INTRODUCTION.

Fonar was formed in 1978 to engage in the business of designing, manufacturing and selling MRI scanners. In 1997, we formed a wholly-owned subsidiary, Health Management Corporation of America, also referred to as "HMCA", formerly known as U.S. Health Management Corporation, in order to expand into the physician and diagnostic management services business.

Fonar's principal MRI products are its Stand-Up(R)/Upright(R) MRI and Fonar
360(TM) MRI scanners. The Stand-Up(R) MRI allows patients to be scanned for the first time under weight-bearing conditions. The Company has been aggressively seeking new sales. The Stand-Up(R) MRI is the only MRI capable of producing images in the weight bearing state.

At 0.6 Tesla field strength, the Upright(R) MRI and Fonar 360(TM) magnets are 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 MRI scanners in the industry.

HMCA commenced operations in July, 1997 and 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. Since July 2005, HMCA has engaged only in the management of MRI facilities.

For the fiscal years ended June 30, 2009 and June 30, 2008, 28.4% and 30.8%, respectively, of HMCA's revenues were derived from contracts with facilities owned by Dr. Raymond V. Damadian, the President of Fonar and HMCA 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 are based on the number of procedures performed and ranged from $300 to $400 per MRI scan. The balance of HMCA's revenues are derived from contracts with MRI facilities purchased by Dr. Robert Diamond from Dr. Damadian. The MRI facilities owned by Dr. Diamond are charged a flat fee, pursuant to new contracts executed in connection with the sale of the MRI facilities at the end of fiscal 2007. The fees are reviewed and if appropriate, adjusted on an annual basis by mutual agreement.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to investments, intangible assets, income taxes, contingencies and litigation. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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, 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 record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. As of June 30, 2009, we recorded a valuation allowance which reduced our deferred tax assets to equal our deferred tax liability.

We amortize our intangible assets, including patents, purchased management agreements 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.

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 2009 COMPARED TO FISCAL 2008

In fiscal 2009, we experienced a net income of $1.1 million on revenues of $39.7 million, as compared to a net loss of $13.5 million on revenues of $35.6 million for fiscal 2008. This represents an increase in revenues of 11.7%. Included in net income for fiscal 2009 is a gain of $1.4 million recognized by the Company on the sale of a consolidated subsidiary. The impact of increased unrelated party product sales, which increased by 51.6%, was the principal factor accounting for the increased revenues of the Company. Related management fees decreased by 11.9%. In addition, total costs and expenses decreased by 23.0%. Our consolidated operating results improved by $16.2 million to an operating loss of $704,000 for fiscal 2009 as compared to an operating loss of $16.9 million for fiscal 2008.

Discussion of Operating Results of Medical Equipment Segment Fiscal 2009 Compared to Fiscal 2008

Revenues attributable to our medical equipment segment increased by 25.3% to $29.5 million in fiscal 2009 from $23.5 million in fiscal 2008, with product sales revenues increasing 51.6% from $11.3 million in fiscal 2008 to $17.2 million in fiscal 2009, and service revenue decreasing by 4.6%, from $11.0 million in fiscal 2008 to $10.5 million in fiscal 2009. This increase in revenues was attributable to an increase in sales of our Upright(R) MRI to unrelated parties, notwithstanding the decrease in service and repair fees.

We anticipate an improvement in our Upright(R) MRI sales because the Upright(R) 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. An important event in our ongoing effort to educate both the medical community and payors about the benefits, if not necessity, of utilizing Upright(R) MRI scanning, occurred in fiscal 2007 when we sold an Upright(R) MRI scanner to the largest orthopedic hospital in the Netherlands, St. Maartenskliniek. Upon placing the order, the Chairman of Spine Surgery at St. Maartenskliniek expressed the view that for their hospital to continue to engage in spine surgery without Fonar's Upright(R) MRI technology, now that it was available was "unacceptable" and that owning the scanner "was not optional, but mandatory". He further stated that "[o]nce our active research program has discovered the benefits of this new Fonar technology for patients, we intend to publish the results in a lot of peer reviewed scientific journals".

In addition, significant progress is being made in developing the Fonar 360(TM) MRI scanner so that it can be used in interventional procedures. At the Oxford-Nuffield site in the United Kingdom, where we installed the first Fonar
360(TM) MRI, Fonar software engineers have completed and installed our 2nd generation tracking software, which is designed to enable the surgeons to insert needles into the patient and accurately advance them under direct visual image guidance to the target tissue, such as a tumor, in order to inject therapeutic agents directly into the tissue.

Product sales to unrelated parties increased by 51.6% in fiscal 2009 from $11.3 million in fiscal 2008 to $17.2 million in fiscal 2009. There were no product sales to related parties in fiscal 2009 and 2008.

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. Nevertheless, no other competitor offers a whole body weight bearing MRI scanner such as the Upright(R) MRI, and the General Electric Medical Systems division of General Electric acts as a manufacturer's representative for the Stand-Up(R) MRI.

We believe that our aggregate product sales to unrelated parties of Upright(R) Scanners shows that we are successfully meeting that challenge.

The operating results for the medical equipment segment improved by $14.2 million from a loss of $14.1 million in fiscal 2008 to an income of $27,000 in fiscal 2009. This improvement is attributable most significantly to an increase in our scanner sales and a decrease in our total costs and expenses.

We recognized revenues of $16.6 million from the sale of our Upright(R) MRI scanners in fiscal 2009. In fiscal 2008, we recognized revenues of $11.2 million from the sale of Upright(R) MRI scanners.

None of our revenues for fiscal 2009 and fiscal 2008 were attributable to sales to related parties.

License and royalty revenue in fiscal 2009 increased to $1.8 million as compared to $1.2 million in fiscal 2008.

Research and development expenses, net of capitalized costs, decreased by 28.2% to $3.6 million in fiscal 2009 as compared to $5.0 million in fiscal 2008. Our expenses for fiscal 2009 represented continued research and development of Fonar's scanners, Fonar's new hardware and software product, Sympulse(TM) and new surface coils to be used with the Upright(R) MRI scanner.

Discussion of Operating Results of Physician and Diagnostic Services Management Segment.
Fiscal 2009 Compared to Fiscal 2008

Revenues attributable to the Company's physician and diagnostic services management segment, HMCA, decreased by 14.9% to $10.3 million in fiscal 2009 from $12.0 million in fiscal 2008. The decrease in revenues was primarily due to the sale of a 92.3% equity interest in an enterprise managing an MRI center. Presently, nine of the ten MRI facilities managed by HMCA have Upright(R) MRI scanners.

Cost of revenues as a percentage of the related revenues for our physician and diagnostic services management segment decreased from $8.6 million or 71.3% of related revenues for the year ended June 30, 2008 to $7.3 million, or 71.2% of related revenue for the year ended June 30, 2009. The decrease in revenues resulted from our sale of a 92.3% equity interest in an enterprising managing an MRI center.

Operating results of this segment improved from an operating loss of $2.8 million in fiscal 2008 to operating loss of $731,000 in fiscal 2009. We attribute the improvement to a decrease in our cost of revenues.

Discussion of Certain Consolidated Results of Operations Fiscal 2009 Compared to Fiscal 2008

Interest and investment income decreased in 2009 compared to 2008. We recognized interest income of $346,506 in 2009 as compared to $728,711 in fiscal 2008, representing an decrease of 52.4%.

Interest expense of $333,229 was recognized in fiscal 2009, as compared to $535,322 in fiscal 2008, representing an decrease of 37.8%.

Notwithstanding that revenue increased by 11.7%, selling, general and administrative expenses, decreased by 34.2% to $13.4 million in fiscal 2009 from $20.4 million in fiscal 2008.

Compensatory element of stock issuances also increased from approximately $360 in fiscal 2008 to $4,061 in fiscal 2009. This reflected Fonar's policy to refrain from using its stock bonus plans to pay employees and others, in order to prevent dilution of its outstanding stock.

The lower provision for bad debts of $1.3 million in fiscal 2009 as compared to $2.2 million in fiscal 2008, reflected an increase in reserves of certain indebtedness in fiscal 2008 by our physician and diagnostic services management segment. In fiscal 2009, 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.

Service and repair fees have decreased, from $11.0 million in fiscal 2008 and to $10.5 million in fiscal 2009.

Continuing our tradition as the originator of MRI, we remain committed to maintaining our position as the leading innovator of the industry through aggressive investing in research and development. In fiscal 2009 we continued our investment in the development of our new MRI scanners, together with software and upgrades, with an investment of $4,085,177 in research and development, $491,707 of which was capitalized, as compared to $5,463,963, $457,372 of which was capitalized, in fiscal 2008. The research and development expenditures were approximately 12.2% of revenues attributable to our medical equipment segment, and 9.0% of total revenues, in 2009 and 21.3% of medical equipment segment revenues, and 14.1% of total revenues in fiscal 2008. This represented a 28.2% decrease in research and development expenditures in fiscal 2009 as compared to fiscal 2008. Notwithstanding the decrease in research and development expenditures, in connection with our overall cost cutting programs, the Company remains fully committed to developing new features, software and upgrades to improve its products.

The physician and diagnostic services management segment, HMCA, revenues decreased, from $12.0 in fiscal 2008 to $10.3 million in fiscal 2009. This is primarily attributable to the sale of HMCA's 92.3% equity interest in an entity providing management services to a scanning center in Bensonhurst, New York.

We have been taking steps to improve HMCA revenues by our marketing efforts, which focus on the unique capability of our Upright(R) MRI scanners to scan patients in different positions.

Marketing expenditures are likely to increase, as the Company continues its efforts to promote sales.

In the beginning of fiscal 2006, in July of 2005, HMCA sold the portion of its business engaged in the management of physical therapy and rehabilitation facilities to Health Plus Management Services, L.L.C. for a purchase price of $6.6 million, payable pursuant to a promissory note payable in 120 monthly installments.

The first twelve installments were interest only and the remaining 108 payments were to consist of equal installments of principal and interest in the amount of $76,014 each. The note was secured by a first lien on all of the assets of Health Plus, including its accounts receivable. The note was subject to prepayment provisions to the extent Health Plus resells all or part of the assets and business or utilizes the assets sold as collateral in any debt financing.

Pursuant to a Modification Agreement dated August 8, 2008, Health Plus made a prepayment of $2,000,000 on the note and received a discount of $1,000,000 in return. A new note was executed for the balance of the indebtedness remaining, in the amount of $2,378,130, providing for 60 consecutive equal monthly payments of principal and interest of $47,090 each. The security agreement and the mandatory prepayment provisions applicable to the original note are also applicable to the replacement note.

In fiscal 2008 and 2009, HMCA received no revenue from the physical therapy and rehabilitation business.

The Company's management fees are dependent on collection by its 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 the Company's clients from time to time. The Company's future revenues and results of operations may be adversely impacted by future reductions in reimbursement rates.

In 2009, the Obama administration announced its intentions for healthcare reform in the United States. The plan includes providing healthcare coverage for some 40 million uninsured Americans. The plan calls for, among other things, more vigilant control of healthcare utilization, including diagnostic imaging services. 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 high controversial topic. The Company cannot predict whether the current administration's healthcare plan and the use of RBMs will negatively impact its business, but it is possible that the Company's financial position and results of operations could be negatively affected by increased utilization of RBMs.

While the Company has prepared certain estimates of the impact of the above discussed changes and proposed changes, it is not possible to fully quantify their impact on its business. There can be no assurance that the impact of these changes will not be greater than estimated or that any future health care legislation or reimbursement changes will not adversely affect the Company's business.

LIQUIDITY AND CAPITAL RESOURCES

Cash, cash equivalents and marketable securities decreased by 52.1% from $2.4 million at June 30, 2008 to $1.2 million at June 30, 2009.

Marketable securities approximated $23,000 as of June 30, 2009, as compared to $1.1 million as of June 30, 2008.

Cash used in operating activities for fiscal 2009 approximated $6.1 million. Cash used in operating activities was attributable to a decrease in customer advances of $5.0 million and a decrease in billings in excess of costs and estimated earnings on uncompleted contracts of $3.7 million, offset by the net income of $1.1 million and an increase in notes receivables of $508,000.

Cash provided by investing activities for fiscal 2009 approximated $5.9 million. The principal uses of cash from investing activities were purchases of property and equipment of $28,000, costs of capitalized software development of $492,000 and costs of patents and copyrights of $331,000. The principal source of cash provided by investing activities were the proceeds of approximately $2.3 million from the sale of a consolidated subsidiary, proceeds from note receivables of $2.0 million and proceeds of $1.3 million from the cash surrender value of life insurance.

Cash used in financing activities for fiscal 2009 approximated $83,000. The principal sources of cash in financing activities were proceeds from the long term debt of $258,000 and proceeds of $127,000 from repayment of notes receivable from employee stockholders, offset by the repayment of borrowings and capital lease obligations of $279,000 and distributions to holders of minority interests of $23,000.

Total liabilities decreased by 20.5% during fiscal 2009, from approximately $39.3 million at June 30, 2008 to approximately $31.2 million at June 30, 2009. The decrease in total liabilities reflected principally an decrease in billings in excess of costs and estimated earnings on uncompleted contracts of 64.9% from $5.8 million at June 30, 2008 to $2.0 million at June 30, 2009 and a decrease in customer advances of 35.3% from $14.3 million at June 30, 2008 to $9.2 million at June 30, 2009, resulting from our decreased backlog.

Our contractual obligations and the periods in which they are scheduled to become due are set forth in the following table:

                             Due in
                             Less         Due         Due         Due
Contractual                  than 1       in 1-3      in 4-5      after 5
Obligation         Total     Year         years       years       years
--------------  ----------  -----------  ----------  ----------  ----------
Long-term debt  $  962,591  $   235,771  $  191,136  $     -     $  535,684

Capital lease
Obligation      $  313,799   $  121,232  $  192,567  $     -     $     -

Operating
  leases        $12,054,134  $1,994,523  $4,068,513  $3,623,430  $2,367,668

Stipulation
  Agreements    $   763,511  $  579,343  $  184,168  $     -     $     -
                -----------  ----------  ----------  ----------  ---------

Total cash
Obligations     $14,094,035  $2,930,869  $4,636,384  $3,623,430  $2,903,352
                ===========  ==========  ==========  ==========  ==========

As at June 30, 2009, our obligations included approximately $2.4 million in various state sales taxes.

At June 30, 2009, however, we had a working capital deficit of approximately $10.8 million as compared to a working capital deficit of $16.0 million at June 30, 2008 and a stockholders' deficiency of $2.9 million at June 30, 2009 as compared to a stockholders' deficiency of $4.2 million at June 30, 2008. For the year ended June 30, 2009, we realized a net income of $1.1 million, which included non-cash charges of approximately $3.1 million. Our net income for fiscal 2009 included a gain of $1.4 million recognized on the sale of a consolidated subsidiary.

Our principal source of liquidity has been derived from revenues, as well as by cash provided by the sale of marketable securities and other assets.

In July 2007, we sold our 50% interest in a consolidated subsidiary and our 20% interest in a non-consolidated subsidiary, and received proceeds of approximately $4.8 million.

Effective September 30, 2008, a wholly-owned subsidiary of HMCA sold its 92.3% equity interest in an entity providing management services to a scanning center in Bensonhurst, New York for approximately $2.3 million.

In August, 2008, the Company entered into a modification agreement with regard to the asset purchase agreement with Health Plus Management Services, L.L.C. The Company received a $2,000,000 payment on the note issued by Health Plus.

Our business plan includes an aggressive program for manufacturing and selling our Upright(R) 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 existing MRI scanners with new Upright(R) MRI scanners. Presently, of the 10 MRI facilities managed by HMCA, 9 are equipped with Upright(R) MRI scanners.

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 $11.0 million for the year ended June 30, 2008 and $10.5 million for the year ended June 30, 2009.

In order to reduce our net losses and demands on our cash and other liquid reserves, we instituted an aggressive program of cost cutting during and following the end of fiscal 2008. These measures included consolidating HMCA's office space with Fonar's office space, reductions in the size of our workforce, compensation and benefits, as well as across the board reduction of expenses. The cost reductions were intended to enable us to withstand periods of low volumes of MRI scanner sales, by keeping expenditures at levels which, if necessary, can be supported by service revenues and HMCA revenues. We are also seeking equity and debt financing and have been engaged in discussions with several possible sources.

In order to promote sales, we are continuing to focus on marketing campaigns to strengthen the demand for our products and services. Management anticipates that Fonar's capital resources will improve if Fonar's MRI scanner products gain wider market recognition and acceptance resulting in both increased product sales and scan volumes. If we are not successful with our marketing efforts to increase sales, we will experience a shortfall in cash, and it will be necessary to further reduce operating expenses in a manner or obtain funds through equity or debt financing in sufficient amounts to avoid the need to curtail our operations subsequent to June 30, 2010. Current economic credit conditions have contributed to a slowing business environment. Given such liquidity and credit constraints in the markets, the business may suffer, should the credit markets not improve in the near future. The direct impact of these conditions is not fully known. However, there can be no assurance that we would be able to secure additional funds if needed and that if such funds were available, whether the terms or conditions would be acceptable to us. In such case, the reduction in operating expenses might need to be substantial in order for us to generate positive cash flow to sustain our operations.

If we are unable to meet expenditures with revenues or financing then it will be necessary to reduce expenses further, or seek other sources of funds through the issuance of debt or equity financing in order to conduct operations as now conducted subsequent to fiscal 2010.

Capital expenditures for fiscal 2009 approximated $28,000. Capitalized software costs were approximately $492,000, and capitalized patent costs were approximately $331,000.

Fonar has not committed to making capital expenditures in the 2010 fiscal year other than its plans to continue research and development expenditures at current levels.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and assume that the Company will continue as a going concern. The Company has suffered recurring losses from operations, continues to generate negative cash flows from operating activities and had negative working capital at June 30, 2009. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.