UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED SEPTEMBER 30, 1998 Commission File Number 0-10248 FONAR CORPORATION ------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 11-2464137 -------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 110 Marcus Drive Melville, New York 11747 ------------------------------------------------------------------------ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (516) 694-2929 ------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---- ---- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the close of the period covered by this report. Class Outstanding at September 30, 1998 - - -------------------------------- --------------------------------------- Common Stock, par value $.0001 53,010,965 Class B Common Stock, par value $.0001 5,411 Class C Common Stock, par value $.0001 9,562,824 Class A Preferred Stock, par value $.0001 7,836,286
FONAR CORPORATION AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets - September 30, 1998 and June 30, 1998 Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 1998 and September 30, 1997 Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 1998 and September 30, 1997 Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended September 30, 1998 and September 30, 1997 Notes to Condensed Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II - OTHER INFORMATION
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (000's OMITTED) ASSETS September 30, June 30, 1998 1998 (UNAUDITED) Current Assets: --------- ------- Cash and cash equivalents $33,845 $41,751 Marketable securities 18,336 20,252 Accounts receivable - net 12,333 9,877 Costs and estimated earnings in excess of billings on uncompleted contracts 261 834 Inventories 3,500 3,514 Prepaid expenses and other current assets 661 286 ------ ------ Total current assets 68,936 76,514 ------ ------ Restricted cash 5,000 5,000 Property and equipment - net 10,038 9,102 Advances and notes to affiliates and related parties- net 1,322 1,350 Notes receivable - net 492 66 Excess of cost over net assets of businesses acquired-net 23,473 14,746 Other intangible assets - net 1,132 1,162 Other assets 484 508 -------- -------- $110,877 $108,448 ======== ======== See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (000's OMITTED) September 30, June 30, LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1998 (UNAUDITED) Current Liabilities: ---------- -------- Current portion of debt and capital leases $ 4,182 $ 2,443 Accounts payable 1,547 2,030 Other current liabilities 11,178 11,256 Dividends payable 2,585 3,909 Customer advances 473 670 Billings in excess of costs and estimated earnings on uncompleted contracts 31 31 Income taxes payable 955 955 Deferred income taxes 794 794 ------ ------ Total current liabilities 21,745 22,088 Long-term debt and capital lease obligations less current portion 20,610 13,560 Other non-current liabilities 118 113 ------ ------ Total liabilities 42,473 35,761 ------ ------ Minority interest 34 114 ------ ------ Commitments and contingencies - - STOCKHOLDERS' EQUITY Common Stock $.0001 par value; 60,000,000 shares authorized; 53,010,965 issued and outstanding at September 30, 1998 and 52,954,465 at June 30, 1998 5 5 Class B Common Stock $ .0001 par value; 4,000,000 shares authorized, (10 votes per share), 5,411 issued and outstanding at September 30 and at June 30, 1998 - - Class C Common Stock $.0001 par value; 10,000,000 shares authorized, (25 votes per share), 9,562,824 issued and outstanding at September 30 and at June 30, 1998 1 1 Class A non-voting Preferred Stock $.0001 par value; 8,000,000 authorized, 7,836,286 issued and outstanding at September 30 and at June 30, 1998 1 1 Paid-in capital in excess of par value 94,580 94,502 Accumulated other comprehensive income ( 1,282) ( 42) Accumulated deficit (22,489) (19,645) Notes receivable - stockholders ( 1,854) ( 1,854) Treasury stock - 202,864 shares of common stock at September 30 and 108,864 at June 30, 1998 ( 592) ( 395) ------- ------- Total stockholders' equity 68,370 72,573 ------- ------- Total liabilities and stockholders' equity $110,877 $108,448 ======= ======= See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (000's OMITTED, except per share data) FOR THE THREE MONTHS ENDED SEPTEMBER 30, --------------------- 1998 1997 REVENUES -------- -------- Product sales - net $ 494 $ 1,511 Service and repair fees - net 569 616 Scanning and management fees - net 6,473 4,601 -------- -------- Total Revenues - Net 7,536 6,728 -------- -------- COSTS OF REVENUES: Cost of product sales 855 2,174 Cost of service and repair fees 520 658 Cost of scanning and management fees - net 4,500 2,890 Research and development expenses 1,615 1,213 Selling, general and administrative expenses 3,116 2,389 Provision for bad debt - 273 Compensatory element of stock issuances - 286 Amortization of excess of cost over assets acquired 225 35 -------- -------- Total Costs and Expenses 10,831 9,918 -------- -------- Loss From Operations ( 3,295) ( 3,190) Interest Expense ( 308) ( 92) Interest Income 777 1,063 Other income-principally gain on litigation awards 9 - ------ ------- Loss before provision for taxes and minority interest ( 2,817) ( 2,219) Provision for income taxes 1 - ------- ------- Loss before minority interest ( 2,818) ( 2,219) Minority interest in net (income) loss of subsidiary and partnership ( 26) ( 46) ------- ------- NET LOSS $( 2,844) $( 2,265) ======= ======= Net Loss per share $(.04) $(.04) ====== ====== Weighted average number of shares outstanding 63,837 60,073 ====== ====== See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (000'S OMITTED) FOR THE THREE MONTHS ENDED SEPTEMBER 30, ----------------- 1998 1997 ------ ------ Cash Flows from Operating Activities Net Loss $( 2,844) $( 2,265) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Minority interest in net income (loss) 26 46 Depreciation and amortization 999 861 Imputed interest on deferred payment obligation 27 - Provision for losses on accounts and notes receivable and accounts receivable from affiliates - 168 Compensatory and fee element of stock issuances - 44 Stock issued in settlement of current liabilities 74 248 (Increase) decrease in operating assets, net: Receivable from litigation award - 77,223 Accounts and notes receivable ( 982) ( 1,493) Costs and estimated earnings in excess of billings on uncompleted contracts 573 286 Inventories 14 333 Prepaid expenses and other current assets ( 375) 86 Other assets 24 ( 202) Receivables and advances to affiliates and related parties 28 702 Increase (decrease) in operating liabilities, net: Accounts payable ( 409) ( 116) Other current liabilities ( 222) 219 Customer advances ( 197) ( 322) Billings in excess of costs and estimated earnings on uncompleted contracts - ( 192) Other liabilities 5 ( 92) ------ ------ Net cash provided by (used in) operating activities ( 3,259) 75,534 ------ ------ Cash Flows from Investing Activities: Investment (reduction) in marketable securities 676 - Acquisitions, net of cash acquired ( 2,000) - Purchases of property and equipment - net ( 1,340) ( 1,257) Cost of capitalized software development and patents ( 47) ( 26) ------ ------ Net cash used in investing activities ( 2,711) ( 1,283) ------ ------ See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (000'S OMITTED) FOR THE THREE MONTHS ENDED SEPTEMBER 30, ----------------- 1998 1997 ------ ------ Cash Flows from Financing Activities: Distribution to minority interest ( 106) ( 41) Repayment of borrowings and capital lease obligations ( 309) ( 154) Proceeds from sale of stock - 300 Repayment of notes receivable in connection with shares issued under stock option and bonus plans - net - 82 Dividends paid ( 1,324) - Purchase of treasury stock ( 197) - ------ ------ Net cash provided by financing activities ( 1,936) 187 ------ ------ Increase (Decrease) in Cash ( 7,906) 74,438 Cash at beginning of period 41,751 5,861 ------ ------ Cash at end of period $33,845 $80,299 ====== ====== See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (000'S OMITTED) FOR THE THREE MONTHS ENDED SEPTEMBER 30, ----------------- 1998 1997 ------ ------ Net loss $(2,844) $(2,265) Other comprehensive income, net of tax: Unrealized gains (losses) on securities, net of tax (1,240) - ------- ------- Total comprehensive loss $(4,084) $(2,265) ======= =======
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) 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 and one acquisition consummated in August of 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. 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 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 September 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. 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 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. 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 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. 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 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). 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 September 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 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, accounted for approximately 77% and 68% of revenues for the three months ended September 30, 1998 and 1997, respectively. At September 30, 1998, the Company had cash deposits approximately $39,000,000 in excess of federally insured limits. Fair Value of Financial Instruments ----------------------------------- The financial statements include various estimated fair value information at September 30, 1998 and June 30, 1998, 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) 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 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. 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) 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. 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 Management 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 3 - ACQUISITIONS (Continued) 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 September 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. 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 3 - ACQUISITIONS (Continued) 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. Dynamic Health Care Management, Inc. ------------------------------------ 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. A substantial portion of the convertible 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 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 $8,951,907 and is being amortized on a straight-line basis over 20 years. The accompanying consolidated financial statements include the operations of Dynamic from the date of acquisition, August 20, 1998.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 4 - MARKETABLE SECURITIES --------------------- The following is a summary of marketable securities at September 30, 1998: (000's omitted) --------------- Unrealized Holdings Fair Market Cost Gains (Loss) Value --------- ----------- ----------- U.S. Government Obligations $ 6,015 $ 23 $ 6,038 Corporate and government agency bonds 2,598 13 2,611 Equity securities including mutual stock funds 11,005 (1,318) 9,687 --------- ----------- ----------- $19,618 $(1,282) $18,336 ========= =========== =========== NOTE 5 - ACCOUNTS RECEIVABLE, NET ------------------------ Accounts receivable, net is comprised of the following: (000's omitted) --------------- September 30, 1998 June 30, 1998 ------------------ ------------- Receivable from equipment sales $ 1,205 $ 1,930 Receivables assigned from related PC's 14,125 10,344 Less: Allowance for doubtful accounts and contractual allowances (2,997) (2,397) ------- ------- $12,333 $ 9,877 ======= ======= 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 5 - ACCOUNTS RECEIVABLE, NET (Continued) Approximately 14% and 13% of the PC's September 30, 1998 and September 30, 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 - INVENTORIES Inventories included in the accompanying consolidated balance sheets consist of: (000's omitted) September 30, 1998 June 30, 1998 ------------------ ------------- Purchased parts, components and supplies $2,542 $ 2,549 Work-in-process 958 965 ------ ------- $3,500 $ 3,514 ====== =======
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 7 - SUPPLEMENTAL CASH FLOW INFORMATION During the three months ended September 30, 1998 and 1997, the Company paid $188,827 and $91,806 for interest, respectively. During the three months ended September 30, 1998 and 1997, the Company paid $1,076 and $0 for income taxes, respectively. During the three months ended September 30, 1998, the Company acquired the assets and assumed the liabilities of Dynamic. The transaction had the following non-cash impact on the balance sheet: (000,s omitted) ------------- Accounts receivable $ 1,900 Equipment 60 Intangibles 8,952 Accrued Liabilities (75) Notes payable to sellers (8,837) ---------- Net Cash Used For Acquisition $ 2,000 ========== NOTE 8 - 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. 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 9 - Litigation ---------- On August 4, 1998, Beal Bank filed a notice of motion for summary judgment 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.
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 10 - PROFORMA INFORMATION The Company's consolidated financial statements for the three months ended September 30, 1997 do not include the results of operations of A&A and Dynamic and the consolidated financial statements for the three months ended September 30, 1998 do not include the results of operations of Dynamic for the period July 1, 1998 through August 20, 1998. The following summarizes the unaudited proforma results of operations for the three months ended September 30, 1998, and 1997, assuming the foregoing acquisitions had occurred on June 30, 1997 (in thousands, except per share data): 1998 1997 ------------ ----------- (Unaudited) (Unaudited) Revenues, net $ 8,215 $ 9,022 Loss from operations $ (3,044) $ (2,594) Income (loss) before income taxes $ (2,656) $ (1,883) Fully diluted net income (loss) per share $(.04) $(.03) NOTE 11 - 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 in thousands of dollars net revenues, operating income and other financial information by industry segment for the three months ended September 30, 1998 and 1997:
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (UNAUDITED) NOTE 11 - SEGMENT INFORMATION (continued) 1998 1997 Net revenues: ------- ------- Medical equipment $ 1,338 $ 2,454 Physician practice management 6,473 4,601 Intersegment eliminations ( 275) ( 327) ------- ------- Total $ 7,536 $ 6,728 ======= ======= Income (loss) from operations: Medical equipment $ (4,157) $ (3,887) Physician practice management 862 697 ------- ------- Total $ (3,295) $ (3,190) ======= ======= Depreciation and amortization: Medical equipment $ 395 $ 311 Physician practice management 604 550 ------- ------- Total $ 999 $ 861 ======= ======= Capital expenditures: Medical equipment $ 1,252 $ 435 Physician practice management 88 848 ------- ------- Total $ 1,340 $ 1,283 ======= ======= At September 30, At June 30, 1998 1998 ---------------- ----------- Identifiable assets: Medical equipment $ 70,726 $ 79,236 Physician practice management 40,151 29,212 ------- ------- Total $ 110,877 $108,448 ======= =======
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS. For the fiscal quarter ended September 30, 1998 (first quarter of fiscal 1999), the Company reported a net loss of $2.8 million on revenues of $7.5 million as compared to a net loss of $2.3 million on revenues of $6.7 million for the first quarter of fiscal 1998. The Company operates in two industry segments: the manufacture and servicing of medical (MRI) equipment, the Company's traditional business which is conducted directly by Fonar and physician practice management, a new line of business for the Company, which is conducted through Fonar's wholly-owned subsidiary, Health Management Corporation of America ("HMCA"). HMCA income from operations was approximately $862,000 for the first quarter of fiscal 1999 compared to operating income of $697,000 for the first quarter of fiscal 1998. The results for fiscal 1998 reflected the profitability of HMCA's five acquisitions, Dynamic Health Care Management, Inc. ("Dynamic"), A & A Services, Inc. ("A & A"), Central Health Care Management Services LLC ("Central Health"), Affordable Diagnostics, Inc. and its related companies ("Affordable") and Raymond V. Damadian, M.D. MR Scanning Centers Management Company and two related Florida companies ("RVDC"). Dynamic is a management services organization (MSO) managing three multi-specialty physician practices in Nassau and Suffolk Counties in New York, A & A is an MSO managing four primary care practices in Queens County and Central Health is a multi-specialty MSO in Yonkers, New York. Affordable was engaged in the business of providing management services, office space, equipment and non-medical personnel to three diagnostic imaging centers and one physical rehabilitation center. RVDC was engaged in the business of providing management and other services to 21 diagnostic imaging centers. Results of operations of Dynamic are included from and after August 20, 1998, the closing of the acquisition. Dynamic, A & A and Central Health were acquired following September 30, 1997, and hence the results of operations for HMCA for the first quarter of fiscal 1998 do not include the results of operations of these companies. The income from operations attributable to HMCA (physician practice management) was not sufficient to offset the operating loss from the Company's traditional MRI equipment manufacturing and service business ($4.2 million for the first quarter of fiscal 1999 as compared to $3.9 million for fiscal 1998). Accordingly the Company's consolidated operating loss was $3.3 million for the first quarter of fiscal 1999 as compared to an operating loss of $3.2 million for the first quarter of fiscal 1998. The Company's operating loss was offset in part, however, by interest income of approximately $777,000 (as compared to interest income of $1.1 million for the first quarter of fiscal 1998). Interest income was derived from the interest earned on the Company's cash deposits and cash equivalents and investments and marketable securities, which were approximately $57 million as at September 30, 1998. The principal reason for the Company's operating losses is low product sales volumes. Sales revenues attributable to the Company's medical (MRI) equipment business (sales and service) were $1.3 million for the first quarter of fiscal 1999 as compared to $2.5 million for the first quarter of fiscal 1998 (against costs of revenues attributable to the Company's medical equipment business of $1.6 million for the first quarter of fiscal 1999 and $3.2 million for the first quarter of fiscal 1998). The increased operating losses for the Company's medical equipment business in the first quarter of fiscal 1999 ($4.2 million operating loss) over the first quarter of fiscal 1998 ($3.9 million operating loss) was attributable primarily to increases of approximately $400,000 in research and development expenditures and $200,000 in selling, general and administrative expenses reduced by the improvement in the spread between the sales revenue and related cost of revenues for the medical equipment segment. The Company's efforts to improve equipment sales volume is focused on research and development (expenditures of $1.6 million for the first quarter of fiscal 1999 as compared to $1.2 million for the first quarter of fiscal 1998) to improve the competitiveness of its products and increasing marketing and sales efforts. The Company's QUAD (TM) 7000 and QUAD (TM) 12000 MRI scanners, together with other research and development projects, are intended to significantly improve the Company's competitive position. 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. As part of its marketing program, the Company will also attend the industry's annual trade show, RSNA (Radiological Society of North America) 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 its high-field "Open MRI" scanners since image quality increases are currently resulting from the company's new R&D investments and from the higher magnetic field of its Open scanner. 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. With respect to the revenues attributable to the Company's physician practice management business, the difference between the $6.5 million in revenues for the first quarter of fiscal 1999 and $4.6 million in revenues for the first quarter of fiscal 1998 reflects approximately $2.1 million in revenues attributable to Dynamic, A & A and Central Health, its most recent acquisition. The Company has continued its cost containment programs, which include increasing the portion of manufacturing conducted on the Company's premises. This has 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 has continued its efforts to increase scanner sales in foreign countries as well as domestically. Revenues from foreign product sales were $306,000 (approximately 62% of product sales revenues and 4% of all revenues) for the first quarter of fiscal 1999, against costs of revenues for such sales of $530,000 (approximately 62% of costs of revenues for product sales and 9% of all costs of revenues). This compares to $696,371 in foreign product sales revenues in the first quarter of fiscal 1998 (approximately 46% of product sales revenues and 10% of all revenues) against $939,785 in costs of foreign product sales revenues (approximately 43% of costs of revenues for product sales and 10.0% of all costs of revenues) for the first quarter of fiscal 1998. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents declined from $42 million at June 30, 1998 to $34 million at September 30, 1998. Principal uses of cash during the quarter included; cash used for acquisition of Dynamic $2 million (see Note 3- Dynamic Acquisition), capital expenditures $1.3 million, payment of special dividend to shareholders $1.3 million, purchase of treasury stock $.2 million and $3 million to fund the loss for the quarter. Marketable securities approximated $18 million as of September 30, 1998 as compared to $20 million as of June 30, 1998. The unrealized loss on marketable securities increased from $42,000 at June 30, 1998 to $1,282,000 at September 30, 1998. Subsequent to September 30, 1998, the unrealized loss on marketable securities has decreased from $1,282,000 at September 30, 1998 to approximately $200,000 at November 16, 1998 due to the improvement in market conditions for equity securities. As of September 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 and expanding its new physician practice management business. The Company believes that it has sufficient cash resources and other liquid assets to support its operations. 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.
PART II - OTHER INFORMATION Item 1 - Legal Proceedings: There were no material changes in litigation for the first quarter of fiscal 1999 from that described in Form 10-K for the fiscal year ended June 30, 1998. Item 2 - Changes in Securities: None Item 3 - Defaults Upon Senior Securities: None Item 4 - Submission of Matters to a Vote of Security Holders: None Item 5 - Other Information: None Item 6 - Exhibits and Reports on Form 8-K: (1) Form 8-K filed on April 7, 1998 for acquisition of A & A. Financial Statements for A & A filed by Amendment on June 5, 1998. (2) Form 8-K filed on September 4, 1998 for acquisition of Dynamic. Financial statements for Dynamic filed by Amendment on November 3, 1998.
SIGNATURES Pursuant to the requirements 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 (Registrant) By: /s/ Raymond V. Damadian Raymond V. Damadian President & Chairman Dated: November 16, 1998