SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549

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FORM 10-K

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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 2017

OR

 

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the transition period from _____________ to _____________

 

Commission File No. 0-10248

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FONAR CORPORATION
(Exact name of registrant as specified in its charter)

  

  DELAWARE  11-2464137  
  (State of incorporation)  (IRS Employer Identification Number)  
        
  110 Marcus Drive, Melville, New York  11747  
  (Address of principal executive offices)   (Zip Code)  

 

  631) 694-2929  
  (Registrant's telephone number, including area code)  

____________________________________________________

 

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $.0001 per share

 

Securities registered pursuant to Section 12(g) of the Act:

None

_________________________________________________________________________

  

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ____ No __X__

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ____ No __X__

 

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 _______

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FONAR CORPORATION AND SUBSIDIARIES

 

Indicate by check mark whether the registrant (1) has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ___X____ No ______

 

Indicate by check mark if disclosure of delinquent filers, pursuant to Item 405 of Regulation S-K, §229.405 of this Chapter, is not contained, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this 10-K or any amendment to the Form 10-K. [X]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ____ Accelerated filer X

Non-accelerated filer ____ Smaller reporting company

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ____ No __X_

 

The aggregate market value of the shares of Common Stock held by non-affiliates as of December 30, 2016 based on the closing price of $19.15 per share on such date as reported on the NASDAQ System, was approximately $114 million. The other outstanding classes do not have a readily determinable market value.

 

As of September 14, 2017, 6,287,511 shares of Common Stock, 146 shares of Class B Common Stock, 382,513 shares of Class C Common Stock and 313,438 shares of Class A Non-voting Preferred Stock of the registrant were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

None

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 FONAR CORPORATION AND SUBSIDIARIES

 

FORM 10-K ITEMS

  

PART I.    Page
Item 1.  Business 3
Item 1A.  Risk Factors 24
Item 1B.  Unresolved Staff Comments 26
Item 2.  Properties 26
Item 3.  Legal Proceedings 27
Item 4.  Mine Safety Disclosures 27
PART II.     
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities 27
Item 6.  Selected Consolidated Financial Data 29
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations 29
Item 8.  Financial Statements and Supplementary Data 38
Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 79
Item 9A.  Controls and Procedures 79
Item 9B.  Other Information 81
PART III.     
Item 10.  Directors, Executive Officers and Corporate Governance 81
Item 11.  Executive Compensation 84
Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 86
Item 13.  Certain Relationships and Related Transactions, and Director Independence 87
Item 14.  Principal Accountant Fees and Services 88
PART IV.     
Item 15.  Exhibits and Financial Statement Schedules 89

 

PART I

ITEM 1. BUSINESS

GENERAL

 

Fonar Corporation, sometimes referred to as the "Company" or "Fonar", is a Delaware corporation which was incorporated on July 17, 1978. Our address is 110 Marcus Drive, Melville, New York 11747 and our telephone number is 631-694-2929. Fonar also maintains a website at www.fonar.com. Fonar provides copies of its filings with the Securities and Exchange Commission on Forms 10-K, 10-Q and 8-K and amendments to these reports to stockholders on request.

 

We conduct our business in two segments. Our medical equipment segment is conducted directly through Fonar. Our physician management and diagnostic services segment is conducted through our subsidiary Health Management Company of America (“HMCA”), also called Health Diagnostics Management, LLC. HMCA provides management services, administrative services, billing and collection services, office space, equipment, repair, maintenance service, and clerical and other non-medical personnel to medical providers engaged in diagnostic imaging. In addition to acting as a management company, HMCA owns and operates four diagnostic imaging facilities in Florida, where the corporate practice of medicine is permitted.

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We restructured the corporate organization of our physician and diagnostic services management segment of our business effective July 1, 2015. Imperial Management Services, LLC (“Imperial”), a subsidiary which owned the assets used in the business of its parent, Health Management Corporation of America (which is wholly-owned by Fonar), transferred those assets to Health Diagnostics Management, LLC (“HDM”), which is another subsidiary of Health Management Corporation of America. As a result, going forward our physician and diagnostic management business will be conducted entirely through HDM, which is operating under the assumed name Health Management Company of America.

 

Fonar is engaged in the business of designing, manufacturing, selling and servicing magnetic resonance imaging scanners, also referred to as "MRI" or "MR" scanners, which utilize MRI technology for the detection and diagnosis of human disease, abnormalities, other medical conditions and injuries. Fonar’s founders built the first MRI scanner in 1977 and Fonar introduced the first commercial MRI scanner in 1980. Fonar is also 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. We introduced the first "open" MRI in 1980. Since that time we have concentrated on further application of our “open” MRI, introducing most recently the Upright® Multi-Position™” MRI scanner (also referred to as the “Upright®” or “Stand-Up®” MRI scanner) and the Fonar 360™ MRI scanner. The Fonar 360™ MRI is not presently being marketed.

 

See Note 17 to the Consolidated Financial Statements for separate financial information regarding our medical equipment and physician and diagnostic management services segments.

 

FORWARD LOOKING STATEMENTS.

 

Certain statements made in this Annual Report on Form 10-K are

"forward-looking statements", within the meaning of the Private Securities Litigation Reform Act of 1995, regarding the plans and objectives of Management for future operations. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements are based on current expectations that involve numerous risks and uncertainties. Our plans and objectives are based, in part, on assumptions involving the expansion of business. These assumptions 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 our control. Although we believe that our 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 Annual Report will prove to be accurate. In light of the significant uncertainties inherent in our forward-looking statements, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.

 

THE UPRIGHT® MRI SCANNER

 

The Upright® MRI scanner is the product we are presently promoting. The Upright® MRI (also known as the “Stand-Up® MRI”) is a “whole-body” MRI, meaning it can be used to scan any part of the body. Unlike conventional recumbent MRI scanners, the Upright® MRI permits MRI diagnoses to be made in the weight-bearing state. The Upright® MRI allows patients to be scanned while standing, sitting, bending or lying down. This means that an abnormality or injury, such as a slipped disk, may be scanned in a weight-bearing posture, which more often than not is the position in which patients experience pain. An adjustable bed allows patients to stand, sit or lie on their backs, sides or stomachs. The Upright® MRI is by design a non-claustrophobic MRI scanner. We have introduced the name “Upright®” as an alternative to “Stand-Up®” because of the multiplicity of positions in which the patient may be scanned where the patient is not standing.

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HMCA manages a total of 26 MRI scanning facilities, four of which are owned by subsidiaries of HMCA. Seventeen facilities are located in New York and seven are located in Florida. (The four facilities owned by HMCA subsidiaries are in Florida, where the corporate practice of medicine is permitted.) Twenty-five facilities are equipped with Upright® MRI scanners. We believe that the utilization of Fonar Upright® MRI scanning systems, which are produced under the protection of our patents, have been a significant factor in the increased patient volume of the scanning facilities.

 

MEDICAL EQUIPMENT SEGMENT

 

PRODUCTS

 

The Fonar Upright® MRI is a weight-bearing whole-body open MRI system which enables positional MRI (pMRI®) applications. Operating at a magnetic field strength of 0.6 Tesla, the scanner is a powerful, diagnostically versatile and cost-effective open MRI that provides a broad range of clinical capabilities and a complete set of imaging protocols. Patients can be scanned standing, bending, sitting, upright at an intermediate angle and in the conventional recumbent position. This multi-positional MRI system accommodates an unrestricted range of motion for flexion, extension, lateral bending, and rotation studies of the cervical (upper) and lumbar (lower) spine. Previously difficult patient scanning positions can be achieved and compared using the system’s MRI-compatible, three-dimensional, motorized patient handling system. The system’s lift and tilt functions deliver the targeted anatomical region to the center of the magnet. True image orientation is assured, regardless of the rotation angle, via computer read-back of the table’s position.

 

There is considerable evidence that the weight-bearing Upright® MRI provides medical benefits not duplicated by any other MRI scanner because patient positioning plays a critical role in detecting clinically significant pathology.

 

For instance, the Fonar Upright® technology has demonstrated its key value on patients with the Arnold-Chiari Syndrome, which is believed to affect 200,000 to 500,000 Americans. In this syndrome, brain stem compression and subsequent severe neurological symptoms occur in these patients, when because of weakness in the support tissues within the skull, the brain stem descends and is compressed and entrapped at the base of the skull in the foramen magnum, which is the circular bony opening at the base of the skull where the spinal cord exits the skull. The brain structures “entrapped” in Chiari Syndrome are the lowest lying structures of the brain, the tonsils of the cerebellum. The Chiari Syndrome is therefore alternately named Cerebellar Tonsillar Ectopia (CTE) indicating the displacement (ectopia) of these Cerebellar tonsils in this syndrome. Classic symptoms of the Chiari Syndrome include the “drop attack,” where the patient unexpectedly experiences an explosive rush or nervous discharge at the base of the brain which rushes down the body to the extremities, causing the patient to collapse in a temporary neuromuscular paralysis; this subsides when the patient is lying down. Conventional lie-down MRI scanners cannot make an adequate evaluation of the pathology since the patient’s pathology is most visible and the symptoms are most acute when the patient is scanned in the upright weight-bearing position.

 

A publication in the Journal “Brain Injury” (Brain Injury 2010, 24 (7-8) 988-994) of 1,200 neck pain patients reported that the fallen cerebellar tonsils of the brain (CTE) were missed 75% of the time when the patient was scanned only in the recumbent position. It is critical to have an image of the patient in an upright position so that the neurosurgeons can fully evaluate the extent of the brain stem and choose the most appropriate surgical approach for the operative repair.

 

The study was published by 10 authors from distinguished universities in the United States and around the world. The study reported that Cerebellar Tonsillar Ectopia Herniation (CTE) was missed 75% of the time when the patient was scanned lying down instead of upright. At the current rate of 1,000,000 automobile whiplash injuries in the U.S. per year, 600,000 patients each year would have the pathology responsible for their symptoms go undetected if they were examined solely in a conventional recumbent-only MRI.

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The Upright® MRI has also demonstrated its value for patients suffering from scoliosis. Scoliosis patients have been typically subjected to routine x-ray exams for years and must be imaged upright for an adequate evaluation of their scoliosis. Because the patient must be standing for the exam, an x-ray machine has been the only modality that could provide that service. The Upright® MRI is the only MRI scanner that allows the patient to stand during the MRI exam. Fonar has developed a new RF receiver and scanning protocol that for the first time allows scoliosis patients to obtain diagnostic pictures of their spines without the risks of x-rays. A study by the National Cancer Institute (2000) of 5,466 women with scoliosis reported a 70% increase in breast cancer resulting from 24.7 chest x-rays these patients received on the average in the course of their scoliosis treatment.

 

Other important new applications are Upright® imaging of the pelvic floor and abdomen to image prolapses and inguinal hernias. Fonar has also developed the first non-invasive method to image the prostate: the patient simply sits on a flat, seat-like coil.

 

The Upright® MRI is also the world’s most non-claustrophobic whole-body MRI scanner. Patients can simply walk into the magnet, stand or sit for their scans and then walk out. Any site with a Fonar Upright® MRI scanner is capable of providing Open Sky® MRI scanning services. The magnet’s front-open and top-open design provides an unprecedented degree of comfort because there is nothing in front of the patient’s face except a large (42”) flat-screen TV that is mounted on the wall. The default position for the bed is a tilt back of six degrees that minimizes patient motion. Special coil fixtures, a patient seat, Velcro straps, and transpolar stabilizing bars are also used to keep the patient comfortable and motionless throughout the scanning process.

 

Full-range-of-motion studies of the joints in a multiple of directions are possible, an especially promising feature for sports injuries. Full range of motion cines, or movies, of the lumbar spine can also be achieved under full body weight.

 

Fonar created the high-field open MRI market segment. The Fonar Upright® MRI operates at a significantly higher magnetic field strength than the 0.2-0.35 Tesla open MRIs that preceded it, and, therefore, benefits from more of the MRI image-producing signal needed to make high-quality MRI images.

 

Fonar maximizes image quality through an optimal combination of image signal to noise (S/N) and contrast-to noise (C/N) ratios. Technical improvements incorporated into the scanner design include increased image processing speed, high-S/N Organ Specific(TM) RF receiver coils, high performance 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, a major determinant of image quality that must be considered is contrast, the quality that enables reading physicians to clearly distinguish adjacent, and sometimes minute, anatomical structures from their surroundings. 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 Upright® MRI scanners operate squarely in the optimum C/N range.

 

FONAR’s scanners are equipped with a variety of software features which enhance versatility and diagnostic capability. For example, SMART™ scanning allows for same-scan customization of multi-slice scans, each slice with its own thickness, resolution, angle and position. This is an important feature for scanning parts of the body that include small-structure sub-regions requiring finer slice parameters. There is also Multi-Angle Oblique™ (MAO) imaging, and oblique imaging.

 

During fiscal 2017, sales of our Upright® MRI scanners accounted for approximately 0.9% of our total revenues and 6.4% of our medical equipment revenues, as compared to 1.1% of total revenues and 7.7% of medical equipment revenues in fiscal 2016, and 2.3% of our total revenues and 14.1% of medical equipment revenues in fiscal 2015.

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FONAR’s principal selling, marketing and advertising efforts have been focused on the Upright® MRI, which we believe is a particularly unique product, being the only MRI scanner which is both open and allows for weight-bearing imaging. We expect to continue our focus on the Upright® MRI in the immediate future.

 

The materials and components used in the manufacture of our products (circuit boards, computer hardware components, electrical components, steel and plastic) are generally available at competitive prices. We have not had difficulty acquiring such materials.

 

PRODUCT MARKETING

 

The principal markets for the Company's scanners are private diagnostic imaging centers and hospitals.

 

We use internal and independent manufacturer’s representatives for domestic and foreign markets. None of Fonar’s competitors are entitled to make the Fonar Upright® MRI scanner.

 

Fonar’s Website includes interactive product information for interested customers.

 

During fiscal 2017, foreign sales were made to customers in the United Arab Emirates and the United Kingdom. CEO Matthias Schulz of Medserena, Fonar’s principal foreign sales representative and distributor, has said, “The large number of requests coming from our physicians in Germany are arising because of the special medical need for FONAR’s unique technology. This is in spite of an intensely active MRI market in Germany, where there are already many conventional lie-down MRIs installed.” Medserena also has expanded its market to the United Kingdom with the opening of a Fonar Upright® MRI scanner in London.

Fonar’s marketing strategy has been designed to reach key purchasing decision makers with information concerning the Upright® MRI. This has led to many inquiries and to some sales of the Upright® MRI scanner and is intended to increase Fonar’s presence in the medical market. Fonar focuses on four target audiences: neurosurgeons, orthopaedic surgeons, radiologists and physicians in general.

 

1)       Neurosurgeons and Orthopaedic Surgeons: These are the surgeons who can most benefit from the superior diagnostic benefits of the Fonar Upright® MRI with its Multi-Position® diagnostic ability.

2)       Radiologists: These physicians can now offer a new modality to their referring physicians.

3)       All Physicians: The vast number of doctors who send patients for MRI’s need to be aware of the diagnostic advantages of the Fonar Upright® Multi-Position™.

 

Our advertising for Fonar and HMCA re-enforces the unique value provided by Fonar MRI scanners. We have increased internet awareness of our product by driving patient traffic to the Upright® scanning centers we manage via the Fonar website (www.fonar.com) as well as by creating Websites for each HMCA location. These websites give prospective customers of Upright® MRI scanners a view of operating Upright® MRI centers and highlight the benefits of using an Upright® MRI scanner. The success of HMCA-managed sites not only increases management fees to HMCA but encourages new sales for Fonar as well. A complete list of the sites managed by HMCA can be found at HMCA’s website, hmca.com.

 

SERVICE AND UPGRADES FOR MRI SCANNERS

 

Our customer base of installed scanners has been and will continue to be an additional source of income, independent of direct sales.

 

Income is generated from the installed base in two principal areas, namely, service and upgrades. Service and maintenance revenues from our external installed base were approximately $9.5 million in fiscal 2016 and $9.6 million in fiscal 2017. Our objective is to maintain service revenues at present levels or better, based on the longevity of the technology, and the refurbishments and upgrades which keep the scanners competitive with the latest techniques.

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We also anticipate that our scanners will result in upgrades income in future fiscal years. The potential for upgrades income, originates in the versatility and productivity of the Upright® Imaging technology. New medical uses for MRI technology are constantly being discovered and are anticipated for the Upright® Imaging technology as well. New features can often be added to the scanner by the implementation of little more than versatile new software packages, which when coupled with hardware upgrades can add years of useful life to the scanner.

 

RESEARCH AND DEVELOPMENT

 

During the fiscal year ended June 30, 2017, we incurred expenditures of $1,480,670, none of which were capitalized, on research and development, as compared to $1,631,846, none of which were capitalized, during the fiscal year ended June 30, 2016.

 

Research and development activities have focused principally on software improvements to the user interface of the MRI scanner. The Windows-based Sympulse™ platform controls all of the functions of the UPRIGHT® scanner except those of the versatile, multi-position patient table. Separate, dedicated, motion-control software is used to maneuver the UPRIGHT® bed, and development of this software is ongoing as well.

 

While software improvements to the user interface are important in their own right, significant value is added to the MRI scanner by the modification of existing protocols for examining various parts of the body, and the development of new protocols that utilize new underlying capabilities of the pulse sequence software. Over time, FONAR users have become accustomed to the steady improvement in the recommended clinical protocols that accompany new software releases. More significantly, in recent years we have seen increasing adoption of FONAR-recommended clinical protocols over those developed on site. This is a testament to the superior image quality they produce in attractively short scan times.

 

The development of clinically practical scan protocols and software depends on close contact between research and development scientists and engineers, and end users. That close contact is facilitated in part by the relationship with HMCA and the scanning centers. In addition to that collaboration, R&D staff have pursued a variety of novel and Upright® MRI-specific research projects. It is anticipated that these will ultimately lead to new applications that are made available to existing customers as upgrade add-ons to their machines. For example, phase-contrast imaging techniques originally developed for angiography have recently been applied to cerebro-spinal fluid (CSF) flow. Analysis of CSF flow in upright and recumbent postures may prove to be of significant value in the evaluation of a variety of disorders.

 

BACKLOG

 

Our backlog of unfilled orders at September 13, 2017 was approximately $735,000, as compared to $1.7 million at September 9, 2016. It is expected that the existing backlog of orders will be filled within the 2018 fiscal year.

 

PATENTS AND LICENSES

We currently have numerous patents in effect which relate to the technology and components of our MRI scanners. We believe that these patents, and the know-how we have developed, are material to our business.

 

One of our patents, issued in the name of Dr. Damadian and licensed to Fonar, was United States patent No. 3,789,832, Apparatus and Method for Detecting Cancer in Tissue, also referred to in this report as the "1974 Patent". The 1974 Patent was the first MRI patent issued by the United States Patent Office. The development of our MRI scanners has been based upon the 1974 Patent, and we believe 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.

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We have significantly enhanced our patent position within the industry and now possesses a substantial patent portfolio which provides us, 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. As of June 30, 2017, 201 patents had been issued to Fonar, and approximately 20 patents were pending. A number of Fonar’s existing patents specifically relate to protecting Fonar’s position in the Upright MRI market. The patents further enhance Dr. Damadian's pioneer patent, the 1974 Patent, that initiated the MRI industry and provided the original invention of MRI scanning. The terms of the patents in Fonar’s portfolio extend to various times.

 

We also have patent cross-licensing agreements with other MRI manufacturers. We have not licensed, however, any technology relating to Upright® MRI scanning.

 

PRODUCT COMPETITION

 

MRI SCANNERS

 

MRI takes advantage of the nuclear magnetic resonance signal elicited from the body's tissues and the exceptional sensitivity of this signal for detecting disease discovered by Fonar. Much of the serious disease of the body occurs in the soft tissue of vital organs. 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% while the contrast in the brain by MRI is 25 times greater at 40%. X-ray contrasts among the body’s soft tissues are maximally 4%. Their contrast by MRI is 32.5 times greater (130%).

 

The soft tissue contrasts with which to distinguish cancers on images by MRI are up to 180%. In the case of cancer these contrasts can be even more marked making cancers readily visible and detectable anywhere in the body. This is because the nuclear resonance signals from the body's normal soft tissue vital organs, as discovered in the original publication that founded MRI, differ so dramatically from each other (e.g. small intestine 257 milliseconds, brain 595 milliseconds). Liver cancer and healthy liver signals differ by 180% for example.

 

A majority of the MRI scanners in use in hospitals and outpatient facilities and at mobile sites in the United States are based on high field (1.5 - 3.0 Tesla) air core superconducting magnet technology.

 

The remainder, described as Open MRIs, are recumbent-only machines based on Fonar’s original iron-frame vertical magnetic field magnet design. These systems have been manufactured and sold by many of our largest competitors over the years. They generally operate at low field strengths (0.2 - 0.35 Tesla). Their prevalence in the marketplave has led to the perception of the medical community that Open MRIs are useful only for anxious and claustrophobic patients, that the Open MRI’s image quality is poor, and that the scan times are long. Recently our competitors have introduced higher field strength Open MRI products (0.5 – 1.2 Tesla). Significantly better imaging performance (especially at 1.2 T) compared to the low field strength systems, is beginning to change that perception. However, Fonar continues to maintain its competitive advantage at 0.6 Tesla due to our front-open non-claustrophobic configuration in which there is nothing in front of the patient’s face, and our unique ability to scan patients in weight-bearing positions that is sometimes more consequential than a small increase in the image resolution and decrease in scan time. It is also noteworthy that our horizontal transaxial magnetic field allows the Upright MRI, in contrast to the recumbent-only Open MRIs, to use the same flat planar-style radiofrequency reeiver coil as the high-field MRI systems to image the lumbar and thoracic spine.

 

One of the Upright MRI’s big competitive advantages is that it is dramatically different from the Open MRI in several important ways:

 

The Upright MRI does something clinically valuable that the high-field MRI machines cannot do (i.e. positional imaging, weight-bearing imaging).

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Although the patient can extend his arms and possibly see out the sides while recumbent in an Open MRI, there is still a large intimidating magnet pole very close to and directly in front of the patient’s face. The Upright MRI allows the patient to look directly out of the scanner and view a large flatscreen TV.

 

The Upright MRI uses the same configuration RF receiver coil as a high-field MRI system to image the spine. Open MRIs cannot do this. (This is because of the rule in MRI that the axis of symmetry of the RF receiver coil should be perpendicular to the direction of the main magnetic field). The upright patient sits comfortably with his back against a flat (“planar”) RF receiver coil in our horizontal transaxial magnetic field. In contrast, the vertical magnetic field in the recumbent-only Open MRI precludes the use of this type of receiver coil.

 

Relative to the high-field systems, the Upright MRI has two major competitive advantages:

 

Sometimes patient positioning is more consequential than a small increase in the image resolution and decrease in the scan time. As it is critical for physicians to not “miss” anything in the images, they recognize that the position-dependent pathology visualized with the Upright MRI will be invisible (“missed”) if their patients are scanned at a higher field strength.

 

Image artifacts arising from metal implants such as surgical screws are diminished with the 0.6 Tesla Upright MRI compared to those from the high-field MRIs. It is well known that such artifacts get smaller as the MRI magnet’s field strength is reduced, so the anatomy adjacent to implanted hardware will be less obscured with the Upright MRI. This is particularly valuable for surgeons referring their postoperative patients for diagnostic imaging studies.

 

Fonar faces competition within the MRI industry from such firms as General Electric Company, Philips N.V., Toshiba Corporation, Hitachi Corporation and Siemens A.G. Most competitors have marketing and financial resources more substantial than those available to us. They have in the past, and may in the future, heavily discount the sales price of their scanners. Such competitors sell both high field air core superconducting MRI scanners and iron frame products. Fonar’s original iron frame design, ultimately imitated by Fonar’s competitors to duplicate Fonar’s origination of “Open” MRI magnets, gave rise to current patent protected Upright® MRI technology with the result that Fonar today is the unique and only supplier of the highest field MRI magnets (0.6 Tesla) that are not superconducting, do not use liquid helium and are not therefore susceptible to severe consequences and downtime cause by a system quench.

 

The iron frame, because it controls the magnetic lines of force and places them where wanted and removes them from where not wanted, provides a more versatile magnet design than is possible with air core magnets. Air core magnets contain no iron but consist entirely of turns of current carrying wire.

 

Fonar expects to be the leader in weight-bearing and positional MRI for providing dynamic visualization of body parts including the spine and extremities.

 

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 display 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:

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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, also referred to as "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 utility of the images produced by its MRI scanners is generally superior to the utility of the images produced by those other methodologies.

 

GOVERNMENT REGULATION

 

FDA Regulation

 

The Food and Drug Administration in accordance with Title 21 of the Code of Federal Regulations regulates the manufacturing and marketing of Fonar’s MRI scanners. The regulations can be classified as either pre-market or post-market. The pre-market requirements include obtaining marketing clearance, proper device labeling, establishment registration and device listing. Once the products are on the market, Fonar must comply with post-market surveillance controls. These requirements include the Quality Systems Regulation, or “QSR”, also known as Current Good Manufacturing Practices or CGMPs, and Medical Device Reporting, also referred to as MDR regulations. The QSR is a quality assurance requirement that covers the design, packaging, labeling and manufacturing of a medical device. The MDR regulation is an adverse event-reporting program.

 

Classes of Products

 

Under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act, all medical devices are classified by the FDA into one of three classes. A Class I device is subject only to general 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. Fonar’s products are Class II devices. Class II devices are subject to "General Controls"; General Controls include:

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1. Establishment registration of companies which are required to register under 21 CFR Part 807.20, such as manufacturers, distributors, re-packagers and re-labelers.

2. Medical device listing with FDA of devices to be marketed.

3. Manufacturing devices in accordance with the Current Good Manufacturing Practices Quality System Regulation in 21 CFR Part 820.

 

4. Labeling devices in accordance with labeling regulations in 21 CFR Part 801 or 809.

 

5. Submission of a Premarket Notification, pursuant to 510(k), before marketing a device.

 

In addition to complying with general controls, Class II devices are also subject to special controls. Special controls may include special labeling requirements, guidance documents, mandatory performance standards and post-market surveillance.

 

On October 3, 2000 Fonar received FDA clearance for the Upright® MRI under the name “Indomitable”.

 

Premarketing Submission

 

Each person who wants to market Class I, II and some III devices intended for human use in the U.S. must submit a 510(k) to FDA at least 90 days before marketing unless the device is exempt from 510(k) requirements. A 510(k) is a pre-marketing submission made to FDA to demonstrate that the device to be marketed is as safe and effective, that is, substantially equivalent, SE, to a legally marketed device that is not subject to pre-market approval, PMA. Applicants must compare their 510(k) device to one or more similar devices currently on the U.S. market and make and support their substantial equivalency claims.

 

The FDA is committed to a 90-day clearance after submission of a 510(k), provided the 510(k) is complete and there is no need to submit additional information or data.

 

The 510(k) is essentially a brief statement and description of the product. As Fonar’s scanner products are Class II products, there are no pre-market data requirements.

 

An investigational device exemption, also referred to as IDE, allows the investigational device to be used in a clinical study pending FDA clearance in order to collect safety and effectiveness data required to support the Premarket Approval, also referred to as PMA, application or a Premarket Notification pursuant to 510(k), submission to the FDA. Clinical studies are most often conducted to support a PMA.

 

For the most part, however, we have not found it necessary to utilize IDE’s. The standard 90 day clearance for our new MRI scanner products classified as Class II products makes the IDE unnecessary, particularly in view of the time and effort involved in compiling the information necessary to support an IDE.

 

Quality System Regulation

 

The Quality Management System is applicable to the design, manufacture, administration of installation and servicing of magnetic resonance imaging scanner systems. 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.

 

Medical Device Reporting Regulation

 

Manufacturers must report all MDR reportable events to the FDA. Each manufacturer must review and evaluate all complaints to determine whether the complaint represents an event which is required to be reported to FDA. Section 820.3(b) of the Quality Systems regulation defines a complaint as, "any written, electronic or oral communication that alleges deficiencies related to the identity, quality, durability, reliability, safety, effectiveness, or performance of a device after it is released for distribution."

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A report is required when a manufacturer becomes aware of information that reasonably suggests that one of their marketed devices has or may have caused or contributed to a death, serious injury, or has malfunctioned and that the device or a similar device marketed by the manufacturer would be likely to cause or contribute to a death or serious injury if the malfunction were to recur.

 

Malfunctions are not reportable if they are not likely to result in a death, serious injury or other significant adverse event experience.

 

A malfunction which is or can be corrected during routine service or device maintenance still must be reported if the recurrence of the malfunction is likely to cause or contribute to a death or serious injury if it were to recur.

 

We have established and maintained written procedures for implementation of the MDR regulation. These procedures include internal systems that:

 

provide for timely and effective identification, communication and evaluation of adverse events;

 

provide a standardized review process and procedures for determining whether or not an event is reportable; and

 

provide procedures to insure the timely transmission of complete reports.

 

These procedures also include documentation and record keeping requirements for:

 

information that was evaluated to determine if an event was reportable;

 

all medical device reports and information submitted to the FDA;

 

any information that was evaluated during preparation of annual certification reports; and

 

systems that ensure access to information that facilitates timely follow up and inspection by FDA.

 

FDA Enforcement

 

FDA may take the following actions to enforce the MDR regulation:

 

FDA-Initiated or Voluntary Recalls

 

Recalls are regulatory actions that remove a hazardous, potentially hazardous, or a misbranded product from the marketplace. Recalls are also used to convey additional information to the user concerning the safe use of the product. Either FDA or the manufacturer can initiate recalls.

 

There are three classifications, i.e., I, II, or III, assigned by the Food and Drug Administration to a particular product recall to indicate the relative degree of health hazard presented by the product being recalled.

 

Class I

Is a situation in which there is a reasonable probability that the use of, or exposure to, a violative product will cause serious adverse health consequences or death.

 

Class II

Is a situation in which use of, or exposure to, a violative product may cause temporary or medically reversible adverse health consequences or where the probability of serious adverse health consequences is remote.

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Class III

Is a situation in which use of, or exposure to, a violative product is not likely to cause adverse health consequences.

 

Fonar has initiated six voluntary recalls. Five of the recalls were Class II and one was Class III. The recalls involved making minor corrections to the product in the field. Frequently, corrections which are made at the site of the device are called field corrections as opposed to recalls.

 

Civil Money Penalties

 

The FDA, after an appropriate hearing, may impose civil money penalties for violations of the FD&C Act that relate to medical devices. In determining the amount of a civil penalty, FDA will take into account the nature, circumstances, extent, and gravity of the violations, the violator's ability to pay, the effect on the violator's ability to continue to do business, and any history of prior violations.

 

Warning Letters

 

FDA issues written communications to a firm, indicating that the firm may incur more severe sanctions if the violations described in the letter are not corrected. Warning letters are issued to cause prompt correction of violations that pose a hazard to health or that involve economic deception. The FDA generally issues the letters before pursuing more severe sanctions.

 

Seizure

 

A seizure is a civil court action against a specific quantity of goods which enables the FDA to remove these goods from commercial channels. After seizure, no one may tamper with the goods except by permission of the court. The court usually gives the owner or claimant of the seized merchandise approximately 30 days to decide a course of action. If they take no action, the court will recommend disposal of the goods. If the owner decides to contest the government's charges, the court will schedule the case for trial. A third option allows the owner of the goods to request permission of the court to bring the goods into compliance with the law. The owner of the goods is required to provide a bond or, security deposit, to assure that they will perform the orders of the court, and the owner must pay for FDA supervision of any activities by the company to bring the goods into compliance.

 

Citation

 

A citation is a formal warning to a firm of intent to prosecute the firm if violations of the FD&C Act are not corrected. It provides the firm an opportunity to convince FDA not to prosecute.

 

Injunction

 

An injunction is a civil action filed by FDA against an individual or company. Usually, FDA files an injunction to stop a company from continuing to manufacture, package or distribute products that are in violation of the law.

 

Prosecution

 

Prosecution is a criminal action filed by FDA against a company or individual charging violation of the law for past practices.

 

Foreign and Export Regulation

 

We obtain approvals as necessary in connection with the sales of our products in foreign countries. In some cases, FDA approval has been sufficient for foreign sales as well. Our standard practice has been to require either the distributor or the customer to obtain any such foreign approvals or licenses which may be required.

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Legally marketed devices that comply with the requirements of the Food Drug & Cosmetic Act require a Certificate to Foreign Government issued by the FDA for export. Other devices that do not meet the requirements of the FD&C Act but comply with the laws of a foreign government require a Certificate of Exportability issued by the FDA. All products which we sell have FDA clearance and would fall into the first category.

 

Foreign governments have differing requirements concerning the import of medical devices into their respective jurisdictions. The European Union, also referred to as EU, has some essential requirements described in the EU’s Medical Device Directive, also referred to as MDD. In order to export to one of these countries, we must meet the essential requirements of the MDD and any additional requirements of the importing country. The essential requirements are similar to some of the requirements mandated by the FDA. In addition the MDD requires that we enlist a Notified Body to examine and assess our documentation, a Technical Construction File, and verify that the product has been manufactured in conformity with the documentation. The notified body must carry out or arrange for the inspections and tests necessary to verify that the product complies with the essential requirements of the MDD, including safety performance and Electromagnetic Compatibility, also referred to as EMC. Also required is a Quality System, ISO-9001, assessment by the Notified Body. We were approved for ISO 9001 certification for its Quality Management System in April, 1999.

 

We received clearance to sell the Upright® MRI scanners in the EU in May, 2002.

 

Other countries require that their own testing laboratories perform an evaluation of our devices. This requires that we must bring the foreign agency’s personnel to the USA to perform the evaluation at our expense before exporting.

 

Some countries, including many in Latin America and Africa, have very few regulatory requirements, beyond FDA clearance.

 

To date, Fonar has been able to comply with all foreign regulatory requirements applicable to its export sales.

 

PHYSICIAN AND DIAGNOSTIC SERVICES MANAGEMENT BUSINESS

 

Effective July 1, 2015 we restructured the corporate organization of the physician and diagnostic services management segment of our business. Previously, Health Management Corporation of America had transferred its business and assets to Imperial Management Services, LLC (“Imperial”), a New York limited liability company, in connection with raising capital from investors. Health Management Corporation of America maintained a majority interest in Imperial. The assets continued to be used in our business of managing diagnostic imaging facilities.

 

Subsequently, through an agreement dated March 6, 2013, Health Management Corporation of America acquired another business engaged in the management and, in the case of four sites located in Florida, the ownership, of diagnostic imaging facilities (HMCA did not take over the operation of said four sites, however, until April, 2013). The purchase of this business was made through a new limited liability company, Health Diagnostics Management, LLC (“HDM”), which raised part of the capital necessary for the acquisition from investors. The investors received in the aggregate 49% of the interests in HDM.

 

On June 30, 2016 the Company purchased 100% of the equity in Turnkey Services of New York, LLC and 100% of the equity in TK2 Equipment Management LLC. Turnkey Service of New York LLC and TK2 Equipment Management LLC, both by way of several operating leases, had provided the Company with ancillary diagnostic imaging equipment to our managed (and in the case of four Florida sites, owned)MRI facilities.

 

As a result of scheduled reacquisitions of interests held by the investors, as of July 1, 2016, Health Management Corporation of America owned a 100% interest in Imperial and a 70% interest in HDM immediately prior to the reorganization.

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The reorganization was structured to more completely integrate the operations of Health Management Corporation of America and HDM. Imperial contributed all of its assets (which were utilized in the business of Health Management Corporation of America) to HDM and received a 24.2% interest in HDM. Health Management Corporation of America retained a direct ownership interest of 45.8% in HDM, and the original investors in HDM retained a 30.0% ownership interest in the newly expanded HDM.

 

The entire physician and diagnostic services management business segment is now being conducted by HDM. HDM’s Florida subsidiaries are directly engaged in the practice of medicine. HDM will operate under the assumed name, “Health Management Company of America” (“HMCA”).

 

The combined business (HDM, Imperial and Health Management Corporation of America) will be referred to as “HMCA” for all periods before and after July 1, 2015, unless otherwise indicated.

 

HMCA provides comprehensive non-medical management services to diagnostic imaging facilities. These services include development, administration, leasing of office space, facilities, equipment, provision of supplies, staffing, training and supervision of non-medical personnel, credentialing, accounting, billing and collection, assistance with compliance matters and the development and implementation of practice growth and marketing strategies.

 

As of August 1, 2017, HMCA managed a total of 26 MRI centers. For the 2016 fiscal year, the revenues HMCA recognized from the MRI facilities had increased to $62.6 million, and for the 2017 fiscal year the revenues further increased to $66.8 million. Four of these facilities in Florida are owned by HMCA subsidiaries.

 

 

HMCA GROWTH STRATEGY

 

HMCA’s growth strategy focuses on upgrading and expanding the existing facilities it manages and expanding the number of facilities it manages for its clients, including new sites. In connection with improving the performance of the facilities, we have added high field MRI scanners, extremity scanners and x-ray machines to the Upright® MRI scanner at certain of the sites where such additional diagnostic imaging modalities are expected to produce the greatest return.

 

PHYSICIAN AND DIAGNOSTIC MANAGEMENT SERVICES

 

HMCA’s services to the facilities it manages encompass substantially all of their business operations. Each facility is controlled, however, not by HMCA, but by the physician owner, or in the case of the four Florida sites owned by HMCA subsidiaries, by the medical director, and all medical services are performed by physicians and other medical personnel under the physician-owner’s supervision. HMCA is the management company and performs services of a non-professional nature. These services include:

 

1. Offices and Equipment. HMCA identifies, negotiates leases for and/or 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. HMCA processes the necessary tax, insurance and other documentation relating to employees.

3. Administrative. HMCA assists in the scheduling of patient appointments, purchasing of office and medical supplies and equipment and handling of reporting, accounting, processing and filing systems. It prepares and files the physician portions of complex applications to enable its clients to participate in managed care programs and to qualify for insurance reimbursement. HMCA assists the clients to implement programs and procedures to ensure full and timely regulatory compliance and appropriate cost reimbursement under no-fault insurance and Workers' Compensation guidelines, as well as compliance with other applicable governmental requirements and regulations, including HIPAA and other privacy requirements.

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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. HMCA is presently using a third party to perform its billing and collection services for its clients’ No-Fault and Workers’ Compensation scanning business.

5. Cost Saving Programs. Based on available volume discounts, HMCA seeks to assist in obtaining favorable pricing for office and medical supplies, medical imaging film, equipment, contrast agents, such as gadolinuim, and other inventory for its clients.

6. Diagnostic Imaging and Ancillary Services. HMCA can offer access to diagnostic imaging equipment through diagnostic imaging facilities it manages. The Company is expanding the ancillary services offered in its network to include x-rays, ultrasound and other MRI equipment such as high-field MRI scanners and extremity MRI scanners.

7. Marketing Strategies. HMCA is responsible for developing and proposing marketing plans for its clients.

8. Expansion Plans. HMCA assists the clients in developing expansion plans including the opening of new or replacement facilities where appropriate.

 

HMCA’s objective is to free physicians from as many non-medical duties as is practicable, allowing physicians to spend less time on business and administrative matters and more time practicing medicine.

 

The exceptions to this general model of operation are four of the facilities acquired by HMCA from Health Diagnostics, LLC in April, 2013 in Florida. These Florida facilities are owned by limited liability companies which, as our subsidiaries, conduct their operations directly and bill and collect their fees from the patients and third party payors.

 

The facilities enter into contracts with third party payors, including managed care companies. None of HMCA’s clients, however, participate in any capitated plans or other risk sharing arrangements. Capitated plans are those HMO programs where the provider is paid a flat monthly fee per patient.

 

The management fees payable by the facilities to HMCA are flat monthly fees. In fiscal 2016, the aggregate amount of management fees was $3,674,059 per month. In fiscal 2017, the aggregate amount of management fees was $3,926,536 per month.

 

Fees under the management agreements are subject to adjustment by mutual agreement on an annual basis.

 

Dr. Damadian owns three HMCA-managed MRI facilities in Florida. The fees for these three sites in Florida owned by Dr. Damadian are flat monthly fees which are subject to adjustment by mutual agreement on an annual basis. In fiscal 2017, the aggregate monthly amount of management fees payable to HMCA by these sites was $735,374.

 

The Florida facilities owned by HMCA subsidiaries directly bill their patients or the patients’ insurance carriers. Patient fees net of provision for bad debt were $20,229,166 in fiscal 2017.

 

HMCA contracts with an outside billing company (located in Melville, New York) to perform billing and collection for their clients’ No-Fault and Workers’ Compensation business. The fixed monthly fees were $85,000 for HMCA in fiscal 2016 and fiscal 2017.

 

HMCA MARKETING

 

HMCA's marketing strategy is to expand the business and improve the facilities which it manages. HMCA is seeking to increase the number of locations of those facilities where market conditions are promising and to promote growth of our clients' and Florida subsidiaries’ patient volume and revenue.

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DIAGNOSTIC IMAGING FACILITIES

 

Diagnostic imaging facilities 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 facilities 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 physicians. Following diagnostic procedures, the images are reviewed by the interpreting physicians who prepare reports of these tests and their findings. Reports for the New York facilities are transcribed by HMCA personnel and reports for the Florida facilities are outsourced to independent contractors.

 

HMCA develops marketing programs and educational programs in an effort to establish and maintain referring physician relationships for our clients and Florida subsidiaries and to maximize reimbursement yields. HMCA also directs its marketing and educational efforts to managed care providers.

 

Managed care providers are an important factor in the diagnostic imaging industry. To further its position, HMCA is seeking to expand the imaging modalities offered at its managed and owned diagnostic imaging facilities. Three facilities in New York and four facilities in Florida have two MRI scanners. One facility in New York and two in Florida also perform x-rays.

 

REIMBURSEMENT

 

HMCA’s clients receive reimbursements for their services through Medicare, Medicaid, managed care, private commercial insurance, third party administrators, Workers’ Compensation, No-Fault and other insurance.

 

Medicare

 

The Medicare program provides reimbursement for hospitalization, physician, diagnostic and certain other services to eligible persons 65 years of age and over and certain other individuals. Providers are paid by the federal government in accordance with regulations promulgated by the Department of Health and Human Services, HSS, and generally accept the payment with nominal deductible and co-insurance amounts required to be paid by the service recipient, as payment in full. Hospital inpatient services are reimbursed under a prospective payment system. Hospitals receive a specific prospective payment for inpatient treatment services based upon the diagnosis of the patient.

 

Under Medicare’s prospective payment system for hospital outpatient services, or OPPS, a hospital is paid for outpatient services on a rate per service basis that varies according to the ambulatory payment classification group, or APC, to which the service is assigned rather than on a hospital’s costs. Each year the Centers for Medicare and Medicaid Services, or CMS, publishes new APC rates that are determined in accordance with the promulgated methodology.

 

Services provided in non-hospital based freestanding facilities are paid under the Medicare Physician Fee Schedule, or MPFS. All of HMCA’s clients are presently in this category. The MPFS is updated on an annual basis and sometimes modified more frequently.

 

Healthcare Reform Legislation

 

Healthcare reform legislation enacted in the first quarter of 2010 by the Patient Protection and Affordable Care Act or PPACA, specifically requires the U.S. Department of Health and Human Services, in computing physician practice expense relative value units, to increase the equipment utilization factor for advanced diagnostic imaging services (such as MRI, CT and PET) from a presumed utilization rate of 50% to 65% for 2010 through 2012, 70% in 2013, and 75% thereafter. Excluded from the adjustment are low-technology imaging modalities such as ultrasound, X-ray and fluoroscopy. The Health Care and Education Reconciliation Act of 2010 (H.R. 4872) or Reconciliation Act, which was approved by the President on March 30, 2010, amends the provision for higher presumed utilization of advanced diagnostic imaging services to a presumed rate of 75%. These changes may result in decreased revenue for the services performed by our clients for Medicare beneficiaries. Other changes in reimbursement for services rendered by Medicare Advantage plans may also reduce the revenues for services rendered to Medicare Advantage enrollees

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We have experienced reimbursement reductions for radiology services provided to Medicare beneficiaries, including reductions pursuant to the Deficit Reduction Act, or DRA.

 

The DRA, which became effective in 2007, set reimbursement for the technical component for imaging services (excluding diagnostic and screening mammography) in non-hospital based freestanding facilities at the lesser of OPPS or the MPFS.

 

In addition to the foregoing changes to the usage assumptions, CMS’ 2010 regulatory changes to the MPFS also included a downward adjustment to services primarily involving the technical component rather than the physician work component, by adjusting downward malpractice payments for these services. These adjustments have been phased in over a four year period. For our fiscal year ended June 30, 2017, Medicare revenues represented approximately 4.8% of the revenues for HMCA’s clients and subsidiaries as compared to 5.0% for the fiscal year ended June 30, 2016. In January, 2014 additional reductions in Medicare reimbursement were adopted, and New York State is expected to propose reducing Workers’ Compensation reimbursements.

 

Because of the many variables involved, we are unable to predict how the legislative mandates contained in PPACA will be implemented, in their complete and final form, whether any additional changes to PPACA or regulations (including interpretations), will occur in the future, or what effect any other future legislation or regulation would have on our business. Many commercial insurance companies, however, tie their reimbursement rates to the government reimbursement levels.

 

Medicaid

 

The Medicaid program is a jointly-funded federal and state program providing coverage for low-income persons. In addition to federally-mandated basic services, the services offered and reimbursement methods vary from state to state. In many states, Medicaid reimbursement is patterned after the Medicare program; however, an increasing number of states have established or are establishing payment methodologies intended to provide healthcare services to Medicaid patients through managed care arrangements. In fiscal 2017, approximately 0.19% of the revenues of HMCA’s clients were attributable to Medicaid, as compared to 0.37% in fiscal 2016. Four of the Florida facilities (those owned by HMCA subsidiaries) do not participate in Medicaid.

 

Managed Care and Private Insurance.

 

Health Maintenance Organizations, or HMO’s, Preferred Provider Organizations, or PPOs, and other managed care organizations attempt to control the cost of healthcare services by a variety of measures, including imposing lower payment rates, preauthorization requirements, limiting services and mandating less costly treatment alternatives. Managed care contracting is competitive and reimbursement schedules are at or below Medicare reimbursement levels. Some managed care organizations have reduced or otherwise limited, and other managed care organizations may reduce or otherwise limit, reimbursement in response to reductions in government reimbursement. These reductions could have an adverse impact on our financial condition and results of operations. These reductions have been, and any future reductions may be, similar to the reimbursement reductions proposed by CMS, Congress and the current federal government administration.

 

HMCA COMPETITION

 

The physician and diagnostic management services field is highly competitive. A number of large hospitals have acquired medical practices and this trend may continue. HMCA expects that more competition will develop. Many competitors have greater financial and other resources than HMCA. 

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With respect to the diagnostic imaging facilities 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, as well as emphasizing to potential referral sources the advantages of Upright® MRI scanning. 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. HMCA believes that it will be able to effectively meet the competition in the outpatient diagnostic imaging industry with the Fonar Upright® MRI scanners and strategically placed high field MRI scanners at its facilities.

 

 

GOVERNMENT REGULATION APPLICABLE TO HMCA

 

 

FEDERAL REGULATION

 

The healthcare industry is highly regulated and changes in laws and regulations can be significant. Changes in the law or new interpretation of existing laws can have a material effect on our permissible activities, the relative costs associated with doing business and the amount of reimbursement by government and other third-party payors.

 

Federal False Claims Act

 

The federal False Claims Act and, in particular, the False Claims Act’s “qui tam” or “whistleblower” provisions allow a private individual to bring actions in the name of the government alleging that a defendant has made false claims for payment from federal funds. After the individual has initiated the lawsuit the government must decide whether to intervene in the lawsuit and to become the primary prosecutor. If the government declines to join the lawsuit, the individual may choose to pursue the case alone, although the government must be kept apprised of the progress of the lawsuit, and may intervene later. Whether or not the federal government intervenes in the case, it will receive the majority of any recovery.

When an entity is determined to have violated the federal False Claims Act, it must pay three times the actual damages sustained by the government, plus mandatory civil penalties for each separate false claim and the government’s attorneys’ fees. Liability arises when an entity knowingly submits, or causes someone else to submit, a false claim for reimbursement to the federal government. The False Claims Act defines the term “knowingly” broadly, though simple negligence will not give rise to liability under the False Claims Act. Examples of the other actions which may lead to liability under the False Claims Act:

   

 

 

 

 

 

 

 

 

 

Failure to comply with the many technical billing requirements applicable to our Medicare and Medicaid business.

 

Failure to comply with the prohibition against billing for services ordered or supervised by a physician who is excluded from any federal healthcare program, or the prohibition against employing or contracting with any person or entity excluded from any federal

healthcare program.

 

Failure to comply with the Medicare physician supervision requirements for the services we provide, or the Medicare documentation requirements concerning physician supervision.

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The Fraud Enforcement and Recovery Act of 2009 expanded the scope of the False Claims Act by, among other things, broadening protections for whistleblowers and creating liability for knowingly retaining a government overpayment, acting in deliberate ignorance of a government overpayment or acting in reckless disregard of a government overpayment. The recently enacted healthcare reform bills in the form of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “PPACA”) expanded on changes made by the 2009 Fraud Enforcement and Recovery Act with regard to such “reverse false claims.” Under PPACA, the knowing failure to report and return an overpayment within 60 days of identifying the overpayment or by the date a corresponding cost report is due, whichever is later, constitutes a violation of the False Claims Act. HMCA and its clients have never been sued under the False Claims Act and believe they are in compliance with the law.

 

Stark Law

 

Under the federal Self-Referral Law, also referred to as 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. The federal government has taken the position that a violation of the federal Stark Law is also a violation of the Federal False Claims Act. 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 believes that it and its clients are in compliance with these laws.

 

Anti-kickback Regulation

 

We are subject to federal and state laws which govern financial and other arrangements between healthcare providers. These include the federal anti-kickback statute which, among other things, prohibits the knowing and willful solicitation, offer, payment or receipt of any remuneration, direct or indirect, in cash or in kind, in return for or to induce the referral of patients for items or services covered by Medicare, Medicaid and certain other governmental health programs. Under PPACA, knowledge of the anti-kickback statute or the specific intent to violate the law is not required. Violation of the anti-kickback statute may result in civil or criminal penalties and exclusion from the Medicare, Medicaid and other federal healthcare programs, and according to PPACA, now provides a basis for liability under the False Claims Act. In addition, it is possible that private parties may file “qui tam” actions based on claims resulting from relationships that violate the anti-kickback statute, seeking significant financial rewards. Many states have enacted similar statutes, which are not limited to items and services paid for under Medicare or a federally funded healthcare program. Neither HMCA nor its clients engage in this practice.

 

In fiscal 2017, approximately 5.0% of the revenues of HMCA’s clients were attributable to Medicare and 0.19% were attributable to Medicaid. In fiscal 2016, approximately 5.0% of the revenues of HMCA’s clients were attributable to Medicare and 0.37% were attributable to Medicaid.

 

Deficit Reduction Act (DRA)

 

On February 8, 2006, the President signed into law the DRA. Effective January 1, 2007, the DRA provides that Medicare reimbursement for the technical component for imaging services (excluding diagnostic and screening mammography) performed in freestanding facilities will be capped. Payment is the lesser of the Medicare Physician Fee Schedule or the Hospital Outpatient Prospective Payment System (OPPS) rates. Implementation of these reimbursement reductions contained in the DRA has had an adverse effect on our business. We have been able to counter this effect by increasing our clients’ scan volumes through our vigorous marketing efforts and reducing our operating expenses.

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The DRA also codified the reduction in reimbursement for multiple images on contiguous body parts previously announced by CMS, the agency responsible for administering the Medicare program. In November 2005, CMS announced that it would pay 100% of the technical component of the higher priced imaging procedure and 50% of the technical component of each additional imaging procedure for imaging procedures involving contiguous body parts within a family of codes when performed in the same session. CMS had indicated that it would phase in this 50% rate reduction over two years, so that the reduction was 25% for each additional imaging procedure in 2006 and another 25% reduction in 2007. However, for services furnished on or after July 1, 2010, the PPACA requires the full 50% reduction to be implemented.

 

 

Health Insurance Portability and Accountability Act

 

Congress enacted the Health Insurance Portability and Accountability Act of 1996, or HIPAA, in part, to combat healthcare fraud and to protect the privacy and security of patients’ individually identifiable healthcare information. HIPAA, among other things, amends existing crimes and criminal penalties for Medicare fraud and enacts new federal healthcare fraud crimes, including actions affecting non-government healthcare benefit program by means of false or fraudulent representations in connection with the delivery of healthcare services is subject to a fine or imprisonment, or potentially both. In addition, HIPAA authorizes the imposition of civil money penalties against entities that employ or enter into contracts with excluded Medicare or Medicaid program participants if such entities provide services to federal health program beneficiaries. A finding of liability under HIPAA could have a material adverse effect on our business, financial condition and results of operations.

 

Further, HIPAA requires healthcare providers and their business associates to maintain the privacy and security of individually identifiable protected health information (“PHI”). HIPAA imposes federal standards for electronic transactions, for the security of electronic health information and for protecting the privacy of PHI. The Health Information Technology for Economic and Clinical Health Act of 2009 (“HITECH”), signed into law on February 17, 2009, dramatically expanded, among other things, (1) the scope of HIPAA to now apply directly to “business associates,” or independent contractors who receive or obtain PHI in connection with providing a service to a covered entity, (2) substantive security and privacy obligations, including new federal security breach notification requirements to affected individuals, DHHS and prominent media outlets, of certain breaches of unsecured PHI, (3) restrictions on marketing communications and a prohibition on covered entities or business associates from receiving remuneration in exchange for PHI, and (4) the civil and criminal penalties that may be imposed for HIPAA violations, increasing the annual cap in penalties from $25,000 to $1.5 million per occurrence. In 2013 additional legal requirements were adopted to provide further protection for PHI.

 

In addition, many states have enacted comparable privacy and security statues or regulations that, in some cases, are most stringent than HIPAA requirements. In those cases it may be necessary to modify our operations and procedures to comply with the more stringent state laws, which may entail significant and costly changes for us. We believe that we are in compliance with such state laws and regulations. However, if we fail to comply with applicable state laws and regulations, we could be subject to additional sanctions.

 

We believe that we are in compliance with the current HIPAA requirements, as amended by HITECH, together with other legislation and regulations, and comparable state laws, but we anticipate that we may encounter certain costs associated with future compliance. Moreover, we cannot guarantee that enforcement agencies or courts will not make interpretations of the HIPAA standards that are inconsistent with ours, or the interpretations of our contracted radiology practices or their affiliated physicians. A finding of liability under the HIPAA standards may result in significant criminal and civil penalties. Noncompliance also may result in exclusion from participation in government programs, including Medicare and Medicaid. These actions could have a material adverse effect on our business, financial condition, and results of operations.

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Civil Money Penalty Law and Other Federal Statutes

 

The Civil Money Penalty, or CMP, law covers a variety of practices. It provides a means of administrative enforcement of the anti-kickback statute, and prohibits false claims, claims for medically unnecessary services, violations of Medicare participating provider or assignment agreements and other practices. The statute gives the Office of Inspector General of the HHS the power to seek substantial civil fines, exclusion and other sanctions against providers or others who violate the CMP prohibitions.

 

In addition, in 1996, Congress created a new federal crime: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs such as the Medicare and Medicaid programs.

 

Certificates of Need

 

Some states require hospitals and certain other healthcare facilities and providers to obtain a certificate of need, or CON, or similar regulatory approval prior to establishing certain healthcare operations or services, incurring certain capital projects and/or the acquisition of major medical equipment including MRI and PET/CT systems. We are not operating in any such states.

 

Patient Protection and Affordable Care Act

 

On March 23, 2010, President Obama signed into law healthcare reform legislation in the form of PPACA. The implementation of this law will likely have a profound impact on the healthcare industry. Most of the provisions of PPACA are being phased in over time and can be conceptualized as a broad framework not only to provide health insurance coverage to millions of Americans, but to fundamentally change the delivery of care by bringing together elements of health information technology, evidence-based medicine, chronic disease management, medical “homes,” care collaboration and shared financial risk in a way that will accelerate industry adoption and change. There are also many provisions addressing cost containment, reductions of Medicare and other payments and heightened compliance requirements and additional penalties, which will create further challenges for providers. We are unable to predict the full impact of PPACA at this time due to the law’s complexity and current lack of implementing regulations or interpretive guidance. Moving forward, we believe that the federal government will likely have greater involvement in the healthcare industry than in prior years.

 

State Regulation

 

In addition to the federal self-referral law and federal Anti-kickback statute, many States, including those in which HMCA and its clients operate, have their own versions of self-referral and anti-kickback laws. These laws are not limited in their applicability, as are the federal laws, to specific programs. HMCA believes that it and its clients are in compliance with these laws.

 

Various States prohibit business corporations from practicing medicine. Various States, including New York, also prohibit the sharing of professional fees or fee splitting. Consequently, in New York HMCA leases space and equipment to clients and provides clients with a range of non-medical administrative and managerial services for agreed upon fees. Under Florida law a business entity can bill patients and third party payors directly if that entity is properly licensed through AHCA. Four of the seven facilities in Florida are licensed healthcare clinics through AHCA.

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HMCA’s clients and subsidiaries generate revenue from patients covered by no-fault insurance and workers' compensation programs. For the fiscal year ended June 30, 2017 approximately 54.5% of our clients’ receipts were from patients covered by no-fault insurance and approximately 8.0% of our client’s receipts were from patients covered by workers’ compensation programs. For the fiscal year ended June 30, 2016, approximately 51.6% of HMCA’s clients’ receipts were from patients covered by no-fault insurance and approximately 7.8% of HMCA’s clients’ receipts were from patients covered by workers’ compensation programs. (The foregoing numbers do not include payments from third party administrators). 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.

 

Compliance Program

 

We maintain a program to monitor compliance with federal and state laws and regulations applicable to the healthcare entities. We have a compliance officer who is charged with implementing and supervising our compliance program, which includes the adoption of (i) Standards of Conduct for our employees and affiliates and (ii) a process that specifies how employees, affiliates and others may report regulatory or ethical concerns to our compliance officer. We believe that our compliance program meets the relevant standards provided by the Office of Inspector General of the Department of Health and Human Services.

 

An important part of our compliance program consists of conducting periodic audits of various aspects of our operations and that of the contracted radiology practices. We also conduct mandatory educational programs designed to familiarize our employees with the regulatory requirements and specific elements of our compliance program.

 

HMCA believes that it and its clients are in compliance with applicable Federal, State and local laws. HMCA does not believe that such laws will have any adverse material effect on its business.

 

EMPLOYEES

 

Fonar and HMCA had approximately 500 employees as of August 15, 2017. This total number included 15 in production, 28 in customer support, 7 in research and development, 5 in information technology, 60 in marketing and sales, 15 transcriptionists, 35 technologists, 50 in billing and collections, and 285 in various administrative positions. Approximately 300 employees were employed at the MRI facilities managed or owned by HMCA, primarily in administrative positions.

 

ITEM 1A. RISK FACTORS

 

An investment in our securities is subject to various risks, the most significant of which are summarized below.

 

1.     Reduced Reimbursement Rates. Most of our revenues are derived from our scanning center business conducted by HCMA. We are experiencing lower reimbursement rates from Medicare, other government programs and private insurance companies. To date, we have been able to counter the impact of these reductions by increasing our volume of scans and reducing our operating expenses, thereby maintaining profitability in this business segment. There is, however, no assurance that we will be able to continue to do so.

 

2. Demand for MRI Scanners. The reduced reimbursement rates also affects our sales of MRI scanners negatively. With lower revenue projections, fewer prospective customers will be able to operate demand and lower prices for scanners. Although the reduced reimbursements may not affect foreign demand, a lower number of sales in the aggregate could reduce economies of scale and consequently, profit margins.

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3. Manufacturing Competition. Many if not most of our competing scanner manufacturers have significantly greater financial resources, production capacity, and other resources than we do. Such competitors would include General Electric, Siemens, Hitachi and Phillips. Although Fonar is the only company which can manufacture and sell the unique Stand-Up® (Upright®) MRI scanner, potential customers must be convinced that the purchase of a Fonar scanner is their best choice. We believe that with time, that objective will be reached, particularly with customers scanning patients having neck, back, knee and various orthopedic issues who would benefit from being scanned in weight-bearing positions.

 

4. Dependence on Referrals. HMCA derives substantially all of its revenue, directly or indirectly, from fees charged for the diagnostic imaging services performed at the facilities. We depend on referrals of patients from unaffiliated physicians and other third parties to the facilities we manage or own for the services we perform. If these physicians and other third parties were to reduce the number of patients they refer or discontinue referring patients, scan volumes could decrease, which would reduce our net revenue and operating margins.

 

5.Pressure to Control Healthcare Costs. One of the principal objectives of health maintenance organizations and preferred provider organizations is to control the cost of healthcare services. Healthcare providers participating in managed care plans may be required to refer diagnostic imaging tests to certain providers depending on the plan in which a covered patient is enrolled. In addition, managed care contracting has become very competitive. The expansion of health maintenance organizations, preferred provider organizations and other managed care organizations within New York or Florida could have a negative impact on the utilization and pricing of services performed at the facilities HMCA manages or owns to the extent these organizations exert control over patients’ access to diagnostic imaging services, selections of the provider of such services and reimbursement rates for those services.

 

6.Scanning Facility Competition. The market for diagnostic imaging services is highly competitive. The facilities we manage or own compete for patients on the basis of reputation, location and the quality of diagnostic imaging services. Groups of radiologists, established hospitals, clinics and other independent organizations that own and operate imaging equipment are the principal competitors.

 

7. Eligibility Changes to Insurance Programs. Due to potential decreased availability of healthcare through private employers, the number of patients who are uninsured or participate in governmental programs may increase. Healthcare reform legislation will increase the participation of individuals in the Medicaid program in states that elect to participate in the expanded Medicaid coverage. A shift in payor mix from managed care and other private payors to government payors or an increase in the number of uninsured patients may result in a reduction in the rates of reimbursement or an increase in uncollectible receivables or uncompensated care, with a corresponding decrease in net revenue. Changes in the eligibility requirements for governmental programs such as the Medicaid program and state decisions on whether to participate in the expansion of such programs also could increase the number of patients who participate in such programs and the number of uninsured patients. Even for those patients who remain in private insurance plans, changes to those plans could increase patient financial responsibility, resulting in a greater risk of uncollectible receivables. These factors and events could have a material adverse effect on our business, financial condition, and results of operations.

 

8. Proposed Reduction of New York Workers’ Compensation Benefits. A proposal was published by the New York State Workers’ Compensation Board (“NYSWCB”) in 2014 to change the fee schedule for Workers’ Compensation payments. Initially, the fees proposed would be set at approximately 130% of the Medicare fees. This would reduce fees for the most commonly billed radiology procedures by approximately 60%. Further, since the Workers’ Compensation fees are coupled with the New York State No Fault Program, radiology providers would suffer similar reductions for No-Fault fees. Although we and the HMCA clients wrote to the NYSWCB to argue against this proposal, and other affected parties commented as well, there can be no assurance that the NYSWCB will withdraw or modify this proposal, or if they elect to do so, the extent to which the NYSWCB would modify their proposal. No further action, however, has been taken by the NYSWCB to advance this proposal for approximately two years. A significant reduction in Workers’ Compensation and No-Fault fees could have a material adverse impact on our business.

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9. Possible changes in Florida Insurance Law. A bill has been introduced into the Florida legislature, whose goal is to eliminate the no-fault system and the requirement that motorists carry personal injury protection, commonly referred to as “PIP”. Currently, drivers and passengers get car damages and PIP, paid for up to $10,000, no matter who is at fault in an accident. Drivers have to pay an additional cost to insurance companies to pay for bodily injuries, which covers them if they are at fault. While PIP is required, coverage for bodily injury is not. The insurance industry is pushing to scrap PIP and instead mandate all motorists to carry coverage that includes a minimum of $25,000 bodily injury if they are at fault. Eliminating PIP would mean that the $10,000 drivers now get paid toward medical costs through their insurers might not be there for them to pay for injured drivers. Importantly, payments would be reduced by approximately 60% due to claims being paid at commercial rates instead of at the presently prevailing PIP fee schedule. This would negatively impact our seven diagnostic imaging facilities (both those we own and those we manage) with more unpaid bills, lower reimbursement rates and elongated waiting times.  

 

10. Federal and state privacy and information security laws. We must comply with numerous federal and state laws and regulations governing the collection, dissemination, access, use, security and privacy of PHI, including HIPAA and its implementing privacy and security regulations, as amended by the federal HITECH Act and collectively referred to as HIPAA. If we fail to comply with applicable privacy and security laws, regulations and standards, properly maintain the integrity of our data, protect our proprietary rights to our systems, or defend against cybersecurity attacks, our business, reputation, results of operations, financial position and cash flows could be materially and adversely affected.

 

Information security risks have significantly increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct our operations, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state agents. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information in our computer systems and networks.

 

11. Changes in Domestic and Worldwide Economic Conditions. We are subject to risk arising from adverse changes in general domestic and global economic conditions, including recession or economic slowdown and disruption of credit markets.

 

Turbulence and uncertainty in the United States and international markets and economies may adversely affect our liquidity, financial condition, revenues, profitability and business operations generally.

 

 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

 

 

ITEM 2. PROPERTIES

 

Fonar and HMCA currently lease approximately 78,000 square feet of office and plant space at its principal offices in Melville, New York. The term of the lease runs through November, 2026. Management believes that the premises will be adequate for its current needs. HMCA also maintains office space for the Facilities owned by its subsidiaries in Florida and for its clients at the clients’ sites in New York and Florida under leases having various terms. HMCA owns the building for the client’s premises in Tallahassee, Florida. The Company received approval from the Suffolk County IDA on February 29, 2016 of a 50% property tax abatement, valued at $440,000, over a 10 year period commencing January, 2017.

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ITEM 3. LEGAL PROCEEDINGS

 

Matt Malek Madison v. Fonar Corporation, United States District Court, Northern District of California, was commenced by plaintiff on August 27, 2007 to recover a down payment for a scanner in the amount of $300,000, with interest. The plaintiff sought costs of suit and attorney’s fees as well. Fonar answered the complaint and sued the plaintiff for breach of contract in the amount of $450,000. Although down payments are usually expressly non-refundable in Fonar’s quotations and agreements, in this case, the quotation contemplated the sale of four scanners, and provided that the deposit would be refundable with interest, if the customer were unable to find suitable locations in the San Francisco Bay area. The issue was whether the customer made a good faith effort to find locations; Fonar’s position was that the customer did not. The case went to trial before a judge; the parties submitted post-trial briefs, and judgment was awarded to the plaintiff. Fonar appealed the trial court’s decision, but on January 31, 2012, the U.S. Court of Appeals for the 9th Circuit affirmed the lower court’s decision awarding the plaintiff the $300,000 deposit with prejudgment interest from July 1, 2006. Fonar sought to have the Court of Appeals reconsider the decision en banc, (by all or a larger number of the judges on the Circuit Court of Appeals), but this was not granted. After no action being taken by the plaintiff for several years, on June 30, 2016 Fonar received a letter from plaintiff’s attorney seeking payment of the judgment. The plaintiff has agreed to accept the sum of $300,000 in full satisfaction of the judgment, which amount was paid in October, 2016.

 

Shapiro v. Fonar Corporation, New York Supreme Court, Suffolk County. Previously, Fonar and Dr. Shapiro had settled an action commenced in Nassau County under the same name. The amount remaining payable under the settlement agreement according to Fonar’s records is $258,400, but the payment and timing of the payment was dependent on obtaining an order for an Upright® MRI Scanner for Fonar and the making of installment payments thereunder by the customer. Briefly stated, the balance of $258,400 was not yet due. Dr. Shapiro claimed that Fonar was in breach of the settlement agreement. Following settlement negotiations, Fonar agreed to pay Dr. Shapiro the sum of $258,400 in installments with interest.

 

ITEM 4. MINE SAFETY DISCLOSURES. Not Applicable

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

Our Common Stock is traded in the Nasdaq SmallCap market under the National Association of Securities Dealers Automated Quotation System, also referred to as "NASDAQ", under the symbol FONR. The following table sets forth the high and low trades reported in NASDAQ System for the periods shown.

 

Fiscal Quarter  High  Low
January  -   March    2015    14.25    10.00 
April    -   June    2015    13.27    10.50 
July     -   September     2015    13.80    9.10 
January  -   March    2016    18.27    12.76 
April    -   June    2016    21.95    13.65 
July     -   September     2016    23.90    19.10 
January  -   March    2017    20.85    17.30 
April    -   June    2017    29.40    17.20 
July     -   September 14,  2017    31.90    25.31 
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Performance Graph

 

The following graph compares the annual change in the Company’s cumulative total shareholder return on its Common Stock during a period commencing on June 30, 2012 and ending on June 30, 2017 (as measured by dividing (i) the sum of (A) the cumulative amount of dividends for the measurement period, assuming dividend reinvestment and (B) the difference between the Company’s share price at the end and the beginning of the measurement period; by (ii) the share price at the beginning of the measurement period) with the cumulative total return of each of: (a) the CRSP Composite Total Return Index for Nasdaq (“Nasdaq”); (b) the CRSP Total Return Index for Nasdaq Medical Equipment Manufacturers (“Nas-MED”); and (c) the CRSP Total Return Index for Nasdaq Healthcare companies (“Nas-Hea.”) during such period, assuming a $100 investment on June 30, 2012. The stock price performance on the graph below is not necessarily indicative of future price performance.

  

 

Relative Dollar Values

   6/29/12  6/28/13  6/30/14  6/30/15  6/30/16  6/30/17
FONAR Common Stock  $100.00   $160.00   $297.50   $273.25   $525.84   $704.31 
NASDAQ  $100.00   $117.60   $154.25   $176.52   $173.55   $222.66 
NAS-MED  $100.00   $123.41   $160.65   $189.39   $220.24   $261.61 
NAS-Hea  $100.00   $126.84   $157.32   $225.33   $213.19   $255.68 

  

On September 14, 2017, we had approximately 1,050 stockholders of record of our Common Stock, 10 stockholders of record of our Class B Common Stock, 3 stockholders of record of our Class C Common Stock and 1,100 stockholders of record of our Class A Non-voting Preferred Stock.

 

At the present time, the only class of our securities for which there is a market is the Common Stock.

 

We currently have a policy of retaining earnings to finance the development and expansion of our business. We expect to continue this policy for the foreseeable future.

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ITEM 6. SELECTED FINANCIAL DATA.

 

The following selected consolidated financial data has been extracted from our consolidated financial statements for the five years ended June 30, 2017. This consolidated selected financial data should be read in conjunction with our consolidated financial statements and the related notes included in Item 8 of this form.

 

 

   As of and For the Periods Ended June 30,
  2017  2016  2015  2014  2013
STATEMENT OF OPERATIONS               
Revenues  $78,036,586   $73,368,210   $69,050,996   $68,505,477   $49,141,814 
Cost of Revenues  $38,052,425   $38,870,898   $38,404,281   $37,247,449   $26,121,365 
Research and Development Expenses  $1,480,670   $1,631,846   $1,812,398   $1,760,821   $1,438,560 
Net Income(Loss)  $23,678,798   $18,795,517   $15,430,383   $13,396,769   $10,256,362 
Basic Net Income (Loss)per common share  $2.98   $2.43   $2.00   $1.62   $1.37 
Diluted Net Income (Loss) per common share  $2.92   $2.38   $1.95   $1.58   $1.34 
Basic Weighted average number of shares outstanding   6,161,599    6,050,893    6,050,632    6,009,822    5,933,318 
Diluted Weighted average number of shares outstanding   6,289,103    6,178,397    6,178,136    6,137,326    6,060,822 
                          
BALANCE SHEET DATA                         
Working capital  $39,177,703   $24,946,326   $24,828,161   $21,898,699   $16,748,144 
Total Assets  $98,762,566   $84,887,606   $76,492,077   $76,789,843   $73,150,650 
Long-term debt and obligations under capital leases  $336,761   $2,059,236   $5,699,302   $8,481,830   $12,887,005 
Stockholder’s (deficiency) equity  $82,909,953   $60,776,307   $50,783,513   $45,906,592   $37,799,276 

 

 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.

 

INTRODUCTION.

 

Fonar was formed in 1978 to engage in the business of designing, manufacturing and selling MRI scanners. HMCA, a subsidiary of Fonar, provides management services to diagnostic imaging facilities.

 

Fonar's principal MRI product is its Stand-Up® MRI (also called Upright® MRI) scanner. The Stand-Up® MRI allows patients to be scanned for the first time under weight-bearing conditions. The Stand-Up® MRI is the only MRI capable of producing images in the weight-bearing state.

 

At 0.6 Tesla field strength, the Upright® MRI is among the highest field open MRI scanners in the industry, offering non-claustrophobic MRI together with high-field image quality. Fonar’s open MRI scanners were the first high field strength open MRI scanners in the industry.

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HMCA generates revenues from providing comprehensive management services, including development, administration, accounting, billing and collection services, together with office space, medical equipment, supplies and non-medical personnel to its clients. Revenues are in the form of fees which are earned under contracts with HMCA’s clients except for its three Florida subsidiaries which engage in the practice of medicine, and bill and collect fees from patients, insurers and other third party payors directly.

 

For the fiscal years ended June 30, 2017 and June 30, 2016 10.5% and 10.2%, respectively, of total revenues were derived from contracts with facilities owned by Dr. Raymond V. Damadian, the President and principal stockholder of Fonar. The agreements with these MRI facilities are for one-year terms which renew automatically on an annual basis, unless terminated. The fees for these sites, which are located in Florida, are flat monthly fees.

 

For services for which Medicare is billed directly, the sites are paid under the Medicare Physician Fee Schedule, which is updated on an annual basis. Under the Medicare statutory formula, payments under the Physician Fee Schedule would have decreased for the past several years if Congress failed to intervene.

 

Many private payors use the Medicare Physician Fee Schedule to determine their own reimbursement rates.

 

While Congress has repeatedly intervened to mitigate the negative reimbursement impact associated with the formula, there is no guarantee that Congress will continue to do so in the future. Moreover, the existing methodology may result in significant yearly fluctuations in the Medicare Physician Fee Schedule amounts, which may be unrelated to changes in the actual costs of providing physician services.

 

The 2013 Medicare Physician Fee Schedule expands a reduction in reimbursement for multiple images. Payment will be made at 75% for the professional component and 50% for the technical component of the second and subsequent scans furnished by the same physician, to the same patient, in the same session, on the same day.

 

In addition, effective January 1, 2014, Medicare made significant reductions in the MRI fee schedule, by nearly 40% for some MRI studies.  

 

Critical Accounting Policies

 

Our discussion and analysis of financial condition and results of operations are based on our consolidated financial statements that were prepared in accordance with U.S. generally accepted accounting principles, or GAAP.  Management makes estimates and assumptions when preparing financial statements.  These estimates and assumptions affect various matters, including:

 

our reported amounts of assets and liabilities in our consolidated balance sheets at the dates of the financial statements 

our disclosure of contingent assets and liabilities at the dates of the financial statements; and

 

our reported amounts of net revenue and expenses in our consolidated statements of operations during the reporting periods

 

These estimates involve judgments with respect to numerous factors that are difficult to predict and are beyond management’s control.  As a result, actual amounts could differ materially from these estimates.

 

The Securities and Exchange Commission defines critical accounting estimates as those that are both most important to the portrayal of a company’s financial condition and results of operations and require management’s most difficult, subjective or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. In the notes to our consolidated financial statements, we discuss our significant accounting policies.

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We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We recognize revenue and related costs of revenue from sales contracts for our MRI scanners and major upgrades, under the percentage-of-completion method. Under this method, we recognize revenue and related costs of revenue, as each sub-assembly is completed. Amounts received in advance of our commencement of production are recorded as customer advances.

 

We continuously, qualitatively and quantitatively evaluate the realizability (including both positive and negative evidence) of the net deferred tax assets and assess the valuation allowance periodically. Our evaluation considers the financial condition of the Company and both the business conditions and regulatory environment of the industry. If future taxable income or other factors are not consistent with our expectations, an adjustment to our allowance for net deferred tax assets may be required.  For net deferred tax assets we consider estimates of future taxable income, including tax planning strategies, in determining whether our net deferred tax assets are more likely than not to be realized. Our ability to project future taxable income may be significantly affected by our ability to determine the impact of regulatory changes which could adversely affect our future profits. As a result, the benefits of our net operating loss carry forwards could expire before they are utilized.

 

At June 30, 2016, the net deferred tax asset was valued at $13,042,306. At June 30, 2017, the net deferred tax asset was valued at $17,861,777.

 

We depreciate our long-lived assets over their estimated economic useful lives with the exception of leasehold improvements where we use the shorter of the assets useful lives or the lease term of the facility for which these assets are associated.

 

The Company provides for medical receivables that could become uncollectible by establishing an allowance for doubtful accounts in order to adjust medical receivables to estimated net realizable value. In evaluating the collectability of medical receivables, the Company considers a number of factors, including the age of the account, historical collection experiences, payor type, current economic conditions and other relevant factors. There are various factors that impact collection trends, such as payor mix, changes in the economy, increase burden on copayments to be made by patients with insurance and business practices related to collection efforts. These factors continuously change and can have an impact on collection trends and the estimation process.

 

We amortize our intangible assets, including patents, and capitalized software development costs, over the shorter of the contractual/legal life or the estimated economic life. Our amortization life for patents and capitalized software development costs is 15 to 17 years and 5 years, respectively. Our amortization of the non-competition agreements entered into with certain individuals in connection with the HDM transaction are depreciated over seven years, and customer relationships are amortized over 20 years.

 

Goodwill is recorded as a result of business combinations. Management evaluates goodwill, at a minimum, on an annual basis and whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. Impairment of goodwill is tested by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. The fair value of a reporting unit is estimated using a combination of the income or discounted cash flows approach and the market approach, which uses comparable market data. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. Based on our test for goodwill impairment, we noted no impairment related to goodwill. However, if estimates or the related assumptions change in the future, we may be required to record impairment charges to reduce the carrying amount of goodwill.

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 FONAR CORPORATION AND SUBSIDIARIES

 

We periodically assess the recoverability of long-lived assets, including property and equipment, intangibles and management agreements, 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.

 

RESULTS OF OPERATIONS. FISCAL 2017 COMPARED TO FISCAL 2016

 

In fiscal 2017, we recognized net income of $23.7 million on revenues of $78.0 million, as compared to net income of $18.8 million on revenues of $73.4 million for fiscal 2016. This represents an increase in revenues of 6.4%. Patient fee revenue net of contractual allowances increased by 9.7%. Total costs and expenses increased by 0.1%. Our consolidated operating results improved by $4.5 million to an operating income of $19.1 million for fiscal 2017 as compared to operating income of $14.4 million for fiscal 2016.

 

Discussion of Operating Results of Medical Equipment Segment

Fiscal 2017 Compared to Fiscal 2016

 

Revenues attributable to our medical equipment segment increased by 4.0% to $11.2 million in fiscal 2017 from $10.8 million in fiscal 2016, with product sales revenues increasing by 23.1% from $1.3 million in fiscal 2016 to $1.6 million in fiscal 2017. Service revenue increased from $9.5 million in fiscal 2016 to $9.6 million in fiscal 2017.

 

The Upright® MRI is unique in that it permits MRI scans to be performed on patients upright in the weight-bearing state and in multiple positions that correlate with symptoms.

 

Product sales to unrelated parties increased by 23.1% in fiscal 2017 from $1.3 million in fiscal 2016 to $1.6 million in fiscal 2017. There were no product sales to related parties in fiscal 2017 or 2016.

 

We believe that one of our principal challenges in achieving greater market penetration is attributable to the better name recognition and larger sales forces of our larger competitors such as General Electric, Siemens, Hitachi, Philips and Toshiba and the ability of some of our competitors to offer attractive financing terms through affiliates, such as G.E. Capital.

 

In addition, lower reimbursement rates have reduced the demand for our MRI products, resulting in lower sales volumes. As a result of fewer sales, service revenues have decreased since as older scanners are taken out of service, there are fewer new scanners available to sign service contracts.

 

The operating results for the medical equipment segment decreased from an operating loss of $1.9 million in fiscal 2016 to an operating loss of $2.3 million in fiscal 2017. The losses are attributable most significantly to the fact that costs increased by a greater amount than revenues.

 

We recognized revenues of $714,000 from the sale of our Upright® MRI scanners in fiscal 2017, while in fiscal 2016, we recognized revenues of $834,000 from the sale of Upright® MRI scanners.

 

Research and development expenses, decreased to $1.5 million in fiscal 2017 from $1.6 million in fiscal 2016. Our expenses for fiscal 2017 represented continued research and development of Fonar’s scanners, Fonar’s new hardware and software product, Sympulse® and new surface coils to be used with the Upright® MRI scanner.

 

Discussion of Operating Results of Physician and Diagnostic Services Management Segment.

 

Fiscal 2017 Compared to Fiscal 2016

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FONAR CORPORATION AND SUBSIDIARIES

 

Revenues attributable to the Company's physician and diagnostic services management segment, HMCA, increased by 6.8% to $66.8 million in fiscal 2017 from $62.6 million in fiscal 2016. The increase in revenues was due to $1.8 million of patient fees (net of contractual allowances and discounts less provision for bad debts) from patient and third party payors recognized by four of the facilities in Florida. One of these locations added additional medical equipment which allowed it to increase volume coupled with an increase in management and other fees of $2.4 million.

 

Cost of revenues as a percentage of the related revenues for our physician and diagnostic services management segment decreased from $35.4 million or 56.6% of related revenues for the year ended June 30, 2016 to $34.1 million, or 51.0% of related revenues for the year ended June 30, 2017. The revenues increased more than the costs relating to these revenues.

 

Operating results of this segment increased from operating income of $16.3 million in fiscal 2016 to operating income of $21.4 million in fiscal 2017. We believe that our efforts to expand and improve the operation of our physician and diagnostic services management segment are directly responsible for the profitability of this segment and our company as a whole.

 

Discussion of Certain Consolidated Results of Operations

Fiscal 2017 Compared to Fiscal 2016

Interest and investment income decreased slightly in 2017 compared to 2016. We recognized interest income of $193,141 in 2017 as compared to $224,263 in fiscal 2016, representing a decrease of 13.9%.

 

Interest expense recovery of $28,299 was recognized in fiscal 2017, as compared to interest expense of $262,193 in fiscal 2016. This was due to additional principal payments being made to retire our debt.

 

While revenue increased by 6.4%, selling, general and administrative expenses increased by 4.8% to $19.4 million in fiscal 2017 from $18.5 million in fiscal 2016.

 

The compensatory element of stock issuances increased from approximately $2,006 in fiscal 2016 to $2,397,276 in fiscal 2017, reflecting a increase in Fonar’s use of its stock bonus plans.

 

The higher provision for bad debts of $477,577 in fiscal 2017, as compared to $202,000 in fiscal 2016, reflected an increase in reserves for certain indebtedness and some bad debt recoveries in fiscal 2017 by our physician and diagnostic services management segment. In addition in fiscal 2017, the Company recorded a provision for bad debts for patient fee revenue of $16.2 million for the MRI facilities in Florida which bill patients and third party payors directly. The three Florida sites managed by HMCA jointly and severally guaranteed the payment of their management fees to HMCA, further securing HMCA’s management fee receivables.

 

Revenue from service and repair fees increased from $9.5 million in fiscal 2016 to $9.6 million in fiscal 2017.

 

Continuing our tradition as the originator of MRI, we remain committed to maintaining our position as the leading innovator of the industry through investing in research and development. In fiscal 2017 we continued our investment in the development of our new MRI scanners, together with software and upgrades, with an investment of $1,480,670 in research and development, none of which was capitalized, as compared to $1,631,846, none of which was capitalized, in fiscal 2016. The research and development expenditures were approximately 13.2% of revenues attributable to our medical equipment segment and 1.9% of total revenues in 2017, and 15.1% of medical equipment segment revenues and 2.2% of total revenues in fiscal 2016. This represented a 9.3% decrease in research and development expenditures in fiscal 2017 as compared to fiscal 2016.

 

For the physician and diagnostic services management segment, HMCA, revenues increased, from $62.6 million in fiscal 2016 to $66.8 million in fiscal 2017. This is primarily attributable to an increase in patient scans resulting from our marketing efforts.

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 FONAR CORPORATION AND SUBSIDIARIES

 

For the fiscal year 2017 the Company recorded an income tax benefit, net of $5.0 million compared with $4.3 million for 2016. The income tax benefits is attributable to the expected tax benefits associated with the projected realization and utilization of our net operating losses in future periods. The Company has recorded a deferred tax asset of $17.9 million as of June 30, 2017, primarily relating to the tax benefits from the net operating loss carry forwards available to offset future taxable income. The utilization of these tax benefits is dependent on the Company generating future taxable income. Although the Company is projecting to generate taxable income in future periods, they cannot accurately measure the full impact of the adoption of healthcare regulations, including the impact of continuing changes in MRI scanning reimbursement rates, which could materially impact operations. A partial valuation allowance will be maintained until evidence exists to support that it is no longer needed.

 

RESULTS OF OPERATIONS. FISCAL 2016 COMPARED TO FISCAL 2015

 

In fiscal 2016, we recognized net income of $18.8 million on revenues of $73.4 million, as compared to net income of $15.4 million on revenues of $69.1 million for fiscal 2015. Our consolidated operating results improved by $1,455,739 to an operating income of $14.4 million for fiscal 2016 as compared to an operating income of $12.9 million for fiscal 2015.

Discussion of Operating Results of Medical Equipment Segment

Fiscal 2016 Compared to Fiscal 2015

 

Revenues attributable to our medical equipment segment decreased by 6.1% to $10.8 million in fiscal 2016 from $11.5 million in fiscal 2015, with product sales revenues decreasing by 29.9% from $1.8 million in fiscal 2015 to $1.3 million in fiscal 2016. Service revenue decreased from $9.7 million in fiscal 2015 to $9.5 million in fiscal 2016.

Product sales to unrelated parties decreased by 29.9% in fiscal 2016 from $1.8 million in fiscal 2015 to $1.3 million in fiscal 2016. There were no product sales to related parties in fiscal 2016 or 2015.

The operating results for the medical equipment segment decreased from income of $505,000 in fiscal 2015 to an operating loss of $1.9 million in fiscal 2016. This decrease was attributable most significantly to the fact that costs increased and the revenues decreased.

We recognized revenues of $834,000 from the sale of our Upright® MRI scanners in fiscal 2016, while in fiscal 2015, we recognized revenues of $1,662,000 from the sale of Upright® MRI scanners.

Research and development expenses, decreased to $1.6 million in fiscal 2016 from $1.8 million in fiscal 2015. Our research and development expenses represented continued research and development of our scanners, our new hardware and software product, Sympulse® and new surface coils to be used with the Upright® MRI scanner.

 

Discussion of Operating Results of Physician and Diagnostic Services Management Segment.

Fiscal 2016 Compared to Fiscal 2015

Revenues attributable to the Company's physician and diagnostic services management segment, HMCA, increased by 8.7% to $62.6 million in fiscal 2016 from $57.6 million in fiscal 2015. The increase in revenues was primarily due to including $3.1 million of patient fees (net of contractual allowances and discounts less provision for bad debts) from patient and third party payors recognized by four of the facilities in Florida.

 

Cost of revenues as a percentage of the related revenues for our physician and diagnostic services management segment increased from $34.3 million or 59.6% of related revenues for the year ended June 30, 2015 to $35.4 million, or 56.6% of related revenues for the year ended June 30, 2016.

 

Operating results of this segment increased from operating income of $12.4 million in fiscal 2015 to operating income of $16.3 million in fiscal 2016. We believe that our efforts to expand and improve the operation of our physician and diagnostic services management segment are directly responsible for the profitability of this segment and our company as a whole.

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 FONAR CORPORATION AND SUBSIDIARIES

 

Discussion of Certain Consolidated Results of Operations

Fiscal 2016 Compared to Fiscal 2015

 

Interest and investment income decreased in 2016 compared to 2015. We recognized interest income of $224,263 in 2016 as compared to $225,270 in fiscal 2015, representing a decrease of 0.4%.

 

Interest expense of $262,193 was recognized in fiscal 2016, as compared to $702,095 in fiscal 2015, representing a decrease of 62.7%.

 

While revenue increased by 6.3%, selling, general and administrative expenses increased by 39.0% to $18.7 million in fiscal 2016 from $13.5 million in fiscal 2015.

 

The compensatory element of stock issuances decreased from approximately $53,200 in fiscal 2015 to $2,000 in fiscal 2016, reflecting a decrease in Fonar’s use of its stock bonus plans to pay employees and others.

The lower provision for bad debts of $202,000 in fiscal 2016 as compared to $2.5 million in fiscal 2015, reflected a decrease in reserves for certain indebtedness in fiscal 2016 by our physician and diagnostic services management segment. In addition in fiscal 2016, the Company recorded a provision for bad debts for patient fee revenue of $14.5 million for the four MRI facilities in Florida which bill patients and third party payors directly. The three Florida sites managed by HMCA jointly and severally guaranteed the payment of their management fees to HMCA, further securing HMCA’s management fee receivables.

 

For the fiscal year 2016 the Company recorded an income tax benefit of $4.3 million compared with $2.6 million for 2015. The income tax benefit is attributable to the income tax benefits associated with the increase in the deferred tax asset for the years then ended. The Company recorded a deferred tax asset of $13.0 million as of June 30, 2016 relating to the tax benefits resulting from the net operating loss carry forwards available to be offset in the future.

 

Revenue from service and repair fees decreased from $9.7 million in fiscal 2015 to $9.5 million in fiscal 2016.

 

In fiscal 2016 we continued our investment in the development of our new MRI scanners, together with software and upgrades, with an investment of $1,631,846 in research and development, none of which was capitalized, as compared to $1,812,398, none of which was capitalized, in fiscal 2015. The research and development expenditures were approximately 15.1% of revenues attributable to our medical equipment segment and 2.2% of total revenues in 2016, and 15.8% of medical equipment segment revenues and 2.6% of total revenues in fiscal 2015. This represented a 10.0% decrease in research and development expenditures in fiscal 2016 as compared to fiscal 2015.

 

We have been taking steps to improve HMCA revenues by our marketing efforts, which focus on the unique capability of our Upright® MRI scanners to scan patients in different positions. We have also been increasing the number of health insurance plans in which our clients participate.

 

Our management fees are dependent on collection by our clients of fees from reimbursements from Medicare, Medicaid, private insurance, no fault and workers’ compensation carriers, self–pay and other third-party payors. The health care industry is experiencing the effects of the federal and state governments’ trend toward cost containment, as governments and other third-party payors seek to impose lower reimbursement and utilization rates and negotiate reduced payment schedules with providers. The cost-containment measures, consolidated with the increasing influence of managed-care payors and competition for patients, have resulted in reduced rates of reimbursement for services provided by our clients from time to time. Our future revenues and results of operations may be adversely impacted by future reductions in reimbursement rates.

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 FONAR CORPORATION AND SUBSIDIARIES

 

 

Certain third-party payors have proposed and implemented changes in the methods and rates of reimbursement that have had the effect of substantially decreasing reimbursement for diagnostic imaging services that HMCA’s clients provide. To the extent reimbursement from third-party payors is reduced, it will likely have an adverse impact on the rates they pay us, as they would need to reduce the management fees they pay HMCA to offset such decreased reimbursement rates. Furthermore, many commercial health care insurance arrangements are changing, so that individuals bear greater financial responsibility through high deductible plans, co-insurance and higher co-payments, which may result in patients delaying or foregoing medical procedures. More frequently, however, patients are scanned and we experience difficulty in collecting deductibles and co-payments. We expect that any further changes to the rates or methods of reimbursement for services, which reduce the reimbursement per scan of our clients may partially offset the increases in scan volume we are working to achieve for our clients, and indirectly will result in a decline in our revenues.

 

On March 23, 2010, President Obama signed into law healthcare reform legislation in the form of the Patient Protection and Affordable Care Act, or PPACA. Healthcare cost containment, reductions of Medicare and other payments, and increased regulation will present additional challenges for healthcare providers. We are unable to predict the full impact of PPACA, or the possible amendment or repeal and replacement of PPACA. It may, however, adversely affect the revenues or the profitability of either or both our medical equipment segment and physician and diagnostic services management segment.

 

In addition, the use of radiology benefit managers, or RBM’s has increased in recent years. It is common practice for health insurance carriers to contract with RBMs to manage utilization of diagnostic imaging procedures for their insureds. In many cases, this leads to lower utilization of imaging procedures based on a determination of medical necessity. The efficacy of RBMs is still a highly controversial topic. We cannot predict whether the healthcare legislation or the use of RBMs will negatively impact our business, but it is possible that our financial position and results of operations could be negatively affected.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash, and cash equivalents increased by 18.9% from $8.5 million at June 30, 2016 to $10.1 million at June 30, 2017.

 

Cash provided by operating activities for fiscal 2017 approximated $16.8 million. Cash provided by operating activities was attributable to the net income of $23.7 million, depreciation and amortization of $3.5 million, which was offset by the deferred income tax benefit of $5.0 million and the increase in accounts, medical and management fee receivables of $5.9 million.

 

Cash used in investing activities for fiscal 2017 approximated $4.3 million. The use of cash from investing activities was attributable to purchases of property and equipment of $2.9 million, costs of acquisitions of $1.3 million, and costs of patents of $155,000.

 

Cash used by financing activities for fiscal 2017 approximated $10.9 million. The principal uses of cash in financing activities included the repayment of loans and capital lease obligations of $4.0 million, and distributions to non-controlling interests of $7.0 million.

 

Total liabilities decreased by 34.3% during fiscal 2017, from approximately $24.1 million at June 30, 2016 to approximately $15.9 million at June 30, 2017.

 

As at June 30, 2017, our obligations included approximately $4.6 million in various state sales taxes, inclusive of penalties and interest. The Company is in the process of negotiating settlements of these obligations.

 

At June 30, 2017, we had working capital of approximately $39.2 million as compared to working capital of $24.9 million at June 30, 2016, and stockholders’ equity of $82.9 million at June 30, 2017 as compared to stockholders’ equity of $60.8 million at June 30, 2016. For the year ended June 30, 2017, we realized a net income of $23.7 million.

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FONAR CORPORATION AND SUBSIDIARIES

 

Our principal sources of liquidity are derived from revenues.

 

Our business plan includes a program for manufacturing and selling our Upright® MRI scanners. In addition, we are enhancing our revenue by participating in the physician and diagnostic services management business through our subsidiary, HMCA and have upgraded the facilities which it manages, most significantly by the replacement of the original MRI scanners with new Upright® MRI scanners. Presently, 25 of the 26 MRI facilities managed by HMCA, are equipped with Upright® MRI scanners. We have also intensified our marketing activities through the hiring of additional marketers for HMCA’s clients.

 

Our business plan also calls for a continuing emphasis on providing our 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 our installed base of scanners were $9.5 million for the year ended June 30, 2016 and $9.6 million for the year ended June 30, 2017.

 

In order to promote profitability and to reduce demands on our cash and other liquid reserves, we maintain an aggressive program of cost cutting. Previously, these measures included consolidating HMCA’s office space with Fonar’s office space and reducing the size of our workforce, compensation and benefits. We continue to reduce and contain expenses across the board. The cost reductions are intended to enable us to withstand periods of low volumes of MRI scanner sales, by keeping expenditures at levels which can be supported by service revenues and HMCA revenues.

 

Current economic credit conditions have contributed to a slower than optimal business environment. Given liquidity and credit constraints in the markets, our business may suffer, should the credit markets not improve in the near future. The direct impact of these conditions is not fully known.

 

Revenues from HMCA have been the principal reason for our profitability, and we have so far been able to maintain and increase such revenues by increasing the number of scans being performed by the sites we manage and those we own, notwithstanding reductions in reimbursement rates from third party payors. The likelihood and effect of any subsequent reductions is not fully known.

 

Capital expenditures for fiscal 2017 approximated $3.0 million. Capitalized patent costs were approximately $155,000. Purchases of property and equipment were approximately $2.9 million.

 

Fonar has not committed to making capital expenditures in the 2018 fiscal year, except for acquiring an additional scanner to place at the Tallahassee site and providing a new scanner to replace the scanner at the Miami site.

The Company believes that its business plan has been responsible for the past four consecutive fiscal years of profitability (fiscal 2017, fiscal 2016, fiscal 2015 and fiscal 2014) and that its capital resources will be adequate to support operations at current levels through June 30, 2018.

 

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET

RISK

 

The Company does not have any investments in marketable securities, foreign currencies, mutual funds, certificates of deposit or other fixed rate instruments. All of our funds are in cash accounts or money market accounts which are liquid.

 

All of our revenue, expense and capital purchasing activities are transacted in United States dollars.

 

See Note 10 to the consolidated Financial Statements for information on long-term debt.

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FONAR CORPORATION AND SUBSIDIARIES

 

ITEM 8.

 

FINANCIAL STATEMENTS

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

  Page No.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 39
   
CONSOLIDATED BALANCE SHEETS  
At June 30, 2017 and 2016 40
   
CONSOLIDATED STATEMENTS OF INCOME  
For the Years Ended June 30, 2017, 2016 and 2015 43
   
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY  
For the Years Ended June 30, 2017, 2016 and 2015 45
   
CONSOLIDATED STATEMENTS OF CASH FLOWS  
For the Years Ended June 30, 2017, 2016 and 2015 48
   
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 50

 

 Page 38 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the Audit Committee of the

Board of Directors and Stockholders of

FONAR Corporation and Subsidiaries

 

 

We have audited the accompanying consolidated balance sheets of FONAR Corporation and Subsidiaries (the “Company”) as of June 30, 2017 and 2016, and the related consolidated statements of income, stockholders’ equity and cash flows for the three years in the period ended June 30, 2017. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 as of June 30, 2017 and 2016, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), FONAR Corporation and Subsidiaries’ internal control over financial reporting as of June 30, 2017, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013) and our report dated September 27, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

 

 

/s/ Marcum LLP

Marcum LLP 

New York, NY

September 27, 2017

 

 

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FONAR CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

 

ASSETS

 

  

   June 30,
   2017  2016
Current Assets:          
Cash and cash equivalents  $10,139,621   $8,528,309 
Accounts receivable – net of allowances for doubtful accounts of $190,244 and $284,279 at June 30, 2017 and 2016, respectively   4,321,760    4,370,155 
Medical receivables –net of allowances for doubtful accounts of $19,853,318 and $17,451,782 at June 30, 2017 and 2016, respectively   11,744,704    10,126,397 
Management and other fees receivable – net of allowances for doubtful accounts of $12,859,750 and $13,553,005 at June 30, 2017 and 2016, respectively   18,593,894    15,637,831 
Management and other fees receivable – related party medical practices – net of allowances for doubtful accounts of $582,001 and $392,505 at June 30, 2017 and 2016, respectively   4,959,598    4,063,539 
Costs and estimated earnings in excess of billings on uncompleted contracts   736,061    —   
Inventories   1,624,262    2,074,300 
Prepaid expenses and other current assets   1,293,806    759,042 
           
Total Current Assets   53,413,706    45,559,573 
Deferred income tax asset   17,861,777    13,042,360 
Property and Equipment – Net   16,462,504    14,512,706 
Goodwill   3,927,123    3,322,158 
Other Intangible Assets – Net   6,644,504    7,719,358 
Other Assets   452,952    731,451 
Total Assets  $98,762,566   $84,887,606 

 

See accompanying notes to consolidated financial statements.

 

 Page 40 

 

FONAR CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

 LIABILITIES

 

  

   June 30,
   2017  2016
Current Liabilities:          
Current portion of long-term debt and capital leases  $180,090   $2,447,693 
Accounts payable   1,423,217    1,254,485 
Other current liabilities   7,203,278    10,826,793 
Unearned revenue on service contracts   4,641,534    4,678,914 
Customer deposits   787,884    1,198,739 
Billings in excess of costs and estimated earnings on uncompleted contracts   —      206,623 
Total Current Liabilities   14,236,003    20,613,247 
Long-Term Liabilities:          
Deferred income tax liability   331,527    481,779 
Due to related party medical practices   227,543    245,041 
Long-term debt and capital leases, less current portion   336,761    2,059,236 
Other liabilities   720,779    711,996 
Total Long-Term Liabilities   1,616,610    3,498,052 
Total Liabilities   15,852,613    24,111,299 

 

 

Commitments, Contingencies and Other Matters

 

See accompanying notes to consolidated financial statements.

 

 Page 41 

 

FONAR CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

STOCKHOLDERS' EQUITY

 

  

   June 30,
   2017  2016
Stockholders' Equity:          
 Class A non-voting preferred stock $.0001 par value; 453,000 shares authorized at June 30, 2017 and 2016, 313,438 issued and outstanding at June 30, 2017 and 2016  $31   $31 
 Preferred stock $.001 par value; 567,000 shares authorized at June 30, 2017 and 2016, issued and outstanding – none   —      —   
 Common stock $.0001 par value; 8,500,000 shares authorized at June 30, 2017 and 2016, 6,299,154 and 6,062,809 issued at June 30, 2017 and 2016, respectively; 6,287,511 and 6,051,166 outstanding at June 30, 2017 and 2016, respectively   630    607 
 Class B convertible common stock (10 votes per share) $.0001 par value; 227,000 shares authorized at June 30, 2017 and 2016, 146 issued and outstanding at June 30, 2017 and 2016   —      —   
 Class C common stock (25 votes per share) $.0001 par value; 567,000 shares authorized at June 30, 2017 and 2016, 382,513 issued and outstanding at June 30, 2017 and 2016   38    38 
 Paid-in capital in excess of par value   179,131,780    173,702,335 
 Accumulated deficit   (101,003,389)   (120,624,010)
 Notes receivable from employee stockholders   (16,546)   (23,879)
Treasury stock, at cost – 11,643 shares of common stock at  June 30, 2017 and 2016   (675,390)   (675,390)
Total Fonar Corporation’s Stockholders’ Equity   77,437,154    52,379,732 
Noncontrolling interests   5,472,799    8,396,575 
Total Stockholders' Equity   82,909,953    60,776,307 
Total Liabilities and Stockholders' Equity  $98,762,566   $84,887,606 

 

See accompanying notes to consolidated financial statements.

 

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FONAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

 

   For the Years Ended June 30,
   2017  2016  2015
Revenues         
Product sales – net  $1,572,148   $1,276,882   $1,820,979 
Service and repair fees – net   9,537,040    9,396,736    9,549,316 
Service and repair fees – related parties – net   110,000    110,000    110,000 
Patient fee revenue, net of contractual allowances and discounts   36,400,600    32,985,809    28,153,598 
Provision for bad debts for patient fee   (16,171,434)   (14,539,786)   (12,770,249)
Management and other fees – net   38,361,514    36,633,230    34,805,627 
Management and other fees – related party medical practices – net   8,226,718    7,505,339    7,381,725 
Total Revenues – Net   78,036,586    73,368,210    69,050,996 
Costs and Expenses               
Costs related to product sales   931,501    1,254,328    1,882,230 
Costs related to service and repair fees   2,996,736    2,148,143    2,189,373 
Costs related to service and repair fees – related parties   34,564    25,147    25,220 
Costs related to patient fee revenue   8,987,673    9,418,935    7,939,524 
Costs related to management and other fees   20,828,581    21,949,583    20,970,116 
Costs related to management and other fees – related party medical practices   4,273,370    4,074,762    3,883,953 
Research and development   1,480,670    1,631,846    1,812,398 
Selling, general and administrative, inclusive of compensatory element of stock issuances of $2,397,276, $2,006 and $53,200 for the years ended June 30, 2017, 2016 and 2015, respectively   19,407,411    18,509,850    17,448,305 
Total Costs and Expenses   58,940,506    59,012,594    56,151,119 
Income from Operations   19,096,080    14,355,616    12,899,877 
Other Income and (Expenses):               
Interest expense   28,299    (262,193)   (702,095)
Investment income   193,141    224,263    225,270 
Other (expense) income – net   (1,156)   190,560    394,810 
Income before benefit for income taxes and noncontrolling interests   19,316,364    14,508,246    12,817,862 
Benefit for Income Taxes   4,362,434    4,287,271    2,612,521 
Net Income  $23,678,798   $18,795,517   $15,430,383 
Net Income – Noncontrolling Interests   (4,058,177)   (3,070,892)   (2,519,732)
Net Income – Attributable to FONAR  $19,620,621   $15,724,625   $12,910,651 

 

See accompanying notes to consolidated financial statements.

 

 Page 43 

 

FONAR CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME (Continued)

 

 

 

   For the Years Ended June 30,
   2017  2016  2015
Net Income Available to Common Stockholders  $18,390,586   $14,702,834   $12,071,670 
Net Income Available to Class A Non-Voting Preferred Stockholders  $916,769   $761,561   $625,309 
Net Income Available to Class Common Stockholders  $313,266   $260,230   $213,672 
Basic Net Income Per Common Share Available to Common Stockholders  $2.98   $2.43   $2.00 
Diluted Net Income Per Common Share Available to Common Stockholders  $2.92   $2.38   $1.95 
Basic and Diluted Income Per Share – Class C Common  $0.82   $0.68   $0.56 
Weighted Average Basic Shares Outstanding – Common Stockholders   6,161,599    6,050,893    6,050,632 
Weighted Average Diluted Shares Outstanding – Common Stockholders   6,289,103    6,178,397    6,178,136 
Weighted Average Basic and Diluted Shares Outstanding – Class C Common   382,513    382,513    382,513 

 

 

See accompanying notes to consolidated financial statements.

 

 Page 44 

 

FONAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

FOR THE YEAR ENDED JUNE 30, 2017, 2016 AND 2015

 

   Class A Non-Voting Preferred  Common Shares  Stock Amount  Class C Common Stock
Balance - June 30, 2014  $31    6,045,840   $606   $38 
Net income   —      —      —      —   
Stock issued to employees under stock bonus plans   —      5,000    1    —   
Payments on notes receivable from employee stockholders   —      —      —      —   
Issuance of stock for goods and services   —      —      —      —   
Redemption of noncontrolling interests   —      —      —      —   
Buyout of noncontrolling interests   —      —      —      —   
Distributions to noncontrolling interests   —      —      —      —   
Balance - June 30, 2015  $31    6,050,840   $607   $38 
Net income   —      —      —      —   
Stock issued to employees under stock bonus plans   —      146    —      —   
Payments on notes receivable from employee stockholders   —      —      —      —   
Redemption of noncontrolling interests   —      —      —      —   
Buyout of noncontrolling interests   —      —      —      —   
Distributions to noncontrolling interests   —      —      —      —   
Stock option exercised   —      180    —      —   
Balance - June 30, 2016  $31    6,051,166   $607   $38 
Net income   —      —      —      —   
Stock issued to employees under stock bonus plans   —      193,221    19    —   
Payments on notes receivable from employee stockholders   —      —      —      —   
Issuance of stock for acquistion   —      42,884    4    —   
Distributions to noncontrolling interests   —      —      —      —   
Stock option exercised   —      240    —      —   
Balance - June 30, 2017  $31    6,287,511   $630   $38 

 

See accompanying notes to consolidated financial statements.

 

 Page 45 

 

FONAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

FOR THE YEAR ENDED JUNE 30, 2017, 2016 AND 2015

 

 

   Paid-in Capital in Excess of Par Value  Accumulated Deficit  Notes Receivable From Employee Stockholders
Balance - June 30, 2014  $175,284,437   $(149,259,286)  $(38,828)
Net income   —      12,910,651    —   
Stock issued to employees under stock bonus plans   53,199    —      —   
Payments on notes receivable from employee stockholders   —      —      7,333 
Issuance of stock for goods and services   109,950    —      —   
Redemption of noncontrolling interests   —      —      —   
Buyout of noncontrolling interests   —           —   
Distributions to noncontrolling interests   —      —      —   
Balance - June 30, 2015  $175,447,586   $(136,348,635)  $(31,495)
Net income   —      15,724,625    —   
Stock issued to employees under stock bonus plans   2,006    —      —   
Payments on notes receivable from employee stockholders   —      —      7,616 
Redemption of noncontrolling interests   —      —      —   
Buyout of noncontrolling interests   (1,749,012)          
Distributions to noncontrolling interests   —           —   
Stock option exercised   1,755    —      —   
Balance - June 30, 2016  $173,702,335   $(120,624,010)  $(23,879)
Net income   —      19,620,621    —   
Stock issued to employees under stock bonus plans   4,636,559    —      —   
Payments on notes receivable from employee stockholders   —      —      7,333 
Issuance of stock for acquistion   791,206    —      —   
Distributions to noncontrolling interests   —           —   
Stock option exercised   1,680    —      —   
Balance - June 30, 2017  $179,131,780   $(101,003,389)  $(16,546)

 

See accompanying notes to consolidated financial statements.

 

 Page 46 

 

FONAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED JUNE 30, 2017, 2016 AND 2015

 

 

   Treasury Stock  Noncontrolling Interests  Total
Balance - June 30, 2014  $(675,390)  $20,594,984   $45,906,592 
Net income   —      2,519,732    15,430,383 
Stock issued to employees under stock bonus plans   —      —      53,200 
Payments on notes receivable from employee stockholders   —      —      7,333 
Issuance of stock for goods and services   —      —      109,950 
Redemption of noncontrolling interests   —      (1,125,000)   (1,125,000)
Buyout of noncontrolling interests        (4,971,094)   (4,971,094)
Distributions to noncontrolling interests   —      (4,627,851)   (4,627,851)
Balance - June 30, 2015  $(675,390)  $12,390,771   $50,783,513 
Net income   —      3,070,892    18,795,517 
Stock issued to employees under stock bonus plans   —      —      2,006 
Payments on notes receivable from employee stockholders   —      —      7,616 
Redemption of noncontrolling interests   —      (1,155,988)   (2,905,000)
Distributions to noncontrolling interests        (5,909,100)   (5,909,100)
Stock option exercised   —      —      1,755 
                
Balance - June 30, 2016  $(675,390)  $8,396,575   $60,776,307 
Net income   —      4,058,177    23,678,798 
Stock issued to employees under stock bonus plans   —      —      4,636,578 
Payments on notes receivable from employee stockholders   —      —      7,333 
Issuance of stock for acquistion   —      —      791,210 
Distributions to noncontrolling interests        (6,981,953)   (6,981,953)
Stock option exercised   —      —      1,680 
Balance - June 30, 2017  $(675,390)  $5,472,799   $82,909,953 

 

See accompanying notes to consolidated financial statements.

 

 Page 47 

 

FONAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For the Years Ended June 30,
   2017  2016  2015
CASH FLOWS FROM OPERATING ACTIVITIES               
Net income  $23,678,798   $18,795,517   $15,430,383 
Adjustments to reconcile net income to net cash provided by operating activities:               
Depreciation and amortization   3,533,564    3,297,289    3,544,470 
Abandoned patents or software written off   —      88,796    413,589 
Provision for bad debts   477,577    (201,949)   2,475,032 
Deferred income tax benefit – net   (4,969,669)   (4,647,767)   (2,756,517)
Gain on acquisition   —      (192,999)   —   
Compensatory element of stock issuances   2,397,276    2,006    53,200 
Gain on extinguishment of debt   —      —      (394,797)
Stock issued for costs and expenses   2,239,302    —      109,950 
Stock option exercised   1,680    1,755    —   
(Increase) decrease in operating assets, net:               
Accounts, medical and management fee receivables   (5,899,611)   (3,557,507)   (4,258,147)
Notes receivable   11,511    28,280    135,592 
Costs and estimated earnings in excess of billings on uncompleted contracts   (736,061)   681,660    78,149 
Inventories   450,038    117,549    251,687 
Prepaid expenses and other current assets   (513,507)   72,718    67,192 
Other assets   254,721    18,054    41,125 
Increase (decrease) in operating liabilities, net:               
Accounts payable   168,733    (527,957)   (699,555)
Other current liabilities   (3,660,895)   3,065,673    (1,041,214)
Customer advances   (410,855)   (739,074)   11,000 
Billings in excess of costs and estimated earnings on uncompleted contracts   (206,623)   64,406    —   
Other liabilities   8,783    242,798    (190,561)
Due to related party medical practices   (17,498)   8,121    2,339 
NET CASH PROVIDED BY OPERATING ACTIVITIES   16,807,264    16,617,369    13,272,917 

 

See accompanying notes to consolidated financial statements.

 

 Page 48 

 

FONAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

   For the Years Ended June 30,
CASH FLOWS FROM INVESTING ACTIVITIES:  2017  2016  2015
Purchases of property and equipment   (2,851,158)   (712,216)   (131,308)
Cost of acquisition   (1,312,769)   (4,223,567)   —   
Cost of patents   (155,156)   (113,072)   (139,534)
NET CASH USED IN INVESTING ACTIVITIES   (4,319,083)   (5,048,855)   (270,842)
CASH FLOWS FROM FINANCING ACTIVITIES:               
Repayment of borrowings and capital lease obligations   (3,990,078)   (3,682,519)   (2,788,401)
Repayment of notes receivable from employee stockholders   7,333    7,616    7,333 
Distributions to noncontrolling interests   (6,981,953)   (5,909,100)   (4,627,851)
Redemption of noncontrolling interests   —      (2,905,000)   (1,125,000)
Proceeds received from acquisition -net   87,829    —      —   
Buyout of  noncontrolling interest   —      —      (4,971,094)
NET CASH USED IN FINANCING ACTIVITIES   (10,876,869)   (12,489,003)   (13,505,013)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   1,611,312    (920,489)   (502,938)
CASH AND CASH EQUIVALENTS – BEGINNING OF YEAR   8,528,309    9,448,798    9,951,736 
CASH AND CASH EQUIVALENTS – END OF YEAR  $10,139,621   $8,528,309   $9,448,798 

 

See accompanying notes to consolidated financial statements.

 

 Page 49 

 

FONAR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017, 2016 and 2015

 

 

 

NOTE 1 - DESCRIPTION OF BUSINESS AND LIQUIDITY AND CAPITAL RESOURCES

 

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 our installed-base of customers through our service and upgrade programs.

 

FONAR, through its wholly-owned subsidiary Health Management Corporation of America ("HMCA") provides comprehensive management services to diagnostic imaging facilities. 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.

 

On June 30, 2016, the Company purchased 100% of the equity in Turnkey Services of New York, LLC and 100% of the equity in TK2 Equipment Management, LLC. Turnkey Service of New York, LLC and TK2 Equipment Management, LLC. These entities had provided the Company with ancillary diagnostic imaging equipment (under operating leases) to our managed MRI facilities. The Company paid $4,223,567 to acquire these two entities with net assets at fair value of $2,861,506.

 

On July 1, 2015, the Company restructured the corporate organization of the management of diagnostic imaging centers segment of our business. The reorganization was structured to more completely integrate the operations of Health Management Corporation of America and HDM. Imperial contributed all of its assets (which were utilized in the business of Health Management Corporation of America) to HDM and received a 24.2% interest in HDM. Health Management Corporation of America retained a direct ownership interest of 45.8% in HDM, and the original investors in HDM retained a 30.0% ownership interest in the newly expanded HDM. The entire management of diagnostic imaging centers business segment is now being conducted by HDM.

 

 

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 and partnerships. The operating activities of subsidiaries are included in the accompanying consolidated statements from the date of acquisition. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

 Page 50 

 

FONAR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017, 2016 and 2015

 

 

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States 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 receivable allowances, intangible assets, income taxes and related tax asset valuation allowances, useful lives of property and equipment, contingencies, revenue recognition and the assessment of litigation. 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.

 

Inventories

 

Inventories consist of purchased parts, components and supplies, as well as work-in-process, and are stated at the lower of cost, determined on the first-in, first-out method, or market.

 

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 their estimated useful lives. 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 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. Maintenance and repair expenses totaled approximately $1,116,000, $1,113,000 and $1,200,000 for the years ended June 30, 2017, 2016 and 2015, respectively. The estimated useful lives in years are generally as follows:

 

Diagnostic equipment under capital lease   2.5 
Diagnostic equipment   5–13 
Research, development and demonstration equipment   3-7 
Machinery and equipment   2-7 
Furniture and fixtures   3-9 
Leasehold improvements   2–10 
Building   28 

 

Long-Lived Assets

 

The Company periodically assesses the recoverability of long-lived assets, including property and equipment and intangibles, other than goodwill, 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. 

 

 Page 51 

 

FONAR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017, 2016 and 2015

 

 

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Deferred Rent

 

Rent expense is recorded on the straight-line method based on the total minimum rent payments required over the term of the lease. The cumulative difference between the lease expense recorded under this method and the contractual lease payment terms is recorded as deferred rent.

 

Other Intangible Assets