 3. They are more open, quiet and in the case of the QUAD scanners allow for faster throughput of patients. 4. They require smaller space to install. 5. Their annual operating costs are lower. 6. Their set-up and disconnect time for a FONAR mobile scanner is shorter than for a mobile superconductive scanner. 7. They can scan the trauma victim, the cardiac arrest patient, the respirator-supported patient, and premature and newborn babies. This is not possible with superconductive scanners because their magnetic field interferes with conventional life-support equipment. FONAR faces competition within the MRI industry from such firms as General Electric Company; Picker International, which is a Division of General Electric Company PLC, of England; Elscint Ltd; Philips N.V.; Toshiba Corporation, Hitachi Corporation, Shimadzu Corporation and Siemens A.G. Most competitors have marketing and financial resources more substantial than those available to the Company and have in the past, and may in the future, heavily discount the sales price of their scanners. Such competitors sell both superconductive and non-superconductive products. FONAR's current market share of the market for MRI scanners is less than 5%. FONAR introduced the first "Open MRI" in 1982. "Open MRI" was made possible by FONAR's introduction of an MRI magnet built on an iron frame. Thus the magnetic flux generating apparatus of the magnet (magnet coils or permanent magnet bricks) was built into a frame of steel. The steel frame provided a return path for the magnetic lines of force and thereby kept the magnetic lines of force contained within the magnet. This enabled FONAR, from 1982 on, to show that the FONAR magnet was the only magnet that allowed the patients to stretch out their arms, the only "open" MRI. The iron frame, because it could control the magnetic lines of force and place them where wanted and remove them from where not wanted (such as in the operating room where surgeons are standing), provided a much more versatile magnet design than was possible with superconductive magnets. Superconductive magnets contain no iron but consist entirely of turns of current carrying wire. They therefore lack the versatility of design that the iron frame provides the "open" MRI magnet. Thus the superconductive magnets made by Fonar's large competitors that have dominated the MRI market since 1983 have been of the confining "tunnel" design that the public has generally resented. For an 11 year period, 1983-1994, Fonar's large competitors (with one exception) generally rejected Fonar's "open" design but in 1994 all (with one exception) added an "open" magnet to their MRI product line. In 1997 the sale of non-superconductive "open" magnets exceeded the sale of traditional superconductive magnets for the first time. One principal reason for this market shift, in addition to patient claustrophobia, is the growing awareness that the "open" magnet designs permit access to the patient to perform surgical procedures under MRI image guidance, a field which is now growing rapidly and is called "interventional MRI." Fonar's OR 360 explicitly addresses this growing market reception of MRI guided surgical procedures but is not yet available as a product. Fonar's QUAD series magnets do also. Although not enabling a full operating theater as the OR 360 does, the "Open" QUAD design permits ready access to the patient from four sides and therefore enables a wide range of interventional surgical procedures such as biopsies and needle or catheter delivered therapies to be performed under MRI image guidance. The "tunnel" superconductive scanners do not permit access to the patient while the patient is inside the scanner. While Fonar's current market share of the domestic MRI market is under 5% and its current market share of the domestic "Open MRI" market is only of the order of 10% at present, FONAR expects to be a leader in this market for several reasons. In MRI, scanning speed and image quality is controlled by the strength of the magnetic field. Fonar's QUAD 12000 scanner operates at twice the field strength of its closest market share "Open MRI" competitor, Hitachi (.6 Tesla vs. .3 Tesla). High field MRI manufacturers convinced the marketplace for FONAR, and the marketplace accepts, that higher field strength translates directly into superior image quality and faster scanning speeds. This is the principal reason GE's 1.5 Tesla superconductive scanner achieved market dominance in the MRI market before the marketplace shifted and registered its preference for "Open MRI." All of Fonar's other competitors in the "Open MRI" market are lower in field strength than the Hitachi product other than Toshiba at .35 Tesla. No companies possess the OR 360 and FONAR possesses the pioneer patents on "Open MRI" technology. OTHER IMAGING MODALITIES FONAR's MRI scanners also compete with other diagnostic imaging systems, all of which are based upon the ability of energy waves to penetrate human tissue and to be detected by either photographic film or electronic devices for presentation of an image on a television monitor. Three different kinds of energy waves - X-ray, gamma and sound - are used in medical imaging techniques which compete with MRI medical scanning, the first two of which involve exposing the patient to potentially harmful radiation. These other imaging modalities compete with MRI products on the basis of specific applications. X-rays are the most common energy source used in imaging the body and are employed in three imaging modalities: 1. Conventional X-ray systems, the oldest method of imaging, are typically used to image bones and teeth. The image resolution of adjacent structures that have high contrast, such as bone adjacent to soft tissue, is excellent, while the discrimination between soft tissue organs is poor because of the nearly equivalent penetration of x-rays. 2. Computerized Tomography ("CT") systems couple computers to x-ray instruments to produce cross-sectional images of particular large organs or areas of the body. The CT scanner addresses the need for images, not available by conventional radiography, that display anatomic relationships spatially. However, CT images are generally limited to the transverse plane and cannot readily be obtained in the two other planes (sagittal and coronal). Improved picture resolution is available at the expense of increased exposure to x-rays from multiple projections. Furthermore, the pictures obtained by this method are computer reconstructions of a series of projections and, once diseased tissue has been detected, CT scanning cannot be focused for more detailed pictorial analysis or obtain a chemical analysis. 3. Digital radiography systems add computer image processing capability to conventional x-ray systems. Digital radiography can be used in a number of diagnostic procedures which provide continuous imaging of a particular area with enhanced image quality and reduced patient exposure to radiation. Nuclear medicine systems, which are based upon the detection of gamma radiation generated by radioactive pharmaceuticals introduced into the body, are used to provide information concerning soft tissue and internal body organs and particularly to examine organ function over time. Ultrasound systems emit, detect and process high frequency sound waves reflected from organ boundaries and tissue interfaces to generate images of soft tissue and internal body organs. Although the images are substantially less detailed than those obtainable with x-ray methods, ultrasound is generally considered harmless and therefore has found particular use in imaging the pregnant uterus. X-ray machines, ultrasound machines, digital radiography systems and nuclear medicine compete with the MRI scanners by offering significantly lower price and space requirements. However, FONAR believes that the quality of the images produced by its MRI scanners is generally superior to the quality of the images produced by those other methodologies. GOVERNMENT REGULATION Under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act, all medical devices are classified by the Food and Drug Administration (the "FDA") into one of three classes. A Class I device is subject only to certain controls, such as labeling requirements and manufacturing practices; a Class II device must comply with certain performance standards established by the FDA; and a Class III device must obtain pre-market approval from the FDA prior to commercial marketing. The Company received approval to market its Beta 3000 and Beta 3000M scanners as Class III devices on September 26, 1984. On July 28, 1988, the Magnetic Resonance Diagnostic Device which includes MR Imaging and MR Spectroscopy was reclassified by the FDA to Class II status. On June 25, 1992, the Company received FDA approval to market the Ultimate Magnetic Resonance Imaging Scanner as a Class II device. The Company received FDA approval to market the QUAD 7000 in April 1995 and for the QUAD 12000 in November 1995. The Company anticipates that it will need FDA approvals for its OR 360 and breast scanners. The FDA has authority to conduct detailed inspections of manufacturing plants, to establish "good manufacturing practices" which must be followed in the manufacture of medical devices, to require periodic reporting of product defects and to prohibit the exportation of medical devices that do not comply with the law. The Company is subject to these requirements and has received the necessary approvals. In addition, the Company needs to obtain any necessary approvals from the appropriate foreign governmental and other authorities in connection with its export sales. Effective November 22, 1985, the Department of Health and Human Services authorized reimbursement of MRI scans under the Federal Medicare program. In addition, most private insurance companies have authorized reimbursement for MRI scans. Proposed and enacted legislation at the State and Federal levels has restricted referrals by physicians to medical and diagnostic centers in which they or their family members have an interest. In addition, regulations have been adopted by the Secretary of Health and Human Services which provide limited "safe harbors" under the Medicare Anti-Kickback Statute. These safe harbors describe payments and transactions which are permitted between an entity receiving reimbursement under the Medicare program and those having an interest in or dealings with the entity. Although the Company cannot predict the overall effect of the adoption of these regulations on the medical equipment industry, the use and continuation of limited partnerships (where investors may be referring physicians) to own and operate MRI scanners could be greatly diminished. The Company obtains approvals as necessary in connection with the sales of its products in foreign countries. In some cases, U.S. Food and Drug Administration approval has been sufficient for foreign sales as well. The Company's standard practice has been to require either the distributor or the customer to obtain any such foreign approvals or licenses which may be required. Commencing in fiscal 1998, however, export sales to most European countries and certain other countries require CE certification (essentially safety requirements for electrical products). The Company is in the process of complying with these requirements and obtaining this certification. HEALTH MANAGEMENT CORPORATION OF AMERICA (PHYSICIAN PRACTICE MANAGEMENT BUSINESS) Health Management Corporation of America (formerly known as U.S. Health Management Corporation and referred to as "HMCA") was organized by the Company in March 1997 as a wholly-owned subsidiary for the purpose of engaging in the business of providing comprehensive management services to physicians' practices and other medical providers, including diagnostic imaging centers and ancilliary services. The services provided by the Company include development, administration, leasing of office space, facilities and medical equipment, provision of supplies, staffing and supervision of non-medical personnel, legal services, accounting, billing and collection and the development and implementation of practice growth and marketing strategies. This business is sometimes referred to as "physician practice management," "PPM" or "practice management." Since its formation, HMCA has completed five acquisitions. HMCA became actively engaged in the PPM business through its initial two acquisitions which were consummated effective June 30, 1997. Following these two initial acquisitions, HMCA completed two additional acquisitions in fiscal 1998 and one additional acquisition in the first quarter of fiscal 1999 (August 1998). The first acquisition was of a group of several interrelated corporations, limited liability companies and a partnership engaged in the business of managing three diagnostic imaging centers and one multi-speciality practice in New York State. The transaction was effected through a merger between a wholly-owned subsidiary of HMCA (formed for the purpose of effecting the transaction) and Affordable Diagnostics, Inc., one of the acquired companies which immediately prior to the merger had acquired the assets and assumed the liabilities of the other acquired companies (together, the "Affordable Companies"). The business of the Affordable Companies, which is being continued by HMCA, consisted of providing management, space, equipment, personnel and other resources to the four managed facilities. The services provided at the facilities include MRI scans, CAT scans, x-rays, physical rehabilitation, and in connection with physical rehabilitation, ultra-sound and SSEP/EMG electromygographic diagnostics. The four managed facilities are located in Brewster, New York (MRI), Yonkers, New York (MRI and x-ray), Bronx, New York (MRI and CT) and Riverdale, New York (multi-specialty practice, ultra-sound and SSEP/EMG electromygographic diagnostics). The assets acquired through the acquisition include three MRI scanners, one CT scanner, one x-ray machine, rehabilitation equipment and ultra-sound and electromygographic machines. The equipment is leased to and used at the managed facilities. In addition, HMCA is consummating the purchase of an additional MRI scanner pursuant to a contract entered into prior to the acquisition. The scanner is a mobile unit which is intended to be provided to a number of hospitals on a shared basis, as needed, on a mobile route in northern New Jersey and Rockland, Orange and Putnam counties in New York. The second completed acquisition was of Raymond V. Damadian, M.D. MR Scanning Centers Management Company ("RVDC"). Pursuant to the terms of the transaction, HMCA purchased all of the issued and outstanding shares of stock of RVDC from Raymond V. Damadian in exchange for 10,000 shares of the Common Stock of FONAR. Raymond V. Damadian, the principal stockholder, President and Chairman of the Board of FONAR, was the sole stockholder, director and President of RVDC immediately prior to the acquisitions. The business of RVDC, which is being continued by HMCA, was the management of MRI diagnostic imaging centers in New York, Florida, Georgia and other locations. As a result of these transactions with Dr. Damadian, HMCA has acquired the business of managing 21 MRI scanning centers. Seventeen of the scanning centers are managed pursuant to management agreements, and 4 of the centers are partnerships with RVDC as the general partner. Effective July 1, 1997, HMCA entered into new management agreements with the centers. Pursuant to the management agreements, HMCA is providing comprehensive management services, including administrative services, office facilities, office equipment, supplies and personnel (except for physicians) to the centers. Service for the centers' MRI scanning equipment is provided under the management agreements in these cases. MRI scanning systems are provided to 9 of the centers pursuant to scanner leases entered into effective July 1, 1997. All of the facilities previously managed by RVDC are MRI scanning centers. The third completed acquisition, consummated on January 20, 1998, was an acquisition of the business and assets of Central Health management Co., LLC (Central Health). Central Health is a management service organization (MSO) managing a multi-specialty practice in Yonkers, New York. The assets acquired include therapy and rehabilitation equipment, x-ray equipment, office equipment and office furnishings. The fourth completed acquisition, consummated effective March 20, 1998, was the acquisition of A & A Services, Inc. ("A & A Services"), an MSO managing four primary care practices in Queens County, New York. A & A Services provides the practices with management services, office space, equipment, repair and maintenance service for the equipment and clerical and other non medical personnel. The office locations for the practices are located in Woodhaven, Richmond Hill, Corona and Ridgewood in Queens County, New York and account for over 52,000 primary care patient visits per year. The fifth completed acquisition, consummated effective August 20, 1998, was the acquisition of Dynamic Health Care Management, Inc. ("Dynamic"). Dynamic is an MSO which manages three physician practices in Nassau and Suffolk Counties on Long Island, New York. The office locations for these practices are in Bellmore and Hempstead in Nassau County and Deer Park in Suffolk County and account for approximately 85,000 patient visits per year. HMCA GROWTH STRATEGY In addition, HMCA may also pursue acquisitions pursuant to which HMCA would purchase the assets of physicians' practices. Simultaneously with the acquisition of the assets, HMCA would enter into agreements with the physicians (or a professional corporation employing the physicians) pursuant to which HMCA would lease the use of the assets and provide management services. The professional corporation could be either affiliated with HMCA or owned by the selling physicians. HMCA believes that there are numerous existing medical practices that could benefit from improved management techniques which would allow the physicians to spend more time treating patients (thereby increasing their revenue) and less time being concerned with the day to day tasks of managing the business. In addition, expansion plans for HMCA's clients include opening more offices and expanding existing offices so as to enable practices to treat more patients more efficiently. HMCA is seeking to create a network of physicians to participate in managed care and to promote an expansion of the medical services offered by its medical practice clients. HMCA believes that the creation of this network will be particularly helpful to its clients where capitated fee agreements are negotiated with insurers since its clients will be able to offer more services from more locations and thereby obtain a higher capitation rate than they might otherwise have been able to obtain. HMCA's growth strategy is intended to enable its medical practice clients to retain and enhance revenues and to offer patients cost-effective medical care within an integrated practice offering a broad range of evaluation, testing, diagnostic, treatment and therapeutic services. In the longer term, as the network of offices to which it provides its management services grows, HMCA believes that it will be in an excellent position to attract managed care contracts for its clients from employers and insurance carriers. MEDICAL PRACTICE MANAGEMENT SERVICES HMCA's services to the facilities it manages encompass substantially all of the facilities' operations. These services include: (1) Offices and Equipment. HMCA provides office space and equipment to its clients. This includes technologically sophisticated medical equipment. HMCA also provides improvements to leaseholds, assistance in site selection and advice on improving, updating, expanding and adapting to new technology. (2) Personnel. HMCA staffs all the non-medical positions of its clients with its own employees, eliminating the client's need to interview, train and manage non-medical employees, as well as process the necessary tax, insurance and other documentation relating to employees. (3) Administrative. HMCA assists in the scheduling of patient appointments, purchasing of medical supplies and equipment and handling of reporting, accounting, processing and filing systems. It prepares and files the physician portions of complex forms to ensure full and timely regulatory compliance and appropriate cost reimbursement under no-fault insurance and workers' compensation guidelines. (4) Billing and Collections. HMCA is responsible for the billing and collection of revenues from third-party payors including those governed by no-fault and workers' compensation statutes. (5) Cost Saving Programs. Based on available volume discounts, HMCA seeks to obtain favorable pricing for medical supplies, equipment, pharmaceuticals and other inventory for its clients. (6) Diagnostic Imaging and Ancilliary Services. HMCA can offer access to diagnostic imaging equipment through diagnostic imaging facilities managed by it. The Company is expanding the ancilliary services offered in its network to include CT-scans, x-rays, ultrasound, and other ancilliary services useful to its clients. (7) Marketing Strategies. HMCA is responsible for developing marketing plans for its clients. HMCA provides its services pursuant to negotiated contracts with its clients. While HMCA believes it can provide the greatest value to its clients by furnishing the full range of services appropriate to that client, HMCA would also be willing to enter into contracts providing for a more limited spectrum of management services. HMCA MARKETING HMCA's marketing strategy is to increase the size, number and locations of medical practices and facilities which it manages. HMCA will also seek to broaden the types of medical practices which it services and to develop a client base of primary care and speciality practices as well as diagnostic imaging facilities and other ancilliary services. HMCA will seek to promote growth of its clients' patient and revenue bases by developing a network of medical providers and assisting its clients in the development of multi-specialty medical practices. Marketing activities include locating medical practices which meet the size, quality and operating parameters set by HMCA. HMCA will focus on opportunities for expanding the services clients offer and expanding into new geographic areas. HMCA will also seek to increase the patient volume of clients. DIAGNOSTIC IMAGING CENTERS AND OTHER ANCILLIARY SERVICES Diagnostic imaging centers managed by HMCA provide diagnostic imaging services to patients referred by physicians who are either in private practice or affiliated with managed care providers or other payor groups. The centers are operated in a manner which eliminates the admission and other administrative inconveniences of in-hospital diagnostic imaging services. Imaging services are performed in an outpatient setting by trained medical technologists under the direction of interpreting physicians. Following diagnostic procedures, the images are reviewed by the interpreting physicians who prepare a report of these tests and their findings. These reports are transcribed by HMCA personnel and then delivered to the referring physician. In addition, HMCA is expanding the ancilliary services offered in its network to include CT scans, x-rays, ultrasound and other modalities as may be appropriate for the physician practice mix. HMCA develops marketing programs in an effort to establish and maintain profitable referring physician relationships and to maximize reimbursement yields. These marketing approaches identify and target selected market segments consisting of area physicians with certain desirable medical specialties and reimbursement yields. Corporate and center managers determine these market segments based upon an analysis of competition, imaging demand, medical specialty and payor mix of each referral from the local market. HMCA also directs marketing efforts at managed care providers. Managed care providers are becoming an increasingly important factor in the diagnostic imaging industry. To further its position, HMCA will seek to expand the imaging modalities offered at its managed centers or to create networks with other imaging centers. COMPETITION (HMCA) The medical practice management field is highly competitive. A number of large hospitals have acquired medical practices and this trend may continue. HMCA expects that more competition will develop. Many competitors have greater financial and other resources than HMCA. With respect to the diagnostic imaging centers managed by HMCA, the outpatient diagnostic imaging industry is highly competitive. Competition focuses primarily on attracting physician referrals at the local market level and increasing referrals through relationships with managed care organizations. HMCA believes that principal competitors for the diagnostic imaging centers are hospitals and independent or management company-owned imaging centers. Competitive factors include quality and timeliness of test results, ability to develop and maintain relationships with managed care organizations and referring physicians, type and quality of equipment, facility location, convenience of scheduling and availability of patient appointment times. GOVERNMENT REGULATION APPLICABLE TO HMCA Various States prohibit business corporations from practicing medicine. Consequently, HMCA leases space and equipment to clients and provides clients with a range of non-medical administrative and managerial services. HMCA does not engage in the practice of medicine or establish standards of medical practice or policies for its clients. Under the federal Self-Referral Law (the "Stark Law") (which is applicable to Medicare and Medicaid patients) and the self-referral laws of various States, certain health practitioners (including physicians, chiropractors and podiatrists) are prohibited from referring their patients for the provision of designated health services (including diagnostic imaging and physical therapy services) to any entity with which they or their immediate family members have a financial relationship, unless the referral fits within one of the specific exceptions in the statutes or regulations. Statutory exceptions under the Stark Law include, among others, direct physician services, in-office ancillary services rendered within a group practice, space and equipment rental and services rendered to enrollees of certain prepaid health plans. Some of these exceptions are also available under the State self-referral laws. HMCA's clients generate revenue from patients covered by no-fault insurance and workers' compensation programs. In the event that changes in these laws alter the fee structures or methods of providing service, or impose additional or different requirements, HMCA could be required to modify its business practices and services in ways that could be more costly to HMCA or in ways that decrease the revenues which HMCA receives from its clients. HMCA believes that it is in compliance with applicable Federal, State and local laws. HMCA does not believe that such laws will have any material effect on its business. EMPLOYEES As of July 1, 1998, the Company employed 444 persons on a full-time basis. Of such employees, 10 were engaged in marketing and sales, 38 in research and development, 94 in manufacturing, 48 in customer support services, 219 in administration (including 116 on site at facilities and offices managed by HMCA and 57 performing billing, collection and transcription services for those facilities) and 35 professional MRI technicians on site at diagnostic imaging centers managed by HMCA. ITEM 2. PROPERTIES The Company leases approximately 135,240 square feet of office and plant space at its principal offices in Melville, New York and at one other location in Farmingdale, New York at a current aggregate annual rental rate of approximately $913,800, excluding utilities, taxes and other related expenses. The terms of the various leases extend through 1998 and the beginning of 1999, with options to renew ranging from 17 months to 9 years on its principal facilities. Management believes that these premises are adequate for its current needs. In addition, HMCA maintains leased office premises for its clients at approximately 34 site locations having an aggregate annual rental rate of approximately $1.6 million. ITEM 3. LEGAL PROCEEDINGS On September 2, 1992, the Company filed an action against General Electric Company, ("General Electric"), Hitachi Ltd. ("Hitachi") and other defendants for patent infringement in the United States District Court for the Eastern District of New York seeking injunctive relief and damages. (FONAR Corporation and Dr. Raymond V. Damadian v. Hitachi Ltd. et. al. Civil Action No. 92-4196). The defendants contested the Company's claims, and Hitachi counterclaimed, alleging infringement by the Company of two of its patents. In April, 1995, after the opening statements by counsel at the commencement of trial, FONAR and Hitachi reached a settlement. On May 26, 1995, the jury rendered a verdict against General Electric Company awarding FONAR $110,575,000 for infringement of two of its patents: United States Patent Number 3,789,832 entitled "Apparatus and Method for Detecting Cancer in Tissue" and United States Patent Number 4,871,966 entitled "Apparatus and Method for Multiple Angle Oblique Magnetic Resonance Imaging." Subsequent to the verdict General Electric made motions to the Court to enter judgment as a matter of law in its favor and against FONAR with respect to both patents notwithstanding the jury's verdict. FONAR made a motion to the Court for an injunction restraining General Electric Company from using the multi-angle oblique imaging technology covered by U.S. Patent No. 4,871,966. On September 30, 1995 the Court announced its decision. In its decision, the Court awarded FONAR $61,950,000 in damages against General Electric for direct infringement of U.S. Patent No. 4,871,966 (Multiple Angle Oblique Magnetic Resonance Imaging) and granted an injunction against General Electric prohibiting future violations of the patent. (An additional $6,471,726 in pre-judgment interest was awarded to FONAR on November 17, 1995.) The injunction was stayed pending appeal, however, upon the posting of a bond by General Electric. With respect to U.S. Patent No. 3,789,832 (Cancer Detection Patent), the judge agreed with the jury's finding that the patent was valid, but disagreed with the jury finding of infringement and determined that General Electric's MRI scanners did not infringe the patent. The Court also rejected the jury's finding that General Electric had induced others to infringe U.S. Patent No. 4,871,966. General Electric has appealed the portion of the judgment upholding the jury's award of damages to FONAR for direct infringement of U.S. Patent No. 4,871,966 and the issuance of the injunction. FONAR has appealed the portion of the judgment overturning the jury's findings of infringement on U.S. Patent No. 3,789,832 and contributory infringement in respect of U.S. Patent No. 4,871,966. In February 1997, the Court of Appeals for the Federal Circuit affirmed the District Court's judgment against General Electric for infringement of the Company's Multi-Angle Oblique imaging patent (U.S. Patent No. 4,871,966) but left standing the District Court's determination that General Electric was not liable for inducing others to infringe the patent. With respect to the Cancer Detection Patent (U.S. Patent No. 3,789,832), the Court of Appeals reversed the District Court and reinstated the jury verdict against General Electric awarding the Company $35 million for infringement. General Electric subsequently petitioned the Court of Appeals for a rehearing, with the suggestion that the rehearing be held in banc (by all the Circuit judges). On May 8, 1997, the Court of Appeals denied the petition. General Electric then applied for a stay pending an appeal to the United States Supreme Court. The application was denied by the Court of Appeals in the first instance and then by Chief Justice Rehnquist of the Supreme Court. Following the denial of General Electric's petition and application for a stay, the District Court entered a judgment based on the Court of Appeals' decision. On July 2, 1997, General Electric paid $128.7 million (inclusive of interest) without, however, prejudicing its right to appeal to the Supreme Court. In August, 1997, General Electric filed a petition for a writ of certiorari requesting the Supreme Court to hear the case. In October 1997, the Supreme Court denied General Electric's petition. On March 4, 1996, the Company filed an action against Toshiba Corporation, Toshiba America Medical Systems, Inc., Toshiba America MRI, Inc. and others alleging infringement of four of its MRI patents. FONAR Corporation and Dr. Raymond V. Damadian v. Toshiba Corporation, Toshiba America Medical Systems, Inc., Toshiba America MRI, Inc. et al. (U.S. District Court, Eastern District of New York, Civil Action No. 96-0963). Thereafter, in February 1997, Toshiba America MRI, Inc. commenced an action against FONAR in the U.S. District Court for the Northern District of California (Toshiba America MRI, Inc. v. Fonar Corporation, Case No.: C97-00664 SBA ENE) alleging infringement of certain of its patents relating to magnetic resonance imaging technology. Both FONAR and the Toshiba companies asserted counterclaims in the actions brought against them. In May 1998 FONAR and Toshiba amicably resolved the litigation in both the New York and California United States District Courts. Neither party admitted liability in the settlement agreement. The parties cross-licensed each other on the patents-in-suit, and FONAR received a monetary payment from Toshiba. Other terms of the settlement are confidential. On March 4, 1987, Philip B. Kivitz, M.D. and Rad-Sonic Diagnostic Medical Clinics, Inc., filed a complaint against AMD, FONAR, Raymond V. Damadian and others in the San Francisco County Superior Court (Case Action No. 870407) seeking $10,000,000 in compensatory damages and $10,000,000 in punitive damages. In January 1993, the case went to trial and the jury returned a verdict of $880,000 against AMD and $120,000 against FONAR. On June 17, 1993, the Court granted FONAR's and AMD's motion for judgment notwithstanding the verdict, thereby vacating the entire award against both FONAR and AMD. The plaintiffs appealed the Court's granting of judgment notwithstanding the verdict. On February 27, 1995, the appellate court affirmed the lower court's judgment notwithstanding the verdict as to FONAR, but reversed the judgment as to AMD. As a result, the trial court's determination that the plaintiffs could not recover against FONAR was upheld, but the jury verdict against AMD was reinstated. AMD filed a petition for review with the California Supreme Court. AMD's petition was denied on May 17, 1995. Subsequently, judgments were entered on the California judgment in New York, Pennsylvania, Michigan and Florida and enforcement proceedings were commenced. The plaintiffs to date have not collected any part of the judgment in these proceedings. Thereafter, plaintiffs purportedly assigned the judgment to Phoenix General & Health Services, Inc. ("Phoenix"). Phoenix commenced a new and separate action in United States District Court for the Eastern District of New York seeking to enforce the judgment against AMD and FONAR, as well. FONAR is defending this claim on the ground, among others, that in the original California action it was determined that FONAR was not liable, and both FONAR and AMD are defending on the grounds that the assignment to Phoenix, a Nevada corporation, was made solely for the purpose of seeking to bring this case within the diversity jurisdiction of the Federal Courts. A motion to dismiss this case on various grounds is now under consideration by the United States District Court for the Eastern District of New York. In June 1995, a FONAR stockholder commenced an action in the Delaware Court of Chancery against FONAR and its directors, alleging breaches of fiduciary duties by the defendants in connection with a recapitalization plan adopted by the stockholders of the Company on April 3, 1995 (Horace Rubenstein, Individually and on Behalf of All Others Similarly Situated v. Raymond V. Damadian et al., C.A. No. 14378). The action was brought derivatively, on behalf of FONAR and as a class action on behalf of the public holders of FONAR's Common Stock. The defendants answered the complaint and vigorously denied any wrongdoing or liability. The parties reached a settlement agreement which was approved by the Court of Chancery on April 29, 1997. As approved by the Court, the settlement increased the dividends payable on the Company's Common Stock and Class A Non-voting Preferred Stock from the proceeds of its patent litigation. The three percent (3%) dividend originally payable on the Common Stock of any awards collected by the Company on its Cancer Detection Patent (U.S. Patent No. 3,789,832) was increased to 3 1/4% of the first $10 million collected, 4 1/2% of the next $20 million collected and 5 1/2% of any additional amounts collected of any such cash award. The 3% dividend originally payable on the Class A Non-voting Preferred Stock of any awards on the other four patents asserted in the litigation against General Electric Company and Hitachi Ltd., including the Company's Multi-Angle Oblique Imaging Patent, was similarly increased and extended to any patent litigation seeking to enforce those patents commenced prior to November 29, 1997. In addition, the Company agreed to issue Warrants to purchase Common Stock to holders of record of its Common Stock on October 20, 1995 (the record date for determining the stockholders entitled to receive the Class A Non-voting Preferred Stock). The settlement agreement further provided that there would be no further recapitalizations increasing Dr. Damadian's voting control for a period of 5 years without the consent of a majority of the holders of the Company's Common Stock, and Dr. Damadian agreed to share with the holders of the Common Stock any "control premium" he might receive in connection with the sale by him of Class B or Class C Common Stock during a five year period. Subsequently, on December 17, 1997, the parties agreed to modification of the settlement agreement, which was approved by the Court of Chancery on March 2, 1998. The modification provided that the Company issue 2,231,689.3 shares of FONAR Common Stock in substitution for the Warrants which would have been issued under the original terms of the settlement agreement. In addition, the modification provides for a schedule to pay the special dividends on the Company's Common Stock and Class A Non-voting Preferred Stock with respect to awards and settlements already received by the Company in connection with its patent litigations. These first installments (comprising one-half of the total) was paid in May 1998 and the second installment (comprising one-sixth of the total) was paid in September 1998. The remaining two installments (each comprising one-sixth of the total) are required to be paid as follows: one prior to December 31, 1998 and one prior to March 31, 1999. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. Part II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock is traded in the over-the-counter market under the National Association of Securities Dealers Automated Quotation System ("NASDAQ") symbol FONR. The following table sets forth the high and low bid and asked prices reported in NASDAQ System for the periods shown. The prices represent quotations between dealers and do not include certain mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions. Fiscal Quarter Bid Ask High Low High Low ---- ---- ---- ---- July - September 1995 3.84 2.56 4.00 2.63 October - December 1995 3.91 2.50 3.97 2.56 January - March 1996 2.78 2.09 2.81 2.13 April - June 1996 3.00 2.19 3.03 2.25 July - September 1996 2.63 2.13 2.72 2.19 October - December 1996 3.06 2.22 3.13 2.25 January - March 1997 4.44 2.09 4.50 2.13 April - June 1997 3.16 2.28 3.19 2.34 July - September 1997 3.87 2.72 3.94 2.75 October - December 1997 4.03 2.63 4.06 2.66 January - March 1998 3.03 2.38 3.13 2.41 April - June 1998 2.72 1.94 2.75 2.00 July - September 21 1998 2.47 1.25 2.50 1.31 On September 21, 1998, the Company had approximately 5,476 stockholders of record of the Company's Common Stock, 14 stockholders of record of the Company's Class B Common Stock, 4 stockholders of record of the Company's Class C Common Stock and 4,621 stockholders of record of the Company's Class A Non-voting Preferred Stock. At the present time, the only class of the Company's securities for which there is a market is the Common Stock. The Company paid cash dividends in fiscal 1998 and the first quarter of fiscal 1999 on monies it received from the enforcement of its patents. Prior to these dividends, the Company had not paid any cash dividends. The Company anticipates paying additional dividends on monies it receives from the enforcement of its patents. Except for these dividends, however, it is expected that the Company will continue to retain earnings to finance the development and expansion of its business. Item 6. SELECTED FINANCIAL DATA The following selected consolidated financial data has been extracted from the Company's consolidated financial statements for the five years ended June 30, 1998. This consolidated selected financial data should be read in conjunction with the consolidated financial statements of the Company and the related notes included in Item 8 of this form. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of the Company's business plan. As of, or For the Period Ended June 30,
STATEMENT OF OPERATIONS 1998 1997 1996 1995 1994 ----------- ----------- ----------- ----------- ------------ Revenues $27,554,357 $17,633,066 $13,915,725 $16,522,676 $15,387,000 Cost of $23,841,844 $13,828,574 $10,417,384 $10,192,542 $ 7,814,000 revenues Research and $ 6,506,995 $ 3,928,035 $ 3,607,703 $ 3,356,120 $ 2,803,000 Development Expenses Net Income (loss) $(5,653,086) $56,068,771 $(11,407,444) $(7,549,625) $ (335,000) Net income (loss) $(.09) .95 (.22) (.17) (0.01) per common share Weighted average $61,175,986 $56,097,965 51,516,470 45,055,334 36,774,000 number of shares outstanding * BALANCE SHEET DATA - ------------------ Working capital $54,426,483 $62,659,470 $(1,575,857) $(4,498,911) $ (7,749,000) (deficit) Total $108,447,780 $106,690,561 $28,057,384 $27,949,122 $48,418,000 assets Long-term debt and $16,003,479 $ 4,626,269 $ 4,204,935 $ 4,274,420 $ 5,884,000 obligations under capital leases Stockholders' $72,572,486 $ 73,245,262 $11,412,629 $29,394,096 $28,333,000 equity
* Adjusted for stock dividend of Class A Non-voting Preferred Stock declared in October, 1995. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. INTRODUCTION. The Company was formed in 1978 to engage in the business of designing, manufacturing and selling MRI scanners. In 1997, the Company formed a wholly-owned subsidiary, Health Management Corporation of America ("HMCA"), formerly known as U.S. Health Management Corporation, in order to expand into the physician practice management business. FONAR's principal MRI products are its QUAD 7000 and QUAD 12000 MRI scanners. Having received the necessary FDA approvals for its QUAD scanners, the Company believes it is in a position to aggressively seek new sales. The QUAD scanners are highly competitive and totally new non-claustrophobic scanners not previously available in the MRI market. At .6 Tesla field strength, the QUAD 12000 magnet is the highest field "Open MRI" in the industry, offering non-claustrophobic MRI together with high-field image quality for the first time. The Company expects vigorous sales from its new products. As part of its scanner marketing program, the Company attended the industry's annual trade show, RSNA (Radiological Society of North America) in November 1995, 1996 and 1997 and plans to do so again in November 1998. The Company believes that it is uniquely positioned to take advantage of the rapidly expanding "Open MRI" market, as the manufacturer of the only high-field "Open MRI" in the industry. The Company expects marked demand for this product since image quality increases as a direct proportion to magnetic field strength. In addition, the Company's new scanners provide improved image quality and high speed imaging at costs that are significantly less than the competition and more in keeping with the medical cost reduction demands being made by our national leaders on behalf of the public. The Company's efforts to reduce infringement of its intellectual property rights by competitors have produced material benefits, as reflected in the $128.7 million recovered from General Electric Company. After deduction of attorney's fees, the net amount of $77.2 million was collected by the Company on July 2, 1997. The full amount of the award was recognized for financial statement purposes in fiscal 1997. HMCA generates revenues from providing comprehensive management services (including development, administration, accounting and billing and collection services) together with office space, medical equipment, supplies and non-medical personnel to its clients. Revenues are in the form of management and leasing fees. HMCA has completed five acquisitions since it was formed in March 1997. The first acquisition was of a group of companies engaged in the business of managing three diagnostic imaging centers and one multi-specialty practice in New York State (the "Affordable Companies"). The second acquisition was of Raymond V. Damadian, M.D. MR Scanning Centers Management Company ("RVDC"), a company owned by FONAR's principal stockholder, President and Chairman of the Board, Raymond V. Damadian. The business of RVDC, which is being continued by HMCA, was the management of MRI diagnostic imaging centers in New York, Florida, Georgia and other locations. The third acquisition was the acquisition of the business and assets of Central Health Management Co., LLC ("Central Health") a multi-specialty management service organization (MSO) in Yonkers, New York. The fourth acquisition was the acquisition of A & A Services, Inc. ("A & A"), an MSO managing four primary care practices in Queens County, New York, and the fifth acquisition was the acquisition of Dynamic Health Care Management, Inc. ("Dynamic"), an MSO managing three multi-specialty physician practices in Nassau and Suffolk Counties in New York. In addition, HMCA sponsored the opening of two new multi-specialty facilities during fiscal 1998. These facilities are located in Albany County, New York and in Melbourne, Florida. HMCA did not actively engage in business until after June 30, 1997, which was the effective date of its acquisitions of the Affordable Companies and RVDC. As separate businesses, the Affordable Companies had been engaged in business since 1994 and RVDC had been engaged in business since 1990. For financial statement presentation the results of operations, assets and liabilities of the Company and RVDC have been consolidated for prior periods. The Affordable Companies, Central Health and A & A, have been consolidated effective as of the dates of their respective acquisitions. The acquisition of Dynamic was consummated on August 20, 1998, following the end of the 1998 fiscal year, and consequently is not reflected in the financial statements for fiscal 1998. The Company has assessed and continues to assess the impact of the Year 2000 Issue (Y2K) on its financial reporting systems and operations. The Year 2000 Issue is the result of computer programs being written using two digits (rather than four) to define the applicable year. The Company is developing a plan to meet this issue. The Company is reviewing all in-house computer based systems. The MIS department is updating or replacing older systems that are not Y2K compatible. The Company is also reviewing and has started to plan changes to its existing customer base of MRI scanners. The Company expects that all computer based systems will be Y2K compliant and in the final phase of testing in the second quarter of 1999. Based on preliminary information, costs of addressing these items are currently not expected to have a material adverse impact on the Company's financial position. RESULTS OF OPERATIONS. FISCAL 1998 COMPARED TO FISCAL 1997 In fiscal 1998, the Company experienced a net loss of $5.5 million on revenues of $27.6 million as compared to net income of $56.1 million on revenues of $17.6 million for fiscal 1997. As a result of HMCA's acquisitions, revenues attributable to the Company's physician practice management services segment (HMCA) increased dramatically, to $21.1 million in fiscal 1998 from $8.1 million in fiscal 1997. Income of $2.7 million was recognized from the Company's physician practice management services in fiscal 1998, as compared to a loss of $71,769 in fiscal 1997. Revenues attributable to the Company's medical equipment segment declined to $7.8 million in fiscal 1998 from $9.5 million, reflecting lower sales volume in fiscal 1998. Results of operations for the medical equipment segment improved, however, from a loss of $24.3 million in fiscal 1997 to a loss of $20.3 million in fiscal 1998. Other income of $8.7 million (principally the net proceeds from the Company's patent enforcement lawsuits) and interest income of $3.7 million were recognized by the Company in fiscal 1998 as compared to other income of $83.1 million (principally the net proceeds from the Company's patent enforcement lawsuits) and interest income of $385,500 in fiscal 1997. Costs of revenues and expenses increased from $42 million in fiscal 1997 to $45.1 million in fiscal 1998, reflecting the expansion of the Company's physician practice management services operations and an increase in research and development in the medical equipment segment. Costs of revenue and expenses for the Company's physician practice management services increased to $17.0 million in fiscal 1998 from $9.1 million in fiscal 1997. Research and development expenses increased to $6.5 million in fiscal 1998 as compared to $3.9 million in fiscal 1997. Overall, costs of revenues and expenses for the Company's medical equipment segment, however, declined to $28.1 million in fiscal 1998 from $34.4 million in fiscal 1997 reflecting, most significantly, reductions in general and administrative expenses ($7.3 million in fiscal 1998 as compared to $11.8 million in fiscal 1997) and costs of revenue ($11.6 million in fiscal 1998 as compared to $12.3 million in fiscal 1997). Net income for the Company for fiscal 1997 reflects the net income attributable to the award received by the Company in its patent litigation. Revenues generated by sales of QUAD MRI scanners were $1.4 million (10% of total revenues) in fiscal 1996, $4.8 million (approximately 27% of total revenues) in fiscal 1997 and $4.1 million (15% of total revenues) in fiscal 1998. Revenues attributable to sales of the Company's Ultimate scanners during the same period were $94,000 (approximately 1% of total revenues) in fiscal 1996 and $0.00 in fiscal 1997 and fiscal 1998. Sales of Beta scanners approximated $4.7 million in fiscal 1996 (approximately 35.9% of total revenues) as compared to $0.00 in fiscal 1997 and 1998. Of these revenues approximately 94.5% were attributable to sales to affiliates in fiscal 1996. Sales to affiliated parties represented approximately 0.3% ($0.1 million) of the Company's revenues in fiscal 1998, as compared to approximately 4% ($0.7 million) in fiscal 1997 and 54.4% ($7.1 million) in fiscal 1996. Gross profit margins on product sales to unrelated parties were negative (133%) in fiscal 1996, negative (60%) in fiscal 1997 and negative (98%) in fiscal 1998. This reflects the losses on sales of the Company's QUAD scanners. The Company's strategy is to attempt to hold down the price of its QUAD scanners and to increase profitability by reducing manufacturing costs and increasing volume. The effectiveness of this strategy will not be discernible until higher sales volume for the Company's QUAD scanners is achieved. To reduce the cost of manufacturing its QUAD scanners, the Company expanded its manufacturing capacity in fiscal 1998 by acquiring approximately $1.4 million worth of new capital equipment. In addition, the Company expanded its operating capacity by hiring additional personnel. Notwithstanding the Company's increased manufacturing activities, revenues attributable to the Company's medical equipment segment declined to approximately $7.8 million in fiscal 1998 from approximately $9.5 million in fiscal 1997, but were the same as the revenues of $7.8 million in fiscal 1996. The Company has not yet been able to achieve the sales volumes from its new QUAD scanners necessary to become profitable because of intense competition and the challenges of introducing a new product. These trends reflect a decline in service revenue from $3.9 million in fiscal 1996 to $2.7 million in fiscal 1997 and $2.5 million in fiscal 1998 and a decrease in product sales in fiscal 1998 ($4.0 million) from fiscal 1997 ($5.2 million), but an increase in product sales from fiscal 1996 ($2.1 million). The decline in service revenue reflects the retirement of old scanners by the Company's customers. The Company does not expect the decline in revenue to continue. The Company is enthusiastic about the future of its FONAR 360 product line (See Works in Progress) which will bring a new plateau of "openness" to diagnostic MRI and a new frontier in surgery for performing surgical treatments using MRI images to guide surgery. Continuing its tradition as the originator of MRI, the Company remained committed to maintaining its position as the leading innovator of the industry through aggressive investing in research and development. In fiscal 1998 the Company continued its investment in the development of its new MRI scanners, together with software and upgrades, with an investment of $6,506,995 in research and development (none of which was capitalized) as compared to $3,928,035 ($108,809 of which was capitalized) in fiscal 1997. The research and development expenditure was approximately 80.8% of revenues attributable to the Company's medical equipment segment (and 22.9% of total revenues) in 1998 and $41.2% of medical equipment segment revenues in 1997 (and 22.3% of total revenues). The Company has continued its efforts to increase scanner sales in foreign countries as well as domestically. Based on sales to date, further indications of interest, meetings, sales trips abroad and negotiations, the Company is optimistic that foreign sales will continue to prove a significant source of revenue. The Company continued to benefit as a result of programs set in motion in fiscal 1989; namely strict cost containment initiatives and expanding the corporate business into a greater number of profitable enterprises within and related to the MRI and medical industries (e.g., physician practice management, customer service, upgrades). As a result of this expansion, the percentage of the Company's revenue derived from sources other than scanner sales was approximately 85.7% for fiscal 1998 and 70.64% for fiscal 1997. During the fiscal year ended June 30, 1998, the Company realized income of approximately $8.7 million from the settlement of various legal disputes (essentially its patent infringement actions) as compared to approximately $83.1 million in fiscal 1997. FISCAL 1997 COMPARED TO FISCAL 1996 In fiscal 1997, the Company experienced net income of $56.0 million on revenues of $17.6 million as compared to a net loss of $11.4 million on revenues of $13.9 million for fiscal 1996. Revenues and income (losses) attributable to the Company's physician practice management services segment were $8.1 million and ($1.1 million), respectively for fiscal 1997 and $6.2 million and ($3.4 million), respectively for fiscal 1996. As the Company expanded its operations and productive capacity, costs and expenses increased in fiscal 1997. Cost of revenues increased from $10.4 million in fiscal 1996 to $13.8 million in fiscal 1997. Research and development, selling, general and administrative expenses increased to approximately $24.2 million for fiscal 1997 from approximately $17.2 million for fiscal 1996. Costs of revenues and selling general and administrative expenses attributable to RVDC were $1.9 million and $7.2 million respectively for fiscal 1997 and $2.1 million and $6.8 million, respectively for fiscal 1996. As at September 1, 1997, the Company's backlog of unfilled scanner orders was approximately $6.4 million, as compared to $6.8 million at September 1, 1996. In fiscal 1997 the Company invested $3,928,035 in research and development ($108,809 of which was capitalized) as compared to $3,607,703 in research and development ($251,659 of which was capitalized) in fiscal 1996. The research and development expenditure was approximately 22.3% of revenues in 1997 and 25.9% of revenues in 1996. During the fiscal year ended June 30, 1997, the Company realized income of approximately $83.1 million from the settlement of various legal disputes (essentially its patent infringement actions) as compared to $4.0 million in fiscal 1996. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1998, the Company's liquidity and capital resources positions changed from the June 30, 1997 position as follows: June 30, June 30, 1998 1997 Change ____________ ____________ __________ Working capital (deficiency) $54,426,483 $62,659,470 $(8,232,987) The change in the Company's working capital position resulted primarily from its investments in new equipment ($2.8 million), the cash portions of the purchase prices for its acquisitions ($4.0 million) and its overall operating losses, notwithstanding a decrease in its current liabilities ($22.1 million as at June 30, 1998 as compared to $31 million as at June 30, 1997. The increase in long-term debt from $1.8 million as at June 30, 1997 to $13.7 million as at June 30, 1998 was attributable to notes issued in connection with HMCA's acquisitions and new indebtedness for equipment and repayment of existing debt. As at June 30, 1998, the Company's past due obligations consisted of approximately $1.1 million in past due taxes (various state taxes), and approximately $100,000 in other past due indebtedness. The Company is seeking to enter into payment plans with taxing authorities with respect to past due taxes and to restructure its other past due indebtedness. As of June 30, 1998, the Company had no unused credit facilities with banks or financial institutions. The Company's business plan currently includes an aggressive program for manufacturing and selling its new line of QUAD scanners which are achieving success in the marketplace. In addition the Company plans, through its subsidiary, Health Management Corporation of America, to develop and expand its PPM (physician practice management) business (See "Description of Business"). The Company believes its present financial resources are sufficient to achieve the sales, service and production levels necessary to support its operations. The Company offers its products for sale or lease to customers. Cash flows from leasing transactions are derived under the terms of the underlying agreements. Over the long term, the Company expects enhanced cash flows and increased revenues from such transactions while in the short term, such transactions impair cash flow. In order to mitigate the short term effect on cash flow, the Company previously had borrowed money secured by the leases and the underlying equipment. Such debt comprises substantially all of the remaining long-term debt in the accompanying financial statements. In addition to leasing products to customers, the Company has developed and begun to implement a new program to finance a portion of the purchase price of its scanners through a newly formed subsidiary, Fonar Acceptance Corporation, and to assist the customer in obtaining the remaining portion of its financing through an independent source or sources. The new program is intended to increase the overall profitability of the Company by assisting in the sale of scanners and participating in the profits derived from financing those sales. Advances and notes to affiliates and related parties decreased by approximately $0.9 million from June 30, 1997 to June 30, 1998. As these are long-term assets, they tend to reduce the Company's liquidity. There were no past due receivables and lease payments from affiliates as at June 30, 1998 and June 30, 1997. Since 1990 the Company has restructured various long-term loans and notes. The significant changes included extended maturity dates, and the addition of unpaid interest to the note and loan balances. Capital expenditures for each of fiscal 1998 and 1997 approximated $3.6 million and $1.75 million, respectively, and substantially consisted of office and production equipment. The Company's business plan initiated in September 1989, had as its objective the enhancement and stabilization of revenue streams through the generation of additional income from its installed base of scanners and leasing programs. In addition, the Company instituted strict cost containment programs. While continuing to focus on new sources of income, the Company now has commenced aggressive sales and manufacturing of its new generation of Open MRI scanners, the QUAD scanners and is reemphasizing MRI Scanner sales. In addition, the Company is enhancing its revenue by entering into the PPM (physician practice management) business through its new subsidiary, HMCA. Cost containment programs continue in force notwithstanding an increase in costs and expenses resulting from increased manufacturing activity and marketing of its MRI scanners. These programs, which include increasing the portion of manufacturing conducted on the Company's premises, have enabled the Company to achieve significantly lower manufacturing costs than would have otherwise been experienced in the production of its QUAD scanners. This has enabled the Company to pass on to customers a much needed reduction in the sales price of MRI scanners. The Company's plan calls for a continuing emphasis on providing its customers with enhanced equipment service and maintenance capabilities and delivering state-of-the-art, innovative and high quality equipment upgrades at competitive prices. Fees for on-going service and maintenance from the Company's installed base of scanners were $2.7 million for the year ended June 30, 1997 and $2.5 million for the year ended June 30, 1998 (transactions between the Company and its subsidiaries are eliminated in the consolidation). The Company will continue to aggressively develop and market upgrades and enhancements for previously installed scanners. The Company's working capital surplus as of June 30, 1998 approximates $54.4 million, as compared to a working capital surplus of $62.7 million as of June 30, 1997. During fiscal 1998, cash provided by operating activities increased to approximately $68 million from $(3.6) million in fiscal 1997 and cash used in investing activities increased to approximately $27.1 million from approximately $1.5 million in fiscal 1997. Cash used in financing activities increased to approximately $5.6 million for fiscal 1998 from approximately $(7.1) million provided by in fiscal 1997. The Company believes that the above mentioned financial resources will provide the cash flows needed to achieve the sales, service and production levels necessary to support its operations. In addition, the Company is exploring other more permanent financing alternatives which may become available as the success of the previously described programs accelerates. STOCKHOLDER LITIGATION. In June 1995, one of the Company's stockholders commenced an action in the Delaware Court of Chancery against FONAR and its directors, alleging breaches of fiduciary duties by the defendants for adopting the recapitalization plan (Horace Rubenstein, Individually and on Behalf of All Others Similarly Situated v. Raymond V. Damadian et al.) The action was brought derivatively, on behalf of FONAR and as a class action on behalf of the public holders of FONAR's Common Stock. FONAR and its directors answered the complaint and vigorously denied any wrongdoing or liability. The parties reached a settlement agreement, which was approved by the Court of Chancery on April 29, 1997. As approved by the Court, the settlement increased the dividends payable on the Company's Common Stock and Class A Non-voting Preferred Stock from the proceeds of its patent litigation. The three percent (3%) dividend originally payable on the Common Stock of any awards collected by the Company on its Cancer Detection Patent (U.S. Patent No. 3,789,832) was increased to 3 1/4% of the first $10 million collected, 4 1/2% of the next $20 million collected and 5 1/2% of any additional amounts collected of any such cash award. The 3% dividend originally payable on the Class A Non-voting Preferred Stock of any awards on the other four patents asserted in the litigation against General Electric Company and Hitachi Ltd., including the Company's Multi-Angle Oblique Imaging Patent, was similarly increased and extended to any patent litigation seeking to enforce those patents commenced prior to November 29, 1997. In addition, the Company agreed to issue Warrants to purchase Common Stock to holders of record of its Common Stock on October 20, 1995 (the record date for determining the stockholders entitled to receive the Class A Non-voting Preferred Stock). The settlement agreement further provided that there would be no further recapitalizations increasing Dr. Damadian's voting control for a period of 5 years without the consent of a majority of the holders of the Company's Common Stock, and Dr. Damadian agreed to share with the holders of the Common Stock any "control premium" he might receive in connection with the sale by him of Class B or Class C Common Stock during a five year period. Subsequently, on December 17, 1997, the parties agreed to modification of the settlement agreement, which was approved by the Court of Chancery on March 2, 1998. The modification provided that the Company issue 2,231,689.3 shares of FONAR Common Stock in substitution for the Warrants which would have been issued under the original terms of the settlement agreement. In addition, the modification provides for a schedule to pay the special dividends on the Company's Common Stock and Class A Non-voting Preferred Stock with respect to awards and settlements already received by the Company in connection with its patent litigations. These first installments (comprising one-half of the total) was paid in May 1998 and the second installment (comprising one-sixth of the total) was paid in September 1998. The remaining two installments (each comprising one-sixth of the total) are required to be paid as follows: one prior to December 31, 1998 and one prior to March 31, 1999. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK. The Company is exposed to equity price risks on the marketable equity securities included in its portfolio of investments. As at June 30, 1998, equity securities and mutual funds composed of equity securities had a fair value of $10,994,776. The Company's investments in equity securities consist of common stock traded in the major United States security markets. Approximately 97% of the Company's investment in equity securities is composed of United States based companies. The Company's portfolio of common stock is not concentrated in any particular industry. Common stock prices are sensitive to changes in interest rates and economic changes. The Company anticipates the future fair value of its investment in common stock will closely follow the movement of the major United States security markets. The Company also invests in fixed rate instruments. None of the fixed rate instruments in which the Company invests extend beyond June 30, 2000. Below is a tabular presentation of the maturity profile of the fixed rate instruments held by the Company at June 30, 1998. INTEREST RATE SENSITIVITY PRINCIPAL AMOUNT BY EXPECTED MATURITY WEIGHTED AVERAGE INTEREST RATE 6/30/99 6/30/00 Total Fair Value at 6/30/98 Investments in Fixed Rate Instruments $5,652,277 $3,750,000 $9,402,277 $9,257,055 Weighted Average Interest Rate 5.4% 5.7% All of the Company's revenue, expense and capital purchasing activities are transacted in United States dollars. See Note 12 to the Company's Financial Statements for information on long term debt. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FONAR CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES Page No. INDEPENDENT AUDITORS' REPORT F-2 CONSOLIDATED BALANCE SHEETS F-3 to F-5 At June 30, 1998 AND 1997 CONSOLIDATED STATEMENTS OF OPERATIONS F-6 For the Three Years Ended June 30, 1998, 1997 and 1996 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY F-7 to F-12 For the Three Years Ended June 30, 1998, 1997 and 1996 CONSOLIDATED STATEMENTS OF CASH FLOWS F-13; F-14 For the Three Years Ended June 30, 1998, 1997 and 1996 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-15 to F-58 SELECTED FINANCIAL DATA (*) For the Five Years Ended June 30, 1998 (*) Included in Part II, Item 6 of the Form. Information required by other schedules called for under Regulation S-X is either not applicable or is included in the consolidated financial statements or notes thereto. F-1 INDEPENDENT AUDITORS' REPORT ---------------------------- To the Board of Directors FONAR Corporation and Subsidiaries We have audited the accompanying consolidated balance sheets of FONAR Corporation and Subsidiaries as at June 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of FONAR Corporation and Subsidiaries at June 30, 1998 and 1997, and the consolidated results of their operations and cash flows for each of the years in the three-year period ended June 30, 1998, in conformity with generally accepted accounting principles. During each of the years in the three-year period ended June 30, 1998, a significant portion of the Company's revenues was from related parties (see Notes 2, 3 and 19). TABB, CONIGLIARO & McGANN, P.C. s/s TABB, CONIGLIARO & McGANN, P.C. New York, New York September 25, 1998 F-2 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS ------ June 30, ------------------------------ 1998 1997 ------------ ------------ CURRENT ASSETS Cash and cash equivalents $ 41,751,704 $ 5,861,500 Marketable securities 20,251,832 - Receivable from litigation award (received July 1997) - 77,223,460 Accounts receivable, net 9,877,347 6,000,063 Costs and estimated earnings in excess of billings on uncompleted contracts 833,615 818,865 Inventories 3,513,622 3,440,509 Prepaid expenses and other current assets 285,965 409,673 ------------ ------------ TOTAL CURRENT ASSETS 76,514,085 93,754,070 RESTRICTED CASH 5,000,000 - PROPERTY AND EQUIPMENT - Net 9,102,239 6,068,675 ADVANCES AND NOTES TO RELATED PARTIES, Net of discounts and allowance for doubtful accounts of $904,000 and $3,750,000 at June 30, 1998 and 1997, respectively 1,350,114 1,928,625 LONG-TERM ACCOUNTS RECEIVABLE, Net of allowance for doubtful accounts of $2,490,018 at June 30, 1997 - 253,534 NOTES RECEIVABLE, Net of allowance for doubtful accounts of $477,456 and $865,964 at June 30, 1998 and 1997, respectively 65,751 107,384 EXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED, NET 14,745,555 2,796,197 OTHER INTANGIBLE ASSETS, Net 1,161,601 1,544,471 OTHER ASSETS 508,435 237,605 ------------ ------------ TOTAL ASSETS $108,447,780 $106,690,561 ============ ============ See accompanying notes to consolidated financial statements. F-3 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------- June 30, -------------------------- 1998 1997 ------------ ------------ CURRENT LIABILITIES Current portion of debt and capital leases $ 2,443,326 $ 2,802,508 Accounts payable 2,029,552 2,837,421 Other current liabilities 11,256,159 13,470,373 Dividends payable 3,909,366 7,855,067 Customer advances 669,731 764,402 Billings in excess of costs and estimated earnings on uncompleted contracts 31,032 192,932 Income taxes payable 954,642 100,000 Deferred income taxes 793,794 3,071,897 ------------ ------------ TOTAL CURRENT LIABILITIES 22,087,602 31,094,600 ------------ ------------ DEFERRED INCOME TAXES - NON-CURRENT - 221,897 LONG-TERM DEBT AND CAPITAL LEASES, Less current maturities 13,560,153 1,823,761 OTHER LIABILITIES 113,663 100,941 ------------ ------------ 13,673,816 2,146,599 ------------ ------------ MINORITY INTEREST 113,876 204,100 ------------ ------------ COMMITMENTS, CONTINGENCIES AND OTHER MATTERS (Notes 1, 2, 3, 10, 11, 12, 15, 18 and 22) See accompanying notes to consolidated financial statements. F-4 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ (Continued) June 30, ------------------------------ 1998 1997 ------------ ----------- STOCKHOLDERS' EQUITY Common stock - $.0001 par value; issued and outstanding - 52,954,465 shares and 49,133,422 shares at June 30, 1998 and 1997, respectively $ 5,294 $ 4,913 Class B common stock (10 votes per share) - $.0001 par value; issued and outstanding - 5,411 shares at June 30, 1998 and 1997 - - Class C common stock (25 votes per share) - $.0001 par value; 9,562,824 issued and outstanding at June 30, 1998 and 1997 956 956 Class A non-voting preferred stock - $.0001 par value; issued and outstanding - 7,836,286 and 7,855,627 shares at June 30, 1998 and 1997, respectively 784 785 Preferred stock - $.001 par value; issued and outstanding - none - - Paid-in capital in excess of par value 94,502,717 90,640,637 Accumulated other comprehensive income (42,296) - Accumulated deficit (19,645,074) (13,991,988) Notes receivable from stockholders (1,854,450) (1,918,596) Unearned compensation - (1,096,000) Treasury stock - 108,864 shares of common stock at June 30, 1998 and 1997 (395,445) (395,445) ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 72,572,486 73,245,262 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $108,447,780 $106,690,561 ============ ============ See accompanying notes to consolidated financial statements. F-5 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended June 30, 1998 1997 1996 ----------- ----------- ------------ REVENUES Product sales - net $ 3,937,726 $ 5,177,346 $ 2,060,888 Service and repair fees - net 2,520,637 2,686,048 3,927,383 Management and other fees - related parties - net 21,095,994 9,769,672 7,927,454 ----------- ----------- ------------ TOTAL REVENUES - Net 27,554,357 17,633,066 13,915,725 ----------- ----------- ------------ COSTS AND EXPENSES Costs related to product sales 7,800,569 8,277,945 4,818,952 Costs related to service and repair fees 2,373,808 2,202,120 2,451,708 Costs related to management and other fees - related parties 13,667,467 7,948,509 7,146,724 Research and development 6,506,995 3,928,035 3,607,703 Selling and marketing 2,325,479 2,369,652 2,069,045 General and administrative 10,164,060 13,273,396 7,517,538 Provision for bad debts 929,786 3,608,062 1,226,014 Compensatory element of stock issuances 1,108,362 407,052 355,327 Amortization of excess of cost over net assets of business acquired 272,224 - - ----------- ----------- ------------ TOTAL COSTS AND EXPENSES 45,148,750 42,014,771 29,193,011 ----------- ----------- ------------ LOSS FROM OPERATIONS (17,594,393) (24,381,705) (15,277,286) Interest expense (728,327) (311,900) (609,071) Investment income 3,708,938 385,500 310,489 Other income, principally gain on litigation awards 8,610,035 83,099,685 4,007,576 ----------- ----------- ------------ (LOSS) INCOME BEFORE PROVISION FOR TAXES AND MINORITY INTEREST (6,003,747) 58,791,580 (11,568,292) Provision (credit) for income taxes (497,551) 2,950,000 19,965 ----------- ----------- ------------ (LOSS) INCOME BEFORE MINORITY INTEREST (5,506,196) 55,841,580 (11,588,257) Less: Minority interest in net income (loss) of subsidiary and partnerships 146,890 (227,191) (180,813) ----------- ----------- ------------ NET (LOSS) INCOME $(5,653,086) $56,068,771 $(11,407,444) =========== =========== ============ NET (LOSS) INCOME PER SHARE $(.09) $1.00 $(0.22) ===== ===== ====== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 61,175,986 56,097,965 51,516,470 ========== ========== ==========
See accompanying notes to consolidated financial statements. F-6 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEAR ENDED JUNE 30, 1998
Class A Non- Paid-in Notes Per Class A Common Stock Class C Voting Capital in Treasury Receivable Share -------------------- Common Preferred Excess of Stock from Amount Shares Amount Stock Stock Par Value Amount Stockholders ------ ---------- -------- -------- --------- ----------- --------- ------------ Balance - June 30, 1997 $ - 49,133,422 $ 4,913 $ 956 $ 785 $90,640,637 $(395,445) $(1,918,596) Net loss - - - - - - - - Other comprehensive income, net of tax: Unrealized gains on securities, net of tax - - - - - - - - Stock issued to employees under 1995 stock bonus plan 2.96 400,430 40 - - 1,184,838 - - Shares issued under 1993 incentive stock option plan 3.00 153,170 15 - - 459,495 - - Issuance of stock under 1986 incentive option plan .37 3,125 1 - - 1,171 - - Issuance of stock in settlement of liabilities 2.75 236,345 23 - - 650,641 - - Shares issued under 1997 non-statutory plan - 2,600 1 - - 19,836 - - Issuance of stock under consulting contracts 2.79 223,030 22 - - 622,754 - - Additional consideration related to acquisition of Affordable Diagnostics, Inc. 1.60 576,000 57 - - 923,385 - - Issuance of stock in substitution for 4,909,767 warrants - 2,226,343 222 - - (40) - - Net change in notes receivable from stockholders - - - - - - - 64,146 Amortization of unearned compensation - - - - - - - - Class A preferred stock retired - - - - (1) - - - ---------- ---------- -------- -------- --------- ----------- --------- ----------- BALANCE - JUNE 30, 1998 - 52,954,465 $ 5,294 $ 956 $ 784 $94,502,717 $(395,445) $(1,854,450) ========== ========== ======== ======== ========= =========== ========= ===========
See accompanying notes to consolidated financial statements. F-7 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEAR ENDED JUNE 30, 1998
Accumulated Other Total Unearned Comprehensive Accumulated Comprehensive Compensation Income Deficit Total Income ------------ ------------- ------------- ----------- ------------- Balance - June 30, 1997 $(1,096,000) $ - $(13,991,988) $73,245,262 $ - Net loss - - (5,653,086) (5,653,086) (5,653,086) Other comprehensive income, net of tax: Unrealized gains on securities, net of tax - (42,296) - (42,296) (42,296) Stock issued to employees under 1995 stock bonus plan - - - 1,184,878 - Shares issued under 1993 incentive stock option plan - - - 459,510 - Issuance of stock under 1986 incentive option plan - - - 1,172 - Issuance of stock in settlement of liabilities - - - 650,664 - Shares issued under 1997 non-statutory plan - - - 19,837 - Issuance of stock under consulting contracts - - - 622,776 - Additional consideration related to acquisition of Affordable Diagnostics, Inc. - - - 923,442 - Issuance of stock in substitution for 4,909,767 warrants - - - 182 - Net change in notes receivable from stockholders - - - 64,146 - Amortization of unearned compensation 1,096,000 - - 1,096,000 - Class A preferred stock retired - - - (1) - ------------ ------------- ------------ ----------- ----------- BALANCE - JUNE 30, 1998 $ - $ (42,296) $(19,645,074) $72,572,486 $(5,695,382) ============ ============= ============ =========== ===========
See accompanying notes to consolidated financial statements. F-8 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEAR ENDED JUNE 30, 1997
Class A Class A Class B Class C Non-Voting Common Stock Common Stock Common Stock Preferred Stock Per Share ------------------- --------------- -------------------- ----------------- Amount Shares Amount Shares Amount Shares Amount Shares Amount ---------- ---------- ------- ------ ------- --------- -------- --------- ------ Balance - June 30, 1996 $ - 42,871,751 $ 4,287 5,411 $ - 9,562,824 $ 956 7,855,627 $ 785 Shares issued as follows: Stock bonus to employees (measured at the average quoted market price on the award dates) 2.56 159,025 16 - - - - - - Under incentive stock option plan 2.09 259,375 26 - - - - - - Shares issued under non-statutory plans 2.46 2,100,000 210 - - - - - - Issuance of stock in settlement of liabilities 2.49 579,271 58 - - - - - - Issuance of stock under stock bonus plans 2.38 1,000,000 100 - - - - - - Issuance of stock under consulting contracts 2.74 400,000 40 - - - - - - Issuance of stock for acquisition of Affordable Diagnostics, Inc. 2.06 1,764,000 176 - - - - - - Net change in notes receivable from stockholders - - - - - - - - - Dividend - common stock .05 - - - - - - - - Dividend - Class A preferred stock .65 - - - - - - - - Net income - - - - - - - - ---------- ------- ----- -------- --------- -------- --------- ------ BALANCE - JUNE 30, 1997 49,133,422 $ 4,913 5,411 $ - 9,562,824 $ 956 7,855,627 $ 785 ========== ======= ===== ======== ========= ======== ========= ======
See accompanying notes to consolidated financial statements. F-9 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEAR ENDED JUNE 30, 1997
Paid-in Notes Capital in Treasury Stock Receivable Excess of ------------------- from Unearned Accumulated Par Value Shares Amount Stockholders Compensation Deficit ----------- -------- ---------- ------------- ------------- ------------- Balance - June 30, 1996 $75,985,245 108,864 $(395,445) $(1,760,281) $ - $ (62,422,918) Shares issued as follows: Stock bonus to employees (measured at the average quoted market price on the award dates) 407,036 - - - - - Under incentive stock option plan 543,334 - - - - - Shares issued under non-statutory plans 5,159,166 - - - - - Issuance of stock in settlement of liabilities 1,444,464 - - - - - Issuance of stock under stock bonus plans 2,375,296 - - - - - Issuance of stock under consulting contracts 1,095,960 - - - (1,096,000) - Issuance of stock for acquisition of Affordable Diagnostics, Inc. 3,630,136 - - - - - Net change in notes receivable from stockholders - - - (158,315) - - Dividend - common stock - - - - - (2,551,146) Dividend - Class A preferred stock - - - - - (5,086,695) Net income - - - - - 56,068,771 ----------- ------- --------- ----------- ----------- ------------ BALANCE - JUNE 30, 1997 $90,640,637 108,864 $(395,445) $(1,918,596) $(1,096,000) $(13,991,988) =========== ======= ========= =========== =========== ============
See accompanying notes to consolidated financial statements. F-10 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEAR ENDED JUNE 30, 1996
Class A Class A Class B Class C Non-Voting Per Common Stock Common Stock Common Stock Preferred Stock Share -------------------- -------------------- --------------------- ---------------------- Amount Shares Amount Shares Amount Shares Amount Shares Amount ------ ---------- -------- ---------- -------- ---------- -------- ---------- ---------- Balance - June 30, 1995 $ - 38,229,448 $ 3,822 3,193,456 $ 319 - $ - 7,624,117 $ 762 Shares issued as follows: Stock bonus to employees (measured at the average quoted market price on the award dates) 2.67 157,341 16 - - - - - - Under incentive stock option plan 2.66 82,125 8 - - - - - - Shares issued under non-statutory plans 2.69 3,100,000 310 - - - - - - Issuance of stock in settlement of liabilities 2.73 802,400 80 - - - - - - Issuance of stock 2.08 500,000 50 - - - - - - Conversion from Class B to Class A - - - (3,187,608) (318) 9,562,824 956 - - Conversion from Class B to Class A liabilities - 437 1 (437) (1) - - - - Net change in notes receivable from stockholders - - - - - - - - - Stock dividend adjustment - Class A non-voting preferred - - - - - - - 231,510 23 Dividend - Class A preferred stock .03 - - - - - - - - Net loss - - - - - - - - ---------- -------- ---------- -------- --------- --------- --------- ---------- BALANCE - JUNE 30, 1996 42,871,751 $ 4,287 5,411 $ - 9,562,824 $ 956 7,855,627 $ 785 ========== ======== ========== ======== ========= ========= ========= ==========
See accompanying notes to consolidated financial statements. F-11 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEAR ENDED JUNE 30, 1996
Paid-in Notes Capital in Treasury Stock Receivable Excess of ---------------------- from Accumulated Par Value Shares Amount Stockholders Deficit ----------- ---------- ---------- ------------ --------- Balance - June 30, 1995 $63,779,202 108,864 $ (395,445) $(1,897,047) $(50,798,248) Shares issued as follows: Stock bonus to employees (measured at the average quoted market price on the award dates) 420,187 - - - - Under incentive stock option plan 218,780 - - - - Shares issued under non-statutory plans 8,337,190 - - - - Issuance of stock in settlement of liabilities 2,190,892 - - - - Issuance of stock 1,039,655 - - - - Conversion from Class B to Class A (638) - - - - Conversion from Class B to Class A liabilities - - - - - Net change in notes receivable from stockholders - - - 136,766 - Stock dividend adjustment - Class A non-voting preferred (23) - - - - Dividend - Class A preferred stock - - - - (217,226) Net loss - - - - (11,407,444) ----------- ---------- ---------- ----------- ------------ BALANCE - JUNE 30, 1996 $75,985,245 108,864 $ (395,445) $(1,760,281) $(62,422,918) =========== ========== ========== =========== ============
See accompanying notes to consolidated financial statements. F-12 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended June 30, ------------------------------------------ 1998 1997 1996 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) ................... $ (5,653,086) $ 56,068,771 $(11,407,444) Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: Minority interest in subsidiary and partnerships ............... (90,224) (227,191) (180,813) Depreciation and amortization .... 2,917,603 2,023,465 2,636,556 Writedown of assets held for resale ......................... -- -- 148,062 Imputed interest on deferred payment obligation ............. 27,000 -- -- Provision for bad debts .......... 929,786 3,608,027 1,226,014 Compensatory element of stock issuances ...................... 1,108,362 407,052 355,327 Stock issued in settlement of current liabilities ............ 639,715 1,444,522 1,257,909 Writedown of deferred patent litigation costs ............... -- 2,366,200 -- Provision for income taxes ....... (497,551) 2,850,000 -- (Increase) decrease in operating assets, net: Receivable from litigation award ....................... 77,223,460 (77,223,460) -- Accounts and notes receivable (3,911,903) (891,793) 297,973 Costs and estimated earnings in excess of billings on uncompleted contracts ....... (814,750) (482,410) 12,537 Inventories ................... (73,113) 638,735 (916,898) Prepaid expenses and other current assets .............. 123,708 515,504 (207,608) Other assets .................. (270,830) (33,687) (12,049) Receivables and advances to related parties ............. 578,511 681,232 (132,117) Increase (decrease) in operating liabilities, net: Accounts payable ........... (175,483) (320,501) 84,588 Other current liabilities .. (1,998,835) 5,114,858 (1,361,848) Customer advances .......... (94,671) (169,202) 640,117 Billings in excess of costs and estimated earnings on uncompleted contracts ................. (161,900) 22,924 158,906 Other liabilities .......... 12,722 (39,982) (39,998) Deferred taxes payable ..... (1,200,000) -- -- ------------ ------------ ------------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES .. 68,618,521 (3,646,936) (7,440,786) ------------ ------------ ------------
See accompanying notes to consolidated financial statements F-13 FONAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended June 30, -------------------------------------------- 1998 1997 1996 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Investment in marketable securities .. $(20,294,129) $ -- $ -- Acquisitions, net of cash acquired.... (4,025,000) -- -- Purchases of property and equipment, net of capital lease obligations of $1,391,304, $227,665 and $965,442 for the years ended June 30, 1998, 1997 and 1996, respectively................ (2,785,795) (1,256,203) (186,188) Cost of capitalized software development......................... -- (108,809) (505,990) Cost of patents and copyright......... (19,114) (162,297) (103,579) ------------ ------------ ------------ NET CASH USED IN INVESTING ACTIVITIES ..................... (27,124,038) (1,527,309) (795,757) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from bank borrowings, net of capital lease obligations ... 5,000,000 -- -- Restricted cash for collateral of bank loan .......................... (5,000,000) -- -- Repayment of borrowings and capital lease obligations .................. (2,260,424) (745,245) (1,034,927) Proceeds from exercise of stock options and warrants ............... 1,353 3,516 5,859 Repayments of notes receivable in connection with shares issued under stock option and bonus plans . 600,493 7,916,307 9,726,900 Dividends paid ....................... (3,945,701) -- -- ------------ ------------ ------------ NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES ........... (5,604,279) 7,174,578 8,697,832 ------------ ------------ ------------ INCREASE IN CASH ....................... 35,890,204 2,000,333 461,289 CASH - BEGINNING OF YEAR ............... 5,861,500 3,861,167 3,399,878 ------------ ------------ ------------ CASH - END OF YEAR ..................... $ 41,751,704 $ 5,861,500 $ 3,861,167 ============ ============ ============
See accompanying notes to consolidated financial statements. F-14 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 1 - DESCRIPTION OF BUSINESS FONAR Corporation (the "Company" or "FONAR") is a Delaware corporation which was incorporated on July 17, 1978. FONAR is engaged in the research, development, production and marketing of medical scanning equipment which uses principles of Magnetic Resonance Imaging ("MRI") for the detection and diagnosis of human diseases. In addition to deriving revenues from the direct sale of MRI equipment, revenue is also generated from its installed base of customers through its service and upgrade programs. Health Management Corporation of America ("HMCA") was organized by the Company in March 1997 as a wholly-owned subsidiary in order to enable the Company to expand into the business of providing comprehensive management services to medical providers, sometimes referred to as "Physician Practice Management" or ("PPM"), including diagnostic imaging centers and ancillary services. The services to be provided by the Company include development, administration, leasing of office space, facilities and medical equipment, provision of supplies, staffing and supervision of non-medical personnel, legal services, accounting, billing and collection and the development and implementation of practice growth and marketing strategies. HMCA entered the PPM business through the consummation of two acquisitions, effective June 30, 1997, and two acquisitions which were consummated during fiscal 1998. The acquired companies in all cases were actively engaged in the business of managing medical providers. The medical providers are diagnostic imaging centers, principally MRI scanning centers, multi-specialty practices and primary care practices. F-15 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation --------------------------- The consolidated financial statements include the accounts of FONAR Corporation, its majority and wholly-owned subsidiaries/ partnerships and its proportionate share in the accounts of all joint ventures. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates ---------------- The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The most significant estimates relate to contractual and other allowances, income taxes, contingencies and the useful lives of equipment. In addition, healthcare industry reforms and reimbursement practices will continue to impact the Company's operations and the determination of contractual and other allowance estimates. Actual results could differ from those estimates. Investment in Marketable Securities ----------------------------------- The Company accounts for its investments using Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in debt and Equity Securities" ("SFAS No. 115"). This standard requires that certain debt and equity securities be adjusted to market value at the end of each accounting period. Unrealized market value gains and losses are charged to earnings if the securities are traded for short-term profit. Otherwise, such unrealized gains and losses are charged or credited to comprehensive income. Management determines the proper classifications of investments in obligations with fixed maturities and marketable equity securities at the time of purchase and reevaluates such designations as of each balance sheet date. At June 30, 1998, all securities covered by SFAS No. 115 were designated as available for sale. Accordingly, these securities are stated at fair value, with unrealized gains and losses reported in comprehensive income. Realized gains and losses on sales of investments, as determined on a specific identification basis, are included in the Consolidated Statement of Operations. F-16 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Inventories ----------- Inventories consist of purchased parts, components and supplies, as well as work-in-process, and are stated at the lower of cost (materials, labor and overhead determined on the first-in, first-out method) or market. Investments in Joint Ventures and Limited Partnerships ------------------------------------------------------ The minority interests in the equity of consolidated joint ventures and limited partnerships, which are not material, are reflected in the accompanying consolidated financial statements. Investments by the Company in joint ventures and limited partnerships over which the Company can exercise significant influence but does not control are accounted for using the equity method. The Company suspends recognition of its share of joint ventures losses in entities in which it holds a minority interest when its investment is reduced to zero. The Company does not provide for additional losses unless, as a partner or joint venturer, the Company has guaranteed obligations of the joint venture or limited partnership. Property and Equipment ---------------------- Property and equipment procured in the normal course of business is stated at cost. Property and equipment purchased in connection with an acquisition is stated at its estimated fair value, generally based on an appraisal. Property and equipment is being depreciated for financial accounting purposes using the straight-line method over the shorter of their estimated useful lives, generally five to seven years, or the term of a capital lease, if applicable. Leasehold improvements are being amortized over the shorter of the useful life or the remaining lease term. Upon retirement or other disposition of these assets, the cost and related accumulated depreciation of these assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gains or losses are reflected in the results of operations. Expenditures for maintenance and repairs are charged to operations. Renewals and betterments are capitalized. F-17 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Excess of Cost Over Net Assets of Businesses Acquired ----------------------------------------------------- The excess of the purchase price over the fair market value of net assets of businesses acquired is being amortized using the straight-line method over 20 years. Other Intangible Assets ----------------------- 1)Capitalized Software Development Costs Certain software development costs incurred subsequent to the establishment of the software's technological feasibility and completion of the research and development on the product hardware, in which it is to be used, are required to be capitalized. Capitalization ceases when the product is available for general release to customers, at which time amortization of capitalized costs begins. Amortization is calculated on the straight-line basis over 5 years. 2)Patents and Copyrights Amortization is calculated on the straight-line basis over 17 years. Long-Lived Assets ----------------- The Company periodically assesses the recoverability of long-lived assets, including property and equipment, intangibles and excess of cost over net assets of businesses acquired, when there are indications of potential impairment, based on estimates of undiscounted future cash flows. The amount of impairment is calculated by comparing anticipated discounted future cash flows with the carrying value of the related asset. In performing this analysis, management considers such factors as current results, trends, and future prospects, in addition to other economic factors. Revenue Recognition ------------------- Revenue on sales contracts for scanners is recognized under the percentage-of-completion method. The Company manufactures its scanners under specific contracts that provide for progress payments. Production and installation take approximately six months. The percentage of completion is determined by the ratio of costs incurred to date on completed sub-assemblies to the total estimated cost for each scanner. F-18 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Contract costs include material, direct labor and overhead. Provisions for estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. The asset, "Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts", represents revenues recognized in excess of amounts billed. The liability, "Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts", represents billings in excess of revenues recognized. Revenue on scanner service contracts are recognized on the straight-line method over the related contract period, usually one year. Revenue from sales of other items are recognized upon shipment. Revenue under management contracts is recognized based upon contractual agreements for management services rendered by the Company under various long-term agreements with related medical providers (the "PC's"), commencing July 1, 1997. The PC's are primarily owned by Raymond V. Damadian, M.D., President and Chairman of the Board of FONAR. The Company's agreements with the PC's stipulate fees for services rendered, are primarily calculated on activity based efforts at pre-determined rates per unit of activity. All fees are re-negotiable at the anniversary of the agreements and each year thereafter. Research and Development Costs ------------------------------ Research and development costs are charged to expense as incurred. The costs of materials and equipment that are acquired or constructed for research and development activities, and have alternative future uses (either in research and development, marketing or production), are classified as property and equipment and depreciated over their estimated useful lives. Certain software development costs are capitalized. See property and equipment and intangible assets (capitalized software development costs) sections of this note. Advertising Costs ----------------- Advertising costs are expensed as incurred. Income Taxes ------------ Deferred tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Product Warranty ---------------- The Company provides currently for the estimated cost to repair or replace products under warranty provisions in effect at the time of installation (generally for one year). F-19 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Customer Advances ----------------- Cash advances and progress payments received on sales orders are reflected as customer advances until such time as revenue recognition begins. Per Share Data -------------- Net income (loss) per common and common equivalent share has been computed based on the weighted average number of common shares and common stock equivalents outstanding during the year. No effect has been given to options outstanding under the Company's Stock Option Plans as no material dilutive effect would result from the exercise of these items. During fiscal 1998, the Company retroactively adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"), which requires companies to present basic earnings per share and diluted earnings per share. No adjustments were required as a result of this adoption. Cash and Cash Equivalents ------------------------- The Company considers all short-term highly liquid investments with a maturity of three months or less when purchased to be cash or cash equivalents. Restricted Cash --------------- At June 30, 1998, $5,000,000 of cash was pledged as collateral on an outstanding bank loan and was classified as restricted cash on the balance sheet. Concentration of Credit Risk ---------------------------- Financial instruments, which potentially subject the Company to concentrations of credit risk, are primarily cash, trade accounts receivable, notes receivable, investment in sales-type leases and investments, advances and notes to affiliates and related parties. Ongoing credit evaluations of customers' financial condition are performed. The Company generally retains title to the MRI scanners that it sells until the scanners have been paid in full. The Company's customers are concentrated in the industry of providing MRI scanning services. Various related parties (Note 3), accounted for approximately 77%, 55% and 57% of revenues for the years ended June 30, 1998, 1997 and 1996, respectively. At June 30, 1998, the Company had cash deposits approximately $45,000,000 in excess of federally insured limits. F-20 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Fair Value of Financial Instruments ----------------------------------- The financial statements include various estimated fair value information at June 30, 1998, 1997 and 1996, as required by Statement of Financial Accounting Standards 107, "Disclosures about Fair Value of Financial Instruments". Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that Statement and does not purport to represent the aggregate net fair value to the Company. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value: Cash and cash equivalents: The carrying amount approximates fair value because of the short-term maturity of those instruments. Accounts receivable and accounts payable: The carrying amounts approximate fair value because of the short maturity of those instruments. Investment in sales-type leases and investments, advances and notes to affiliates and related parties. The carrying amount approximates fair value because the discounted present value of the cash flow generated by the related parties approximates the carrying value of the amounts due to the Company. Long-term debt and loans payable: The carrying amounts of debt and loans payable approximate fair value due to the length of the maturities, the interest rates being tied to market indices and/or due to the interest rates not being significantly different from the current market rates available to the Company. All of the Company's financial instruments are held for purposes other than trading. Stock-Based Compensation ------------------------ Effective for fiscal year 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation", which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide proforma net income and proforma earnings per share disclosures for employee stock option grants made during the year ended June 30, 1998 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the proforma disclosure provisions of SFAS No. 123. F-21 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounting Changes ------------------ In November 1997, Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"), was issued which establishes standards for reporting and displaying comprehensive income in a full set of financial statements. SFAS No. 130 defines comprehensive income as changes in equity of a business enterprise during the periods presented, except for transactions resulting from investments by an owner and distribution to an owner. SFAS No. 130 does not require a company to present a statement of comprehensive income if no items are present. The Company adopted SFAS No. 130 during fiscal 1998. New Pronouncements ------------------ In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use", which revises the accounting for software development costs and will require the capitalization of certain costs. The Company recognizes the need to ensure its operations will not be adversely impacted by Year 2000 software failures. Software failures due to processing errors potentially arising from calculations using the Year 2000 date are a known risk. The Company is addressing this risk to the availability and integrity of financial systems and the reliability of operational systems. The Company has established processes for evaluating and managing the risks and costs associated with this problem. The computing portfolio was identified and an initial assessment has been completed. The cost of achieving Year 2000 compliance will not have a material impact on the accompanying financial statements. Reclassifications ----------------- Certain prior year balances have been reclassified to conform with the current year presentation. NOTE 3 - ACQUISITIONS Affordable Diagnostics, Inc. ---------------------------- On June 30, 1997, the Company's wholly-owned subsidiary consummated the merger of the assets, liabilities and operations of Affordable Diagnostics, Inc. ("Affordable"), a New York corporation, which managed and operated three diagnostic imaging centers and managed one multi-specialty practice in the Bronx and Westchester, New York. The merger was consummated pursuant to a Merger Agreement ("Agreement") effective June 30, 1997, by and among HMCA's wholly-owned subsidiary, HMCM, Inc. ("HMCM"). Pursuant to the agreement, HMCM acquired all of the assets and liabilities of Affordable through the issuance of 1,764,000 shares of the Company's Common Stock, valued at $3,630,312. F-22 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 3 - ACQUISITIONS (Continued) The merger was accounted for as a purchase, under which the purchase price was allocated to the acquired assets and assumed liabilities based upon fair values at the date of the merger. The excess of the purchase price over the fair value of the net assets acquired amounted to approximately $2,796,000 and is being amortized on a straight-line basis over 20 years. Subject to the centers achieving certain earning objectives within the next one year, an additional 576,000 shares would be issued to the sellers. During fiscal 1998, the earnings objectives were achieved and, accordingly, 576,000 shares of common stock were issued to the sellers. The value assigned to the additional shares issued was $923,442 and has been recorded as additional goodwill subject to amortization over the stated period. The accompanying consolidated financial statements include the operations of Affordable from the date of the acquisition. The shares issued to the Sellers as consideration pursuant to the Agreement are subject to certain registration rights. Concurrent with the above described transactions, HMCM entered into consulting agreements with the shareholders of Affordable. Under such agreements, 400,000 registered shares of FONAR's common stock, valued at $1,096,000, were issued pursuant to one year consulting agreements with HMCM. Acquisition of RVDC ------------------- Effective June 30, 1997, FONAR's wholly-owned subsidiary, HMCA, acquired Raymond V. Damadian, M.D. MR Scanning Centers Mangement Company ("RVDC") and two affiliates, by purchasing all of the issued and outstanding shares of RVDC from Dr. Damadian for 10,000 shares of the common stock of FONAR. The business of RVDC, continued by HMCA was the management of MRI diagnostics imaging centers in New York, Florida and Georgia. The Company has accounted for the acquisition in a manner similar to the pooling-of-interests method due to Dr. Damadian's control over both the Company and RVDC. Accordingly, all financial data for the period from July 1, 1995 have been restated to include the results of RVDC. Prior to June 30, 1997, the Company and RVDC, in the normal course of business entered into certain transactions for the purchase and sale of equipment and service contracts. These intercompany transactions have been eliminated in the accompanying financial statements. Effective July 1, 1997, immediately following the effective date of the acquisition of RVDC by HMCA, all previous management arrangements between RVDC and the imaging centers were terminated and new management agreements and/or scanner lease agreements were entered into by the Centers and HMCA. F-23 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 3 - ACQUISITIONS (Continued) Summarized results of operations of the separate companies for the years ended June 30 are as follows: 1997: ---- Company RVDC Adjustment Consolidated ----------- ----------- ----------- ------------ Net revenues $10,065,830 $ 8,094,286 $ (527,050) $ 17,633,066 =========== =========== =========== ============ Net income $29,838,520 $ 4,321,552 $21,908,699 $ 56,068,771 =========== =========== =========== ============ 1996: ---- Company RVDC Adjustment Consolidated ----------- ----------- ----------- ------------ (As Previously (As Restated) Reported) Net revenues $13,130,003 $ 5,669,056 $(4,883,334) $ 13,915,725 =========== =========== =========== ============ Net income (loss)$(3,376,411) $(4,823,564) $(3,207,469) $(11,407,444) =========== =========== =========== ============ Central Health Care Management Service, Inc. ------------------------------------------- On January 23, 1998, a wholly-owned subsidiary of HMCA acquired the business and assets of Central Health Care Management Services, Inc., a management service organization "MSO" operating in Westchester County, New York. The purchase price is to be determined in the future based on a multiple of the net positive cash flow from the acquired business over the succeeding twelve-month period. The purchase price, when determined, is payable 1/3 in cash or marketable securities, 1/3 in notes and 1/3 in shares of common stock of FONAR or HMCA. An advance of $50,000 was remitted to the seller at the closing date. Based on current financial data, the purchase price is expected to range from $660,000 to $1,100,000. Included in accrued liabilities at June 30, 1998 is $1,000,000 representing an estimate of the additional purchase price. Based on this estimate, the excess of the cost over the acquired net assets would approximate $850,000. F-24 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 3 - ACQUISITIONS (Continued) A&A Services, Inc. ------------------ On March 20, 1998, the Company's physician management subsidiary, HMCA, consummated the acquisition of the common stock of A&A Services, Inc. ("A&A"), a New York corporation, which manages four primary care practices in Queens, New York. Pursuant to the A&A agreements, HMCA acquired all of the common stock of A&A for $4,000,000 in cash, a note payable for $4,000,000 bearing interest at 6.0% per annum, payable in 16 equal quarterly installments of interest and principal, commencing March of 1999, a note payable for $1,293,000, bearing interest at 6.0% per annum, payable in 60 equal monthly installments of principal and interest, commencing April 20, 1998, a deferred payment obligation face amount of $2,000,000 and a contingent payment based on the acquired operations achieving certain earnings objectives over the five-year period following the acquisition date. The promissory notes are collateralized by all of the assets of the acquired operations and are guaranteed by FONAR. The deferred payment obligation of $2,000,000 is convertible into shares of HMCA's common stock upon the effectiveness of an Initial Public Offering ("IPO") of HMCA's securities, provided the IPO is completed by September 20, 2000. In the event an IPO of HMC's securities is not completed by such date, the deferred payment obligation of $2,000,000 is then payable over the following four years with interest at 6.0% per annum. At such time when the deferred payment obligation is converted into shares of HMC's common stock, the holders of such shares will then have certain price protection guarantees from FONAR for a two-year period following such conversions. The acquisition was accounted for as a purchase, under which the purchase price was allocated to the acquired assets and assumed liabilities based upon fair values at the date of the acquisition. The excess of the purchase price over the fair value of the net assets acquired amounted to approximately $10,448,000 and is being amortized on a straight-line basis over 20 years. The accompanying consolidated financial statements include the operations of A&A from the date of the acquisition. Subject to the acquired business achieving certain earnings objectives over the five-year period following the date of acquisition, additional monies would be due to the sellers. The contingent additional purchase price is not determinable as of June 30, 1998 and, accordingly, has not been included in the allocated purchase price in light of the contingent nature of the arrangement. If the earnings objectives are ultimately achieved, the additional purchase price will be recorded as additional goodwill subject to amortization over the stated period. F-25 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 4 - MARKETABLE SECURITIES --------------------- The following is a summary of marketable securities at June 30, 1998: Unrealized Holdings Fair Market Cost Gains (Loss) Value ----------- ----------- ----------- U.S. Government Obligations $ 6,660,360 $ 274 $ 6,660,634 Corporate and government agency bonds 2,595,960 462 2,596,422 Equity securities including mutual stock funds 11,037,808 (43,032) 10,994,776 ----------- -------- ----------- $20,294,128 $(42,296) $20,251,832 =========== ======== =========== NOTE 5 - ACCOUNTS RECEIVABLE, NET ------------------------ Accounts receivable, net is comprised of the following: 1998 1997 ----------- ---------- Receivable from equipment sales $ 1,930,204 $2,314,133 Receivables assigned from related PC's 10,344,490 9,096,318 Less: Allowance for doubtful accounts and contractual allowances (2,397,348) (5,410,388) ---------- --------- $ 9,877,346 $6,000,063 =========== ========== The Company's receivable assigned from the related PC's substantially consists of fees outstanding under management agreements and service contracts with related PC's. Payment of the outstanding fees is based on collection by the PC's of fees from third party medical reimbursement organizations, principally insurance companies. F-26 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 5 - ACCOUNTS RECEIVABLE, NET (Continued) Approximately 14% and 13% of the PC's 1998 and 1997 imaging revenue was derived from the delivery of services, of which the timing of payment is substantially contingent upon the timing of settlement of pending litigation involving the recipient of services and third parties (Letter of Protection or "LOP-type" accounts receivable). By its nature, the realization of a substantial portion of these receivables is expected to extend beyond one year from the date the service was rendered. The Company anticipates that a material amount of its accounts receivable will be outstanding for periods in excess of twelve months in the future. The Company considers the aging of its accounts receivable in determining the amount of allowance for doubtful accounts. Credit losses associated with the receivables are provided for in the consolidated financial statements and have historically been within management's expectations. For LOP-type receivables, the Company provides for uncollectible accounts at substantially higher rates than any other revenue source. NOTE 6 - COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS AND CUSTOMER ADVANCES 1)Information relating to uncompleted contracts as of June 30, 1998 and 1997 is as follows: As of June 30, ------------------------ 1998 1997 ---------- ---------- Costs incurred on uncompleted contracts $2,265,343 $2,360,010 Estimated earnings 560,898 429,673 ---------- ---------- 2,826,241 2,789,683 Less: Billings to date 2,023,658 2,163,750 ---------- ---------- $ 802,583 $ 625,933 ========== ========== F-27 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 6 - COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS AND CUSTOMER ADVANCES (Continued) Included in the accompanying consolidated balance sheets under the following captions: As of June 30, ----------------------------- 1998 1997 ---------- --------- Costs and estimated earnings in excess of billings on uncompleted contracts $ 833,615 $ 818,865 Billings in excess of costs and estimated earnings on uncompleted contracts (31,032) (192,932) --------- --------- $ 802,583 $ 625,933 ========= ========= 2)Customer advances consist of the following: As of June 30, ------------------------------ 1998 1997 ---------- ---------- Total advances from customers $2,693,389 $2,928,152 Less: Advances from customers on contracts under construction 2,023,658 2,163,750 ---------- ---------- $ 669,731 $ 764,402 ========== ========== NOTE 7 - INVENTORIES Inventories included in the accompanying consolidated balance sheets consist of: June 30, ----------------------------- 1998 1997 ---------- ---------- Purchased parts, components and supplies $2,548,596 $2,534,028 Work-in-process 965,026 906,481 ---------- ---------- $3,513,622 $3,440,509 ========== ========== F-28 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 8 - PROPERTY AND EQUIPMENT Property and equipment, at cost, less accumulated depreciation and amortization, at June 30, 1998 and 1997, is comprised of: June 30, ------------------------- 1998 1997 ---------- ---------- Equipment under construction $1,086,118 $ 315,000 Diagnostic equipment 6,560,772 6,215,739 Offsite research scanner 1,154,217 1,154,217 Research, development and demonstration equipment 6,638,985 5,591,626 Machinery and equipment 4,784,164 3,880,488 Furniture and fixtures 2,987,930 1,872,166 Property under lease 2,616,890 2,117,711 Leasehold improvements 2,116,171 1,666,975 ---------- ---------- 27,945,247 22,813,922 Less: Accumulated depreciation and amortization 18,843,008 16,745,247 ---------- ---------- $9,102,239 $6,068,675 ========== ========== Depreciation and amortization of property and equipment for the years ended June 30, 1998, 1997 and 1996 was $2,243,535, $1,166,951 and $1,026,091, respectively. The property under lease has a net book value of $1,736,775 and $1,161,264 at June 30, 1998 and 1997, respectively. NOTE 9 - OTHER INTANGIBLE ASSETS Other intangible assets, net of accumulated amortization, at June 30, 1998 and 1997 are comprised of: June 30, ------------------------- 1998 1997 ---------- ---------- Capitalized software development costs $1,359,618 $1,359,618 Patents and copyrights 1,125,237 1,106,123 ---------- ---------- 2,484,855 2,465,741 Less: Accumulated amortization 1,323,254 921,270 ---------- ---------- $1,161,601 $1,544,471 ========== ========== F-29 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 9 - OTHER INTANGIBLE ASSETS (Continued) Capitalized computer software costs are being amortized over 5 years. Patents costs are being amortized over 17 years. Amortization of other intangible assets for the years ended June 30, 1998, 1997 and 1996 was $401,984, $820,514 and $1,231,093, respectively. NOTE 10 - SIGNIFICANT CUSTOMERS AND DISTRIBUTION AGREEMENTS The Company's machine sale revenues for the three years ended June 30, 1998 were derived as follows: Customers ------------------------- Percent of Foreign Foreign Years Ended (Korea and Revenues to June 30, Domestic Saudi Arabia) Total Total Revenues ----------- -------- ------------ ----- -------------- 1998 9 2 11 5% 1997 7 3 10 4% 1996 9 5 14 17% During the years ended June 30, 1998, 1997 and 1996, revenues from related parties were 77%, 55% and 57%, respectively, of total revenues. Not one unrelated customer accounted for more than 10% of total revenues during fiscal years 1998, 1997 and 1996. Distributorship Agreements -------------------------- In order to facilitate the marketing of its products, the Company has entered into agreements granting exclusive and non-exclusive rights to distribute the Company's existing and certain future products in Europe, Asia and Latin America. F-30 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 11 - CAPITAL STOCK The total number of shares of stock which the Company is authorized to issue is 92,000,000 shares. The classes and the aggregate number of shares of stock of each class are as follows: 1)60,000,000 shares of common stock with a par value of $.0001 per share. On April 3, 1995, shareholders approved an increase in the authorized common shares from 50,000,000 to 60,000,000. 2)4,000,000 shares of Class B common stock, having a par value of $.0001 per share. 3)10,000,000 shares of Class C common stock, having a par value of $.0001 per share (see below). 4)8,000,000 shares of Class A non-voting preferred stock, having a par value of $.0001 per share (see below). 5)10,000,000 shares of preferred stock, having a par value of $.001 per share. Common Stock ------------ Cash dividends payable on the common stock shall, in all cases, be on a per share basis, one hundred twenty percent (120%) of the cash dividend payable on shares of Class B common stock and three hundred sixty percent (360%) of the cash dividend payable on a share of Class C common stock. In addition, as revised pursuant to a legal settlement agreement on April 29, 1997, a special cash dividend shall be payable in an amount equal to 3-1/4% on first $10 million, 4-1/2% on next $20 million, and 5-1/2% on amounts in excess of $30 million of the amount of any cash awards or settlements received by the Company in connection with the enforcement by the Company of United States Patent No. 3,789,832 (Apparatus and Method of Detecting Cancer in Tissue). Pursuant to such dividend entitlement, the Company recorded an obligation of $2,551,146, or approximately $.05 per share of common stock, during fiscal 1997. Class B Common Stock -------------------- Class B common stock is convertible into shares of common stock on a one-for-one basis. Class B common stock has 10 votes per share. During the year ended June 30, 1996, 437 shares of Class B common stock were converted to common stock leaving 5,411 of such shares outstanding as of June 30, 1998. F-31 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 11 - CAPITAL STOCK (Continued) Class C Common Stock -------------------- On April 3, 1995, the shareholders ratified a proposal creating a new Class C common stock and authorized the exchange offering of three shares of Class C common stock for each share of the Company's outstanding Class B common stock. The Class C common stock has 25 votes per share, as compared to 10 votes per share for the Class B common stock and one vote per share for the common stock. The Class C common stock was offered on a three-for-one basis to the holders of the Class B common stock. Although having greater voting power, each share of Class C common stock has only one-third of the rights of a share of Class B common stock to dividends and distributions. Class C common stock is convertible into shares of common stock on a three-for-one basis. During the year ended June 30, 1996, approximately 3.2 million shares of Class B common stock were converted to Class C common stock. Class A Non-Voting Preferred Stock ---------------------------------- On April 3, 1995, the shareholders ratified a proposal consisting of the creation of a new class of Class A non-voting preferred stock with special dividend rights and the declaration of a stock dividend on the Company's common stock consisting of one share of Class A non-voting preferred stock for every five shares of common stock. The stock dividend was payable to holders of common stock on October 20, 1995. Class A non-voting preferred stock issued pursuant to such stock dividend approximates 7.8 million shares. The Class A non-voting preferred stock is entitled to a special dividend equal to 3-1/4% of first $10 million, 4-1/2% of next $20 million and 5-1/2% on amount in excess of $30 million of the amount of any cash awards or settlements received by the Company in connection with the enforcement of five of the Company's patents in its patent lawsuits, discussed in Note 14, less the revised special dividend payable on the common stock with respect to one of the Company's patents. Pursuant to such dividend entitlement, the Company recorded an obligation of $5,086,695, or $.65 per share of Class A preferred stock, during fiscal 1997 and $217,226, or $.03 per share of Class A preferred stock, during fiscal 1996. The Class A non-voting preferred stock participates on an equal per share basis with the common stock in any dividends declared and ranks equally with the common stock on distribution rights, liquidation rights and other rights and preferences (other than the voting rights). The above described features essentially enable the holders of the Class A non-voting preferred stock to share in the earnings potential of the Company on substantially the same basis as the common stock. Accordingly, the Company has classified the Class A non-voting preferred stock as a common stock equivalent. Earnings per share and weighted average shares outstanding have been restated to reflect the Class A non-voting preferred stock dividend. F-32 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 11 - CAPITAL STOCK (Continued) As of June 30, 1998 and 1997, the financial statements reflect authorized Class A non-voting preferred shares of 8,000,000 and deemed issued and outstanding shares of 7,855,627, respectively. Warrants -------- As part of the settlement agreement dated April 29, 1997, the holders of the Company's common stock as of October 20, 1995 received, as of July 29, 1997, one warrant to purchase one share of the Company's common stock for every eight shares of common stock. The total warrants issuable under this agreement totalled 4,909,767 and were exercisable at $2.938 per share, less the special dividend declared on the common stock, as discussed above. The warrants were valued at approximately $5,200,000 and were recorded as a stock dividend out of paid-in capital for the year ended June 30, 1997. On March 2, 1998, the Court of Chancery approved a modification of the settlement agreement dated April 29, 1997, whereby the Company issued 2,226,343 shares of common stock in exchange for cancellation of the 4,909,767 warrants. Options ------- The Company has seven stock option plans which provide for the awarding of incentive and non-qualified stock options to employees, directors and consultants who may contribute to the success of the Company. The options granted vest either immediately or ratably over a period of time from the date of grant, typically three or four years, at a price determined by the Board of Directors or a committee of the Board of Directors, generally the fair value of the Company's common stock at the date of grant. The options must be exercised within ten years from the date of grant. The Company accounts for these plans under APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with FASB Statement No. 123, the Company's net income and earnings per share would have been reduced to the proforma amounts for the years ended June 30, 1997 and 1996 as indicated below: 1997 1996 ------------ ------------ Net income (loss): As reported $ 56,068,771 $(11,407,444) Proforma $ 55,188,946 $(12,698,685) Primary earnings per share: As reported $1.00 $(.22) Proforma $0.98 $(.25) F-33 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 11 - CAPITAL STOCK (Continued) The fair value of each option grant under all plans is estimated on the date of grant using the Black-Scholes option-pricing model based on the following assumptions: 1997 1996 ---------- ---------- All Plans: Dividend yield 0% 0% Expected volatility 33% 33% Expected life (years) 1 1 The risk-free interest rates for 1997 and 1996 were based upon a rate with maturity equal to expected term. U.S. Treasury instruments were utilized. The weighted average interest rate in 1997 and 1996 amounted to 5.0% . Stock option share activity and weighted average exercise prices under these plans and grants for the years ended June 30, 1998, 1997 and 1996 were as follows: Weighted Average Number of Exercise Shares Price ---------- ---------- Outstanding, June 30, 1995 223,360 $ 4.48 Granted 3,154,000 2.69 Exercised (3,182,125) 2.69 Forfeited - - ---------- ------ Outstanding, June 30, 1996 195,235 4.62 Granted 2,350,000 2.43 Exercised (2,359,375) 2.42 Forfeited - - ---------- ------ Outstanding, June 30, 1997 185,860 4.62 Granted 556,200 2.99 Exercised (559,325) 2.98 Forfeited - - ---------- ------ Outstanding, June 30, 1998 182,735 $ 4.62 ========== ====== Exercisable at: June 30, 1996 181,235 $ 4.62 June 30, 1997 181,235 $ 4.62 June 30, 1998 178,110 $ 4.62 The exercise price for options outstanding as of June 30, 1998 ranged from $1.06 to $5.00. F-34 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 11 - CAPITAL STOCK (Continued) Stock Bonus Plans ----------------- On May 9, 1997, April 1, 1995, December 1, 1993, March 26, 1993 and January 17, 1986, the Board of Directors adopted Stock Bonus Plans. Under the terms of the Plans, 5,000,000, 5,000,000, 5,000,000, 2,500,000 and 1,250,000 shares, respectively, of common stock were reserved for issuance and stock bonuses may be awarded no later than March 31, 2005 for the 1995 Plan, November 30, 2003 for the 1994 Plan, March 25, 2003 for the 1993 Plan and January 16, 1996 for the 1986 Plan. An amendment to the 1986 Plan was approved by the Board of Directors on August 26, 1986, whereby an additional 1,250,000 shares were reserved for issuance. During fiscal 1998, 1997 and 1996, 1,653,433, 2,138,296 and 1,463,741 shares, respectively, were issued under the stock bonus plans, of which 4,300, 159,025 and 161,341 shares, respectively, were charged to operations as compensation expense, 632,475, 579,271 and 802,400 shares, respectively, were issued in settlement of liabilities, 155,770, 1,000,000 and 500,000 shares, respectively, were issued in exchange for notes, and 223,030 shares were issued in fiscal 1998 in connection with consulting agreements during 1998 and 400,000 shares were issued during fiscal 1997 in connection with consulting agreements pursuant to the acquisition of Affordable. Compensation expense recognized during the fiscal years ended June 30, 1998, 1997 and 1996 approximated $2,748,000, $407,000 and $355,000, respectively. The balance due under these notes was paid in full. F-35 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 12 - LONG-TERM DEBT, NOTES PAYABLE AND CAPITAL LEASES Long-term debt, notes payable and capital leases consist of the following: June 30, -------------------- 1998 1997 ---------- -------- Represents debt assumed in the Affordable acquisition and consists of a loan with interest at 3% above prime. The loan is to finance a contract to promote and install a picker 1.0 HPQ system within an MRI mobile trailer. The contract is for a price of $525,000. The loan is to be repaid by monthly payments of interest only until acceptance of the equipment upon acceptance repayment of the loan is to be negotiated at mutually agreed upon term. $ 324,266 $ 315,000 Short-term bank credit and loans, with interest at 10.8%, secured by certain assets of the Company. 80,000 100,000 Promissory note payable to a bank, collateralized by $5 million certificate of deposit, requiring monthly payments of interest only, at a rate of 6.06% per annum with payment of the entire principal due on March 20, 2003. 5,000,000 - Note payable to the former shareholders of A&A $ 324,266 $ 315,000 Services, Inc., The note calls for 16 quarterly payments of $300,044, including interest at a rate of 6%, commencing March 20, 1999. The note is collateralized by all of the assets acquired and guaranteed by the Company. 4,000,000 - F-36 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 12 - LONG-TERM DEBT, NOTES PAYABLE AND CAPITAL LEASES (Continued) June 30, -------------------- 1998 1997 ---------- -------- Note payable to the former shareholder of A&A Services, Inc. The note calls for 60 equal monthly installments of principal and interest of $25,000, including interest at a rate of 6% per annum, commencing April 20, 1998. The note is collateralized by all of the assets acquired and guaranteed by the Company. $1,237,258 $ - Note payable dated June 1990 - $765,063, payable interest only at 12%, through July 1991 when the entire balance is due. Repayment terms were $1,237,258 $ - modified during November 1992 requiring 62 monthly payments of $16,601 with the balance due on December 12, 1997. Payments include interest at a rate of 12% and is secured by scanning equipment. - 392,181 Note payable related to construction of a machine, calling for monthly payments of $9,034, including interest at a rate of 8.875% through July 2002. The loan is collateralized by equipment located in Ellwood, Pennsylvania. 369,360 400,000 Capital lease dated March 5, 1993 - $340,895, due - 392,181 $11,162 per month, commencing April 1993, including interest at 11% for 36 months. Such lease is collateralized by equipment, which has been classified as property under lease in the accompanying financial statements. Repayment terms were modified in May 1995 requiring 36 monthly payments of $5,117. 62,306 72,628 Capital lease requiring monthly payments of 369,360 400,000 $12,595, including interest at a rate of 9% through October 1, 2002. The loan is collateralized by related equipment. 535,183 - F-37 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 12 - LONG-TERM DEBT, NOTES PAYABLE AND CAPITAL LEASES (Continued) June 30, ---------------------- 1998 1997 ---------- --------- Deferred payment obligation, aggregating $2,000,000, payable to the former shareholder of A&A Services, Inc., automatically convertible into HMC's common stock upon an initial public offering of HMC's securities if completed by September 20, 2000. If the offering is not completed, the obligation is payable over four years with interest at 6% per annum. The obligation has been recorded with interest imputed at a rate of 6%. $1,807,000 $ - Capital lease dated October 13, 1995 - $513,692, due $11,173 per month, commencing October 1995, including interest of 11% for 60 months. Such lease is collateralized by equipment, which has been classified as property under lease in the $1,807,000 $ - accompanying financial statements. 327,940 385,637 Capital lease dated June 4, 1996 - $412,550, due $8,972 per month, commencing July 1996, including interest of 11% for 60 months. Such lease is collateralized by equipment, which has been classified as property under lease in the accompanying financial statements. 310,587 364,559 Capital lease obligations with maturity dates through November 15, 2000 requiring monthly 327,940 385,637 payments, aggregating $24,750, including interest at 13.15%. 637,344 921,354 Capital lease obligation assumed in connection with the Affordable acquisition related to a purchase of medical equipment aggregating $349,738, due $8,477 per month, including interest of 12.3% through August 31, 2001. Such lease is collateralized by the related equipment. 265,737 325,323 F-38 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 12 - LONG-TERM DEBT, NOTES PAYABLE AND CAPITAL LEASES (Continued) June 30, --------------------- 1998 1997 ---------- -------- Capital lease obligation assumed in connection with the Affordable acquisition related to a purchase of medical equipment aggregating $151,364, due $3,378 per month, including interest of 12.15% through August 2001, is collateralized by the related equipment. $108,411 $132,040 Capital lease obligations assumed in connection with the Affordable acquisition related to the purchase of medical equipment aggregating $94,125, $ 108,411 $ 132,040 calling for payments for $1,760 per month, including interest at rates averaging 13.0%, expiring at various dates through May 2002. Such leases have been collateralized by the related equipment. 55,447 66,541 Other (including capital leases for property and equipment) 882,640 1,151,006 ---------- --------- 16,003,479 4,626,269 Less: Current maturities 2,443,326 2,802,508 ---------- --------- $13,560,153 $1,823,761 =========== ========== The maturities of long-term debt, including debt in arrears, over the next five years and thereafter are as follows: Years Ended June 30, ----------- 1999 $2,443,326 2000 3,793,304 2001 2,314,385 2002 1,637,174 2003 5,815,290 ---------- 16,003,479 ========== F-39 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 13 - INCOME TAXES Components of the provision (credit) for income taxes are as follows: 1998 1997 1996 ---------- ---------- ---------- Current: Federal $1,700,000 $ - $ - State 302,452 100,000 19,965 ---------- ---------- ---------- 2,002,452 100,000 19,965 ---------- ---------- ---------- Deferred: Federal (2,500,000) 2,716,000 - State - 134,000 - ---------- ---------- ---------- (2,500,000) 2,850,000 - ---------- ---------- ---------- Totals $ (497,548) $2,950,000 $ 19,965 ========== ========== ========== A reconciliation of the federal statutory income tax rate to the Company's effective tax rate as reported is as follows: 1998 1997 1996 -------- -------- -------- Taxes at federal statutory rate (34.0)% 34.0% (34.0)% State and local income taxes, net of utilization of credits 5.0 .4 .2 Permanent differences 1.5 - - Net operating loss carry- forwards - (28.8) 34.0 Alternate minimum tax 28.0 2.0 - Utilization of tax credits (8.8) (2.6) - ----- ----- ----- Effective income tax rate (8.3)% 5.0% .2% ===== ===== ===== For federal income tax purposes, the Company has tax credit carryforwards aggregating $1,545,000, which are accounted for under the flow through method. The tax credit carryforwards of $1,086,595, $70,145 and $388,260 expire on June 30, 2006, 2012 and 2013, respectively. F-40 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 13 - INCOME TAXES (Continued) Significant components, tax effected, of the Company's deferred tax assets and liabilities at June 30, 1998 and 1997 are as follows: 1998 1997 ---------- ---------- Deferred tax assets: Allowance for doubtful accounts $ 888,486 $2,211,325 Non-deductible accruals 235,223 1,766,778 Net operating carryforwards - 22,289,938 Tax credits 2,151,961 2,304,028 Inventory capitalization for tax purposes 68,000 67,492 ---------- ---------- 3,343,670 28,639,561 Valuation allowance (3,343,670) (1,019,002) ---------- ---------- Net deferred tax assets - 27,620,559 ---------- ---------- Deferred tax liabilities: Fixed assets and depreciation 378,221 429,093 Capitalized software costs 174,064 98,562 Difference between cash and accrual basis for tax reporting 221,897 443,794 Gain on litigation settlement - 29,942,904 Other 19,612 - ---------- ---------- Gross deferred tax liabilities 793,794 30,914,353 ---------- ---------- Net deferred tax liabilities $ 793,794 $3,293,794 ========== ========== The net change in the valuation allowance for deferred tax assets increased by $2,324,668. During 1997, the Company reduced the valuation allowance to recognize a deferred tax asset of approximately $27 million at June 30, 1997. The recognized deferred tax asset was based upon the expected utilization of net operating loss carryforwards during 1998 due primarily to a gain from a litigation award of approximately $75 million. F-41 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 14 - OTHER CURRENT LIABILITIES Included in other current liabilities are the following: 1998 1997 ----------- ----------- Unearned revenue on service contracts $ 1,283,990 $ 1,399,243 Accrued bonus 1,410,345 4,000,000 Accrued payroll taxes 316,142 606,883 Accrued interest 566,890 245,527 Accrued additional purchase price 1,000,000 - Accrued salaries and commissions 631,293 336,225 Accrued professional fees 1,260,029 1,813,255 Litigation judgement 1,645,305 1,325,824 Excise and sales taxes 1,455,476 1,438,930 Other 1,686,689 2,304,486 ----------- ----------- $11,256,159 $13,470,373 =========== =========== NOTE 15 - COMMITMENTS AND CONTINGENCIES Leases ------ The Company rents its operating facilities and certain equipment pursuant to operating lease agreements expiring at various dates through February 2009. The leases for certain facilities contain escalation clauses relating to increases in real property taxes as well as certain maintenance costs. F-42 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Future minimum lease commitments consisted of the following at June 30, 1998: Facilities Year Ended and June 30, Equipment Capital ---------- ----------- ----------- 1999 $ 2,906,454 $ 1,432,436 2000 2,767,812 571,169 2001 2,654,932 741,725 2002 2,434,888 135,846 2003 2,216,933 - ----------- ----------- 12,981,019 2,881,176 Thereafter 4,048,599 - ----------- ----------- Total minimum obligations $17,029,618 2,881,176 =========== Less: Amount representing interest 332,922 ----------- Present value of net minimum lease obligations $ 2,548,244 =========== Rent expense for operating leases approximated $2,382,000, $1,386,000 and $1,380,000 for the three years ended June 30, 1998, 1997 and 1996, respectively. F-43 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Litigation ---------- 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. In April 1995, FONAR and Hitachi settled. In May 1995, the jury rendered a verdict against General Electric awarding FONAR $110,575,000, for infringement of FONAR's MAO patent and Cancer Detection patent. Following appeals, on July 2, 1997, General Electric paid $128.7 million (inclusive of interest). After the deduction of attorney's fees and expenses, the net amount of the judgement proceeds to FONAR was $77.2 million, which is included in other income for the fiscal year ended June 30, 1997 in the accompanying financial statements. On June 16, 1995, the Company filed an action against Siemens Medical Systems, Inc. ("Siemens"), 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 alleged that four of its patents were infringed. Previously, in May 1995, Siemens had filed a complaint against FONAR in the United States District Court for the District of Delaware seeking a declaratory judgement that the four patents were invalid and unenforceable, as well as an adjudication that Siemens was not infringing on the four patents. 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 judgement that FONAR's U.S. Patents Nos. 3,789,832 and 4,871,966 are invalid, unenforceable and not infringed. Subsequently, the action was transferred to U.S. District Court for the District of Delaware. 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. In April 1996, the Company entered into an agreement with Philips Electronics N.V., Philips Electronics North America Corp., Philips Medical Systems North American and U.S. Philips Corp. settling the lawsuits and claims between them. F-44 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Litigation (Continued) ---------- In September 1996, the Company 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 as cross-license by Siemens and the Company of certain patents relating to MRI technology. The Company received a monetary payment from Siemens and an agreement by Siemens to pay the Company royalties. On March 4, 1996, the Company filed an action against Toshiba Corporation, Toshiba America Medical Systems, Inc., Toshiba American MRI, Inc. and others alleging infringement of four of its MRI patents. Thereafter, in February 1997, Toshiba America MRI, Inc. commenced an action against FONAR in the U.S. District Court for the Northern District of California (Toshiba America MRI, Inc. V. FONAR Corporation, Case No.: C97-00664 SBA ENE) alleging infringement of certain of its patents relating to magnetic resonance imaging technology. Both FONAR and the Toshiba companies asserted counterclaims in the actions brought against them. In May 1998, FONAR and Toshiba amicably resolved the litigation in both the New York and California United States District Courts. Neither party admitted liability in the settlement agreement. The parties cross-licensed each other on the patents-in-suit, and FONAR received a monetary payment from Toshiba. Other terms of the settlement are confidential. F-45 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Litigation (Continued) ---------- On March 4, 1987, Philip B. Kivitz, M.D. and Rad-Sonic Diagnostic Medical Clinics, Inc., filed a complaint against AMD, FONAR, Raymond V. Damadian and others in the San Francisco County Superior Court (Case Action No. 870407). In his complaint, Dr. Kivitz had claimed $10,000,000 in compensatory damages and $10,000,000 in punitive damages. In January 1993, the case went to trial and the jury returned a verdict of $880,000 against AMD and $120,000 against FONAR. On June 17, 1993, the Court granted FONAR's and AMD's motion for judgement notwithstanding the verdict, thereby vacating the entire award against both FONAR and AMD. The case was appealed by the plaintiff and on February 27, 1995, the Appellate Court affirmed the lower court's judgement notwithstanding the verdict as to FONAR, but reversed the judgement as to AMD. Subsequently, AMD filed a petition for review with the California Supreme Court and was denied on May 17, 1995. Subsequently, judgements were entered on the California judgement in New York, Pennsylvania, Michigan and Florida and enforcement proceedings were commenced. The plaintiffs, to date, have not collected any part of the judgement in these proceedings. Thereafter, plaintiffs purportedly assigned the judgement to Phoenix General & Health Services, Inc. ("Phoenix"). Phoenix commenced a new and separate action in United States District Court for the Eastern District of New York seeking to enforce the judgement against AMD and FONAR, as well. FONAR is defending this claim on the ground, among others, that in the original California action, it was determined that FONAR was not liable, and both FONAR and AMD are defending on the grounds that the assignment to Phoenix, a Nevada corporation, was made solely for the purpose of seeking to bring this case within the diversity jurisdiction of the Federal Courts. A motion to dismiss this case on various grounds is now under consideration by the United States District Court for the Eastern District of New York. As of June 30, 1998, the verdict of $880,000, plus interest, was provided for. On April 3, 1990, Summit, Rovins and Feldesman commenced an action in the Supreme Court of the State of New York, County of New York against the Company. The complaint alleges unpaid fees for legal services and disbursements to the amount of $664,371. On June 25, 1997, the parties entered into a settlement agreement, whereby the Company has agreed to pay Summit, Rovins and Feldesman $415,000. In prior years, the Company had recorded a provision for potential liability related to this action. No further accrual was necessary for the year ended June 30, 1998. F-46 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Litigation (Continued) ---------- During February 1994, a FONAR subsidiary, ("Medical SMI" formerly "Vonar Limited") issued shares to Long Investment, Ltd., an Israeli company, in consideration for $700,000. Long Investment, Ltd. claims the investment was made assuming Medical SMI would complete a private offering. The private offering was subsequently cancelled. Long Investment, Ltd. appealed to the District Court to appoint an arbitrator to decide if the Company should refund the investment. The case went to arbitration during the year and was dismissed. On June 28, 1995, Horace Rubinstein commenced an action in the Delaware Court of Chancery against the four directors of the Company and FONAR, as nominal defendant, challenging the recapitalization plan approved by the stockholders at the annual meeting on April 3, 1995 (see Note 10). The complaint alleged that the directors failed to act in the best interests of the Company and its common stockholders in adopting the plan, which permits Dr. Raymond V. Damadian, the founder, President and principal stockholder of the Company, and other holders of FONAR's Class B common stock, to exchange their shares of Class B common stock for shares of a new Class C common stock having greater voting power. The action was brought as a class action on behalf of the holders of the common stock and derivatively, for the benefit of the Company. F-47 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Litigation (Continued) ---------- The defendants and the Company strongly believe that the recapitalization, approved by the stockholders in tandem with a proposal to distribute shares of a new class of preferred stock to the holders of the common stock, was both fair and in the best interests of the Company and its stockholders. The defendant answered the complaint and a proposed settlement agreement was reached. In April 1997, the settlement was approved by the Delaware Court of Chancery. The settlement increased the dividends payable on the Company's common stock and Class A non-voting preferred stock from the proceeds of its patent litigation. The three percent (3%) dividend originally payable on the common stock of any awards collected by the Company on its Cancer Detection patent (U.S. Patent No. 3,789,832) was increased to 3-1/4% of the first $10 million collected, 4-1/2% of the next $20 million collected and 5-1/2% of any additional amounts collected of any such cash award. The 3% dividend originally payable on the Class A non-voting preferred stock of any awards on the other four patents asserted in the litigation against General Electric Company and Hitachi, Ltd., including the Company's Multi-Angle Oblique Imaging patent, was similarly increased and extended to any patent litigation seeking to enforce those patents commenced prior to November 29, 1997. In addition, the Company agreed to issue warrants to purchase common stock to holders of record of its common stock on October 25, 1995. The settlement agreement further provided that there would be no further recapitalization increasing Dr. Damadian's voting control for a period of 5 years without the consent of a majority of the holders of the Company's common stock, and Dr. Damadian agreed to share with the holders of the common stock any "control premium" he might receive in connection with the sale by him of Class B or Class C common stock during a five-year period. Subsequently, on December 17, 1997, the parties agreed to modification of the settlement agreement, which was approved by the Court of Chancery on March 2, 1998. The modification provided that the Company issue 2,231,689.3 shares of FONAR common stock in substitution for the warrants, which would have been issued under the original terms of the settlement agreement. In addition, the modification provides for a schedule to pay the special dividends on the Company's common stock and Class A non-voting preferred stock with respect to awards and settlements already received by the Company in connection with its patent litigations. These first installments (comprising one-half of the total) was paid in May 1998 and the second installment (comprising one-sixth of the total) was paid in September 1998. The remaining two installments (each comprising one-sixth of the total) are required to be paid as follows: one prior to December 31, 1998, and one prior to March 31, 1999. As of June 30, 1997, a dividend payable was provided. F-48 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Litigation (Continued) ---------- An entity has impliedly asserted that FONAR's equipment infringes on at least one of the entity's patents. The entity had sought royalties in the range of 2% or 3% of the net selling price of FONAR's equipment for licenses under their assertedly infringed patents. At July 1, 1995, the Company entered into an agreement with the entity, whereby the Company must pay 1.2% of the Company's future sales of certain MRI apparatus. The Company also is involved in a number of smaller litigations which aggregate approximately $3,560,000. The Company has interposed answers in all cases, except where an answer is not yet due. The Company has established provisions for most of the liabilities represented by these smaller claims, and where provisions have not been established, management believes it will prevail on the merits and intends to vigorously contest the claims. Based on its past experience dealing with such claims, the Company anticipates it will be able to settle most of these smaller litigations with provisions to pay over periods of time which are manageable for the Company. License Agreement and Self-Insurance ------------------------------------ The Company entered into a license agreement during 1990 with an entity whereby the Company must pay a royalty of 1.35% on the Company's future sales of certain NMR imaging apparatus through January 31, 1995 in the United States and April 17, 1996 in Canada. In August 1998, the Company entered into a licensing agreement, whereby the Company paid a royalty of $395,000 for the use of certain patent rights. Subject to the terms of the agreement, the Company acquired a non-exclusive right to make, have made, use, modify, enhance, sell, lease or otherwise dispose of the licensed products and to practice any and all methods and processes in the manufacture, testing and assembly thereof. Royalty expense charged to operations for the years ended June 30, 1998, 1997 and 1996 approximated $47,000 $-0- and $15,000, respectively. The Company is self-insured with respect to substantially all insurable business risks except for insurance on certain equipment pledged as collateral for long-term debt. During the fiscal years ended June 30, 1998, 1997 and 1996, no material claims arose. F-49 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 15 - COMMITMENTS AND CONTINGENCIES (Continued) Management Contract ------------------- In connection with the acquisition of Affordable Diagnostics, Inc. HMC entered into a management agreement with the former President of Affordable effective July 1, 1997. The agreement provides for a base fee of $52,000 per year for a 5-year period commencing July 1, 1997 and 60,000 shares of HMC's common stock valued at $60,000, as a signing bonus. In addition, an additional 240,000 shares of HMC's common stock are issuable to the consultant provided certain financial hurdles are met over the 5-year term of the agreement. Employment Agreements --------------------- On March 20, 1998, an affiliate of HMCA entered into two employment agreements with the former owners of A&A. The agreements provide for a base annual salary of $300,000 for the first five years and $630,000 per annum for each year thereafter and shall be increased by 5% per annum up to a minimum base salary of $500,000 per annum. Additionally, the agreement provides for a bonus commencing in the sixth year of the contract, contingent upon meeting certain thresholds of net income. The employment agreements expire fifteen years from March 20, 1998. NOTE 16 - OTHER INCOME (EXPENSE) AND SUPPLEMENTARY PROFIT AND LOSS DATA Other income consists of: For the Years Ended June 30, --------------------------------------- 1998 1997 1996 ---------- ----------- ---------- Other income (expense) $ (61,382) $ (336,681) $ 248,034 Gain on settlement of various legal disputes and other claims 8,671,417 83,436,366 3,759,542 ---------- ----------- ---------- $8,610,035 $83,099,685 $4,007,576 ========== =========== ========== Advertising expense approximated $651,000, $199,000 and $57,000 for the years ended June 30, 1998, 1997 and 1996, respectively. Maintenance and repair expenses totalled approximately $224,000, $312,000 and $358,000 for the years ended June 30, 1998, 1997 and 1996, respectively. Royalty expenses approximated $47,000, $-0-, and $15,000 for the years ended June 30, 1998, 1997 and 1996, respectively. Amortization of intangible assets was approximately $674,000, $794,000 and $1,233,000 for the years ended June 30, 1998, 1997 and 1996, respectively. F-50 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 17 - SUPPLEMENTAL CASH FLOW INFORMATION During the years ended June 30, 1998, 1997 and 1996, the Company paid $343,418, $336,857 and $668,956 for interest, respectively. During the years ended June 30, 1998, 1997 and 1996, the Company paid $1,202,449, $861 and $68,552 for income taxes, respectively. During the years ended June 30, 1998 and 1997, the Company acquired the assets and assumed the liabilities of various entities. The transactions had the following non-cash impact on the balance sheets: 1998 1997 ---------- ---------- Accounts receivable $ 600,000 $1,196,000 Equipment 300,000 1,116,000 Other assets - 20,000 Intangibles 11,298,000 2,796,000 Accrued liabilities (1,100,000) (85,000) Notes payable to sellers (7,073,000) (315,000) Capital lease obligation - (524,000) Other liabilities - (82,000) Deferred taxes payable - (444,000) Equity - (3,680,000) ---------- ---------- Net Cash (Used For) Provided From acquisition $4,025,000 $ (2,000) ========== ========== Non-Cash Transactions --------------------- During the year ended June 30, 1998: a)The Company issued 236,345 shares of its common stock in settlement of current liabilities aggregating $632,386. b)The Company issued 576,000 shares of its common stock valued at $923,442 as additional contingent consideration related to acquisition of Affordable Diagnostics, Inc. c)The Company issued 385,530 shares of its common stock to employees in satisfaction of accrued liabilities incurred during the fiscal year ended June 30, 1997 aggregating $1,147,906. d)Accrued interest aggregating $146,330 was reclassified to long-term debt pursuant to a debt restructuring agreement. e)Equipment costing $800,000 was reclassified from Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts to Property and Equipment. f)The Company purchased $1,391,304 of machinery and equipment under capital leases. F-51 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 17 - SUPPLEMENTAL CASH FLOW INFORMATION (Continued) Non-Cash Transactions (Continued) --------------------- During the year ended June 30, 1997: a)The Company received promissory notes of $8,074,616 in connection with the exercise of stock options and issuance of common stock. b)The Company issued 579,271 shares of its common stock in settlement of current liabilities aggregating $1,444,522. c)TheCompany issued 1,764,000 shares of its common stock valued at $3,630,312 in connection with the acquisition of Affordable Diagnostics, Inc. d)Pursuant to consulting contracts with shareholders of Affordable Diagnostics, Inc., the Company issued 400,000 shares of its common stock valued at $1,096,000. During the year ended June 30, 1996: a)Common stock issued and options exercised in exchange for notes received from stockholders totalled $9,590,134. b)Property and equipment with a book value of $411,347 was reclassified to inventory. c)Receivables under a lease agreement for an MRI scanner were acquired in exchange for common stock valued at $351,000. d)Advances for legal fees of $475,000 were paid by the issuance of common stock. e)An obligation of $217,226 was accrued pursuant to special dividend rights of Class A non-voting preferred stock. NOTE 18 - GOVERNMENT REGULATIONS The healthcare industry is highly regulated by numerous laws, regulations, approvals and licensing requirements at the federal, state and local levels. Regulatory authorities have very broad discretion to interpret and enforce these laws and promulgate corresponding regulation. The Company believes that its operations under agreements pursuant to which it is currently providing services are in material compliance with these laws and regulations. However, there can be no assurance that a court or regulatory authority will not determine that the Company's operations (including arrangements with new or existing clients) violate applicable laws or regulations. F-52 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 18 - GOVERNMENT REGULATIONS (Continued) If the Company's interpretation of the relevant laws and regulations is inaccurate, the Company's business and its prospects could be materially and adversely affected. The following are among the laws and regulations that affect the Company's operations and development activities; corporate practice of medicine; fee splitting; anti-referral laws; anti-kickback laws; certificates of need, regulation of diagnostic imaging; no-fault insurance; worker's compensation; and proposed healthcare reform legislation. NOTE 19 - ADVANCES AND NOTES TO RELATED PARTIES Effective December 1, 1993, Albany Magnetic Imaging Center, P.C., a Georgia professional corporation, of which Raymond V. Damadian is the sole stockholder ("Albany Center"), purchased the scanner being utilized at its site from the Company for a purchase price of $1,128,844. Of the purchase price, $574,077 was paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner. Such indebtedness to the lender was retired pursuant to a new equipment finance lease between the lender and the Albany Center. Following payment of the lease, the remaining $554,767 of the purchase price due to the Company is required to be paid pursuant to a promissory note, with interest at 10% per annum, over an 18-month term (17 payments of $35,000 each and one final payment of $2,454.08). Effective December 1, 1993, RVDC assigned its purchase option under the lease to Daytona Beach Magnetic Resonance Imaging, P.A., a Florida professional association of which Raymond V. Damadian is the sole shareholder, Director and President ("Daytona Beach Center") and the Daytona Beach Center exercised the option and purchased the scanner from the Company for a purchase price of $1,416,717. Of the purchase price, $328,044 is to be paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner. Such indebtedness to the lender is to be retired pursuant to a new equipment finance lease between the lender and the Daytona Beach Center. The remaining $1,088,673 of the purchase price due to the Company will be paid pursuant to a promissory note, with interest at 10% per annum, over a 45 month term commencing July 1, 1994 as follows: eleven installments of $15,000 each, thirty-three installments of $35,000 each and one installment of $19,097. F-53 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 19 - ADVANCES AND NOTES TO RELATED PARTIES (Continued) During the year ended June 30, 1992, RVDC agreed to lease one of the Company's mobile scanners for a term of five years at a monthly lease payment of $36,119 commencing January 1, 1992. The lease was originally classified by the Company as a sales-type lease. Effective June 30, 1994, RVDC assigned its purchase option under the lease to Melville MRI, P.C., a New York professional corporation of which Raymond V. Damadian is the sole shareholder, Director and President ("Melville Center") and the Melville Center concurrently exercised the option and purchased the scanner from the Company for a purchase price of $1,011,431. Of the purchase price, $900,000 is to be paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner pursuant to a note bearing interest at 14% per annum and providing for 60 monthly payments of $20,700 each. The remaining $111,431 of the purchase price is to be paid concurrently with the payments to the lender pursuant to a note, with interest at 10% per annum, providing for 60 monthly payments of $2,367 each. Effective July 1994, RVDC assigned its purchase option under the lease to Deerfield Magnetic Resonance Imaging P.A., a Florida professional association of which Raymond V. Damadian is the sole shareholder, Director and President ("Deerfield Center") and the Deerfield Center exercised the option and purchased the scanner from the Company for a purchase price of $962,185. Of the purchase price, $311,934 is to be paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner. Such indebtedness is to be retired pursuant to a new equipment finance lease between the lender and the Deerfield Center. The remaining $454,005 of the purchase price due to the Company will be paid pursuant to a promissory note with interest at 10% per annum, over a 17-month term commencing January 1, 1996 as follows: sixteen installments of $30,000 each and one installment of $7,275. The Deerfield Center paid the remaining balance due under the note during fiscal 1998. Pursuant to an agreement dated September 30, 1993, Advanced Medical Diagnostics Corporation ("AMD"), a subsidiary of the Company sold to Dade County MRI, P.A. its interests in a partnership which had formerly operated an MRI scanning center in Miami, Florida. The purchase price of $100,000 is payable, with interest at 10% per annum in sixty (60) equal consecutive monthly installments of principal and interest (including interest accrued from September 30, 1993), commencing 90 days after the scanner is placed in service. The partnership is presently inactive. Dade County MRI, P.A. is a Florida professional association of which Raymond V. Damadian is the sole stockholder, director and President. F-54 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 19 - ADVANCES AND NOTES TO RELATED PARTIES (Continued) Canarsie MRI Associates ("Canarsie"), a joint venture partnership of which MRI Specialties, Inc. ("Specialties") is an owner, is party to a service agreement for its scanner with the Company at an annual fee of $70,000 for the period September 1, 1997 through August 31, 1999. Timothy Damadian, a Vice-President of the Company, is the sole stockholder , director and president of Specialties. Pursuant to an agreement dated January 2, 1996, Guardian MRI, Inc. ("Guardian") engaged the Company to de-install, transport and reinstall an MRI scanner purchased for Pompano MRI Associates ("Pompano") from a third party. Timothy Damadian, a Vice-President of the Company, is a stockholder, director and officer of Guardian. Pompano is a joint venture partnership of which Guardian is an owner. The agreement provides for a price of $120,000 payable in 36 monthly installments of $3,760.36 each (inclusive of interest at 8% per annum) pursuant to a note executed and delivered by Guardian upon the completion of the reinstallation. The agreement also provides that the Company will provide a six-month warranty for the scanner and a service agreement thereafter for the periods October 1, 1996 to September 30, 1997 and October 1, 1997 to September 30, 1998, at an annual price of $70,000. In addition, the agreement provided that the Company provide updated software, Signal Plus Surface Coils, Whisper Gradients and a Four Post Canopy and Steel upgrade for the scanner. As at June 30, 1998 and 1997, the aggregate indebtedness of Specialties and Canarsie to the Company was $12,447 and $19,547, respectively, and the aggregate indebtedness of Guardian and Pompano to the Company was $53,732 and $97,757, respectively. F-55 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 20 - SEGMENT INFORMATION The Company operates in two industry segments - manufacturing and the servicing of medical equipment and management of physician practices, including diagnostic imaging services. The following table shows net revenues, operating income and other financial information by industry segment for the years ended June 30: 1998 1997 1996 ----------- ----------- ----------- Net revenues: Medical equipment $ 7,807,549 $ 9,534,048 $ 7,758,805 Physician management services 21,095,994 8,099,018 6,156,920 Intersegement eliminations (1,349,186) - - ----------- ----------- ----------- Total $27,554,357 $17,633,066 $13,915,725 =========== =========== =========== Income (loss) from operations: Medical equipment $(20,292,707) $(24,309,936) $(11,912,687) Physician practice management 2,698,314 (71,769) (3,364,599) ------------ ----------- ------------ Total $(17,594,393) $(24,381,705) $(15,277,286) ============ ============ ============ Identifiable assets: Medical equipment $98,342,625 $96,623,863 $24,914,610 Physician practice management 10,105,155 10,066,698 3,142,774 ------------ ------------ ----------- Total $108,447,780 $106,690,561 $28,057,384 ============ ============ =========== Depreciation and amortization: Medical equipment $1,415,923 $1,593,586 $2,259,183 Physician practice management 1,501,820 429,879 377,373 ----------- ----------- ----------- Total $2,917,743 $2,023,465 $2,636,556 =========== =========== =========== Capital expenditures: Medical equipment $1,889,450 $1,530,145 $1,761,199 Physician practice management 2,287,398 218,574 - ----------- ----------- ----------- Total $4,176,848 $1,748,719 $1,761,199 =========== =========== =========== F-56 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 21 - PROFORMA INFORMATION (UNAUDITED) The Company's consolidated financial statements for the years ended June 30, 1996 and 1997 do not include the results of operations of Affordable Diagnostics, Inc. and the consolidated financial statements do not include the results of operations of A&A Services, Inc. for the years ended June 30, 1996 and 1997 and for the period July 1, 1997 through March 20, 1998. The following summarizes the unaudited proforma results of operations for the years ended June 30, 1998, 1997 and 1996, assuming the foregoing acquisition had occurred on June 30, 1998, 1997 and 1996 (in thousands, except per share data): 1998 1997 1996 ------------ ----------- ------------ (Unaudited) (Unaudited) (Unaudited) Revenues, net $ 30,790 $ 24,982 $ 18,592 Loss from operations $ (1,686) $ (23,098) $ (14,232) Income (loss) before income taxes $ (5,539) $ 59,646 $ (10,883) Fully diluted net income (loss) per share $(.09) $1.01 $(0.21) NOTE 22 - SUBSEQUENT EVENTS Acquisition ----------- On August 20, 1998, the Company's physician management subsidiary, HMCA, consummated the acquisition of the common stock of Dynamic Health Care Management, Inc. ("Dynamic"), a New York corporation, which manages three physician practices on Long Island, New York. The practices consist of internal medicine, physiatry and physical rehabilitation. Pursuant to the Dynamic agreements, HMCA acquired all of the common stock of Dynamic for $2,000,000 in cash, a note payable for $1,265,000 bearing interest at 8% per annum, payable in sixty monthly installments, or commencing one month following the closing date, a note payable for $2,870,000 bearing interest at 8% per annum payable in three annual installments of principal and interest commencing one year after the closing date, and convertible notes face amount of $5,490,000, payable in thirty-six monthly installments of principal and interest, commencing two years after the closing date. The promissory notes are collateralized by all of the assets of the acquired operations and are guaranteed by the Company. F-57 FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1998 NOTE 22 - SUBSEQUENT EVENTS (Continued) A substantial portion of the covertible notes of $5,490,000 are convertible into shares of HMCA's common stock upon the effectiveness of an Initial Public Offering ("IPO") of HMCA's securities providing the IPO is consummated within two years of the closing date. The Company intends to account for this acqusition as a purchase. Litigation ---------- On August 4, 1998, Beal Bank filed a notice of motion for summary judgement against Melville Magnetic Resonance Imaging, P.C. ("Melville Magnetic") and the Company. The motion for summary judgement seeks to recover $733,855, plus accrued interest of $221,809 for payment of a bank loan executed by Melville Magnetic and guaranteed by the Company. In the event a judgement is levied against the Company as a guarantor on the loan, the Company will exercise its rights to seek recovery from Melville Magnetic. F-58 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Directors serve from the date of their election until the next annual meeting of stockholders and until their successors are elected and qualify. Officers serve at the discretion of the Board of Directors. The officers and directors of the Company are set forth below: Raymond V. Damadian, M.D. 62 President, Chairman of the Board and a Director Timothy R. Damadian 34 Vice President of Operations David B. Terry 51 Secretary and Treasurer Claudette J.V. Chan 61 Director Robert J. Janoff 71 Director Herbert Maisel * 54 Director Charles N. O'Data ** 62 Director * Mr. Maisel resigned on March 9, 1998. ** Mr. O'Data was elected on February 20, 1998. Raymond V. Damadian, M.D. has been the Chairman of the Board and President of FONAR since its inception. Dr. Damadian was employed by the State University of New York, Downstate Medical Center, New York, as an Associate Professor of Biophysics from 1967 until September 1979. Dr. Damadian received an M.D. degree in 1960 from Albert Einstein College of Medicine, New York, and a B.S. degree in mathematics from the University of Wisconsin in 1956. In addition, Dr. Damadian conducted post-graduate work at Harvard University, where he studied extensively in the fields of physics, mathematics and electronics. Dr. Damadian is the author of numerous articles and books on the nuclear magnetic resonance effect in human tissue, which is the theoretical basis for the FONAR MRI scanners. Dr. Damadian is a 1988 recipient of the National Medal of Technology and in 1989 was inducted into the National Inventors Hall of Fame, for his contributions in conceiving and developing the application of magnetic resonance technology to medical applications including whole body scanning and diagnostic imaging. Dr. Damadian is the director of HMCA. Timothy R. Damadian has been a Vice President of FONAR since July 1992 and President of HMCA since its formation in March 1997. Mr. Damadian served as a field service technician for FONAR, after graduating from Suburban Technical School in 1982, where he studied digital computer technology. Mr. Damadian became Director of Manufacturing in October 1989 and was promoted to Vice President of Operations of FONAR in July 1992. Timothy Damadian is the son of Raymond V. Damadian and nephew of David Terry and Claudette Chan. David B. Terry is the Secretary and Treasurer of the Company. Mr. Terry has been serving as Secretary and Treasurer since May 1990, and previously served as Secretary from July 1978 through June 1987 and as Treasurer from August 1981 through June 1987. From July 1978 through June 1987, he was also a Director of the Company. Between July 1987 and January 1990, Mr. Terry was a co-owner and actively engaged in the business of Carman-Terry Realty, a real estate brokerage firm. In January 1990, Mr. Terry resumed his employment with the Company. Mr. Terry is the brother-in-law of Raymond V. Damadian and uncle of Timothy R. Damadian. Claudette J.V. Chan has been a Director of FONAR since October 1987. Mrs. Chan has been employed since 1992 by Raymond V. Damadian, M.D. MR Scanning Centers Management Company as "site inspector," in which capacity she is responsible for supervising and implementing standard procedures and policies for MRI scanning centers. From 1989 to 1994 Mrs. Chan was employed by St. Matthew's and St. Timothy's Neighborhood Center, Inc., as the director of volunteers in the "Meals on Wheels" program, a program which cares for the elderly. In approximately 1983, Mrs. Chan formed the Claudette Penot Collection, a retail mail-order business specializing in women's apparel and gifts, of which she was the President until she stopped operating the business in approximately 1989. Mrs. Chan practiced and taught in the field of nursing until 1973, when her son was born. She received a bachelor of science degree in nursing from Cornell University in 1960. Mrs. Chan is the sister of Raymond V. Damadian and aunt of Timothy R. Damadian. Robert J. Janoff has been a Director of FONAR since February, 1989. Mr. Janoff has been a self-employed New York State licensed private investigator for more than thirty-five years and was a Senior Adjustor in Empire Insurance Group for more than 15 years until retiring from that position on July 1, 1997. Mr. Janoff also served, from June 1985 to June 1991, as President of Action Data Management Strategies, Ltd., a supplier of computer programs for use by insurance companies. Mr. Janoff is a member of the Board of Directors of Harmony Heights of Oyster Bay, New York, which is a nonprofit residential school for girls with learning disabilities. Herbert Maisel was a Director of FONAR from February, 1989 to March, 1998. Mr. Maisel has been the manager of Melville MRI, P.C., an MRI scanning center located in Melville, New York, since January, 1992, and of Damadian MRI in Garden City, P.C., an MRI scanning center located in Garden City, New York since April, 1995. Mr. Maisel was also manager of Damadian MRI in Islandia, P.C. from December, 1993 to March, 1995. Prior to that time Mr. Maisel had been the President and owner of Bagel World, Inc., a bagel bakery, from March 1984 to January 1992. Prior thereto, Mr. Maisel served as a supervisor of a commercial printing plant. Charles N. O'Data has been a Director of FONAR since February, 1998. From 1968 to 1997, Mr. O'Data was the Vice President for Development for Geneva College, a liberal arts college located in western Pennsylvania. In that capacity, he acted as the College's chief investment officer. His responsibilities included management of the College's endowment fund and fund raising. In July 1997, Mr. O'Data retired from Geneva College after 36 years of service and took a position as a National Sales Executive with SC Johnson Company (Johnson Wax), where his responsibilities include health care and education. Mr. O'Data also acts as an independent financial consultant to various entities, including Pittsburgh National Bank. Mr. O'Data served on the board of the Medical Center of Beaver, Pennsylvania for 22 years, from 1975 to 1997, with three years as the chair. He presently serves as a director of and the President of Beaver County Community Foundation, a philanthropic organization he founded in 1992. Mr. O'Data is a graduate of Geneva College, where he received a B.S. degree in Economics in 1958. Mr. O'Data is listed as a finance associate in the Middle States Association, Commission on Higher Education. The commission is the formal accrediting body for higher education in the eastern region of the country. In this capacity he evaluates the financial aspects of educational organizations. ITEM 11. EXECUTIVE COMPENSATION. With the exception of the Chief Executive Officer, the compensation of the Company's executive officers is based on a combination of salary and bonuses based on performance. The Chief Executive Officer's compensation consists only of a salary which has remained constant for more than the past three fiscal years. The Board of Directors does not have a compensation Committee: Dr. Raymond V. Damadian, President, Chief Executive Officer and Chairman of the Board, is the only executive officer who is a member of the Board of Directors. Dr. Damadian participates in the determination of executive compensation for the Company's officers. The Board of Directors has established an audit committee. The members of the committee are Raymond V. Damadian, Robert J. Janoff and Charles N. O'Data. There is set forth in the following Summary Compensation Table the compensation provided by the Company during fiscal 1998 to its Chief Executive Officer. There is set forth in the following Option Grant Table and Option Exercise Table any stock options granted and exercised by Dr. Damadian during fiscal 1997. I. SUMMARY COMPENSATION TABLE
Long Term Compensation Annual Compensation Awards Payouts (a) (b) (c) (d) (e) (f) (g) (h) (i) Other Name Annual Restricted All Other and Compen- Stock Options LTIP Compen- Principal Salary Bonus sation Award(s) SARs Payouts sation Position Year ($) ($) ($) ($) (#) ($) ($) - -------- ---- ---------- ----- ------ -------- --- ------- ------ Raymond V. 1998 $84,218.10 - - - - - - Damadian, 1997 $86,799.95 - - - - - - President & 1996 $86,679.95 - - - - - - CEO
- -------------------------------------------------------------------------------- II. OPTION/SAR GRANTS IN LAST FISCAL YEAR
Potential Realizable Value at Assumed Annual Rates of Alternative Stock Price to (f) and Appreciation for (g): Grant Individual Grants Option Term Date Value (a) (b) (c) (d) (e) (f) (g) (f) % of Total Options/ SARs Options/ Granted to SARs Employees Excercise or Grant Date Granted in Fiscal Base Price Expiration Present Name (#) Year ($/Sh) Date 5% ($) 10% ($) Value $ - ----- ------- --------- ---------- ---- ------ ------- ------- Raymond V. Damadian, 0 - - - - - - President & CEO
- ------------------------------------------------------------------------------- III. OPTION/SAR EXERCISES AND YEAR-END VALUE TABLE
Aggregated Options/SAR Exercises in Last Fiscal Year, amd FY-End Option/Sar Value (a) (b) (c) (d) (e) Number of Value of Unexercised Name Shares Acquired Value Realized Unexercised In-the-Money on Exercise (#) ($) Options/SARs Options/SARs at at FY-End (#) FY-End ($) Exercisable/ Exercisable/ Unexercisable Unexercisable - ---- --------------- ------------- ------------- ------------- Raymond V. 0 - 0 - Damadian, President and CEO
EMPLOYEE COMPENSATION PLANS The Company's 1993 Incentive Stock Option Plan, adopted on March 26, 1993, is intended to qualify as an incentive stock option plan under Section 422A of the Internal Revenue Code of 1954, as amended. The 1993 Incentive Stock Option Plan permits the issuance of stock options covering an aggregate of 1,500,000 shares of Common Stock. The options have an exercise price equal to the fair market value of the underlying stock on the date the option is granted, are nontransferrable, are exercisable for a period not exceeding ten years and expire upon the voluntary termination of employment. The 1993 Stock Option Plan will terminate on March 25, 2003. As of June 30, 1998, options to purchase 0 shares of Common Stock were available for future grant under the plan. The Company's 1995 Stock Bonus Plan, adopted on April 1, 1995, permits the Company to issue an aggregate of 5,000,000 shares of Common Stock as a bonus or compensation. The Company selects the persons to whom bonus stock will be issued, the number of shares to be awarded and such other terms and conditions as it deems advisable. The 1995 Stock Bonus Plan will terminate on March 31, 2005. As of June 30, 1998, 190,150 shares of Common Stock were available for future grant. The Company's 1997 Nonstatutory Stock Option Plan, adopted on May 9, 1997, permits the issuance of stock options covering an aggregate of 5,000,000 shares of Common Stock. The options may be issued at such prices and upon such terms and conditions as are determined by the Company. The 1997 Nonstatutory Stock Option Plan will terminate on May 8, 2007. As of June 30, 1998, options to purchase 4,797,400 shares of Common Stock were available for future grant. The Company's 1997 Stock Bonus Plan, adopted on May 9, 1997, permits the Company to issue an aggregate of 5,000,000 shares of Common Stock as a bonus or compensation. The Company selects the persons to whom bonus stock will be issued, the number of shares to be awarded and such other terms and conditions as it deems advisable. The 1997 Stock Bonus Plan will terminate on May 8, 2007. As of June 30, 1998, 5,000,000 shares of Common Stock were available for future grant. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth the number and percentage of shares of the Company's securities held by each director, by each person known by the Company to own in excess of five percent of the Company's voting securities and by all officers and directors as a group as of September 21, 1998. Name and Address of Shares Percent Beneficial Owner (1) Beneficially Owned of Class Raymond V. Damadian, M.D. c/o FONAR Corporation Melville, New York Director, President CEO, 5% + Stockholder Common Stock 2,488,274 4.71% Class C Stock 9,561,174 99.98% Class A Preferred 477,328 6.09% Claudette Chan Director Common Stock 4,195 * Class A Preferred 800 * Robert J. Janoff Director Common Stock 50,000 * Class A Preferred 1,999 * Charles N. O'Data Director Common Stock 100 * All Officers and Directors as a Group (6 persons) (2) Common Stock 2,563,327 4.85% Class C Stock 9,561,174 99.98% Class A Preferred 492,744 6.29% ___________________________ * Less than one percent 1. Address provided for each beneficial owner owning more than five percent of the voting securities of the Company. 2. Includes 101 shares of the Company's Common Stock and 19 shares of the Company's Class A Non-voting Preferred Stock held by an officer jointly with his wife and 192 shares of the Company's Common Stock and 38 shares of the Company's Class A Non-voting Preferred Stock held in trust by an officer for his children. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Background. On April 7, 1989, at a time when the Company lacked both the financing and working capital to establish its own centers, Donna Damadian, the wife of Raymond V. Damadian, M.D., Chairman and President of the Company, purchased from FONAR a scanner for a purchase price of $1,508,000 (the price paid by FONAR's customers for like equipment). $1.2 million was paid in cash, providing a much needed cash infusion for the Company, and the balance was paid over time with interest pursuant to a promissory note of even date. The scanner was leased to Macon Magnetic Resonance Imaging, P.C., a Georgia professional corporation wholly-owned by, and of which Dr. Damadian is, the President. Thereafter, between 1990 and 1996, Raymond V. Damadian, M.D. MR Scanning Centers Management Company, a Delaware corporation of which Dr. Damadian was the sole stockholder, director and President ("RVDC"), purchased and leased scanners from Fonar to establish a network of professional corporations operating MRI scanning centers ("Centers"), including the Macon Center, in New York, Florida, Georgia and other locations. Dr. Damadian was the owner, director and President of each of these professional corporations. RVDC provided the necessary management and the scanners to the Centers, although in certain situations, a Center would acquire the scanner directly from FONAR. ACQUISITION OF RVDC. Effective June 30, 1997, FONAR's wholly-owned subsidiary, Health Management Corporation of America ("HMCA"), formerly known as U.S. Health Management Corporation, acquired RVDC by purchasing all of the issued and outstanding shares of RVDC from Dr. Damadian for 10,000 shares of the Common Stock of FONAR. The transactions can be rescinded by Dr. Damadian, however, in the event of a change of control in FONAR or the bankruptcy of FONAR. In connection with the transaction, FONAR granted RVDC a nonexclusive royalty free license to FONAR's patents and software. These licenses may be terminated by FONAR in the event of the bankruptcy of RVDC or a change in control of RVDC. In connection with and immediately prior to the sale of RVDC to HMCA, certain leases and sales of scanners to RVDC were terminated. The scanners were then leased directly to the Centers at which they were installed pursuant to new scanner leases between HMCA and the Centers. NEW AGREEMENTS WITH HMCA. Effective July 1, 1997, immediately following the effective date of the acquisition of RVDC by HMCA, all previous management arrangements between RVDC and the Centers were terminated and new management agreements were entered into by the Centers and HMCA ("Management Agreements"). Pursuant to the Management Agreements, HMCA is providing comprehensive management and administrative services and office facilities, including marketing, advertising, billing and collection of accounts, payroll and accounts payable processing, supplies and utilities to the Centers. Under the Management Agreements, HMCA provides service through FONAR for the scanners at the Centers, eliminating the need for the Centers to have separate service agreements for their scanners. In total, 17 of the Centers previously managed by RVDC have Management Agreements with HMCA. With respect to the scanners at 9 of the 17 Centers, the lease or sales agreement between RVDC (or the Center in some cases) and FONAR were terminated. In substitution for the previous arrangements, HMCA, effective as of July 1, 1997, entered into new scanner leases ("Scanner Leases") with these Centers pursuant to which the scanners are provided to the Centers. The fees to HMCA under both the Management Agreements and the Scanner Leases are on a per scan basis. In addition, a new Center owned by Dr. Damadian and managed by HMCA was established in Latham, New York, in March 1998. During the fiscal year ended June 30, 1998 the aggregate of fees payable to HMCA by the Centers owned by Dr. Damadian was approximately $12.8 million. Effective December 1, 1993, one of the Centers, Albany Magnetic Resonance Imaging, P.C. (the "Albany Center"), a Georgia professional corporation of which Raymond V. Damadian is the sole shareholder, director and President, purchased the scanner being utilized at its site from the Company for a purchase price of $1,128,844. Of the purchase price, $574,077 was paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner. Such indebtedness to the lender was retired pursuant to a new equipment finance lease between the lender and the Albany Center, guaranteed by the Company, providing for 18 monthly payments of $35,000 each. Following payment of the lease, the remaining $554,767 of the purchase price due to the Company is required to be paid pursuant to a promissory note, with interest at 10% per annum, over an 18 month term (17 payments of $35,000 each and one final payment of $2,454.08). In July 1994, Deerfield Magnetic Resonance Imaging, P.A. (the "Deerfield Center"), a Florida professional association of which Raymond V. Damadian is the sole shareholder, director and President, purchased the scanner being utilized at its site from the Company by assuming the Company's indebtedness to the lender secured by the scanner in the amount of $508,180.07, which was paid pursuant to a note, guaranteed by the Company, with interest at 10% per annum over a period of 18 months. In connection with assuming the debt to the lender, the Deerfield Center also assumed the remaining outstanding lease obligation of RVDC to the Company respecting the scanner in the amount of $454,005.11. This amount was paid pursuant to a promissory note, bearing interest at the rate of 10% per annum, in 17 monthly installments (16 installments of $30,000 each and one installment of $7,274.79) commencing January 1, 1996. The Deerfield Center paid the remaining balance due under the note during fiscal 1998. Effective December 1, 1993, Daytona Beach Magnetic Resonance Imaging, P.A. (the "Daytona Beach Center"), a Florida professional association of which Raymond V. Damadian is the sole shareholder, director and President, purchased the scanner being utilized at its site from the Company for a purchase price of $1,416,717. Of the purchase price, $328,044 was paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner. Such indebtedness to the lender was retired pursuant to a new equipment finance lease between the lender and the Daytona Beach Center, guaranteed by the Company, providing for 18 monthly payments of $20,000 each. The remaining $1,088,673 of the purchase price due to the Company is required to be paid pursuant to a promissory note, with interest at 10% per annum, over a 45 month term commencing July 1, 1994 as follows: eleven installments of $15,000 each, thirty-three installments of $35,000 each and one installment of $19,097.26. Melville MRI, P.C. (the "Melville Center"), a New York professional corporation of which Raymond V. Damadian is the sole shareholder, director and President, purchased the scanner being utilized at its site from the Company for a purchase price of $1,011,431.12. Of the purchase price, $900,000 is to be paid by the assumption and payment of the Company's indebtedness to the lender secured by the scanner pursuant to a note bearing interest at 14% per annum and providing for 60 monthly payments of $20,700 each. The remaining $111,431.12 of the purchase price is to be paid concurrently with the payments to the lender pursuant to a note, with interest at 10% per annum, providing for 60 monthly payment of $2,367.58 each. Effective November 13, 1993, Damadian MRI at Islandia, P.C. (the "Islandia Center"), a New York professional corporation of which Raymond V. Damadian is the sole shareholder, director and President, entered into a lease with the Company for one of the Company's scanners. The lease provided for monthly payments of $15,586.21 for a term of 84 months commencing February 1, 1994. Effective June 30, 1997, his lease was terminated. ACQUISITION OF THE AFFORDABLE COMPANIES. Effective June 30, 1997, HMCA acquired a group of several interrelated corporations, limited liability companies and a partnership engaged in managing three diagnostic imaging centers and one multi-specialty practice in New York State (the "Affordable Companies") pursuant to a series of transactions concluding with a merger between a wholly-owned subsidiary of HMCA and Affordable Diagnostics, Inc. Concurrently with the acquisition, Raymond V. Damadian purchased three New York professional corporations to which the Affordable Companies were providing their services under several agreements. Dr. Damadian is the sole stockholder, director and President of these professional corporations (the "Affordable Professional Corporations"). During the fiscal year ended June 30, 1998, the aggregate of fees recognized by HMCA from the Affordable Professional Corporations was approximately $5.1 million. ACQUISITION OF A & A SERVICES. Effective March 20, 1998, HMCA acquired A & A Services, Inc. ("A & A Services"), an MSO managing four primary care practices in Queens County, New York. Concurrently with the acquisition, Raymond V. Damadian purchased the four New York professional service corporations under contract with A & A Services (the "A & A Professional Corporations"). During the fiscal year ended June 30, 1998, the aggregate of fees recognized by HMCA from the A & A Professional Corporations was $1.3 million. Pursuant to an agreement dated March 31, 1993, RVDC agreed to purchase the Company's general partnership interest (approximately 92% of the partnership) in a partnership owning and operating an MRI scanning center in Bensonhurst (Brooklyn), New York. Robert Janoff, a director of the Company, is a limited partner in the partnership. The partnership is also party to a service agreement with the Company. The current annual rate is $50,000 for the one year service contract from May 18, 1998 to May 17, 1999. The price in effect during the prior year from May 18, 1997 to May 17, 1998 was $50,000. Pursuant to an agreement dated September 30, 1993, AMD sold its interests in a partnership operating an MRI scanning center in Melbourne, Florida to Melbourne Magnetic Resonance Imaging, P.A. (the "Melbourne Facility"), for a purchase price of $150,000. The purchase price is payable, with interest at 10% per annum, over a period of fifteen months commencing September 1, 1995 as follows: $13,500 per month for the first fourteen months and $1,185.60 for the fifteenth month. The Melbourne Facility is a Florida professional corporation of which Raymond V. Damadian is the sole stockholder, director and President. From May 19, 1997 to May 18, 1998, the partnership was party to a service agreement with the Company at a price of $53,200 per annum. For May 19, 1998 to May 19, 1999 the price is $53,200 per annum. Pursuant to an agreement dated September 30, 1993, AMD sold to Dade County MRI, P.A. its interests in a partnership which had formerly operated an MRI scanning center in Miami, Florida. The purchase price of $100,000 is payable, with interest at 10% per annum, in sixty (60) equal consecutive monthly installments of principal and interest (including interest accrued from September 30, 1993), commencing 90 days after the scanner is placed in service. The partnership is presently inactive. Dade County MRI, P.A. is a Florida professional association of which Raymond V. Damadian is the sole stockholder, director and President. Pursuant to a sales agreement dated April 1, 1996, RVDC agreed to purchase an MRI scanner with certain upgrades from the Company which RVDC then contributed to Orlando MRI Associates, Limited Partnership (the "Orlando Partnership"), a limited partnership. The Orlando Partnership is utilizing the scanner at a site located in Orlando, Florida. The sales agreement provides for a purchase price of $400,000 payable in installments as follows: (1) $40,000 down payment within thirty (30) days of execution and (2) $360,000 in 84 monthly installments of $5,611.04 each (inclusive of interest at 8% per annum) pursuant to a promissory note executed by RVDC upon acceptance of the scanner. Commencing October 8, 1996, the Orlando Partnership has been party to a service agreement for the scanner with the Company at an annual fee of $70,000, which fee will remain in effect for a period of five years. Timothy Damadian, a Vice President of the Company, is a limited partner in Orlando. Canarsie MRI Associates ("Canarsie"), a joint venture partnership of which MRI Specialties, Inc. ("Specialties") is an owner, is party to a service agreement for its scanner with the Company at an annual fee of $70,000 for the periods September 1, 1997 through August 31, 1998 and September 1, 1998 through August 31, 1999. Timothy Damadian, a Vice President of the Company, is the sole stockholder, director and President of Specialties. Pursuant to an agreement dated January 2, 1996, Guardian MRI, Inc. ("Guardian") engaged the Company to deinstall, transport and reinstall an MRI scanner purchased for Pompano MRI Associates ("Pompano") from a third party. Timothy Damadian, a Vice President of the Company, is a stockholder, director and officer of Guardian. Pompano is a joint venture partnership of which Guardian is an owner. The agreement provides for a price of $120,000 payable in 36 monthly installments of $3,760.36 each (inclusive of interest at 8% per annum) pursuant to a note executed and delivered by Guardian upon the completion of the reinstallation. The agreement also provided a six month warranty for the scanner and a service agreement thereafter at an annual price of $70,000 for the periods October 1, 1996 to September 30, 1997 and October 1, 1997 to September 30, 1998. In addition, the agreement provided that the Company provide updated software, Signal Plus Surface Coils, Whisper Gradients and a Four Post Canopy and Steel upgrade for the scanner. As at June 30, 1998, the indebtedness of Canarsie to the Company was $25,076.00 and the aggregate indebtedness of Guardian and Pompano to the Company was $72,058. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. a) FINANCIAL STATEMENTS AND SCHEDULES The following consolidated financial statements are included in Part II, Item 8. Report of Independent Certified Public Accountants. Consolidated Balance Sheets as at June 30, 1998 and 1997. Consolidated Statements of Operations for the Three Years Ended June 30, 1998, 1997 and 1996. Consolidated Statements of Stockholders' Equity for the Three Years Ended June 30, 1998, 1997 and 1996. Consolidated Statements of Cash Flows for the Three Years Ended June 30, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. The following consolidated financial statement schedules are included in Item 14 (d). Report of Independent Certified Public Accountants on Schedules. Information required by schedules called for under Regulation S-X is either not applicable or is included in the consolidated financial statements or notes thereto. b) REPORTS ON FORM 8-K None. c) EXHIBITS 3.1 Certificate of Incorporation, as amended, of the Company incorporated herein by reference to Exhibit 3.1 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365. 3.2 Article Fourth of the Certificate of Incorporation, as amended, of the Company incorporated by reference to Exhibit 4.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-62099. 3.3 By-Laws, as amended, of the Company incorporated herein by reference to Exhibit 3.2 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365. 4.1 Specimen Common Stock Certificate incorporated herein by reference to Exhibit 4.1 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365. 4.2 Specimen Class B Common Stock Certificate incorporated herein by reference to Exhibit 4.2 to the Registrant's registration statement on Form S-1, Commission File No. 33-13365. 10.1 License Agreement between FONAR and Raymond V. Damadian incorporated herein by reference to Exhibit 10 (e) to Form 10-K for the fiscal year ended June 30, 1983, Commission File No. 0-10248. 10.2 1983 Nonstatutory Stock Option Plan incorporated herein by reference to Exhibit 10 (a) to Form 10-K for the fiscal year ended June 30, 1983, Commission File No. 0-10248, and amendments thereto dated as of March 7, 1984 and dated August 22, 1984, incorporated herein by referenced to Exhibit 28 (a) to Form 10-K for the year ended June 30, 1984, Commission File No. 0-10248. 10.3 1984 Incentive Stock Option Plan incorporated herein by reference to Exhibit 28 (c) to Form 10-K for the year ended June 30, 1984, Commission File No. 0-10248. 10.4 1986 Nonstatutory Stock Option Plan incorporated herein by reference to Exhibit 10.7 to Form 10-K for the fiscal year ended June 30, 1986, Commission File No. 0-10248. 10.5 1986 Stock Bonus Plan incorporated herein by reference to Exhibit 10.8 to Form 10-K for the fiscal year ended June 30, 1986, Commission File No. 0-10248. 10.6 1986 Incentive Stock Option Plan incorporated herein by reference to Exhibit 10.9 to Form 10-K for the fiscal year ended June 30, 1986, Commission File No. 0-10248. 10.7 Lease Agreement, dated as of August 18, 1987, between FONAR and Reckson Associates incorporated herein by reference to Exhibit 10.26 to Form 10-K for the fiscal year ended June 30, 1987, Commission File No. 0-10248. 10.8 1993 Incentive Stock Option Plan incorporated herein by reference to Exhibit 28.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-60154. 10.9 1993 Non-Statutory Stock Option Plan incorporated herein by reference to Exhibit 28.2 to the Registrant's registration statement on Form S-8, Commission File No. 33-60154. 10.10 1993 Stock Bonus Plan incorporated herein by reference to Exhibit 28.3 to the Registrant's registration statement on Form S-8, Commission File No. 33-60154. 10.11 1994 Non-Statutory Stock Option Plan incorporated herein by reference to Exhibit 28.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-81638. 10.12 1994 Stock Bonus Plan incorporated herein by reference to Exhibit 28.2 to the Registrant's registration statement on Form S-8, Commission File No. 33-81638. 10.13 1995 Non-Statutory Stock Option Plan incorporated herein by reference to Exhibit 28.1 to the Registrant's registration statement on Form S-8, Commission File No. 33-62099. 10.14 1995 Stock Bonus Plan incorporated herein by reference to Exhibit 28.2 to the Registrant's registration statement on Form S-8, Commission File No. 33-62099. 10.15 1997 Non-Statutory Stock Option Plan incorporated herein by reference to Exhibit 28.1 to the Registrant's registration statement on Form S-8, Commission File No.: 333-27411. 10.16 1997 Stock Bonus Plan incorporated herein by reference to Exhibit 28.2 to the Registrant's registration statement on Form S-8, Commission File No: 333-27411. 10.17 Stock Purchase Agreement, dated July 31, 1997, by and between U.S. Health Management Corporation, Raymond V. Damadian, M.D. MR Scanning Centers Management Company and Raymond V. Damadian, incorporated herein by reference to Exhibit 2.1 to the Registrant's Form 8-K, July 31, 1997, Commission File No: 0-10248. 10.18 Merger Agreement and Supplemental Agreement dated June 17, 1997 and Letter of Amendment dated June 27, 1997 by and among U.S. Health Management Corporation and Affordable Diagnostics Inc. et al., incorporated herein by reference to Exhibit 2.1 to the Registrant's 8-K, June 30, 1997, Commission File No: 0-10248. 10.19 Stock Purchase Agreement dated March 20, 1998 by and among Health Management Corporation of America, Fonar Corporation, Giovanni Marciano, Glenn Muraca et al., incorporated herein by reference to Exhibit 2.1 to the Registrant's 8-K, March 20, 1998, Commission File No: 0-10248. 21. Subsidiaries of the Registrant. See Exhibits. SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FONAR CORPORATION Dated: September 28, 1998 By: /s/ Raymond Damadian Raymond V. Damadian, President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/ Raymond Damadian Chairman of the September 28, 1998 Raymond V. Damadian Board of Directors, President and a Director (Principal Executive Officer) /s/ Claudette J.V. Chan Director September 28, 1998 Claudette J.V. Chan /s/ Robert J. Janoff Director September 28, 1998 Robert J. Janoff _____________________ Director Charles N. O'Data EX-27 2
5 0000355019 FONAR CORPORATION 1000 12-MOS JUN-30-1998 JUN-30-1998 41,752 20,252 12,274 2,397 3,514 76,514 27,945 18,843 108,448 22,088 0 0 1 6 72,566 108,448 3,938 27,554 7,800 23,842 6,507 930 728 (6,004) (498) (5,653) 0 0 0 (5,653) (.09) (.09)
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