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  Fonar: Flop or fixer-upper?

BENJ GALLANDER and BEN STADELMANN

Tuesday, May 23, 2006

It's been a long time since we have suffered a certified blowout, but Fonar is putting our streak of fortune in severe jeopardy.

The stock of our MRI manufacturer was hammered last week to 26 cents (U.S.) as third-quarter revenues imploded to a paltry $7.1 million, compared with $25.3 million in 2005. After a nominal profit last year, losses have been mounting at a harrowing pace, now standing at $21 million over nine months. Have North Americans suddenly become so healthy that they have no need for this miracle of medical science?

Sadly, that is not the case, as demand remains strong and plenty of MRI machines continue to be sold, but it is the folks selling competing models who are buying the first round of frosty margaritas. Fonar's flagship scanner, the "Upright" is special, different, revolutionary, superior and fully protected both by patents and the U.S. Supreme Court, or so the company says to anyone who will listen — which does not appear to include many who make purchasing decisions of big-ticket medical equipment.

When we shelled out $1.25 a share for the company just over a year ago, there were strong indicators that Fonar was carving out a niche, and our $2.05 target would be a piece of cake. Sales of the Upright were on a sharp upward trajectory, with revenues for the first six months of 2005 up by 75 percent, compared with 2004.

It takes time for any new technology to penetrate a market, and it was plausible that an MRI machine that was friendly enough to allow patients to comfortably watch television while being scanned was ready to hit its stride.

And with an estimated 10 million MRI scans of the spine being performed each year in the United States, even a small slice of such a large pie would pay off handsomely.

What went wrong?

We knew from the outset that Fonar was a minnow swimming in a big pond, populated by global giants like General Electric, Toshiba, Hitachi and Siemens. Fonar stated that "the reduction in product revenue recognition was primarily due to increased marketing and advertising pressure from our competitors attempting to minimize the unique medical benefits of the Fonar Upright."

Well, that is the nature of competition, guys. Of course, company founder and CEO Dr. Raymond Damadian also took umbrage when the 2003 Nobel Prize for medicine went to Dr. Paul Lauterbur and Sir Peter Mansfield for their development of the MRI. So upset was Dr. Damadian that full-page advertisements appeared in The New York Times and Washington Post, pouring scorn on the Nobel committee for failing to recognize his work. Tsk, tsk.

While we recognize that inflated egos are a dime a dozen in the business world, the company's horrible results had us poised to make a few inquiries during the conference call. However no shareholder questions were entertained. Way to build management credibility!

We have considered taking our lumps and marking this one a tax loss against our substantial gains. This option appears eminently prudent, considering the discomfiting fact that Fonar has failed to meet the Nasdaq Capital Market's continued listing requirement. The stock price will have to be boosted to the $1 level before the end of the year, or demotion to over-the-counter hell is the consequence.

At this point, though, we will hold. Daniel Culver, Fonar's director of communications, was confident during our conversation that the boat will turn around and the stock will break the greenback barrier. Dr. Damadian is putting his money where his mouth is, having purchased over 190,000 shares this year, almost half of those last week at 55 cents, after the dismal results were reported.

Is this the equivalent of the maestro striking up the band to play "Nearer My God to Thee" while the ship plows into the iceberg, or does Captain Damadian have a personal life preserver that we don't know about?

One way or another, we aren't expecting a Nobel Prize in economics for this investment.


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