**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

**__________________________**

 

**FORM 10-K**

 
| ý                                                                                                                                                                                                                                                                                                                                                                                  | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------|
| **For the fiscal year ended December 31,  2004**                                                                                                                                                                                                                                                                                                                                   |
| o                                                                                                                                                                                                                                                                                                                                                                                       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| **For the transition period from                           to                               .** |

 

**Commission file number 0-19386**

**__________________________**

 

**FISCHERIMAGING CORPORATION**

(Exact name of registrant as specified in itscharter)

 
| **DELAWARE**  (State of incorporation)                                                 | **36-2756787**  (I.R.S. Employer Identification No.) |
|----------------------------------------------------------------------------------------|------------------------------------------------------|
| **12300 North Grant Street  Denver, Colorado**(Address of principal executive offices) | **80241**  (Zip Code)                                |

 

**Registrant’s telephone number, including areacode: (303) 452-6800**

 

**Securities Registered Pursuant toSection 12(b) of the Act: None**

 

**Securities Registered Pursuant toSection 12(g) of the Act:**

 

**Common Stock, Par Value $0.01 Per Share**

**__________________________**

 

                Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

                Indicate by check mark ifthe disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

 

                Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act). o

 

                The aggregate marketvalue of the Common stock held by non-affiliates of the registrant as ofJune 30, 2004 was approximately $41.3 million.

 

                The number of shares ofregistrant’s Common stock outstanding as of March 24, 2005 was 9,382,817.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

                Portions of theRegistrant’s definitive Proxy Statement for the 2004 Annual Meeting ofStockholders to be filed within 120 days after the end of the Registrant’sfiscal year ended December 31, 2004 are incorporated by reference intoPart III of this report on Form 10-K to the extent statedtherein.

 

 

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**TABLE OF CONTENTS**

 
| ** **                    | ** **                                                                                      | ** ** |
|-------------------------------|-------------------------------------------------------------------------------------------------|------------|
| PART I                   |                                                                                            | 3          |
| ITEM 1.                       | BUSINESS                                                                                        | 3          |
| ITEM 2.                       | PROPERTIES                                                                                      | 25         |
| ITEM 3.                       | LEGAL PROCEEDINGS                                                                               | 25         |
| ITEM 4.                       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                            | 26         |
| PART II                  |                                                                                            | 27         |
| ITEM 5.                       | MARKET FOR REGISTRANT’S COMMON EQUITY AND  RELATED STOCKHOLDER MATTERS                     | 27         |
| ITEM 6.                       | SELECTED CONSOLIDATED FINANCIAL DATA                                                            | 27         |
| ITEM 7.                       | MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS     | 29         |
| ITEM 7A.                      | QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK                                     | 39         |
| ITEM 8.                       | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                     | 40         |
| ITEM 9.                       | CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE           | 40         |
| ITEM 9A.                      | CONTROLS AND PROCEDURES                                                                         | 40         |
| PART III                 |                                                                                            | 41         |
| ITEM 10.                      | DIRECTORS AND EXECUTIVE OFFICERS OF THE  REGISTRANT                                             | 41         |
| ITEM 11.                      | EXECUTIVE COMPENSATION                                                                          | 41         |
| ITEM 12.                      | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL  OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 41         |
| ITEM 13.                      | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS                                                 | 41         |
| ITEM 14.                      | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                          | 41         |
| PART IV                  |                                                                                            | 42         |
| ITEM 15.                      | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND  REPORTS ON FORM 8-K                           | 42         |
| SIGNATURES AND CERTIFICATIONS | 45                                                                                              |

 

 

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**PART I**

 

**Forward-looking Statements**

 

                This Form 10-Kcontains or incorporates by reference “forward-looking statements,” asthat term is used in federal securities laws, about our financial condition,results of operations and business. These statements include, among others:

 

•                    statements concerning possiblerevenue benefits resulting from enhancements of our current products orintroduction of new products;

•                    statements concerning possibleexpense benefits resulting from our operating and service initiatives;

•                    projections regarding growth in themarket for our products;

•       statements regarding theoutcome of the current FDA audit;

•                    statements concerning possiblerevenue or expense benefits resulting from our supply or distributionpartnerships; and

•                    statements of our expectations,beliefs, future plans and strategies, anticipated developments and othermatters that are not historical facts.

 

                These statements may bemade expressly in this document or may be incorporated by reference to otherdocuments we will file with the Securities and Exchange Commission (SEC). Youcan find many of these statements by looking for words such as “believes,”“expects,” “anticipates,” “estimates,” or similar expressions used orincorporated by reference in this report.

 

                **Theseforward-looking statements are subject to numerous assumptions, risks anduncertainties including those discussed in “Risk Factors” in this Form 10-Kthat may cause our actual results to be materially different from any futureresults expressed or implied by us in those statements. These risk factorsshould be considered in connection with any subsequent written or oral forward-lookingstatements that we or persons acting on our behalf may issue. We do notundertake any obligation to review or confirm analysts’ expectations orestimates or to release publicly any revisions to any forward-lookingstatements to reflect events or circumstances after the date of this report orto reflect the occurrence of unanticipated events. Further, the informationcontained in this document is a statement of our intention as of the date ofthis filing and is based upon, among other things, the existing regulatoryenvironment, industry conditions, market conditions and prices, the economy ingeneral and our assumptions as of such date. We may change our intentions, atany time and without notice, based upon any changes in such factors, in ourassumptions or otherwise.**

 

                Fischer®, FischerImaging®, MammoTest®, SenoScan®, MammoPlus®, MammoVision®, MammoSound®, Traumex®,VersaRad®, SenoScan® , MammoTest®, MammoTest Plus®, MammoVision®, MammoSound®,BloomTM, EPX-60TM, SenoSoundTM, SenoViewTM, SenoView PlusTM and SPXTM aretrademarks of ours. This Annual Report on Form 10-K may also includetrademarks and trade names owned by other parties, and all other trademarks andtrade names mentioned in this Annual Report on Form 10-K are theproperty of their respective owners.

 

                Unless the contextotherwise requires, references in this report to “Fischer Imaging,” “Fischer,”“we,” “us,” “our” and the “Company” refer to Fischer Imaging Corporation andits consolidated subsidiaries.

 

**ITEM1. BUSINESS**

 

**Business Overview**

 

                We design, manufactureand sell innovative mammography and digital imaging products used to diagnosebreast cancer and other diseases. Our primary focus is on using our digitalimaging technology in screening and diagnostic mammograms and minimallyinvasive breast biopsy to aid in the early identification of breast cancer. Weoffer high-resolution digital mammography products enabling radiologists,surgeons and other healthcare professionals to diagnose or rule out breastcancer early and treat patients with less-invasive procedures. We also marketand sell products that meet selected needs of the broader radiology and electrophysiologymarkets.

 

                Our SenoScan digitalmammography system is used for both screening and diagnostic mammography.  The SenoScan product’s advantages overconventional x-ray film mammography systems stem from the ability to acquirehigh-resolution images at a reduced radiation dose, to manipulate the resultingdigital images, to transmit the images to remote locations to facilitatediagnosis, and to store the images in a cost-effective digital archive.

 

                Our MammoTeststereotactic breast biopsy system is used for minimally invasive breast biopsy.The MammoTest

 

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system permits a procedure that is less-invasive and less expensivethan surgical biopsy, and can be performed under local anesthesia on an outpatientbasis. We believe that our MammoTest product line represents the premieroffering for stereotactic minimally-invasive breast biopsy.

 

Our RE&S (Radiology, Electrophysiology and Surgery) product lineconsists of  film and digital generalradiology systems, an electrophysiology stimulation system, electrophysiologyx-ray imaging systems and a specialized surgical C-arm system.

 

                We currently service ourproducts directly in North America and Europe and through a network of dealerselsewhere in the world.  We alsosell  a limited amount of consumablesupplies to our customers.

 

**Significant Events in 2004**

 

                During 2004 severalfactors continued to affect our business operations, financial performance, andbusiness prospects.  These activitiesrequired significant financial resources and time from our senior management.

 

                *SECInvestigation and Settlement.* During 2004 the SEC completed its investigation and inNovember 2004 the SEC issued an Order making findings of fact regardingour financial accounting practices in the past and ordering us to comply withaccounting regulations going forward.  Nofines or penalties were assessed against us. Certain former officers and directors of the Company remain subject tofurther investigation or actions by the SEC. In April 2003 we voluntarilydisclosed to the SEC that we would restate our financial results for theperiods beginning January 1, 2000 and ending September 30, 2002. Wemade this disclosure following the formation of an independent board committee,assisted by the law firm of Hogan & Hartson LLP, to review the factsand circumstances underlying our decision to restate our financial results. InJune 2003, we received notice of a formal order of investigation andsubpoena from the SEC. 

 

                *SorkinClass Action Lawsuits.* Following our announcement regarding our voluntary disclosure to theSEC, we, together with certain former officers, were named as defendants ina  class-action lawsuits allegingfraud and  violations of  federal securities laws. In September 2004we reached agreement in priniciple with plaintiffs’ attorneys and ChubbInsurance, our director and officer liability insurance provider, regardingsettlement of these claims.  InMarch 2005 U.S. District Court Judge Richard Matsch declined to approvethe proposed settlement agreement.  As aresult, litigation will continue in this lawsuit.  For a further description of the nature andstatus of these legal proceedings see “Item 3—Legal Proceedings.”

 

                *ProductPerformance and Reliability.* Following the initial commercial launch of our SenoScan product line inlate 2001, we identified product reliability and performance issues for thisproduct that continued through 2004. We have implemented plans intended toaddress historical reliability, performance and servicability concerns, therebyimproving the competitiveness of our products and systems.  These plans have necessitated the additionsof permanent employee and contractor head count in engineering, manufacturing,test and service.  While the primaryemphasis has been on the redesign of the SenoScan product, efforts areaffecting all products as well as supply chain management.  We have continued to invest in increasing thesize of and training for our customer service function to better serve our customersand to ensure our existing installed SenoScan products were upgraded toincorporate our new product enhancements and exchange defective parts andcomponents.

 

                *Receiptof Patent Settlement Payments*. On June 2, 2004 we reached an agreement with Thermo ElectronCorporation and received the remaining $5.4 million owed Fischer from a2002 patent settlement in a single payment of $4.3 million.  As a result we recorded $4.3 million of otherincome in the quarter ending June 30, 2004.

 

*Formation of Partnership with Philips Medical Systems*.  InOctober 2004, we announced a 3-year distribution agreement withPhilips Medical Systems, whereby we will supply Philips with a digitalmammography system based on the

 

 

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SenoScan platform.  Thisrelationship provides us the opportunity for significant expansion of marketshare and revenues. Under the agreement, Philips has non-exclusive worldwidedistribution rights.

 

**Significant Events Subsequent toDecember 31, 2004**

** **

                In addition to the eventsdescribed above, we completed the following material transaction inearly 2005:

 

                *Noteand Warrant Purchase Agreement with ComVest Investment Partners II LLC.*  On February 22, 2005, we entered into aNote and Warrant Purchase Agreement (the “Purchase Agreement”) with ComVestInvestment Partners II LLC (“ComVest”), which provides for up to$10.0 million of senior secured debt financing to the Company. At closing,we issued and sold a senior secured promissory note in the principal amount of$5.0 million (the “Initial Note”) and a warrant to purchase 2,000,000shares of Common Stock (the “Warrant”) to ComVest.  The availability of the additional fundingunder this arrangement is subject to certain conditions, including our certificationto ComVest regarding certain outcomes related to the FDA audit that iscurrently underway.  Due to unforeseendelays in the FDA audit we renegotiated this arrangement to gain access to anadditional $2 million.  On March 30,2005 we amended the Purchase Agreement and ComVest provided an  additional $2.0 million in funding, bringingtheir total investment to $7.0 million. In connection with this funding we agreed to amend the Warrant toprovide ComVest with a put option, exercisable at $0.90 per warrant share, uponthe occurrence of certain trigger events. The trigger events are a Change of Control or liquidation or dissolutionof the Company.   Change of Control isdefined to include a sale of the Company or a material asset of theCompany.  The remaining $3.0 millionavailable under the commitment may be borrowed by us from time to time, subjectto the satisfaction of certain conditions, through November 15, 2005.

 

*FDA Audit.*  In December 2002, following an earlierperiodic inspection that resulted in the FDA issuing a Form 483, the FDAissued a warning letter regarding deficiencies in the way our quality systemsatisfies the FDA’s Quality System Regulation (QSR). We responded to thewarning letter findings and observations and instituted corrective actions. TheFDA initiated a follow up compliance audit on January 31, 2005 which isongoing.  There have been a number ofinformal observations of potential deficiencies, focusing primarily on ourCorrective and Preventive Action (CAPA) system, complaint system, and designcontrol system. The outcome of this inspection will be either the issuance of aFDA Form 483, a FDA Warning Letter, or an injunction.  If FDA issues an injunction, it may precludeus from shipping products until corrective action is taken and verified by theFDA.  In addition, FDA enforcementactions could include, among other things, product seizure and/or criminal orcivil proceedings being initiated without further notice.   Further, failure to satisfy FDA requirementscan result in an inability to receive awards of federal government contracts,to receive new marketing or export clearance for products.

 

**Our Business Strategy**

 

        Ourbusiness strategy is to focus on our core capabilities and technologies and toaugment our resources with development and sales partnerships to providecomplete solutions to customers and to grow revenue.  In addition, we are implementing initiativesto reduce manufacturing, service and operating expenses.  Elements of our business strategy include:

•                    *Improve our FinancialPerformance and Operating Efficiency*—During 2004 we implemented a number of key initiatives to improve ouroperating efficiencies, including business process, manufacturing process andsupply chain management improvements. We will continue with these efforts throughout 2005.  We have undertaken to redesign elements ofour products in order to improve quality and reliability and to lower material,manufacturing and service costs.   Overtime we believe these changes will have a positive effect on our product andservice gross margins.  Although theseefforts commenced in early 2004 we do not anticipate that the impact ofimproved product performance and reliability will be realized until at least thesecond half of 2005.  Gross margin improvementin our service business is dependent on successful implementation of productperformance and reliability improvements.

•                    *Form Strategic Supply Partnerships for Non-CoreSolution Components. *—  The market for our products is increasinglycomplex, as our imaging systems comprise one element of an overall customersolution that also includes review workstations, networking and data storagecomponents.  In the past we attempted tointernally develop, market, sell and support all of these components.  We believe our differentiated value in themammography market is to continue to develop and sell imaging products thathave both the highest image resolution and the lowest radiation dose, as wellas ease of use for radiology professionals. Therefore, we are focusing our internal resources on enhancing ourdigital imaging products and partnering with strategic suppliers for non-coresolution components.  We plan to furtherdevelop existing partnerships and create new relationships that enable us tomarket and sell complete mammography solutions while focusing our internalresources on our core competencies.

 

•                    *Continue to Develop and Enhance CorporateRelationships to Augment our Direct Sales Force*—During 2004 weformed distribution relationships with Eastman Kodak Company for our VersaRadproduct and with Philips Medical Systems for our SenoScan digital imagingsystem.  In addition, we negotiated anextension of our existing distribution arrangement with Ethicon Endosurgery forour MammoTest product and a supply agreement with Virtual Imaging for x-raysystem components.  In markets we do notaddress directly, we intend to seek additional corporate relationships  to broaden our products’ reach and increaseour revenues.   Over time we believethese corporate relationships will have a positive effect on product revenuesand operating expense as a percentage of revenue.  If we are not successful in

 

 

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forming and executing these relationships our product revenues may notincrease and we may have to scale back expenditures to maintain our financialliquidity.

 

*•      ExecuteInternational Sales and Service Through Partnerships—*In 2003 we established a significant directsales and service presence in Europe in anticipation of sales opportunities forour SenoScan product.  The expenseassociated with these operations has been high and the market has been slow todevelop.  Therefore, we are reassessingour sales and distribution strategy in relation to Europe and other internationalmarkets.  Our plan is  to maintain regulatory approvals for ourdigital imaging products in select international markets and to sell andsupport our products internationally through strategic distributionrelationships such as our partnerships with Philips Medical Systems and EthiconEndo-surgery, Inc.  This will enableus to focus our direct sales and service resources on North America.

 

•                    *Continueto Improve Financial, Operational and Quality Controls and Reporting**—*During 2004 ourfocus was on implementing essential financial controls and reportingsystems.  We will continue to refinethese functions going forward, as well as implement more broad and robustoperational controls and reporting systems to monitor product quality,engineering, manufacturing and service efficiency and financial performance.

 

**OurMarket**

 

                We design, manufactureand sell innovative mammography and digital imaging products used to diagnosepresent cancer and other diseases.  Wemarket and sell our products to public and private hospitals, as well asspecialized private care centers.

 

                Breast cancer is thesecond leading cause of cancer death in women today. World Health Organizationestimates that more than 1.2 million people worldwide will be diagnosed withbreast cancer in 2005 and American Cancer Society estimates that approximately211,000 women in the U.S. will be diagnosed with breast cancer in 2005.  In addition, approximately 59,000 cases ofin-situ breast cancer will be diagnosed in the U.S. in 2005.

 

                American Cancer Society and U.S.Department of Health and Human Services recommend mammography as an effectivetool for the early detection of breast cancer. American Cancer Societyestimates that the five-year survival rate for women with detected breastcancer that is confined to the breast is nearly 100%.  FDA estimates that there are more than33 million screening and diagnostic mammograms performed in the U.S.annually. Age has proven to be the largest risk factor for breast cancer. Datafrom the National Cancer Institute show a woman’s risk of breast cancer at age40 is 145 per 10,000 women, rising to 431 per 10,000 women by age 65. This facthas resulted in women being recommended for a baseline mammogram at a youngerage than in the past.  In 2002, the U.S.Department of Health & Human Services renewed its recommendation thatwomen over 40 receive an annual mammogram, with a baseline mammogramrecommended for women between the ages of 34 and 40.

 

                Frost & Sullivanestimates that in 2004 the mammography segment of the overall radiology marketwas approximately $300 million in revenues worldwide, includingapproximately $250 million in North America and $50 million in therest of the world. The overall mammography market is predicted to grow to over$450 million worldwide by 2009, with the majority of the growth coming inthe full-field digital mammography market that our SenoScan product addresses.The U.S. Food and Drug Adminstration (FDA) reports that of the 13,647accredited mammography systems in the U.S. in 2005, only 829 systems, or 6% ofthe total, are full-field digital mammography systems.  Frost & Sullivan projects that by2009 full-field digital mammography will grow to comprise 80% of estimatedtotal revenues in the mammography market, as hospitals and mammography centersconvert from film systems to digital systems. Screening mammography is increasingly accepted as an effective method ofdetecting breast cancer at its earliest, most treatable stage.

 

*Screening Mammography*

 

                According to the Centersfor Disease Control and Prevention, over 75% of women over age 50 received amammogram in 2002. The sensitivity of modern mammography is estimated to bearound 75%; that is, if a cancer is present there is a 75% chance thatscreening mammography will detect it. However, the specificity of screeningmammography is not very high as an average of 13% of screened women are calledback for further tests while only about 0.5% of the women screened willactually have breast cancer. These false positives create anxiety for womenwhile adding significant expense to screening mammography

 

 

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programs.

 

*Diagnostic Mammography*

 

                If an abnormality isdetected in a screening mammogram, or a woman or clinician discovers a palpablelump, diagnostic mammography is performed. Call back rates range from 4% to 20%of women screened and average about 13% across the U.S. While the total numberof diagnostic mammograms performed per year is not known, we estimate thatabout 20% of all mammograms are diagnostic exams.

 

*Breast Biopsy*

 

                Following diagnosticmammography and ultrasound, about 20% to 30% of patients called back from ascreened mammogram require a tissue biopsy. A biopsy may either be performedsurgically or through a percutaneous (through the skin) procedure underultrasound or stereotactic imaging guidance.

 

*Needle Biopsy Contrasted with Surgical TissueBiopsy*

 

                A traditional surgicaltissue biopsy involves the removal of a golf-ball sized piece of tissue fromthe breast. This procedure has several disadvantages:

 

•                    The surgery is typically performedin an operating room under anesthesia;

 

•                    The surgery takes about an hour andrequires one to two days of home recuperation;

 

•                    The overall expense of the surgicalprocedure is significantly higher than the needle biopsy;

 

•                    The incision can be disfiguring andscarring normally occurs; and

 

•                    Internal scar tissue can interferewith the ability to detect suspicious lesions during subsequent mammograms.

 

                A less-invasive form ofbreast biopsy can be performed using a small needle and imaging guidance todirect the needle into the lesion detected by the mammogram. Approximately 40%of breast biopsies are performed with a needle under image guidance. Wepioneered the clinical development of prone, stereotactic core needle biopsytogether with several radiologists in the late 1980’s. These clinical studiesresulted in the development of the MammoTest system. Stereotactic core needlebiopsies are less expensive than surgical biopsies because surgical biopsiesare most often performed in a hospital or surgery center. A significant portionof the cost savings for core needle biopsy results from the lower overheadassociated with physician offices and imaging centers, while maintaining the sameefficacy as the surgical procedure.

 

                In September 2001,the American College of Surgeons published a consensus statement in the *Journal of the American College of Surgeons*that endorsed needle biopsies as preferable to surgical biopsy in mostpatients. The statement also indicated that percutaneous biopsy would oftenallow breast cancer to be treated with only one trip to the operating room,providing substantial cost savings for the healthcare system.

 

*GeneralRadiology*

 

                AmericanHeart Association estimates there are over 70 million Americans with one ormore types of cardiovascular disease (CVD), of which 27 million are estimatedto be age 65 or older.  In 2002 therewere an estimated 1,463,000 diagnostic cardiac catheterizations performed inthe United States. The aging of the population is expected to result in anincreased incidence of chronic diseases, including coronary artery disease,heart failure and stroke.

 

                Thegeneral x-ray medical imaging market is mature and new sales are driven by newproduct innovation and a migration away from analog to digital modalities.Frost & Sullivan estimates the worldwide diagnostic medical imaging marketwas approximately $13.4 billion globally in 2004, and is expected to grow anaverage of 7 percent annually through 2009. Growth of medical imaging productsshould be positively impacted by the growth of Picture Archiving andCommunications Systems (PACS), technology advancements, increased integrationcapabilities, and lower cost.

 

**Our Products**

 

                Our products address twomarkets: mammography and conventional radiology. Our breast cancer diagnosticproduct line includes the SenoScan digital mammography system and the MammoTestprone stereotactic breast biopsy system. Our RE&S product line includesofferings for radiology, electrophysiology and surgery.

 

 

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*SenoScan Digital Mammography System*

 

                We are a leader in thedevelopment of full field-of-view digital mammography systems. Our SenoScandigital mammography system was developed for screening and diagnosticmammography. We sell our SenoScan system directly in the U.S. and Europe, aswell as through a network of dealers worldwide. We installed our first SenoScanat a customer in the fall of 2001. Sales of our SenoScan product constituted40%, 33% and 12% of total product revenue for 2004, 2003 and 2002,respectively. In addition to being approved by the FDA as equivalent toscreening and diagnostic film mammography, a specific claim of up to a 40% to60% reduction in patient x-ray dosage was approved. Key product features of theSenoScan include:

 

•       Theindustry’s lowest x-ray dosage;

 

•                    An ability to image almost allwomen with fewer exposures due to a large field-of-view; and

 

•                    High resolution for improvedvisibility of subtle micro-calcifications that can be strong indicators ofearly breast cancer.

 

                A SenoScan system iscomprised of a gantry, an acquisition station and a local data storagerepository. The acquisition station is installed in a shielded room where thepatient is positioned for the mammogram. The patient’s breast is compressed andis then exposed to x-ray with the image recorded in digital format. The imageis stored locally but is immediately available to one or more third partyreview stations for diagnosis. The image may also be transmitted to a local orremote data archive facility. The SenoScan system is frequently sold withperipheral review station and data storage equipment and software provided tous by third parties.

 

                SenoScan is a patented,slot-scanning system that operates with a detector directly coupled to thex-ray tube. The x-ray detector is a charged-coupled device, which isscanned underneath the breast, providing a very high-resolution digital imageof the breast. Because the system does not require the use of a “scatter grid”to control scatter radiation, the radiation required to form an image is lower,resulting in a lower radiation dose to the patient. The SenoScan system coversa 21cm by 29cm field of view and thus is compatible with the great majority ofbreast sizes in screening mammography. The native resolution of the detector is25 microns per pixel, which is used for diagnostic mammograms in an11cm by 15cm field of view.  Inthe screening mode the resolution is 50 microns per pixel with a field of viewof 21cm by 29cm.

 

                We are engaged in aproduct redesign and enhancement effort of the SenoScan product intended toproduce a new model with greater functionality, manufacturability andreliability.  Completing this redesign ona timely basis and relaunching the SenoScan product is critical to our abilityto compete in the growing digital radiology market and to achieve our financialobjectives.

 

                Diagnostic radiologistshave reported that digital mammography provides a number of advantages overconventional x-ray film mammography. Images acquired utilizing digitalmammography may be displayed on a computer monitor, which allows imagebrightness and contrast to be varied. Diagnostic radiologists have theopportunity to manipulate a digital mammogram in order to improve theirdiagnosis, in some cases eliminating the need for a second mammogram. Becauseyounger women typically have more dense breast tissue, which may not bevisualized adequately with x-ray film mammography, this feature may beparticularly useful in screening women under age 50. SenoScan is unique in itsability to provide mammographic images while exposing the patient to 40% to 60%less radiation than traditional x-ray film mammography. Other benefits include:real time acquisition (film processing is not necessary); digital archivalmedia storage of the mammogram; an ability to implement computer-aideddetection algorithms; and telemammography (digital transmission of mammogramsfor remote display and diagnosis).

 

                Picture Archiving andCommunication Systems (PACS) plays an important role in the migration ofimaging facilities towards a ‘film-less’ environment.  PACS is developing into a mature, standardsbased technology with can take full advantage of the benefits offered bydigital modalities such as FFDM.  ThePACS platform facilitates integration with FFDM products by encompassingenterprise-wide management of images and information.  PACS supports the migration of FFDM imageswith other imaging modalities which can lead to a more cost effective andefficient workflow.  We have beensuccessfully pursuing integration with leading PACS systems to increaseworkflow.

 

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                Because digitalmammography systems are substantially more expensive than x-ray filmmammography systems, a major challenge affecting our sales will be the abilityof health care providers to obtain increased payments by private insurancecarriers and the Medicare program to make it cost effective for health careproviders to acquire and use digital mammography systems. Medicare is estimatedto provide coverage to about 40% of the women who receive an annual mammogram.The Centers for Medicare and Medicare Services, or CMS, finalized Medicarereimbursement for digital mammography effective January 1, 2004. Digitalscreening mammography is reimbursed at $134.41 per exam and digital diagnosticmammography at $141.88 per exam. Film screen reimbursement rates also wereincreased to $84.76 for screening and $96.33 for diagnostic mammography. Theaverage FDA-approved MQSA center performed 21 exams per day, according to anFDA-sponsored survey in August 2001. While CMS provides for higherreimbursements for digital mammography compared to x-ray mammography, as indicatedby these reimbursement rates, the difference between digital mammographyreimbursement rates and film screen reimbursement rates may not, in and ofitself, make it economically compelling for healthcare providers to change todigital mammography systems.

 

### *MammoTest/MammoVisionSystems*

 

                We have produced ourMammoTest stereotactic breast biopsy system since 1988, and sales of thisproduct constituted 39%, 49% and 62% of total product revenues for 2004, 2003and 2002, respectively.  We sell the MammoTestproduct directly in the U.S. and through our partnership with EthiconEndo-surgery, Inc. in Europe, as well as through a network of dealersworldwide.  The MammoTest product enablescore needle biopsy of the breast for the minimally-invasive removal ofsuspicious tissue. The MammoTest system consists of an elevating prone-positiontable, a mammographic x-ray imaging system and a stereotactic needle guidancesystem used during the target localization process, biopsy procedures andplacement of a breast applicator set during interstitial therapy procedures.Stereotactic refers to the technique of locating a lesion in a three-dimensionalfield using x-ray imaging, and directing the tip of a core needle to the siteof the lesion for tissue removal. With the MammoTest system, the patient liesprone on the table with the breast hanging pendulant through an opening in thetable. The digital x-ray imaging camera is located beneath the table where thebreast is compressed and two digital x-ray images are acquired at separateangles.  The MammoTest system is a matureproduct and competes with one other prone breast biopsy systems manufacturedand sold by Hologic. In 1992, we introduced MammoVision, the first charge-coupleddevice imaging system cleared by the FDA that produces breast tissue images ona nearly real-time basis. With the aid of proprietary software, the coordinatesof a breast lesion are automatically calculated. These coordinates are thentransmitted to the Autoguide, a motor-driven needle holder assembly thatprecisely positions the biopsy needle at the lesion.

 

                We have introducedadditional enhanced versions of the MammoTest product. In 1995 we introducedMammoTest Plus and MammoVision Plus. The MammoTest Plus system permits 360-degreeaccess to the breast. It also incorporates features that provide additionalimaging capability important to assuring accuracy of the biopsy and LateralArm, and provides 360-degree access to the breast allowing small breasts(less than 2.5cm when compressed) and breast lesions in difficult locations tobe biopsied more easily. In 1998, we introduced the MammoTest Plus “S” surgicalsystem. The MammoTest Plus “S” is based on the MammoTest Plus prone biopsysystem, with enhancements designed to support the more advanced techniquesperformed in the surgical market segment. During 2001, the Elite Camera was introduced for more advanced, highresolution imaging capability. In 2002, we released the latest version of ourMammotest product, the Mammotest Select. In 2003 we offered three productconfigurations, the MammoTest Basic, MammoTest Advantage and MammoTest Select,which each have different product functionality and performance features tomeet customer requirements. We continue to invest in product developmentefforts focused on further enhancements to MammoTest.

 

Weare also exploring the use of our MammoTest biopsy table in the BreastBrachytherapy market.  BreastBrachytherapy represents a possible new alternative treatment option forearly breast cancer. Interstitial Breast Bracytherapy is being studied as apromising alternative to beam radiation therapy. Breastbrachytherapy entails the precise placement of radioactive implants in,near or around the tumor location. The high-dose-rate of the radioactive implantdelivers an accelerated local dose of radiation to the area over a period ofabout five days. On October 29, 2004, Fischer received FDA

 

 

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clearance to promote BreastBrachytherapy on the MammoTest Stereotactic Breast Biopsy product. The Companyis currently exploring the market opportunity for this promising procedure withthe MammoTest table.

 

*General Radiology Products*

 

                Prior to our introductionof the MammoTest system in 1988, our business was focused primarily onmanufacture and sale of x-ray products directed to the general radiologymarket. Beginning in the third quarter of 2002, we reinitiated efforts to moreaggressively market and sell our Electrophysiology and VersaRad products. Weare selectively redesigning and enhancing these products.

 

                *ElectrophysiologyProducts.*  The treatment ofcardiac arrhythmia patients typically involves a diagnostic study of theelectrical functioning of the heart with an electrophysiology, or EP, study. Weestimate that approximately 200,000 EP studies are performed each year byelectrophysiologists. When an EP study indicates that the patient requires asurgical procedure, the electrophysiologist will map the electrical activity inthe patient’s heart in an effort to locate the precise area of the heart thatis causing the arrhythmia. We manufacture the EP x-ray imaging systems,tilt-tables and our Bloom Stimulator, which are used by electrophysiologists toevaluate the best course of treatment. We market and sell EP/X systems directlyworldwide, as well as through a network of dealers.  In 1995, we introduced the EP/X x-ray system,an economical, state-of-the-art single plane system designed to meet the uniquerequirements of the electrophysiologist. In addition, we manufacture the BloomStimulator that is used by electrophysiologists in the treatment of patientswith cardiac arrhythmia, as well as when patients receive pacemakers andimplantable defibulators. We sell the Bloom Stimulator directly worldwide, aswell as through a distribution arrangement with GE Medical Systems.  We introduced a significant upgrade to theEP/X System in 2003 that includes a new high-resolution digital imaging systemalong with a generator upgrade providing a 300% increase in power output, thusenabling the clinician to better image larger patients without a significantincrease in x-ray dose to the patient or staff.

 

                *VersaRad.*  VersaRad capitalizes on unique positioningcapabilities requiring minimal patient movement, making it well suited foremergency room applications. It is also a versatile general radiographicsystem, allowing x-ray of every bone and joint in the body. The VersaRad isavailable for use with a traditional x-ray film cassette as well as a digitalarray.  We sell the VersaRad systemdirectly worldwide, as well as through a network of dealers.  In addition, we supply the VersaRad productto Eastman Kodak Company, which integrates it with a Kodak digital detector forresale.  We also supply VersaRad toVirtual Imaging, which integrates it with a Canon digital detector for resale.

 

                *SPX(Special Procedure Imaging System).* Over 20 million people in the U.S. suffer from some form of peripheralvascular disease.  SPX is designed forthe special requirements of peripheral radiology, such as mobility and dosecontrol.  SPX offers customers a range ofsoftware and hardware options and upgrades to meet specific physicianrequirements.  We market and sell the SPXsystem directly worldwide, as well a through a network of dealers.

 

**Backlog**

 

As of December 31,2004, we had backlog of $11.5 million compared with backlog of $19.8 million in2003.  The 2003 backlog amount included$8.4 million related to a non-domestic order that shipped in December 2003.  The decrease in backlog is attributable torecognition of revenue relating to this non-domestic order in 2004.  Of the $11.5 million backlog as ofDecember 31, 2004, it is expected that $7.9 million will be filled in thefirst quarter of 2005, $3.0 million in the second quarter of 2005 and $0.6million in the third quarter of 2005.

 

**Research and Development**

 

                We employ 36 developmentengineers who are dedicated to the enhancement of our existing products and thedevelopment of next-generation products for the diagnosis and treatment ofbreast cancer and the general radiology market. The product development effortsof our internal engineering staff are currently focused on engineering, systemdesign and software development to enhance our SenoScan digital imaging systemand MammoTest products. One current product development focus is collaborationwith two companies related to qualifying their cancer detection software tooperate in association with SenoScan. This has enabled us to offer ourcustomers an option package that includes computer-aided detection (CAD)software for use with SenoScan. We believe radiologists will prefer to use CADprograms that are integrated with the digital mammography system, since it ismuch less labor intensive to operate the software as part of a digitalmammography system. With regard to MammoTest we may create developmentpartnerships with surgical instrument companies that desire to qualify theirinstruments on MammoTest to create a complete solution for minimally-invasivesurgery outside the mammography market.

 

 

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                During 2004 we were engaged incollaboration with Philips Electronics that is now concluded, directed atintegrating Philips Electronics ultrasound imaging technology with our digitalmammography capability.  We received$468,000 in funding for this project through a National Cancer Institute PhaseI SBIR grant.  We intend to continue thisresearch and apply for a Phase II SBIR grant from National CancerInstitute.  We entered into a separatecollaboration with IBM supported by a four year, $1.2 million fast trackSBIR grant from the National Cancer Institute to evaluate the performance andclinical efficacy of the advanced IBM T221 flat panel display as part of theSenoScan mammography review workstation.  We have received $67,000 of that grant during 2004 and the grant isongoing.  We offset our research anddevelopment costs with cash receipts we receive from research grants.

 

Our research and product development expenses were approximately$6.5 million, $4.7 million and $4.6 million in 2004, 2003 and2002, respectively.

 

**Sales and Marketing**

 

                Our SenoScan digitalimaging system was introduced in 2001. The marketing plan for SenoScan isprimarily directed towards the physician/user and, to a lesser extent,healthcare administrators. Our marketing to the physician/user is focused onover 1,000 current MammoTest customers that are mammography centers, whetherengaged in screening and diagnostics, teaching or research. Our physicianmarketing for SenoScan focuses on demonstrating the technical, clinical andfinancial benefits of digital imaging as compared to x-ray film diagnosis. Inaddition, we provide the consumer/patient with brochures outlining the digitalmammography process and its potential benefits compared to x-ray film.

 

In October 2004, we announced a 3-year distributionagreement with Philips Medical Systems, whereby we will supply Philips with adigital mammography system based on the SenoScan platform.  This relationship provides us the opportunityfor significant expansion of market share and revenues. Under the agreement,Philips has non-exclusive worldwide distribution rights.

 

                The market for ourMammoTest product in the U.S. is mature, as the use of stereotactic breastbiopsy is a well-established diagnostic procedure. Furthermore, customerrequirements and the competitive landscape are much better known in thephysician community for breast biopsy than for digital imaging. Our marketingeffort for MammoTest focuses on existing customers as well as the emergingcorporate healthcare buyers, such as Health Trust Purchasing, AmeriNet andBroadlane.

 

                We market our RE&Sproducts through several channels including direct sales personnel, partneringand other marketing efforts. We have two direct sales personnel who call onhospitals with our EPX, SPX and VersaRad product lines.   In addition, we sell our VersaRad product toKodak for resale. We also sell our Bloom Stimulator directly to end userphysicians as well as to GE Medical Systems for resale.

 

                The market for each ofour product lines is characterized by an aggregation of buyers due tohealthcare industry consolidations as well as emerging corporate healthcarebuyers used by hospitals to improve cost containment. Therefore, fewer decision-makersare making more substantial purchasing decisions. In this environment, ensuringhigh customer satisfaction is a key strategy for maintaining marketing andsales momentum. Our marketing activities include trade shows, advertising inprofessional journals, conferences and physician training programs. Themarketing group develops sales leads and assesses customer satisfaction withour products, as well as with direct and dealer service performance.

 

                We sell our productsworldwide primarily through our direct sales force and dealers. As ofDecember 31, 2004, we had 22 direct sales people whose territories coverprimarily large metropolitan areas. In addition, we have a limited number ofdealers in the United States. All our international sales and service operationsare now headquartered at Fischer Imaging International, Geneva, Switzerland. In1998, we entered into an agreement with Ethicon Endo-Surgery (EES) Europe, asubsidiary of Johnson & Johnson, Inc., for the distribution ofthe MammoTest system in Europe. Under this agreement, we provide installation,applications and service support, while EES Europe is responsible for sales ofthe MammoTest system. EES Europe’s sales force provides sales coverage in themajor European countries. During 2004, 2003 and 2002, the Company’s totalforeign revenues were $17.4 million, $8.2 million and$2.2 million, respectively.

 

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**Service**

 

                Our service organizationis responsible for installing our products and providing warranty and repairservices. Products sold by our direct sales force typically carry limitedwarranties covering parts and labor for twelve months. Products sold throughdealers also carry limited warranties, with terms that are normally for twelvemonths and covering only parts or components. Service personnel offermaintenance service either under contracts or at hourly rates. In many foreigncountries outside of Europe, we use dealers and third parties to providemaintenance service for our products. As of December 31, 2004, we employed66 field and technical support engineers, 12 applications training personnel,and 13 customer service personnel, administrative and management personnel inour  worldwide service organization.

 

**Manufacturing**

 

                Our products aremanufactured in our production facility in Denver, Colorado. The manufacturingprocess is primarily assembly, integration, testing, and quality control ofout-sourced components and assemblies. This represents a significant change inour manufacturing strategy from the period prior to 2001, when we manufactureda substantial number of these components ourselves. For the most part we nowpurchase all of the parts, peripheral components and sub-components for oursystems.

 

                Many parts and componentsfor our systems are generally readily available from several supply sources.However, for several critical components including detectors, transformers,cameras, autoguides and x-ray tubes used in each of our product lines, we relyon one supplier for each of these key components. The manufacture of thesecomponents is highly complex and requires a precise, high quality manufacturingprocess from our suppliers. Our sole supplier for our detectors has experiencedsub-component supply difficulties from it’s vendors and we have experiencedproduct failures on these detectors during our pre-assembly quality testingprocess. We have also experienced performance issues with several of thesesuppliers in meeting our supply chain needs and quality requirements. As a result,we have experienced unanticipated production problems that have caused us tomiss customer shipment request dates, delay production and incur additionalcosts related to manufacturing, shipping and installation. Changes in designfor our products, including our mammography detectors and our RE&S productline, could result in unanticipated production problems in the future. We areseeking to qualify a second supplier for each of our key components andsubsystems to ensure more consistently higher quality and reliable parts andcomponents and to increase our manufacturing capacity, but cannot assure thatwe will be successful. Obtaining alternative sources of supply of components orsystems that are available from only one or a limited number of suppliers couldinvolve significant delays and other costs, and these supplies may not beavailable to us on reasonable terms, if at all.

 

                As of December 31,2004, we employed 78 employees in our manufacturing organization, including 60in production and 18 in quality and regulatory affairs.

 

**Intellectual Property**

 

                We seek to protect ourproprietary rights through a combination of technical experience, patent, tradesecret and trademark protection and nondisclosure agreements. Our futuresuccess will depend in part on our ability to obtain and enforce patentprotection for our products and processes, preserve our trade secrets andoperate without infringing on the patent or proprietary rights of others. Ourissued patents cover, among other things, certain features of our MammoTeststereotactic breast biopsy system, our SenoScan digital mammography system, ourSPX and EP/X products and related technologies and processes.  The expense of paying required maintenancepayments on issued payments and of prosecuting new patent applications issubstantial.  Due to our limited cashresources and financing alternatives, in the event that operating lossescontinue we may be forced to reduce our patent portfolio or patent applicationswe are pursuing.

 

We have a significant number of U.S. and foreign patents and pendingpatent applications covering various aspects of our products. A number of ourpatents issued between 1985 and 1990 will be expiring during the next fiveyears. We also rely on trade secrets and proprietary knowledge that we seek toprotect, in part, through appropriate confidentiality and proprietaryinformation agreements. These agreements generally provide that allconfidential information developed or made known to an individual during thecourse of his or her relationship with us is not to be disclosed to thirdparties, except in specific circumstances. They also generally provide that allinventions conceived by the individual in the course of his or her services tous

 

 

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are our exclusive property.

 

**Competition**

 

                The medical deviceindustry is intensely competitive. Many companies are actively engaged inresearch and development of medical devices for mammography and breast biopsy.There is significant interest in the development of digital imaging systems andother competing technological approaches for mammography (for example,ultrasound, CT scan, MRI) by many current and prospective competitors. Most ofthese companies have substantially greater financial and other resources,larger research and development staffs, and more extensive marketing andmanufacturing organizations than we do. Additionally, some of them haveconsiderably more experience in regulatory approval procedures.

 

                We face significant competitionin digital imaging from large companies that are pursuing the same digitalmammography market. In 2000 the FDA cleared the Senographe 2000D from GeneralElectric, in 2002 the FDA cleared a digital mammography system from Hologic andin 2004 FDA cleared the Mammomat Novation system from Siemens. Additionalcompanies have announced plans to develop digital mammography systems,including  Fuji, PlanMed and Kodak. Wealso have significant competition in our RE&S products from many companiesthat are pursuing the same market. EPMed manufacturers a product similar to ourBloom Stimulator product. GE, Siemens, Phillips Electronics and Omega MedicalSystems each manufacture and sell products similar to our EPX product. SwissRayis a primary competitor for our VersaRad product line.

 

                We believe that currentcustomer interest in our SenoScan Digital Imaging System results from its highimage resolution, which is currently unique in the market. However,developments by others in digital imaging or in other screening technologiesthat may be able to identify breast abnormality earlier or more accurately mayrender our digital mammography system or other technologies obsolete ornoncompetitive. We will continue to face intense competition from othercompanies for collaborative arrangements and for securing licenses toadditional technologies. These competitors, either alone or with theircollaborative partners, may succeed in developing technologies or products thatare more effective than ours, or they may be more effective at marketing andselling their products. In the smaller, breast biopsy market, similar dynamicsapply but to a lesser degree.

 

**Third-Party Reimbursement**

 

                In general we cannotpredict what effect the policies of government agencies and other third partypayers will have on future sales of our products, and such policies may have amaterial, adverse impact on our business. Third-party reimbursement fromprivate payers have been an inhibitor to the adoption rate of our SenoScandigital imaging system.  While Medicareprovides a higher reimbursement rate for digital mammography than conventionalfilm based mammography third party payers do not follow the same reimbursementschedule since digital mammography systems cost significantly more thanconventional systems, this can be an inhibitor to adoption of digitalmammography. We believe that focusing on cost reduction and increasing thenumber of procedures that can be performed in a given time period may be theoptimal means of addressing the challenges posed by limitations onreimbursement.

 

                Medicare reimbursementfor hospitals represents about 40% of all hospital revenues. Since 1983,Medicare has limited reimbursement for Medicare inpatients to a fixed amount,based on specified categories of diagnosis known as Diagnosis Related Groups orDRG’s. Hospital profit margins have been reduced significantly since theintroduction of fixed reimbursement amounts based on DRG’s. Therefore,hospitals have a financial incentive to use less-costly treatment methods. If anew technology is considered to be more cost effective, hospitals will oftenmake capital investments to provide cost savings. Frequently, but with asignificant time lag, Medicare reimbursement rates are reduced to reflect theadoption of a new procedure or technique and, as a result, hospitals aregenerally willing to implement new cost saving technologies before thesedownward adjustments in rates become effective.

 

                Medicare is estimated toprovide coverage to about forty percent of the women who receive an annualmammogram. The Centers for Medicare and Medicaid Services, or CMS, finalizedMedicare reimbursement for digital mammography effective January 1, 2004.Digital screening mammography is reimbursed at $134.41 per exam and digitaldiagnostic mammography at $141.88 per exam. Film screen reimbursement ratesalso were increased to $84.76 for screening and $96.33 for diagnosticmammography. The average FDA-approved MQSA center performed 21 exams per day,according to an FDA-sponsored survey in August 2001.

 

 

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                In August 2000Medicare implemented a prospective payment system for all outpatient proceduresperformed on behalf of Medicare beneficiaries. The new payment system usesAmbulatory Payment and Classification, or APC’s, to group similar proceduresand make fixed payments to hospitals for the technical expenses associated withoutpatient procedures. This prospective payment system is similar to the DRGinpatient payment system and early experience indicates difficulty in properlydetermining the APC groups to which certain procedures belong. Technicalpayment amounts for some procedures such as diagnostic mammography are wellbelow the cost of performing the procedure and this low reimbursement maydissuade hospitals from expanding diagnostic mammography services. In addition,while technical payments increased for open surgical biopsies beginning inJanuary 2002, the technical fees related to core needle biopsy performedin a hospital outpatient setting actually decreased. These payment changes mayadversely impact our sales of mammography systems and stereotactic breastbiopsy systems.

 

                Reimbursement forphysician services provided to Medicare beneficiaries is made under a physicianfee schedule administered by CMS and the American Medical Association, orAMA. Procedures are assigned specific Common Procedural Codes. The valuation ofthese codes is accomplished by determining the relative value of work requiredto perform the procedure as well as the practice expenses associated with theprocedure. The total number of relative value units, or RVU’s, are multipliedby an annual conversion factor for Medicare payments to physicians. Thisconversion factor is determined annually by CMS. The conversion factortranslates into dollars, and equals the total amount that physicians willreceive for a particular procedure. For 2002, Medicare reduced the conversionfactor for Medicare Part B payments by 4.7%, essentially reducingphysician remuneration by the same amount for all Medicare procedures.Percutaneous breast biopsy procedures however were generally increased as thenumber of RVU’s allocated to the procedure were increased. In addition, ratesfor both diagnostic and screening mammography were increased over the rates in2001 by about 17% and permanent reimbursement amounts were set for bothscreening and diagnostic digital mammography. The rates for digital mammographywere set about $40 higher than the film screen mammography rates.

 

                Normally privateinsurance carriers follow Medicare’s lead in determining whether to providecoverage for medical procedures and frequently base payment from the Medicarephysician fee schedule. Historically private insurance carriers have paid up to40% more than Medicare rates but there is no assurance that private carrierswill continue this practice. For high volume procedures such as mammographyscreening, private insurance carriers negotiate fee schedules with providersthat may in fact be lower than the Medicare fee schedule. While Medicarereimbursement rates for digital mammography procedures is sufficient to allowmost MQSA centers to amortize the cost of systems such as our SenoScan digitalmammography system, failure of a majority of private carriers to adopt Medicarerates for digital mammography could adversely impact our sales of our SenoScansystem. In at least one instance, Blue Cross and Blue Shield of Illinois hasindicated that full field digital mammography is considered “investigational”and therefore is not eligible for coverage.

 

**Regulation**

 

                The medical devicesmanufactured and marketed by us are subject to regulation by the U.S. FDA and,in many instances, by foreign governments. Under the U.S. Federal Food, Drugand Cosmetic Act, known as the FD&C Act, manufacturers of medical devicesmust comply with certain regulations governing the design, testing,manufacturing, packaging and marketing of medical devices. In addition, ourdesign and manufacturing processes are subject to the Quality SystemRegulation, administered by FDA. The majority of our products are also subjectto the Radiation Control for Health and Safety Act, administered by FDA, whichimposes performance standards and record keeping, reporting, product testingand product labeling requirements for devices that emit radiation, such asx-rays.

 

                Additionally, FDA mustclear or approve all our medical devices for marketing before commercialdistribution can take place. FDA clearance is required for products that aresubject to 510(k) filings before initial product distribution and  once cleared, before any change to theproduct’s indicated use. A 510(k) filing is pursuant to Section 510(k) ofthe FD&C Act that provides for FDA clearance of certain devices that aresubstantially equivalent to devices that have been continuously marketed sinceMay 28, 1976. Most of our products are subject to this type of filing,including our MammoTest stereotactic breast biopsy system, ourelectrophysiology programmable stimulator, and other general radiologyequipment.

 

                FDA approval is required forproducts subject to Pre Market Approval (PMA) filings.  The PMA filing and approval process is a morecomplex and lengthy testing and review process than the 510(k) process. Acompany must first obtain an investigational device exemption, known as an IDE,for the manufacturer to conduct extensive clinical testing of the device toobtain the required clinical data for the filing. The FDA will thereafter onlygrant approval if it finds that the safety and efficacy of

 

 

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theproduct has been sufficiently demonstrated through the clinical testing as wellas the manufacturer’s laboratory testing and third party product safety agencytesting. Then, after the FDA approves the product for distribution, annualreports must be submitted to update the FDA on the product’s status. Themanufacturer must obtain further approval if changes to the product affect thesafety and efficacy claims under which the original approval was given. Oneproduct that we manufacture is subject to this process, the SenoScan digitalmammography system. We received pre-market approval from the FDA on theSenoScan in September 2001. This pre-market approval permitted us to beginmarketing efforts in the United States and launch it commercially.

 

                Ourproducts are also subject to approval by certain foreign regulatory and safetyagencies, including the European Union (EU), where we market our products underthe Medical Device Directive.  Two key elements for marketing approval inthe EU and many other foreign countries are:

 

1.               The compliance of our products to relevantinternational standards and the associated manufacturer’s Declaration ofConformity and the CE mark on our products.

2.               The compliance of our quality system to therequirements of ISO 13485 and the associated certificate of compliance by anaccredited Notified Body registrar.

 

Ourquality system is certified by our Notified Body, TUV Product Services and allour European-marketed products carry the required CE Mark.  There may be other requirements forregistration or approval in other countries, but these two elements aretypically the foundation of many foreign countries’ registration and approvalto sell.

 

                We cannot assure that theFDA or foreign regulatory agencies will give the requisite clearances for anyof our medical devices under development on a timely basis, if at all.Moreover, after clearance is given, these agencies can later withdraw theclearance or require us to change the device or its manufacturing process orlabeling, to supply additional proof of its safety and effectiveness, or torecall, repair, replace or refund the cost of the medical device, if it isshown to be hazardous or defective. The process of obtaining clearance tomarket products is costly and time-consuming and can delay the marketing andsale of our products.

 

                As stated above, we aresubject to additional FDA regulations, including the Radiation Control forHealth and Safety Act of 1968, which specifically regulates radiation-emittingproducts. In addition, our manufacturing processes and facilities are subjectto the Quality system Regulation and continuing review by FDA. Most U.S. statesand many other foreign countries monitor and require licensing of X-raydevices. Federal, state and foreign regulations regarding the manufacture andsale of medical devices are subject to future change. We cannot predict whatimpact, if any, such changes might have on our business.

 

                FDA regulations requiremanufacturers of medical devices to adhere to the Quality System Regulation,(QSR), which includes testing, quality control, quality assurance, correctiveaction, preventive action, and documentation procedures for design,manufacturing, installation and servicing. Our manufacturing facilities aresubject to periodic inspections by the FDA.

 

                In December 2002,following an earlier periodic inspection that resulted in the FDA issuing aForm 483, the FDA issued a warning letter regarding deficiencies in theway our quality system satisfies the FDA’s Quality System Regulation (QSR). Weresponded to the warning letter findings and observations and institutedcorrective actions. The FDA initiated a follow up compliance audit onJanuary 31, 2005 which is ongoing. There have been a number of informal observations of potentialdeficiencies focusing primarily on our Corrective and Preventive Action (CAPA)system, complaint system, and design control system. The outcome of thisinspection will be either the issuance of a FDA Form 483, a FDA WarningLetter, or a court-ordered injunction. If FDA seeks an injunction, it may preclude us from shipping productsuntil corrective action is taken and verified by the FDA.  In addition, FDA enforcement actions couldinclude, among other things, product seizure and/or criminal or civilproceedings being initiated without further notice.   Further, failure to satisfy FDA requirementscan result in an inability to receive awards of federal government contracts,to receive new marketing or export clearance for products.

 

                We are also subject toother federal, state, local and international laws and regulations related toworker health and safety, environmental protection and export controls. Some ofour technology is governed by the International Traffic in Arms Regulations ofthe United States Department of State. As a result, the export of some of our systems to some countries may belimited or prohibited. We believe Fischer is in compliance, in all materialrespects, with these other laws and regulations and that maintaining suchcompliance will not have a material financial impact on future capitalexpenditures or results of operations.

 

 

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**Employees**

 

                As of December 31,2004, we had 263 employees, including 241 in our U.S. operations and 22 in ourinternational operations. We employ 91 people in service, 78 in manufacturing,36 in engineering, 31 in sales and marketing and 27 in administration. None ofour employees are parties to a collective bargaining agreement. We considerrelations with our employees to be satisfactory. On an as-needed basis wesub-contract for personnel to augment our needs.

 

**Website Access**

 

                Our website address iswww.fischerimaging.com. You may obtain free electronic copies of our annualreports on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and all amendments to those reports atour website under the heading “Investor Relations” or at the SEC’s websiteaddress, which is www.sec.gov. The SEC website also contains proxy andinformation statements and other Company information. These reports areavailable on our website as soon as reasonably practicable after weelectronically file them with the SEC. The reference to our website does not constituteincorporation by reference of the information contained on the website, and theinformation contained on the website is not part of this document.

 

**Other Sources**

 

                The public may read andcopy any materials the Company files with the SEC at the SEC’s Public ReferenceRoom, located at 450 Fifth Street NW, Washington, DC 20549, and may obtaininformation about the operation of the Public Reference Room by contactingthe SEC at 1-800-SEC-0330.

 

**Risk Factors**

 

                The material risks anduncertainties that may affect our operations and financial results aredescribed below. Additional risks and uncertainties not presently known to usor that we currently deem immaterial may also impair our operations andfinancial results. The occurrence of any of the following risks could harm ourbusiness.  In that case, the tradingprice of our common stock could decline, and you may lose all or part of yourinvestment.

 

**                RisksRelated to Our Business**

 

**We have a history of operating losses thathave substantially reduced our cash reserves and may threaten our continuingoperations.**

 

                We have sustainedoperating losses during 2004 of $12.0 million in the aggregate, of which$3.9 million occurred during the fourth quarter of 2004. During 2004 ouroperating losses were primarily the result of increased costs associated with servicing and supporting an increasedinstalled base, redesigning our Senoscan product, updating our quality systemsto ensure regulatory compliance, and operating losses related to our Europeanoperations.

 

We expect to continue incurring operating losses into 2005.  We have developed an operating plan intendedto return the company to positive cash flow from operations, however, there arerisks associated with our operating plan. We may not be successful in increasing our revenues and in particular inincreasing revenues derived from our SenoScan product.  We may not be successful in completing theredesign of the SenoScan product, in developing upgrades and enhancements tothe image or workflow management software of SenoScan.  Any of these factors may materially adverselyaffect our ability to gain market acceptance for SenoScan and therefore ourability to increase revenue.  Furthermore,we may not be successful in achieving improvements in the component performanceand reliability of our products which would lead to continuing losses in ourservice business.   If we are notsuccessful in increasing revenues and in achieving operating efficiencies tolower our cost of sales and operating expenses as a percentage of revenue wewill be forced to scale back expenditures to maintain our financialliquidity.   We cannot sustain ourcurrent level of operating expenses at the current level of revenues.  We may not be successful in restructuring oursales and service operations in Europe, which would result in continuing lossesin that market.

 

 

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**                Weface risks relating to our liquidity.**

 

                We expect to continueincurring operating losses into 2005.  Wehave developed an operating plan intended to return the company to positivecash flow from operations, however, there are risks associated with ouroperating plan.  We may not be successfulin increasing our revenues and in particular in increasing revenues derived fromour SenoScan product.  We may not besuccessful in completing the redesign of the SenoScan product, in developingupgrades and enhancements to the image or workflow management software ofSenoScan or in introducing new review workstation components for theproduct.  Any of these factors maymaterially adversely affect our ability to gain market acceptance for SenoScanand therefore our ability to increase revenue. Furthermore, we may not be successful in achieving improvements in thecomponent performance and reliability of our products which would lead tocontinuing losses in our service business.  If we are not successful in increasing revenues and in achievingoperating efficiencies to lower our cost of sales and operating expenses as apercentage of revenue we will be forced to scale back expenditures to maintainour financial liquidity.   We cannotsustain our current level of operating expenses at the current level ofrevenues.  We may not be successful inrestructuring our sales and service operations in Europe, which would result incontinuing losses in that market.

 

Should any of those factors outlined above occur, our financialliquidity position will be negatively impacted by our not achieving positivecash flow from operations and we would be required to seek additionalfinancing.  Furthermore, if we fail tosatisfy the conditions to access additional capital from ComVest, we would needadditional financing.  To satisfying ourworking capital requirements we may need to raise additional funds through thesale of equity securities, the incurrence of additional indebtedness, throughfunds derived through entering into collaborative agreements with third partiesor through divestiture of product lines.  In addition, we may be required to reduce our sales and marketingactivities, reduce the scope of or eliminate our research and developmentprograms, or relinquish rights to technologies or products that we mightotherwise seek to develop or commercialize.

 

                In addition, inFebruary 2005, we completed a debt financing with ComVest.  At the closing of that transaction, ComVestprovided $5.0 million in funding, $2.5 million of which was required to be usedto repay our line of credit with Silicon Valley Bank, and the remainder ofwhich was used for working capitaland we issued to ComVest a warrant for the purchase of 2,000,000 shares ofcommon stock.  On March 30, 2005 weamended the Purchase Agreement and Warrant and ComVest provided $2.0 million infunding, bringing their total investment to $7.0 million.  In connection with this amendment we agreedto amend the warrant to provide ComVest with a put option, exercisable at $0.90per warrant share, upon the occurrence of certain trigger events.  The trigger events are a Change of Control orliquidation or dissolution of the Company. Change of Control is defined to include a sale of the Company or a lineof business.  ComVest committed toprovide up to an additional $3.0 million in funding contingent upon us beingable to certify certain outcomes of the FDA audit.  Should the FDA’s findings from the auditprevent us from providing these certifications, we might not have access to theadditional funding from ComVest, which would have a material adverse effect onour working capital, operations and financial results.  In addition, the terms of the PurchaseAgreement limit our ability to obtain funds from other sources withoutComVest’s consent.  For a furtherdescription of the nature of the risks relating to our liquidity see, “Item7—Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Liquidity and Capital Resources.”

 

**We have a history of regulatory issues withour manufacturing and quality systems and we are currently undergoing an auditby the FDA.**

 

                During the past ten yearswe have received several warning letters from the FDA.  In March 1995, we were issued a WarningLetter by the FDA concerning documentation and other deficiencies at our Denverfacility. Following an inspection which concluded in December 1996, the FDAissued Inspectional Observations Form 483, or Form 483, and a WarningLetter concerning manufacturing practices at our Denver facility. InOctober 1998, following a periodic inspection, the FDA issued aForm 483 regarding possible deficiencies in manufacturing, quality, anddocumentation practices. In August 2001, following an inspection by theFDA, we were issued a Form 483 with two minor observations, which we have sincerectified.  These matters were resolvedto the satisfaction of the FDA.

 

                In December 2002,following an earlier periodic inspection that resulted in the FDA issuing aForm 483, the FDA issued a warning letter regarding deficiencies in theway our quality system satisfies the FDA’s Quality System Regulation (QSR). Weresponded to the warning letter findings and observations and institutedcorrective actions. FDA initiated a follow up Compliance audit onJanuary 31, 2005 which is ongoing and currently are undergoing an onsiteaudit from the FDA to verify the effectiveness of our corrective actions.  There have been a number of informalobservations of potential deficiencies focusing primarily on our Corrective andPreventive Action (CAPA) system, complaint system, and Design Control system.The outcome of this inspection will be either the issuance of a FDA form 483, aFDA Warning Letter, or a court-ordered injunction.  If FDA seeks an injunction, it may precludecompany shipment of products until corrective action is taken and verified bythe FDA.  Further, failure to satisfy FDArequirements can

 

 

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result in an inability to receive awards of federal governmentcontracts, to receive new marketing or to export clearance for products.

 

**SenoScan, our digital imaging system, is aproduct requiring significant engineering resources for improvement andenhancements.**

 

                We introduced ourSenoScan digital imaging product in the third quarter of 2001. Through 2004 wehave continued to encounter product and systems problems with the SenoScanproduct that have substantially slowed sales and marketing activities andsubstantially increased the expense of installation, maintenance andservice.  We have been forced to continueto expend scarce engineering resources on software bug fixes and retrofits. Wehave initiated a redesign of SenoScan that we expect to be complete in 2005. Wemay not be able to complete this redesign on a timely basis, if at all, and mayonly be able to do so at considerable expense. We may continue to encounterproblems with design, implementation and integration of our SenoScan product,including delays or malfunctions of the operating software. In addition,SenoScan is one component of a digital imaging solution that incorporatesnetworking, data storage and review station components manufactured by otherparties.  It is essential that SenoScanintegrate with these third party components to meet customer requirements.  Any significant reliability problems weexperience with SenoScan, or our inability to integrate it successfully withrequired third party components, could result in adverse customer reaction andnegative publicity and could harm our business and sales prospects.  In addition, our maintenance and servicebusiness currently incurs an operating loss, largely due to the reliability ofSenoScan and the complexity of digitial imaging installations.  Although we have initiated corrective actionsto reduce these losses, we expect to continue to expend significant resourceson maintenance and service of the SenoScan product.

 

**Our success is dependent upon establishingappropriate manufacturing processes, resolving supply issues, obtainingadequate manufacturing resources, and being able to contain manufacturingcosts.**

 

                The scope of the productlines we offer and the need for product customization require a number ofseparate manufacturing processes and components and significant management andengineering time and expertise. As we develop new products, we will be requiredto refine the prototypes of these products and develop new processes tomanufacture these products in commercial quantities. Additionally, there areseveral critical components including detectors, transformers, cameras,autoguides and x-ray tubes used in each of our product lines for which we relyon one supplier. The manufacture of these components is highly complex andrequires precise high quality manufacturing that is difficult to achieve by oursuppliers. Our sole supplier for our detectors has experienced sub-componentsupply difficulties from its vendors and we have experienced product failureson these detectors during our pre-assembly quality testing process. We havealso experienced performance issues with several of these suppliers in meetingour supply chain needs and quality requirements. As a result, we haveexperienced unanticipated production problems that have caused us to not meetour customer shipment request dates, delay production and incur additionalcosts related to manufacturing, shipping and installation inefficiencies.Changes in design for our products, including for our mammography detectors andour RE&S product line, could result in unanticipated production problems inthe future. In addition, if sales of our products increase certain of our keycomponent suppliers may not be able to scale the manufacturing to meet ourrequirements.  We are seeking to qualifya second supplier for each of our key components and subsystems to ensure amore consistently higher quality and reliability of parts and components and toincrease our manufacturing capacity, but cannot assure that we will besuccessful. Obtaining alternative sources of supply of components or systemsthat are available from only one or a limited number of suppliers could involvesignificant delays and other costs, and these supplies may not be available tous on reasonable terms, if at all.

 

                We have encountered, andmay continue to encounter, difficulties involving inventory supply, length ofproduction cycles and shortages of manufacturing personnel. Due to the shiftingdemand for our products and the high fixed costs associated with manufacturingthese products, we may encounter difficulty managing our operating costs. Wemay not be able to reliably or efficiently manufacture our existing or newproducts at commercially reasonable costs on a timely basis, if at all. Failureto effectively manage the development and manufacture of our products couldadversely affect us.

 

                In addition, we operatewith very limited working capital.  Thishas caused us to actively manage our accounts payable to ensure our continuingoperation.  During 2004 we were subjectto numerous threats from our trade vendors regarding nonpayment of amounts theyclaim are owed to them.  In the aggregatemanagement of the Company spends a significant amount of time managing thesesituations to ensure continued supply of essential parts, components andservices.  As a result of these potentialdisputes, from time to time critical vendors have ceased supplying ustemporarily, which has negatively impacted our ability to manufacture productand meet customer delivery requirements.

 

**We depend on skilled personnel to operate ourbusiness effectively, and if we are unable to retain existing, or hireadditional, personnel, our ability to develop and sell our products could beharmed.**

 

                Our success largelydepends upon the continued service of our sales, marketing, service andtechnical personnel, many of whom could be difficult to replace. Competitionfor qualified technology and market-experienced employees is intense, andour business could be adversely affected by the loss of core competencies inengineering, manufacturing, marketing and sales. We cannot assure you that wewill continue to be successful in hiring and retaining qualified and properlytrained personnel. The illiquidity of our common stock may also affect theattractiveness of equity incentives that are part of our compensation programused to attract and retain key personnel. The failure to attract, retain,motivate and train qualified new personnel could have a material, adverseeffect on our business.

 

**Our market is unpredictable and characterizedby rapid technological changes, competitive technologies and evolvingstandards, and, if we fail to keep up with such changes, our business could benegatively affected.**

 

                The market for ourproducts is characterized by rapid and significant changes in competitivetechnologies, evolving medical industry standards, the frequent introduction ofnew products and alternative surgical procedures. Products based on new technologiescould replace or reduce the importance of current procedures that use ourproducts and render these products noncompetitive or obsolete. Therefore, oursuccess will depend in part on our ability to respond quickly to new productintroductions, marketing campaigns and medical and technological changesthrough the development of new products. Our products comprise one component ofa digital imaging solution that incorporates networking, data storage andreview station components manufactured by other parties.  It is essential that our products integratewith these third party components to meet customer requirements.  Our inability to integrate successfully withrequired third party components, could result in adverse customer reaction andnegative publicity and could harm our business and sales prospects.  In addition, we may not be able to developnew products in a timely or cost-effective manner, if at all, and demand forour current products could be significantly diminished. Because we compete in ahigh technology environment, competitive product introductions occur on afrequent basis. New, breakthrough technology in the areas of computertomography (CT) and position emission tomography (PET) scanning, magneticresonance and ultrasound imaging may trigger a sharp drop in interest in ourproducts. In addition, this convergence of multiple imaging modalities maycause our products to be outdated.

 

**The success of our new products depends onsuccessful product design efforts, receipt of FDA clearances, and marketacceptance.**

 

                Current research anddevelopment efforts are focused on the development of the next generation ofSenoScan, our full field digital mammography system.  These products involve technologicalinnovation and require significant planning, design,

 

 

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development and testing at the technological, product and manufacturingprocess levels. Significant investments in research and development, equipment,inventory, manufacturing and marketing are also required. Lengthy and expensiveclinical trials could also be required prior to submission to the FDA formarketing approval. All of these expenses occur well in advance of anypotential product revenue from that generation of the product. We may not beable to successfully design, manufacture and market new generations of productsand the new products may not receive FDA clearance, or FDA clearance may bedelayed. In addition, our newest products may be used with minimally invasivesurgical procedures and we believe that we must demonstrate to physicians andmanaged healthcare organizations the clinical benefits, safety, efficacy andcost-effectiveness of our products for such procedures. In particular, we mustdemonstrate that our products are an attractive alternative to other productsand methods that are widely known and accepted. Radiologists may not embracesuch techniques as replacements for conventional x-ray imaging in the case ofSenoScan or surgeons may not embrace such techniques for open surgicalprocedures in the case of MammoTest, and hospitals may not be willing to investin, and use, our products. Lack of widespread acceptance of these productscould have a material, adverse effect on our future revenues and earnings.

 

**We compete with companies that havesubstantially greater financial, engineering, marketing and sales capabilities.**

 

                Our market is intenselycompetitive. Our competitors include large, multinational corporations,including GE Medical Systems, Siemens, Philips, Toshiba, and Hitachi, as wellas a number of smaller, more focused companies such as Hologic Corporation.Many of these companies supply a broad range of medical products and equipmentto their customers and as a result have a substantial pre-existing presence resultingtherefrom.

 

                Most of our productrevenue during the past five years has been derived from our MammoTest system,which was introduced in 1988. The market for MammoTest is mature and ourproduct principally competes with the Hologic prone-positioning breastbiopsy system, which is aggressively priced and marketed. Many largercompanies, including GE Medical Systems, Philip and Siemens, also offer a formof stereotactic add-on systems. Due to the maturity of this market, we expectprices and margins for MammoTest to decrease over time, which could adverselyaffect operating revenues and margins. Our SenoScan digital mammography productreceived FDA clearance in September 2001 and currently competes withdigital offerings from GE Medical Systems and Hologic. In 2000, the FDA clearedthe Senographe 2000D from GE Medical Systems for marketing in the U.S. In 2002,the FDA cleared the Selenia, a digital mammography system from Hologic, whichHologic is able to market to its existing analog system customers. Additionalcompanies that have announced plans to develop digital mammography systemsinclude Siemens, Fuji, Kodak, and Planmed. To date none of these companies hasmade public any submission to the FDA for PMA approval.

 

                We also compete withcompanies that are using competitive technologies to address the challenge ofearly, more accurate screening for breast cancer. These technologies include CTscanning, magnetic resonance imaging (MRI) and Ultrasound. One or more of thosecompeting technologies may enable physicians to detect or rule out breastcancer more accurately, or earlier in its development, which would adverselyaffect the market for SenoScan.

 

                Many of our competitorshave larger installed bases and far greater financial, management, manufacturing,sales and marketing and other resources than we do. As a result, they are ableto more quickly adapt to new or emerging technologies and changes in customerrequirements, and devote greater resources to the development, manufacture,promotion and sale of their products. We also face competition from sellers ofused x-ray imaging equipment, particularly general radiology systems, at pricessubstantially below the prices of our new products. If we are unsuccessfulrelative to our competitors, our operating revenue may be adversely affected.

 

 

**Our management members have spentconsiderable time and effort dealing with internal and external investigations,the restatement of historical financial statements and the development andimplementation of improved accounting and disclosure controls and procedures.**

 

                In addition to thechallenges of the SEC investigation, the shareholder class-actionlawsuit, the FDA warning letter and other legal proceedings described below,our new management members have spent considerable time and effort dealing withinternal and external investigations involving our previous internal controls,and in developing and implementing accounting policies and procedures,disclosure controls and procedures and corporate governance policies andprocedures. The significant time and effort spent may have adversely affectedour operations and may continue to do so in the future.

 

 

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                **We face risks related to the class action lawsuit and other legalproceedings.**

 

                We, and certain formerofficers, have been named defendants in a class-action lawsuit. InSeptember 2004 we reached agreement in principle with plaintiff’s counseland our director and officer insurance provider to settle these claims.  In March 2005, the court declined toapprove the settlement agreement, which requires that the parties proceed tolitigation.  We are generally obliged, tothe extent permitted by law, to indemnify our directors and officers who arenamed defendants in some of these lawsuits. We are unable to estimate what ourliability in these matters may be, and we may be required to pay judgments orsettlements and incur expenses in aggregate amounts that could have a material,adverse effect on our business, financial condition, results of operations andcash flows.

 

                We currently havedirector and officer liability insurance that may pay a portion or all of thefees incurred in defending against claims and the damages of an award. However,if the plaintiffs are successful, we may not have enough insurance to cover thejudgment.  In addition, our director andofficer liability insurance provider has notified us that they are reservingtheir right to rescind the insurance if information is revealed in the courseof investigation or litigation that leads them to believe that the insurancepolicy is unenforceable.  If we lose thislawsuit or if our insurance provider rescinds the insurance policy it maycreate uncertainty in the marketplace for the viability of our business or ourproducts. If the judgment is severe, the financial burden may be so great as tojeopardize our continued operations.

 

                For a further descriptionof the nature and status of these legal proceedings see, “Item 3—LegalProceedings.”

 

**The composition of our senior management andboard of directors has changed significantly. Such members’ attention has beendiverted to matters other than our strategic plan and business operations,which may negatively affect our results of operations.**

 

                In the past two years, wereplaced our chief executive officer and our chief financial officer twice,five directors resigned, we added five new members to our board of directorsand we replaced nearly all of our senior operating managers. It will take sometime for our new management team and board of directors to develop strongworking relationships with our operating managers and to execute our strategicplan and annual operating plan. Moreover, new management’s ability to completethis process has been and continues to be hindered by its need to spendsignificant time and effort dealing with internal and external investigations,developing effective corporate governance procedures, strengthening reportinglines and reviewing internal controls. We cannot assure you that thisrestructuring of our board of directors and senior management team, and theaccompanying distractions, will not adversely affect our results of operations.

 

**                Ifwe fail to adequately protect our intellectual property, our competitiveposition could be harmed.**

 

                Development andprotection of our intellectual property are critical to our business. If we donot adequately protect our intellectual property, both in the U.S. and abroad,competitors may be able to practice our technologies. Our success depends inpart on our ability to obtain patent protection for our products and processesboth in the U.S. and other countries. We must also protect trade secrets andprevent others from infringing on our proprietary rights.

 

                We face numerous risksand uncertainties with respect to our patents and other proprietary rights.Currently, most pending patent applications in the U.S. are maintained insecrecy until issuance, and publication of discoveries in the scientific orpatent literature tends to lag behind actual discovery by several months. Thus,we may not have been the first to file patent

 

 

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applications on our inventions. Our patent applications may not resultin any patents. Once granted, the claims of any issued patents may not affordmeaningful protection for our technologies or products. In addition, patentsissued to us or our licensors may not provide competitive advantages for ourproducts or may be challenged by our competitors and subsequently narrowed,invalidated or circumvented. Competitors may also independently develop similaror alternative technologies or duplicate any of our technologies.  The expense of paying required maintenancepayments on issued payments and of prosecuting new patent applications issubstantial.  Due to our limited cashresources and financing alternatives, in the event that operating lossescontinue we may be forced to reduce our patent portfolio or patent applicationswe are pursuing.  If we took this actionit could adversely affect our competitive position.

 

                Litigation, interferenceproceedings, oppositions or other proceedings in which we may become involvedwith respect to our proprietary technologies could result in substantial costto us. Patent litigation is widespread in our industry, and any patentlitigation could harm our business. Costly litigation might be necessary toprotect our proprietary rights, and we may not have the necessary resources topursue such litigation in order to protect our rights. An adverse outcome inlitigation with respect to the validity of any of our patents could subject usto significant liabilities to third parties, divert the attention of managementand technical personnel from other business and development concerns, require disputedrights to be licensed to or from third parties or require us to cease using aproduct or technology or lose our exclusivity rights with respect to suchtechnology.

 

                We also rely upon tradesecrets, proprietary know-how and continuing technological innovation to remaincompetitive. Additionally, our trade secrets and know-how could otherwisebecome known or be independently developed by third parties. Confidentialityagreements with our employees, consultants and corporate partners with accessto proprietary information could be breached, and we might not have adequateremedies for any such breach.

 

**Potential product defects or relatedperformance or safety issues could result in product recalls, loss of marketshare and significant legal or insurance costs.**

 

                Our business exposes usto potential product liability claims that are inherent in the manufacture andsale of medical devices and, as such, we may face substantial liability topatients for damages resulting from the faulty design or manufacture ofproducts.  We have been a defendant, fromtime to time, in product liability actions. We maintain product liabilityinsurance. Product liability claims may exceed coverage limits and productliability insurance may not be available at commercially reasonable rates, ifat all. Consequently, a product liability claim or other claim in excess ofinsured liabilities or with respect to uninsured liabilities could have amaterial, adverse effect on us.

 

                Complex medical devices,such as we produce, can experience performance problems in the field thatrequire review and possible corrective action by the manufacturer. Weperiodically receive reports from users of our products relating to performancedifficulties they have encountered. These or future product problems couldresult in market withdrawals or product recalls, which could have a material,adverse affect on our business, financial condition and results of operations.

 

**Failure of third-party payers toprovide appropriate levels of reimbursement, if at all, for use of our productscould harm our business.**

 

                Sales of medical productshave historically been dependent upon the reimbursement of patients’ medicalexpenses by government healthcare programs and private health insurers. Thecosts of our products are substantial, and market acceptance of our productsdepends upon our customers’ ability to obtain appropriate levels ofreimbursement from third-party payers for use of our products. Technicalpayment amounts for some procedures such as diagnostic mammography are wellbelow the cost to perform the procedure and this low reimbursement may dissuadehospitals from expanding diagnostic mammography services. In at least oneinstance, Blue Cross and Blue Shield of Illinois has indicated that full fielddigital mammography is considered “investigational” and therefore is noteligible for coverage. In addition, while technical payments increased for opensurgical biopsies beginning in January 2002, the technical fees related tocore needle biopsy performed in a hospital outpatient setting decreased. Theuse of our products outside the United States is similarly affected byreimbursement policies adopted by foreign regulatory and insurance carriers. Wecannot predict what effect the policies of government agencies and other thirdparty-payers will have on future sales of our products, and such policiesmay have a material, adverse effect on our business.

 

**Some studies have questioned the efficacy ofmammography to reduce mortality. If mammography proves to be less effective,our business could be seriously harmed.**

 

                From time-to-timeanalyses are published that question the efficacy of mammography to reducemortality from breast

 

 

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cancer. If mammography is proven to be ineffective, our business couldbe seriously harmed. Most recently, researchers in Denmark published a study inthe *Lancet* questioning thejustification for screening for breast cancer with mammography. The studyperformed a re-analysis of several prior studies on the efficacy ofmammography, and concluded that there was no benefit to mammography screeningas a cancer prevention measure. Many academicians and health policy groupsquestion these findings, but even if the findings are untrue, these claimscould influence mammography usage in the United States and undermine adoptionof mammography in countries where screening is not widely adopted. In addition,the American Cancer Society and the U.S. Department of Health and HumanServices currently recommend annual mammograms for women over the age of 40,with an initial screening at age 34. If other articles or studies question theefficacy of mammography, or if cancer organizations or governmental agenciescease recommending regular mammograms, our business could suffer. Also theresults of the DMIST clinical trial to measure the performance of digitalmammography systems against conventional x-ray film systems are expected to beannounced in late 2005. If the results of this clinical trial do not demonstratesufficiently increased performance of digital systems compared to x-raysystems, this could negatively impact the market for our SenoScan product andour business could suffer.

 

**Our success is dependent on complying withthe regulatory requirements of the FDA.**

 

                Our business is subjectto regulation by the FDA. Failure to comply with applicable regulatoryrequirements can result in, among other things, civil and criminal fines,orders to repair or replace devices or to refund the device purchase price,suspensions and withdrawals of approvals, product recalls, detentions orseizures, injunctions and criminal prosecutions. FDA regulations requiremanufacturers of medical devices to adhere to the FDA’s Quality SystemsRegulation, or QSR, which includes testing, quality control and documentationprocedures for design, manufacturing, installation and servicing. Ourmanufacturing facilities are subject to periodic inspection by the FDA such asis ongoing at present.

 

                The FDA haspost-marketing controls that include a requirement to file Medical DeviceReports when a company becomes aware of information suggesting that one of itsproducts may have caused or contributed to a death, serious injury or seriousillness or has malfunctioned in a way which could lead to that result. The FDAuses these reports to determine whether it should exercise enforcement powers,such as mandatory product recalls, temporary suspensions of approvals, orwithdrawal of 510(k) marketing clearances or pre-market approvals. The filingof Medical Device Reports indicating unexpected product hazards or the failureto comply with medical device reporting requirements could have a material,adverse effect on us.

 

                Each of our products isrequired to receive FDA clearance or approval prior to commercialization. Todate, all of our products have been classified by the FDA as Class IImedical devices and have been eligible for FDA marketing clearance. In thatdigital mammography is new technology, the FDA required the SenoScan to be clearedthrough the pre market authorization (PMA) process. Future upgrades andenhancements to SenoScan must go through a more arduous review process thanthat applicable to other products and this may result in extended delays orincreased expense as compared to products covered by a 510(k) clearance.

 

                We are, also, regulatedby the FDA under the Radiation Control for Health and Safety Act of 1968. Thisact specifically addresses radiation-emitting products. Under this law,we must submit initial reports on any new x-ray systems that requirecertification. In addition, we must submit installation reports to the FDAcertifying compliance with installation instructions of the manufacturer. Undercertain circumstances, we also are required to submit product defect reportsconcerning our radiation emitting products to the FDA and, sometimes, to thefirst purchasers of the products. Product defect reports describe any safetyrelated product defects or the failure of a product to conform to an applicablestandard of which we have become aware. Additionally, we are required to submitaccidental radiation occurrence reports regarding the injurious exposure to anyperson.

 

                A failure to comply withthese regulations could have a material, adverse effect on us. Furthermore, discoveryof unexpected product hazards or of failures to meet required standards throughthe reporting system could also have a material, adverse effect on us.

 

**We may not be successful in our internationaloperations.**

 

                During 2004, 2003 and 2002, theCompany’s total foreign revenues were $17.4 million, $8.2 million and$2.2 million, respectively. Our international business may be harmed bythe expense and difficulty of establishing, expanding, and managinginternational operations as well as the difficulty of enforcing agreements,collecting receivables, and protecting intellectual property in foreigncountries. Until 2002, we sold and serviced our products abroad exclusivelythrough our strategic relationship with the Ethicon Endo-surgery Inc. Beginningin the fall of 2002, we assumed direct responsibility for product service inEurope.

 

 

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Providingthis service directly has exposed us to additional organizational complexityand expense.  As a result we are planningto transfer our service responsibilities to a third party and sell our productsin Europe through our partnerships with Ethicon Endo-surgery, Inc. andPhillip Medical Systems.

 

**Risks Related to Our Common Stock**

 

**Our common stock was delisted from The NASDAQStock Market and as a result, trading of our common stock has become moredifficult.**

 

                Our common stock wasdelisted from The NASDAQ Stock Market on July 7, 2003. One result of thisaction is a limited public market for our common stock. Trading is nowconducted in the over-the-counter market in the so-called “Pink Sheets.”Consequently, selling our common stock is more difficult because smallerquantities of shares can be bought and sold, transactions can be delayed andsecurity analyst and news media coverage of us may be reduced. These factorscould result in lower prices and larger spreads in the bid and ask prices forshares of our common stock as well as lower trading volume. As a result of thedelisting of our common stock from The NASDAQ Stock Market, our common stockhas become subject to the “penny stock” regulations, including Rule 15g-9under the Securities Exchange Act of 1934. That rule imposes additionalsales practice requirements on broker-dealers that sell low-pricedsecurities to persons other than established customers and institutionalaccredited investors. For transactions covered by this rule, a broker-dealermust make a special suitability determination for the purchaser and havereceived the purchaser’s written consent to the transaction prior to sale.Consequently, the rule may affect the ability of broker-dealers tosell our common stock and affect the ability of holders to sell their shares ofour common stock in the secondary market. To the extent our common stock remainssubject to the penny stock regulations, the

 

 

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market liquidity for our shares will be adversely affected.Additionally, although we will seek to have our common stock re-listed on TheNASDAQ Small Cap Market once we are in full compliance with our obligations asa reporting company, we can provide no assurance that we will be re-listed.

 

**If we are unable to meet the financialcovenants of our loan agreement with ComVest, our loan availability will be limitedand we could be deemed to be in default.**

 

                In February 2005 weentered into a Note and Warrant Purchase Agreement with ComVest Partners thatprovides for loans of up to $10.0 million to us.  Initially, $5.0 million was made available tous, of which $2.5 million was used to repay our loan facility with SiliconValley Bank and the remaining $2.5 million was used for working capital. On March 30, 2005 ComVest provided anadditional $2.0 million in funding, bringing their total investment to $7.0million.  Availability of the remaining$3.0 million is contingent in part on our continued compliance with certainfinancial covenants.  Our failure to meetany of our covenants under our loan agreement could result in the remaining$3.0 million being unavailable, or in ComVest declaring an event of default,which would significantly harm our liquidity and financial position.

 

**The price of ourcommon stock is subject to significant price fluctuations.**

 

                Because of the relatively low trading volume andpublic float of our common stock, the market price of our common stock issubject to significant fluctuations in response to variations in quarterlyoperating results, announcements of material events, speculative or promotionalactivity in our stock and other factors. In particular, we believe thatspeculative activity in our common stock and activities of promoters who arenot associated with us have, in combination with the limited trading volume andpublic float, at various times caused our common stock to trade at artificiallyhigh prices.  This type of market isinherently unstable, risky and subject to wide positive and negative pricingswings in response to both legitimate and improper trading and promotionalactivities.  In addition, the securitiesmarkets have experienced significant price and volume fluctuations from time totime in recent years that have often been unrelated or disproportionate to theoperating performance of particular companies. These broad fluctuations mayadversely affect the market price of our common stock.

 

**Exercises of a significant number of stockoptions, or other substantial sales of our common stock could adversely affectthe market price of our common stock.**

 

                Although a substantialnumber of our outstanding stock options have exercise prices above currentmarket prices, sales of a substantial number of shares of common stock, or theperception that such sales could occur, could have a material, adverse effecton the market price of our common stock and could impair our ability to raisecapital through the sale of equity securities.

 

**Our policies could be significantlyinfluenced by the voting power of our significant shareholders.**

 

                Five institutionalinvestors and a single individual stockholder, combined, beneficially, own approximately68.5% of our common stock as of December 31, 2004. As a result, a fewshareholders are able to exercise significant influence on the election of ourboard of directors and could thereby direct our policies.

 

**Anti-takeover provisions in our charter coulddiscourage purchases of, or offers to purchase, us, even if those offers mightbe favorable to stockholders.**

 

                Our certificate ofincorporation and bylaws include provisions that may be deemed to haveanti-takeover effects and may delay, defer or prevent a takeover attempt thatstockholders might consider in their best interests. These include a provisionunder which only the board of directors may call meetings of stockholders,certain advance notice procedures for nominating candidates

 

 

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for election to the board of directors and staggered terms for ourboard of directors.

 

                **ITEM 2. PROPERTIES**

 

                We maintain a leasedoffice for our headquarters and manufacturing facility in Denver, Colorado.This facility includes approximately 120,000 square feet of office andmanufacturing space and is leased from JN Properties. A former employee, as ofDecember 31, 2003, who was previously a director of the Company, Chairmanof the Board, Chief Executive Officer and Chief Technology Officer, and a 11.8%shareholder in the Company is a general partner in JN Properties. This facilitysubstantially exceeds our requirements and the lease includes terms that imposesubstantial maintenance expense on us. In addition, the lease provides for escalation of the rental rate basedon market conditions.  We also leaseoffice space in Switzerland.  We believeour present facilities are adequate for the foreseeable future.

 

**ITEM 3. LEGAL PROCEEDINGS**

 

           InApril 2003, Fischer Imaging Corporation reported to the Securities andExchange Commission that it would restate its financial results for thereporting periods beginning January 1, 2000 and ending September 30,2002. On June 9, 2003, the Company received notice of a formal order ofinvestigation and subpoena from the Securities and Exchange Commission. Thisrequest followed the voluntary disclosures that the Company made to the SECbeginning in April 2003 and the creation of an independent board committeeto review the facts and circumstances underlying the Company’s decision torestate financial results. On November 15, 2004, the Company entered intoa settlement agreement with the U.S. Securities and Exchange Commission arisingout of the Commission’s investigation of the Company’s reported financialresults for the periods beginning January 1, 2000 and endingSeptember 30, 2002, which have since been restated by the Company.  In the settlement, the Company has agreed,without admitting or denying the allegations in the Commission’s complaint, tothe entry of a cease and desist order against future violations of theantifraud, reporting, recordkeeping and internal controls provisions of thefederal securities laws.  The Commission’scomplaint alleged that the company violated Section 17(a) of theSecurities Act of 1933, Sections 10 (b), 13 (a), 13 (b) (2) (A), 13(b) (2) (B) and 13 (b)(5) of the Securities Exchange Act of1934, and Rules 10b-5, 12b-20, 13a-1, 13a-13, and13b2-1 thereunder.  The Company wasnot required to pay any civil penalties or fines as part of thesettlement.  The Commission’sinvestigation against other persons or entities who may have been involved isongoing.  The administrative ordercontaining the Commission’s allegations and the terms of the settlement withthe Company is available at www.sec.gov/litigation/admin.shtml.  In addition, we have been informed by theU.S. Department of Justice of their intention to investigate the matters citedin the SEC order.

 

                On April 10, 2003 and on June 3, 2003, TheSorkin, LLC and James K. Harbert filed punitive class action lawsuits againstus and three of our former officers and directors, Morgan Nields, GeraldKnudson and Louis Rivelli, in the United States District Court for theDistrict of Colorado. The complaints are purportedly brought on behalf ofpurchasers of shares of the Company’s common stock during the periodFebruary 14, 2001 to April 1, 2003 and allege that, among otherthings, during the putative class period, the Company and the individual defendantsmade materially false statements in violation ofSection 10(b) of the Exchange Act, Rule 10b-5 promulgatedunder the Exchange Act, and Section 20(a) of the Exchange Act. Thecomplaints seek unspecified compensatory damages and other relief. On August 7,2003, the Company, and Messrs. Nields and Knudson moved to dismiss allclaims asserted by The Sorkin, LLC and Harbert. On August 18, 2003,Mr. Rivelli moved to dismiss all claims asserted in those lawsuits. OnOctober 20, 2003, Mr. Harbert moved to dismiss his lawsuit, which thecourt subsequently granted. On October 21, 2003, the Sorkin, LLC andMr. Harbert filed an amended class action complaint. The amended complaintcontains the same claims for relief against us and Messrs. Nields andRivelli, but does not assert any claims against Mr. Knudson. In addition,the amended complaint seeks to recover unspecified compensatory damages andother relief on behalf of purchasers of shares of our common stock during theperiod February 14, 2001 to July 17, 2003. The Company,Mr. Nields and Mr. Rivelli have filed motions to dismiss all claimsasserted in the amended complaint.  InSeptember 2004 we entered into an agreement in principle to settle thislitigation with plaintiffs’ attorneys and our director and officer liabilityinsurance provider, Chubb Insurance Company. This settlement proposal was submitted to the U.S. District Court forapproval, and on March 3, 2005 the court declined to approve the proposal.  As a result, litigation will continue in thismatter.  A hearing on the motions todismiss is scheduled for May 6, 2005.

 

The Company isa defendant in a breach of contract suit brought by International SurgicalSystems in the federal District Court of Arizona.  The suit claims that Fischer Imaging wrongfullybreached an agreement to supply product to ISS, notwithstanding ISS’nonpayment, and that such breach caused the failure and bankruptcy of ISS.  The suit seeks $1 million in damages, plusattorneys’ fees and expenses.  TheCompany believes the suit is without merit and intends to vigorously defend thecase, as well as assert counterclaims against ISS for nonpayment.

 

The Company is also adefendant in various lawsuits incident to the operation of its business. We donot believe that any of those pending legal proceedings would have a material,adverse effect on the consolidated financial position or results of operationsof the Company.

 

 

25

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**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

None

 

 

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**PART II**

 

**ITEM 5. MARKET FOR REGISTRANT’S COMMONEQUITY AND RELATED STOCKHOLDER MATTERS**

 

                In July  2003, ourstock was delisted from the Nasdaq National Market where it was traded underthe symbol “FIMG.”  At that time ourtrading symbol changed to “FIMG.PK” and our common stock is now available fortrading over-the-counter with trades reported by the Pink Sheets LLC. Thefollowing table sets forth, for each of the periods indicated, the high and lowclosing sale prices per share of our common stock as reported by The NASDAQStock Market or the Pink Sheets LLC, as applicable.

 

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2003**       |       |     |       |    |       |
| First Quarter  |       | $        | 7.43       |    | $          | 5.29 |   |
| Second Quarter |       | 5.39     |       | 3.85    |       |
| Third Quarter  |       | 4.94     |       | 2.75    |       |
| Fourth Quarter |       | 5.25     |       | 3.45    |       |
| **2004**       |       |     |       |    |       |
| First Quarter  |       | $        | 5.10       |    | $          | 4.00 |   |
| Second Quarter |       | 4.50     |       | 2.20    |       |
| Third Quarter  |       | 3.54     |       | 1.90    |       |
| Fourth Quarter |       | 4.25     |       | 2.30    |       |

 

                As of December 31,2004, there were approximately 250 holders of record of our common stock. Webelieve that we actually have in excess of 1,500 beneficial owners.  The closing sale price of our common stock onDecember 30, 2004 as reported by Pink Sheets, LLC was $3.90 per share.  We have not paid any cash dividends on ourcommon stock and intend to retain future earnings to finance the growth of ourbusiness rather than to pay cash dividends.

 

**Securities Authorized for Issuance UnderEquity Compensation Plans**

 

                The information requiredby this Item 201(d) of Regulation S-K regarding securitiesauthorized for issuance under equity compensation plans is incorporated byreference from our definitive Proxy Statement to be filed in connection withthe Annual Meeting of Stockholders.

 

**Recent Sales of Unregistered Securities**

 

Duringthe fiscal year ending December 31, 2004, we issued 26,000 shares ofcommon stock upon the exercise of options held by one officer of the Companyfor an aggregate price of $53,125 and to one director for an aggregate purchaseprice of $4,000.  We believe that each ofthese transactions was exempt from registration requirements pursuant toSection 4(2) of the Securities Act of 1933.

 

**ITEM 6. SELECTED CONSOLIDATED FINANCIALDATA**

 

                Our Selected FinancialData for the 2004, 2003 and 2002 data is derived from our audited financialstatements beginning on page F-1. The years ended December 31, 2001 and 2000 have been restated toincorporate the restatement adjustments. The restatement adjustments for 2001 and 2000 are described in the 2002annual report on Form 10-K.

 

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                You should read thefollowing Selected Consolidated Financial Data with the consolidated financialstatements and related notes and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” appearing elsewhere in thisForm 10-K.

 
| ** **                                             | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statement of Operations Data**          |       |                                      |       |     |       |     |       |     |       |     |       |
| Revenues:                                              |       |                                      |       |     |       |     |       |     |       |     |       |
| Products                                               |       | $                                         | 48,645     |     | $          | 32,814   |       | $        | 30,630     |     | $          | 28,055 |   | $ | 41,352 |   |
| Services                                               |       | 15,395                                    |       | 13,348   |       | 14,480   |       | 13,860   |       | 12,683   |       |
| Total revenues                                         |       | 64,040                                    |       | 46,162   |       | 45,110   |       | 41,915   |       | 54,035   |       |
| Cost of sales:                                         |       |                                      |       |     |       |     |       |     |       |     |       |
| Products                                               |       | 33,648                                    |       | 25,109   |       | 28,180   |       | 17,984   |       | 26,678   |       |
| Services                                               |       | 17,523                                    |       | 13,629   |       | 11,887   |       | 7,307    |       | 9,892    |       |
| Total                                                  |       | 51,171                                    |       | 38,738   |       | 40,067   |       | 25,291   |       | 36,570   |       |
| Gross profit                                           |       | 12,869                                    |       | 7,424    |       | 5,043    |       | 16,624   |       | 17,465   |       |
| Operating expenses:                                    |       |                                      |       |     |       |     |       |     |       |     |       |
| Research and development                               |       | 6,531                                     |       | 4,654    |       | 4,559    |       | 3,257    |       | 3,708    |       |
| Selling and marketing                                  |       | 10,469                                    |       | 9,376    |       | 7,981    |       | 7,278    |       | 6,801    |       |
| General and administrative                             |       | 7,917                                     |       | 8,754    |       | 7,697    |       | 5,028    |       | 5,282    |       |
| Total operating expenses                               |       | 24,917                                    |       | 22,784   |       | 20,237   |       | 15,563   |       | 15,791   |       |
| (Loss) income from operations                          |       | (12,048                                   | )          | (15,360  | )          | (15,194  | )          | 1,061    |       | 1,674    |       |
|                                                   |       |                                      |       |     |       |     |       |     |       |     |       |
| Interest expense                                       |       | (66                                       | )          | (49      | )          | (81      | )          | (138     | )          | (461     | )          |
| Interest income                                        |       | 4                                         |       | 62       |       | 119      |       | 77       |       | 65       |       |
| Patent settlement income (1)                           |       | 5,150                                     |       | 900      |       | 24,950   |       | —   |       | —   |       |
| Other (expense) income                                 |       | 39                                        |       | 34       |       | (74      | )          | (118     | )          | (382     | )          |
| Total other income (expense)                           |       | 5,127                                     |       | 947      |       | 24,914   |       | (179     | )          | (778     | )          |
| Provision (benefit) for income taxes                   |       | —                                    |       | —   |       | —   |       | —   |       | —   |       |
| Net (loss) income                                      |       | $                                         | (6,921     | )        | $          | (14,413  | )          | $        | 9,720      |     | $          | 882 |   | $ | 896 |   |
| Net (loss) income per common share:                    |       |                                      |       |     |       |     |       |     |       |     |       |
| Basic                                                  |       | $                                         | (0.74      | )        | $          | (1.55    | )          | $        | 1.06       |     | $          | 0.10 |   | $ | 0.13 |   |
| Diluted                                                |       | $                                         | (0.74      | )        | $          | (1.55    | )          | $        | 1.00       |     | $          | 0.09 |   | $ | 0.12 |   |
| Shares used to calculate net (loss) income  per share: |       |                                      |       |     |       |     |       |     |       |     |       |
| Basic                                                  |       | 9,353                                     |       | 9,319    |       | 9,204    |       | 8,643    |       | 7,111    |       |
| Diluted                                                |       | 9,353                                     |       | 9,319    |       | 9,692    |       | 9,352    |       | 7,411    |       |
| **Balance Sheet Data (at end of period):**             |       |                                      |       |     |       |     |       |     |       |     |       |
| Working capital                                        |       | $                                         | 4,169      |     | $          | 9,405    |       | $        | 23,199     |     | $          | 14,161 |   | $ | 11,756 |   |
| Total assets                                           |       | 31,374                                    |       | 32,348   |       | 41,079   |       | 31,552   |       | 29,969   |       |
| Total long-term debt (credit  facility)                |       | 1,454                                     |       | 454      |       | 1,181    |       | 1,003    |       | 881      |       |
| Total stockholders’ equity                        |       | 6,593                                     |       | 13,075   |       | 27,493   |       | 17,669   |       | 15,954   |       |

__________________________

 

(1)                                  During the secondquarter of 2002, we settled a patent infringement lawsuit that we had filedagainst Thermo-Electron Corporation and Hologic, Inc. Under the$32.2 million settlement, we received $25.0 million in cash andrecognized $0.9 in each of 2003 and 2004 as annual installments.  In June 2004, we received an acceleratedfinal settlement payment of $4.3 million.

 

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**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Youshould read the following “Management’s Discussion and Analysis” with theconsolidated financial statements and related notes and “Selected ConsolidatedFinancial Data” appearing elsewhere in this Form 10-K.

 

**Overview**

 

Wedesign, manufacture and sell innovative mammography and digital imagingproducts used in the diagnosis of breast cancer and other diseases. Our twoprimary breast cancer products are our MammoTest stereotactic breast biopsysystem, which we introduced in 1988, and our SenoScan digital mammographysystem, introduced in late 2001. Although MammoTest is a mature product weintend to continue to introduce enhancements to this system and expect to seemoderate growth in revenue going forward. We believe SenoScan has significantpotential for growth as digital mammography gains acceptance over traditionalx-ray film mammography. Our ability to grow SenoScan sales and capture marketshare in this emerging digital market is critical to our overall growth. Thatability is dependent upon us being successful on a timely basis with thecurrent redesign program, with the introduction of competitive workflowsolutions and with gaining wider market acceptance for the product. SenoScanwas approved by the FDA for sale in 2001 and we have continued to investsignificant resources to enhance its performance and reliability and itsfeature set, in order to produce a more competitive and attractive product. Wecontinue our efforts to market and sell our Electrophysiology and VersaRadx-ray products to the general radiology market both through our direct salesforce and through strategic distribution agreements. In addition to our productsales, we provide services for installation and application training at thetime our products are installed at the customer’s location. We also sell partsand provide maintenance services under our limited warranties, under long-termcontracts, or at hourly rates.

 

TheCompany incurred significant losses and had negative cash flows from operationsduring 2004.  We incurred a $12.0 million loss from operations and a $6.9million net loss for the year ended December 31, 2004.  We areimplementing an operating plan intended to return the company to sustainablepositive cash flow from operations.   Key components of this planinclude increasing revenues and improving our operating efficiencies to reducecost of sales, thereby improving gross margins, and lowering our overalloperating costs as a percentage of revenues. Our future revenue growth andsuccess depends largely upon increasing sales of our SenoScan product andfurther expanding the number of strategic corporate relationships to broadenthe sales reach of our products. We are undertaking a number of steps toimprove the performance and reliability of our SenoScan product and to advanceour technology for digital imaging.  Some of these steps includeredesigning parts and components to our products, providing upgrades andenhancements to our image and workflow management software and introducingalternative review workstation solutions.  We are anticipating theredesign efforts currently underway for the SenoScan product will be completedin 2005 and that SenoScan will be re-launched at that time. The timing of thecompletion of our redesign of the SenoScan and our ability to introduce theredesigned product to the market will significantly affect our results for2005.  If we are unsuccessful in introducingthe redesigned SenoScan in a timely manner our SenoScan revenues for 2005 willbe negatively impacted.  We have alsobegun implementing manufacturing and supply chain process improvements that webelieve will reduce cost of sales on our products.  Although these effortscommenced in early 2004, we do not anticipate that the full impact of theimproved performance and reliability and the resultant increase in productrevenues and improvement in product gross margins will be realized until atleast the second half of  2005. Provided that the installed base for our products continues to increase weexpect our service revenue to increase, such that our service revenues becomemore in line with our service cost infrastructure. We have continued toinvest additional resources in our service organization to support and servicean increasing base of installed products and have begun an initiative to add aprofessional services department to provide systems integration expertise inour selling, site planning and installation cycle. Gross margin improvementsfor our service organization are also dependent upon successful implementationof performance and reliability improvements.  Accordingly, the full impacton service margin improvements due to performance and reliability enhancements,if they occur, may not be realized until at least the second half of 2005.  We have begun the process of restructuringour sales and service operations in Europe, of transferring our European servicebusiness and addressing this market through a strategic distribution agreement,thereby eliminating the need for the current European infrastructure.  We expect to continue investing resources tobuild the US organizational infrastructure to support our business objectivesand continue meeting corporate governance requirements. However, if necessarywe will scale back our operations, investment and personnel in order tomaintain our financial liquidity.

Implementingthese strategic and operational initiatives during 2004 produced increasedproduct and service revenues, improved product gross margins and loweroperating costs expressed as a percentage of revenue. However, it also

 

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resulted in increasedcosts associated with servicing and supporting an increased installed base,redesigning our Senoscan product, and updating our quality systems to ensureregulatory compliance. These additional costs were comprised primarily of $3.9million additional operating costs in our service business related toadditional parts usage and increasing our service personnel; a $2.8 millionoperating loss associated with our European operations and $1.9 million inadditional research and development costs associated with the redesign of ourSenocan product. We also incurred an additional $1.3 million in manufacturingoperations costs associated with FDA regulatory compliance.

Althoughwe have experienced some improvement in the performance and reliability of theSenoScan product as a result of the implementation of some of our strategic andsales operational initiatives during 2004, our SenoScan backlog has declinedduring the year.  SenoScan sales backlogwas $5.9 million at December 2004, a decrease of $0.8 million, from $6.7million at December 2003.  This decreasein backlog has resulted from delays in the introduction of performanceenhancements for the SenoScan product, as well as sub-component supplyshortages, specifically related to the supplier of detectors for our SenoScanproduct.  Consequently, we haveexperienced manufacturing delays that have prevented us from meeting some ofour customer requested delivery dates. We also believe that some customers have delayed purchases of newSenoScan units pending completion of our enhancement efforts.  In addition, we were unable to ship ourMammoTest product to Europe until May 2004 due to the lapse of our CE Markcertification.  As a result of theseissues, we have incurred additional costs in manufacturing, shipping andinstallation and we believe we have lost sales opportunities to ourcompetitors. The total U.S. domestic and European sales backlog, excluding thenon-domestic SenoScan sale, for all our product lines at December 31, 2004, was$11.5 million compared with $11.4 million at December 31, 2003.  Of the total $9.0 million non-domesticshipment in December 2003, $0.6 million was recognized as revenue in 2003 and$8.4 million was recognized during the year ended December 31, 2004.

 

Weincurred a net loss of $6.9 million for the year ended December 31, 2004compared to a net loss of $14.4 million for the year ended December 31,2003.  The $7.5 million improvement in net loss in 2004 compared to 2003was due to a $4.2 million increase in other income and expense due to theaccelerated payment of the settlement of a patent infringement lawsuit inJune 2004 and a $5.4 million improvement in gross margins, partiallyoffset by $2.1 million increase in operating expenses.  The $5.4 milliongross margin improvement in 2004, as compared to 2003, was attributable to a$17.8 million increase in total revenues to $64.0 million in 2004 from $46.2million in 2003.  Due to higher product sales in 2004, as compared to2003, we generated an additional $7.3 million product gross margin that wasoffset by an increase of $1.8 million in the negative margin on serviceoperations.  Service revenues were $15.4 million in 2004 compared to $13.3million in 2003. The negative margin generated by our service operationsreflects our continuing issues with software, parts and components reliability.

 

We expect to continue incurring operating lossesinto 2005 as it will take time for our strategic and operating initiatives tohave a positive effect on our business operations.  We have developed an operating plan intendedto return the company to positive cash flow from operations, however, there arerisks associated with our operating plan. We may not be successful in increasing our revenues and in particular inincreasing revenues derived from our SenoScan product.  We may not be successful in completing theredesign of the SenoScan product, in developing upgrades and enhancements tothe image or workflow management software of SenoScan or in introducing newreview workstation components for the product. Any of these factors may materially adversely affect our ability to gainmarket acceptance for SenoScan and therefore our ability to increaserevenue.  Furthermore, we may not besuccessful in achieving improvements in the component performance andreliability of our products which would lead to continuing losses in ourservice business.   If we are notsuccessful in increasing revenues and in achieving operating efficiencies tolower our cost of sales and operating expenses as a percentage of revenue wewill be forced to scale back expenditures to maintain our financialliquidity.   We cannot sustain ourcurrent level of operating expenses at the current level of revenues.  We may not be successful in restructuring oursales and service operations in Europe, which would result in continuing lossesin that market.  See“Liquidity and Capital Resources” below for a discussion of the implications ofcontinuing losses on our liquidity.

 

 

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**Results of Operations**

 

                The following table setsforth the percentage relationship to revenues represented by certain dataincluded in our statements of operations for the years ended December 31:

 
| ** **                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenues:                         |       |     |       |     |       |     |       |
| Products                          |       | 76.0     | %          | 71.1     | %          | 67.9     | %          |
| Services                          |       | 24.0     |       | 28.9     |       | 32.1     |       |
| Total revenues                    |       | 100.0    | %          | 100.0    | %          | 100.0    | %          |
| Cost of sales:                    |       |     |       |     |       |     |       |
| Products                          |       | 52.5     |       | 54.4     |       | 62.4     |       |
| Services                          |       | 27.4     |       | 29.5     |       | 26.4     |       |
| Total cost of sales               |       | 79.9     | %          | 83.9     | %          | 88.8     | %          |
| Gross profit                      |       | 20.1     |       | 16.1     |       | 11.2     |       |
| Operating expenses:               |       |     |       |     |       |     |       |
| Research and development          |       | 10.2     |       | 10.1     |       | 10.1     |       |
| Selling and marketing             |       | 16.3     |       | 20.3     |       | 17.7     |       |
| General and administrative        |       | 12.4     |       | 19.0     |       | 17.1     |       |
| Total operating expenses          |       | 38.9     |       | 49.4     |       | 44.9     |       |
| Loss from operations              |       | (18.8    | )          | (33.3    | )          | (33.7    | )          |
| Interest expense                  |       | (0.1     | )          | (0.1     | )          | (0.2     | )          |
| Interest income                   |       | 0.1      |       | 0.1      |       | 0.3      |       |
| Patent settlement                 |       | 7.9      |       | 2.0      |       | 55.3     |       |
| Other income (expense), net       |       | 0.1      |       | 0.1      |       | (0.2     | )          |
| Income (loss) before income taxes |       | (10.8    | )          | (31.2    | )          | 21.5     |       |
| Provision for income taxes        |       | —   |       | —   |       | —   |       |
| Net income (loss)                 |       | (10.8    | )%         | (31.2    | )%         | 21.5     | %          |
|                              |       |     |       |     |       |     |       |

 

**Year Ended December 31, 2004 Compared toYear Ended December 31, 2003**

 

**ProductRevenues**

 

                We generate revenues from salesof our SenoScan systems, MammoTest Systems, and Electrophysiology and VersaRadx-ray products, along with sales of third-party peripherals and softwaresold in conjunction with our system sales. Each of our products has severaldifferent configurations based on product features, performance requirements,and customer requests. Our MammoTest system is a mature product in a maturemarket and we anticipate moderate growth in this product line with promotionalefforts. We expect an increasing percentage of our revenues will be derivedfrom our SenoScan systems with the anticipated re-launch of the redesigned SenoScansystem in 2005.  We sell installationservices, limited warranty and applications training with our large systemsales. We also generate service revenues from long-term service contracts thatrange from one to five years, services charged at hourly rates and from partssales not covered under our limited warranty program or long-term servicecontracts. We do not believe that inflation will have a material impact ourrevenues.

 

Total revenuesincreased 38.7% to $64.0 million for 2004 from $46.2 million for 2003.   Product revenues increased 48.2% to$48.6 million in 2004 from $32.8 million in 2003. SenoScan productrevenue increased 79.4% or $8.5 million to $19.3 million in 2004 from $10.8million in 2003.  Revenues for year endedDecember 31, 2004 include a $8.4 million non-domestic sale that wasshipped in December 2003.  Duringthe fourth quarter 2003, we shipped all the SenoScan systems to a non-domesticcustomer, one unit met our revenue recognition criteria in 2003 and theremaining units met our revenue recognition criteria in 2004.  The non-domestic sale accounts for $7.5million or 87.8% of the $8.5 million increase in SenoScan sales in 2004compared with 2003.  The remaining $1.0million increase in SenoScan sales in 2004 compared

 

 

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with 2003 reflects a15.8% or $1.5 million price increase partially offset by a 4.8% or $0.5 millionvolume decrease.  Excluding thenon-domestic sale, our SenoScan sales volumes decreased 4.8% in 2004, ascompared to 2003, reflecting a modest reduction in market demand.  The price increase in 2004 compared with2003, excluding the non-domestic sale, is due to sales of units in 2004 thatinclude more favorably priced configurations, options and software.  During 2004 we experienced difficulties withmaterial availability, assembly and installation of SenoScan systems, whichaffected our revenues and liquidity.  Ourworld-wide SenoScan backlog was $5.9 million as of December 31, 2004, ascompared to $15.1 million at December 31, 2003.  The 2003 backlog included the $8.4 millionshipment to a non-domestic customer.

 

Our MammoTestproduct revenue increased 17.1% or $2.8 million to $18.9 million in 2004from $16.1 million in 2003. The 17.1% increase in MammoTest product revenuereflects a 23.7% or $3.8 million volume increase offset by a 5.3% or $1.0million pricing decrease.  The increasein MammoTest units sold, is due to a promotional program to upgrade theinstalled base that ran though September 2004 coupled with increasedcustomer demand in the second half of the year for the product.  The decrease in pricing is primarily due tothe promotional program.  The RE&Sproduct sales during 2004 increased $4.6 million, or 76.0%, to $10.5 millionfrom $5.9 million in 2003.  The salesincrease in the RE&S products in 2004, as compared to 2003 was primarilydue to 137.9% or $3.6 million volume increase in VersaRad x-ray products and$0.7 million higher volume for the other RE&S products.

 

**ServiceRevenues**

 

                Ourservice revenues for 2004 increased 15.3% to $15.4 million from $13.3 millioncompared to 2003.  The increase in 2004as compared to 2003 is primarily due to higher number of MammoTest and SenoScanunits on service contracts in both the US and Europe, which was driven bysuccessful conversion of installed units to service contracts after thewarranty period.

 

**ProductCost of Sales**

 

                Cost of sales for our productsconsists of fixed and variable costs incurred for purchased components for ourproducts, assembly, integration and testing of our products, expensesassociated with quality and regulatory affairs, warranty provision, excess andobsolete inventory, shrinkage and other inventory carrying costs. Cost of salesfor our services consists primarily of parts cost, salaries, commissions andtravel costs for personnel in field service, customer service, applicationstraining and testing and service administration and management.

 

                Costof sales for products in 2004 was $33.6 million or 69.2% of productrevenues compared to $25.1 million or 76.5% of product revenues in 2003.The overall decrease in cost of product sales, as a percentage of productrevenues is primarily due to a $1.8 million decrease in manufacturing andrepair costs and a $2.1 million decrease in inventory write offs due toimproved inventory management and control. These decreases were partially offset by a $0.5 million increase inwarranty provision.   The warrantyprovision increased $0.9 million for the SenoScan non-domestic sale because theproduct warranty provided to the customer is longer than the 12-monthstandard warranty period.  This increasewas partially offset by a $0.4 million decrease in the provision in the fourthquarter of 2004 to adjust the warranty obligation to reflect historical experience.

 

**Service Cost of Sales**

 

                 Cost of sales for servicesfor 2004 increased 28.6% to $17.5 million from $13.6 million in2003.  As a percent of service revenues,cost of service sales increased to 113.8% in 2004 from 102.1% in 2003.  Of this increase, $2.2 million relates toparts costs and $1.4 million relates to staffing additions to support andservice our increased installed base. The US MammoTest and SenoScan units under warranty and service contractsupport increased 26.8% and 144.9%, respectively, in 2004 compared to 2003.

 

**Research and Development Expenses**

 

                We incur research anddevelopment expenses to design and develop new products as well as developsignificant enhancements to our existing products. These expenses consistprimarily of compensation and overhead costs for staff engaged in research anddevelopment activities, software development, consulting costs, and costs formaterials and supplies consumed while performing research and developmentactivities. We also offset our research and development costs with income fromresearch grants we receive.

 

 

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Research and developmentexpenses increased 40.3% to $6.5 million for 2004 from $4.7 millionin 2003. We spent 10.2% of revenue on research and development for 2004compared to 10.1% of revenue for 2003. Our employee compensation costs increased $0.4 million or 14.2% as weincreased our staffing levels in software development and engineering to focus onredesigning our products for improved reliability and serviceability; as wellas enhancing the features, functionality and reliability of our SenoScanproduct.   To support these redesign andproduct development efforts currently underway, contract engineering servicesincreased $1.2 million and expenditures for research and development materialsincreased $0.2 million.  These increasesin our operating costs during 2004 were partially offset by $0.3 millionincrease in reimbursement of funding from research grants.  We plan to continue investing resources indeveloping new enhancements for our products and redesigning our product lineto incorporate new technologies.  We alsointend to seek additional research grants and product development collaborationsto fund our research and development efforts and to continue advancing ourtechnology.

 

**Selling and Marketing Expenses**

 

Our selling and marketing expenses consists primarily of salaries,commissions, travel and other overhead costs for employees and activities inthe areas of sales, marketing, sales support, and sales administration.Expenses associated with advertising, trade shows, conferences, promotional andtraining costs related to marketing our products are classified as selling andmarketing expenses. We market our products primarily to physicians, and we selland distribute our products worldwide primarily through our direct sales force,dealers and OEM arrangements.

 

Selling andmarketing expenses increased 11.7% to $10.5 million in 2004 from$9.4 million in 2003.  Our sellingand marketing expenses, as a percent of sales decreased to 16.3% of revenues in2004 from 20.3% of revenues in 2003.  Ofthe total spending increase, $1.3 million relates to commission on non-domesticsales in 2004, $0.2 million relates to commission on higher domestic sales and$0.3 million relates to increased marketing and promotional efforts.  These spending increases were partiallyoffset by $0.5 million decrease in salaries and wages due to lower salespersonnel headcount in 2004 as compared to 2003.  We plan to increase our marketing and salesactivities in the foreseeable future to increase revenues and broaden ourmarket share.

 

**General and AdministrativeExpenses**

 

Our general and administrative expenses consist primarily ofcompensation and overhead costs for employees and activities in the areas offinance, information technology, human resources and administration. Fees forattorneys, independent auditors, consultants and costs directly related to theSEC investigation, class action lawsuit and financial restatement effort arealso included in general and administrative.

 

General andadministrative expenses decreased 9.6% to $7.9 million in 2004 from$8.8 million in 2003.  Our generaland administrative expenses, as a percent of revenues decreased to 12.4% from19.0% in 2003.  Of the total spendingdecrease, $0.7 million related to reduced audit fees and $0.3 million relatedto a reduction in expenditures for consultants as the effort to restate thefinancial statement that commenced in the first quarter of 2003 was completedin April 2004.  In addition, as aresult of cost containment efforts, travel expenses decreased $0.2 million andpersonnel costs decreased by $0.3 million.  These decreases in spending were partially offset by $0.4 million inhigher legal costs associated with the class action lawsuit and the SECinvestigation and $0.4 million in higher insurance costs associated with therenewal of our policies.

 

**Interest Expense/Income**

 

Interest expenseduring 2004 increased to $66,000 from $49,000 for 2003 due to borrowings on thecredit facility. Interest income during 2004 decreased to $4,000 from $62,000in 2003 due to the lower cash balances in 2004.

 

**Other Income**

 

We settled a patent infringement lawsuit in 2002, and $7.2 million ofthe settlement was scheduled to be received in equal annual installments of$0.9 million over the remaining eight-year life of the associated patents.  We recognized an other income item in theamount of $0.9 million during 2003 and 2004. On June 2, 2004 we amended the settlement agreement, received aone-time accelerated payment totaling $4.3 million in lieu of the six remaining$0.9 million payments that were due

 

 

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annually through 2010 and recognized theone-time payment as an other income item.

 

**Income Taxes**

 

We estimated that we wouldnot owe taxes for 2004 and the year ended December 31, 2003. Accordingly,no income tax benefit or provision was recorded. This was determined based uponthe anticipated 2005 results of operations and an available net operating losscarry-forward of $31.4 million at December 31, 2004.  As of December 31, 2004 we had a 100%valuation allowance against our deferred tax asset of $17.8 millionbecause management concluded that the deferred tax asset would be realizedthrough generation of future taxable income.

 

**Year Ended December 31, 2003 Compared to Year EndedDecember 31, 2002**

 

**ProductRevenues**

 

Revenues increased 2.4% to$46.2 million in 2003 from $45.1 million in 2002. Our product revenuesincreased $2.2 million, or 7.1%, while our service revenues decreased$1.1 million, or 7.8%, during 2003. Revenue from our SenoScan digital mammography products increased $7.2million to $10.8 million in 2003 from $3.6 million in 2002.  The SenoScan product revenue increasereflects a 190.9% or $6.8 million volume increase due to a higher level ofmarket acceptance coupled with a 3.7% or $0.4 million pricing increase.  Such higher pricing resulted from discontinuationof lower 2002 introductory pricing.  OurMammoTest breast biopsy products decreased $3.0 million to $16.1 millionin 2003 from $19.1 million in 2002. The decrease in MammoTest productrevenue reflects a 9.1% or $1.6 million pricing decrease coupled with a 7% or$1.3 million volume decrease.  The lowerpricing in 2003, as well as the decrease in MammoTest units sold is primarilydue to increased competition.  Revenuesfrom the RE&S product line decreased $2.1 million to $5.9 million in 2003from $8.0 million in 2002.  The decreasein the RE&S product line in 2003 was primarily due to a $1.1 milliondecrease in the sales volume for the VersaRad product in 2003 as compared to2002 due the temporary suspension of sales efforts during 2003 to redesignaspects of the product and a $1.0 million decrease in pricing for the otherRE&S products which was driven by sales of lower priced equipmentconfigurations and discounted pricing provided for upgrading an installedsystem.

 

**ServiceRevenues**

 

Our service revenuesdecreased primarily from lower parts sales as we had more SenoScan andMammoTest units under warranty or long-term service contracts in 2003 comparedto 2002. We had fewer service contracts on our x-ray products as wediscontinued offering long-term service contracts on this older product line.We also extended our warranty to certain customers who purchased our SenoScanproducts during our initial commercial release thereby delaying new long-termservice contracts that generate revenue. Our SenoScan systems primarilyremained under warranty throughout 2003 as we extended our warranty tocustomers due to the product performance and reliabilities problems weexperienced. We expect service revenues from long-term contracts on ourSenoScan systems to increase as we sell more units and as units come offwarranty and our customers begin purchasing service contracts.

 

**ProductCost of Sales**

 

                Costof sales for our products was $25.1 million, or 76.5% of product revenues,in 2003 as compared to $28.2 million, or 92.0% of product revenues in2002.  The overall decrease in cost ofsales for products as a percentage of product revenue is due primarily to a$7.1 million decrease in inventory related write-offs and a $0.7 decrease inwarranty provision.  Those decreases werepartially offset by a $2.3 million increase in manufacturing and repair costs.

 

**Service Cost of Sales**

 

                Cost of sales for our servicesincreased 14.7% to $13.6 million in 2003 from $11.9 million in 2002.Our service costs were 102.1% of service revenues in 2003 compared to 82.1% in2002. The increase is due to additional operating costs of $1.8 millionoffset by a decrease in parts usage expenses of $0.1 million. Ouroperating costs increased as we added 20% additional staffing in our fieldservice and applications departments to meet the demands of ramping up ourEuropean operations and increased training requirements due to increasedproduct installations. Our parts usage expense and warranty amortizationincreased as a result of the product performance and reliability problems weencountered with our SenoScan products during 2003. We expect our servicemargins will significantly improve as our revenues increase more in line withour service support capacity due to products coming off of warranty andcustomers purchasing long-term service contracts

 

 

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and as a result of the product enhancementswe have made to correct performance and reliability problems with our SenoScanproducts.

 

**Research and Development Expenses**

 

                Researchand development expenses increased 2.1% to $4.7 million in 2003 from$4.6 million in 2002. Our compensation costs increased $0.5 millionrelated to increased staffing levels during 2003 compared with 2002 and fromseverance costs resulting from management changes in 2003. As a part of ourquality assurance program, we increased our staffing levels in softwaredevelopment and engineering to focus on redesigning older products andenhancing the features and functionality of our newly developed products. Theseincreased costs were partially offset by a $0.3 million from a SBIR grantfrom the National Cancer Institute that we began receiving in 2003. We also hadfewer product development initiatives in 2003 resulting in cost reductions of$0.3 million from lower consulting and materials and supplies requirementsas we focused primarily on enhancing our SenoScan product line. We plan tocontinue investing resources in developing new enhancements for our productsand redesigning our older product line under our RE&S division toincorporate new technologies. We also intend to seek additional research grantsand product development collaborations to fund our research and developmentefforts and to continue advancing our technology.

 

**Selling and Marketing Expenses**

 

                Sellingand marketing expenses increased 17.5% to $9.4 million in 2003 from$8.0 million in 2002. Our compensation costs for our sales organizationincreased by $1.4 million due to increased revenues and a significantlygreater backlog at the end of 2003 resulting in paying partial commissions onsale orders for which there is no commensurate revenue in 2003 as revenue willbe recognized at a later date upon completion of the sale. We also hadincreased costs of ramping up our European sales operations in 2003 as wechanged our strategy in Europe by implementing a direct sales business model.Our marketing expenses for trade shows, advertising and promotional costsdecreased by $0.3 million, due primarily to less marketing activity in thefourth quarter of 2003, as we focused our internal resources on enhancing ourproducts. We plan to increase our marketing and sales activities in theforeseeable future to increase revenues and broaden our market share.

 

**General and AdministrativeExpenses**

 

                Generaland administrative expenses increased 13.7% to $8.8 million in 2003 from$7.7 million in 2002. The increase is due primarily to approximately$1.9 million in legal and accounting fees associated with the auditcommittee’s internal review of various accounting and other matters, auditingexpenses and legal costs related to the restatement of our financialstatements. We also had increased expenses primarily from additionalcompensation and travel costs incurred by our European operations to developadministrative infrastructure in support of our new direct sales strategy inEurope. We had significant non-recurring legal costs in connection with ourpatent lawsuit settlement in 2002 that did not recur in 2003. We expect ourgeneral and administrative expenses to decrease as a percentage of revenue nowthat we have completed our financial restatement; however, we plan to continuemaking investments in building an organizational infrastructure to supportimprovements in internal controls, financial reporting and disclosure controlsand meeting corporate governance requirements. We also expect to incursignificant legal and professional accounting expenses associated withsatisfying the listing requirements of The NASDAQ Small Cap Market should ourcommon stock be re-listed and in connection with implementing the requirementsof the Sarbanes-Oxley Act of 2002, in particular, Section 404 thereof,which requires management to report on, and our independent auditors to attestto, the effectiveness of our internal controls.

 

**Other Income/Expenses**

 

Other income/expenses consistprimarily of patent settlement income of $0.9 million that we receiveannually beginning in 2003 for seven years. We received $25.0 million fromthe patent settlement in 2002**.**

 

** **

**Income Taxes**

 

As of December 31, 2003,we had approximately $30.1 million of domestic net operating losscarry-forwards for federal income tax reporting purposes and $1.3 millionof foreign net operating loss carry-forwards that expire at various datesthrough 2021.  We also had availableresearch and development tax credits of approximately $0.2 millionexpiring at various dates through 2020, and alternative minimum tax credits of$0.6 million. The utilization of these loss carryforwards

 

 

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and research and development creditcarryforwards to reduce future income taxes will depend on our ability togenerate sufficient taxableincome prior to the expiration of the net operating loss carryforwards andresearch and development credit carryforwards.

 

                No income tax provisions havebeen recognized for foreign tax jurisdictions and no income tax benefits havebeen recognized for subsidiary losses outside the domestic return.

 

**Liquidity and Capital Resources**

 

As of December 31,2004, we had $1.9 million in cash and $4.2 million in working capitalcompared to $1.4 million in cash and $9.4 million in working capitalat December 31, 2003.  The $5.2million decrease in our working capital reflects cash used to fund our $12.0million loss from operations for 2004. The remainder of the $12.0 million loss from operations was funded bythe $4.3 million accelerated patent lawsuit settlement payment received in thesecond quarter of 2004, $1.5 million borrowing under our credit facility and$1.2 million non-cash charges for depreciation and amortization.

 

                *Cash used inoperating activities*

 

                Ouroperating activities generated $0.3 million of cash for 2004. Our net loss of$6.9 million, reflecting the favorable impact of the $4.3 million acceleratedpatent infringement payment received in June 2004 and recognized as otherincome, was funded by a $5.2 million change in operating assets and liabilitiesand $1.2 million in non-cash charges for depreciation and amortization.  Our $5.2 million net change in current assetsand current liabilities consists primarily of a $2.1 million decrease inaccounts receivable due to stronger collections in the fourth quarter of 2004as compared to fourth quarter 2003; a $0.9 million decrease in prepaid andother assets which related to charging $0.4 million prepaid commission on largenon-domestic sale to expense in 2004 as the units met our revenue recognitioncriteria and the capitalization of $0.5 million fixed asset addition; a $3.2million increase in our payables with a change in our payables policy to payour obligations no earlier than they are due; a $1.0 million increase inwarranty obligation primarily due to longer warranty period provided on unitssold in large non-domestic sale, and a $0.7 million increase in deferredrevenue due to prepayment of service contracts. These sources of funds were partially offset by a $1.1 million increasein inventories to support sales in the first quarter of 2005 and a $1.0 milliondecrease in customer deposits to $3.1 million in 2004 from $4.1 million in 2003due to lower average deposits.  Wetypically receive deposits in connection with sales of large systems to directcustomers and a downturn in bookings and backlog would adversely affected ourliquidity.

 

*Cash used in investing activities*

 

                We used $1.4 million of cashin our investing activities during 2004 which consisted of $1.5 million usedfor capital expenditures to support efforts in manufacturing and research anddevelopment, as well as the purchase of office equipment for staff additions,net of $148,000 of proceeds generated from the sale of an investment.

 

*Cash provided by financingactivities*

 

During 2004, employeesexercising stock options resulted in the issuance of 26,000 shares of commonstock and proceeds totaling $57,000.

 

In June 2003, weentered into an $8.0 million credit facility with Silicon Valley Bank,subject to restrictions based on eligible receivables.  The amount available under the creditfacility at December 31, 2004 was approximately $3.4 million. As amended,this credit agreement expired on March 9, 2005, and was secured by all ofour assets.  Borrowings under theagreement bore interest at the bank’s prime rate, plus 2.75%, with a minimumtotal interest rate of 7%.  The creditfacility required the Company to comply with a tangible net worthcovenant.  We borrowed against the creditfacility during the fourth quarter of 2004 and the outstanding balance on thecredit facility was $1.5 million as of December 31, 2004.  On February 23, 2005, the Companyrefinanced the credit facility on a long-term basis with ComVest and terminatedthis credit facility.  The Company hasaccounted for the refinanced debt as long-term in the accompanying balancesheet pursuant to FASB Statement No. 6, Classification of Short-termObligations Expected to be Refinanced.

 

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*Sources of cash*

 

On February 23, 2005, we entered into a Note and Warrant PurchaseAgreement (the “Purchase Agreement”) with ComVest, which provides for up to $10million of senior secured debt financing to the Company.  At closing, we issued and sold a seniorsecured promissory note in the principal amount of $5.0 million (the “InitialNote”) to ComVest.  Proceeds from thesale of the Initial Note were used to retire $2.5 million of seniorindebtedness that was outstanding as of February 23, 2005 under the $8.0million credit facility and for working capital to fund operations, researchand development and marketing initiatives.  In connection with the issuance of theInitial Note, we issued to ComVest a warrant (the “Warrant”) to purchase2,000,000 shares of Common Stock at an exercise price of $4.25 per share.  The Warrant is exercisable fromAugust 23, 2005 until February 22, 2010.  ComVest also has registration rights thatwill require that we file a registration statement sufficient to cover thecommon shares underlying the Warrants. On March 30, 2005 we amended thePurchase Agreement and ComVest provided an additional $2.0 million in funding,bringing their total investment to $7.0 million.  In connection with this amendment we amendedthe Warrant to provide ComVest with a put option, exercisable at $0.90 perwarrant share, upon the occurrence of certain trigger events.  The trigger events are a Change of Control orliquidation or dissolution of the Company. The remaining $3.0 million available under the commitment may beborrowed by us from time to time, subject to the satisfaction of certainconditions, including completion of the current FDA audit, throughNovember 15, 2005.  The InitialNote, the Second Note and any additional notes issued under the PurchaseAgreement will bear interest at 8.5% per annum with a maturity of the earlierof (i) August 15, 2008 or (ii) a sale of the company and aresecured by all of the assets of the Company, as provided in a SecurityAgreement between the Company and ComVest. Accrued interest on the Initial Noteis payable, commencing on November 15, 2005 and quarterly thereafter oneach February 15, May 15, August 15 and November 15.Principal on the Initial Note is payable in ten equal quarterly installments,each in an amount equal to one (1%) of the original principal amount of thenote, with a final payment of the remaining principal outstanding under the Notesdue on August 15, 2008. The first installment of principal is payable onFebruary 15, 2006, with successive installments continuing on eachMay 15, August 15, November 15 and February 15 thereafter.

 

Availabilityof the remaining $3.0 million is contingent in part on our continued compliancewith certain financial covenants.  Ourfailure to meet any of our covenants under our loan agreement could result inthe remaining $3.0 million being unavailable, or in ComVest declaring an eventof default, which would significantly harm our liquidity and financialposition.  Upon and during thecontinuance of an event of default, the interest rate under the Initial Noteshall be 11.50%.  The unpaid principalbalance of the Initial Note and all accrued interest thereon shall becomeimmediately due and payable upon an event of default consisting of a default inthe payment when due of any principal or interest on the note, the admission bythe Company or other indication of insolvency or the commencement of bankruptcyor similar proceedings.  ComVest maydeclare all outstanding principal amounts and accrued interest due and payableupon the occurrence of other events of default.

 

                Ourfuture capital requirements will depend on a number of factors, including anyjudgments or settlements which may result from the shareholder class-actionlawsuit and other legal proceedings described above in “Item 3—LegalProceedings”; legal, accounting and other professional fees associated withsuch investigations and legal proceedings, as well as our ongoing efforts todevelop and implement internal controls and corporate governance policies andprocedures designed to enhance the accuracy, quality and consistency of ourfinancial information and reporting; costs associated with satisfying the listingrequirements of The NASDAQ Stock Market should our common stock be re-listed;costs associated with implementing the requirements of the Sarbanes-OxleyAct of 2002, in particular, Section 404 thereof, which requires managementto report on, and our independent auditors to attest to the effectiveness ofour internal controls by December 31, 2006; market acceptance of SenoScan, theresources we devote to developing and supporting our products; continuedprogress of our research and development of potential products; the need toacquire licenses to technology; and potential future merger and acquisitionactivity.

 

We believe that our balances of cash, cash flows expected to begenerated by future operating activities, and amounts available under the Noteand Warrant Purchase Agreement with ComVest will be sufficient to meet our cashrequirements over the next twelve months. However, the remaining $3.0 million available under the ComVestcommitment is subject to the satisfaction of certain conditions including thecompletion of an FDA audit that is currently underway.  We may not successfully meet these conditionsor successfully complete the FDA audit and, as a result, we would need to seekadditional financing from other sources.

 

We expect to continue toincur operating losses in 2005 while we implement our strategic and operatinginitiatives that are intended to have a positive effect on our businessoperations.  We have developed anoperating plan intended to

 

 

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return the company to positive cash flow fromoperations that has risks associated with it. Please see “Overview” above for discussion of that plan.

 

Should any of the negative factors outlined in the “Overview”occur, ourfinancial liquidity position will be adversely impacted by our not achievingpositive cash flow from operations and we would be required to seek additionalfinancing.  Furthermore, if we fail tosatisfy the conditions to access additional capital from ComVest, we would needadditional financing.  To satisfying ourworking capital requirements we may need to raise additional funds through thesale of equity securities, the incurrence of additional indebtedness, throughfunds derived through entering into collaborative agreements with third partiesor through divestiture of product lines.  In addition, we may be required to reduce our sales and marketingactivities, reduce the scope of or eliminate our research and developmentprograms, or relinquish rights to technologies or products that we mightotherwise seek to develop or commercialize.

 

Additional equity or debtfinancing may not be available on acceptable terms, or at all. Our common stockwas delisted from The NASDAQ Stock Market on July 7, 2003. One result ofthis action is a limited public market for our common stock. Trading is nowconducted in the over-the-counter market in the so-called “Pink Sheets.” Thisreduced liquidity will likely make it difficult to raise additionalcapital.  In the event that we do raiseadditional equity financing, our current stockholders will be further diluted.In the event that we incur additional indebtedness to fund our operations, wemay have to grant the lender a secondary security interest in our assets sinceour assets are currently pledged as security related to our loan from ComVest.

 

**Off-Balance Sheet Arrangements**

 

                We do not have anyoff-balance sheet arrangements that have, or are reasonably likely to have, acurrent or future effect on our financial condition, changes in financialcondition, revenue or expenses, results of operations, liquidity, capitalexpenditures or capital resources that are material.

 

**Contractual Obligations**

 

                At December 31, 2004our commitments under contractual obligations were as follows (in thousands):

 
| **Payments Due by Period:**        | ** ** | **Total** | ** ** | **Less  Than  1 Year** | ** ** | **1 3  Years** | ** ** | **4 5  Years** | ** ** | **After 5  Years** | ** ** |
|------------------------------------|------------|-----------|------------|------------------------|------------|----------------|------------|----------------|------------|--------------------|------------|
| Capital lease obligation           |       | $         | 224        |                   | $          | 224            |       | $              | —     |               | $          | — |   | $ | — |   |
| Line of credit                     |       | 1,454     |       | —                 |       | 1,454          |       | —         |       | —             |       |
| Operating leases                   |       | 6,819     |       | 925                    |       | 1,870          |       | 1,704          |       | 2,320              |       |
| Total contractual cash obligations |       | $         | 8,497      |                   | $          | 1,149          |       | $              | 3,324      |               | $          | 1,704 |   | $ | 2,320 |   |
|                               |       |      |       |                   |       |           |       |           |       |               |       |
|                                    |            |           |            |                        |            |                |            |                |            |                    |            |  |  |  |  |  |  |  |  |  |

 

**CRITICAL ACCOUNTING POLICIES**

 

                Critical accountingpolicies are those that are most important to the portrayal of our financialcondition and operating results, and require management to make its mostdifficult and subjective judgments, often as a result of the need to makeestimates on matters that are inherently uncertain. These judgments are basedon our historical experience, terms of existing contracts, our observance oftrends in the industry, information provided by our customers and informationavailable from other outside sources, as appropriate. Actual results may differfrom these estimates under different assumptions or conditions.

 

                As of the date of thisfiling, our critical accounting policies include:

 

**Revenue Recognition**

 

                We follow the provisionsof Staff Accounting Bulletin 104, “Revenue Recognition in Financial Statements”(SAB104) which provides for revenue recognition when persuasive evidence of anarrangement exists, delivery has occurred, the fee is fixed and determinableand collectibility is probable. We recognize product revenue upon effectivedelivery for our large, direct-sale medical equipment, although we deferrecognition until all conditions are satisfied in cases where otherarrangements exist or obligations remain to be performed. Revenue related todealers and other product sales are recognized upon shipment, provided thattitle and risk of loss has transferred. We recognize revenue from services whenthey are performed, and from pre-paid service

 

 

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contracts and extended warranty contracts over the periods for whichthe contracts are in effect. We bill for service contracts and extendedwarranties monthly, quarterly and annually in advance, and record deferredrevenue, which is then recognized over the service period. We also sellreplacement parts to customers, and record revenue at the time of shipment whentitle transfers. Certain replaced parts may be returned for partial credit, andwe make estimates to reduce current revenue to account for the future effect ofthose returns.

 

                We carry accountsreceivable at original invoice amounts less an estimate for doubtful accounts andsales returns based on a periodic review of outstanding receivables. We provideallowances for known and anticipated credit losses in the course of regularlyevaluating individual customer receivables. This evaluation takes intoconsideration a customer’s financial condition and credit history as well ascurrent economic conditions. Accounts receivable are written off when deemeduncollectible.  Recovery of accountsreceivable previously written off are recorded when received.

 

**Inventories**

 

                We value inventory at thelower of cost or market using the first-in, first-out (FIFO) method. Managementperiodically assesses the recoverability of inventory based on obsolescence orun-marketability equal to the difference between the cost of inventory and theestimated market value based upon assumptions about future demand and changesin market conditions. These assessments require management judgments andestimates, and valuation adjustments for excess and obsolete inventory may berecorded based on these periodic assessments.

 

**Product Warranty**

 

                We accrue for theestimated cost of product warranties into product cost of sales at the timerevenue is recognized. Although we engage in extensive product quality programsand processes, our warranty obligation is affected by product failure rates andservice delivery costs incurred in correcting a product failure. Should actualproduct failure rates or service costs differ from our estimates, which arebased on historical data, and engineering estimates, where applicable,revisions to the estimated warranty liability would be required. The typicalstandard warranty term is for 12 months starting from the date ofinstallation. We also sell extended warranties ranging from 12 to60 months.

 

**Income Taxes**

 

                As part of the process ofpreparing our financial statements, we are required to estimate our incometaxes in each of the jurisdictions in which we operate. This process involvesestimating actual current tax exposure together with assessing temporarydifferences resulting from different treatment of items for tax and accountingpurposes. These differences result in deferred tax assets and liabilities,which are included within the balance sheet. We must then assess the likelihoodthat the deferred tax assets will be recovered from future taxable income and,to the extent that recovery is not likely, a valuation allowance must beestablished. To the extent a valuation allowance is established, we mustinclude an expense within the tax provision in the statement of operations. Inthe event that actual results differ from these estimates, the provision forincome taxes could be materially impacted. We have fully reserved for ourdeferred tax asset.

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

                Market risk representsthe risk of loss that may impact the financial position, results of operationsor cash flows due to adverse changes in financial and commodity market pricesand rates. We are exposed to market risk in the areas of changes in UnitedStates interest rates and changes in foreign currency exchange rates asmeasured against the United States dollar. These exposures are directly relatedto our normal operating and funding activities. Historically and as ofDecember 31, 2004, we have not used derivative instruments or engaged inhedging activities. There have been no significant changes in our market riskfrom December 31, 2002.

 

**Foreign Currency Risk**

 

                Over the past severalyears, we have expanded our international sales and marketing efforts. Our exposureto foreign currency and other international business risks may increase as ourinternational business grows. We attempt to minimize these risks by:(1) generally requiring payments in U.S. dollars; (2) using lettersof credit; and (3) requiring advance deposits and through other means. Ourinternational sales and marketing efforts may not be successful and we may notsuccessfully minimize associated risks.

 

 

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                We are exposed to foreigncurrency risks through our subsidiary operations in Switzerland and Germany. AtDecember 31, 2004 we had cash, receivables and current liabilitiestotaling $1.2 million that represents a net asset balance denominated inEuros. We do not employ any risk mitigation or hedging techniques with respectto amounts exposed to fluctuations in foreign currency exchange rates.

 

**Interest Rate Risk**

 

                At December 31,2004, we had an $8.0 million credit facility, subject to restrictionsbased on eligible receivables. Borrowings under the credit facility would havereflected interest at the bank’s prime rate plus 2.75% and therefore anyborrowings under the credit facility would have subjected us to interest ratefluctuations. At December 31, 2004, there were $1.5 million in outstandingborrowings under the facility. Increases in interest rates could have increasedthe interest expense associated with future borrowings under our creditfacility. However, the debt was refinanced subsequent to year-end at a fixedinterest rate.  At December 31, 2004we had a capital lease obligation, including current portion, in the aggregateamount of $0.2 million. The capital lease obligation has a remaining termof less than one year and will be repaid with monthly principal and interest paymentsat a fixed interest rate. A change in interest rates would not affect ouroutstanding debt as of December 31, 2004, as the interest rates related tothese obligations are fixed.

 

At times, cash balances with our financial institution exceed FDICinsurance limits.

 

**ITEM 8. FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

                Our audited financialstatements and notes thereto described in Item 15(a) of this report onForm 10-K and appearing on pages F-1 through F-22of this report are incorporated by reference herein. See also “QuarterlyFinancial Data (unaudited)” appearing in Note 13 of our audited financialstatements, which is incorporated herein by reference.

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

                None

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

                We carried out anevaluation, under the supervision and with the participation of our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of ourdisclosure controls and procedures as of December 31, 2004.  Our disclosure controls and procedures aredesigned with the objective of ensuring that information required to bedisclosed in our reports filed under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms.  Theevaluation included certain control areas in which we have made, and arecontinuing to make, changes to improve and enhance controls.  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of December 31,2004, our disclosure controls and procedures are effective in all materialrespects in alerting them to material information required to be included inour periodic SEC reports.  In designingand evaluating the disclosure controls and procedures, management recognizedthat even the most well designed and operated control systems are subject toinherent limitations and assumptions about the likelihood of future events andcan provide only reasonable assurance of achieving the desired controlobjectives.

 

 

40

----

 

**PART III**

 

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT**

 

                Theinformation required by this Item concerning our directors is incorporated byreference to the information set forth in the sections of the Proxy Statemententitled “Proposal 1—Election of Directors” and“Section 16(a) Beneficial Ownership Reporting Compliance.” Theinformation required by this Item concerning our executive officers is incorporatedby reference to the information set forth in the section of the ProxyStatement entitled “Executive Officers and Key Employees.”

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

                Theinformation required by this Item regarding executive compensation is incorporatedby reference to the information set forth in the section of the ProxyStatement entitled “Executive Compensation.”

 

**ITEM 12. SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

                Theinformation required by this Item regarding security ownership of certainbeneficial owners and management is incorporated by reference to theinformation set forth in the section of the Proxy Statement entitled“Security Ownership of Certain Beneficial Owners and Management.” Theinformation required by this Item regarding our equity compensations plans isincorporated by reference to the information set forth in the section ofthe Proxy Statement entitled “Equity Compensation Plan Information.”

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

                Theinformation required by this Item regarding certain relationships and relatedtransactions is incorporated by reference to the information set forth in thesection of the Proxy Statement entitled “Certain Transactions.”

 

**ITEM 14. PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

                Theinformation required by this Item regarding principal accountant fees andservices is incorporated by reference to the information set forth in thesection of the Proxy Statement entitled “Independent Auditor’s Fees.”

 

 

41

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**PART IV**

 

**ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES**

 

**(a)****                                  Documentsfiled as part of this report:**

 

1.             FinancialStatements.

 

                See pages F-1through F-22 of this Form 10-K.

 

2.             FinancialStatement Schedules.

 

                Other than as listedbelow, there were no other financial statement schedules required because theinformation is either provided in the financial statements or is not requiredunder the related instructions or is inapplicable.

 

                Schedule II—Valuationaccounts.

 
| **Fiscal Year** | ** ** | **Description**                  | ** ** | **Balance at  beginning  of year**  | ** ** | **Charged to  expense**  | ** ** | **Write-offs  charged to  allowance** | ** ** | **Balance at  the end of  year**  | ** ** |
|-----------------|------------|----------------------------------|------------|-------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|
| ** **      | ** ** | ** **                       | ** ** | **(in thousands)**                  | ** ** |
| 2004            |       | Allowance  for doubtful accounts |       | $                                   | 942        |                     | $          | 37                                    |       | $                                 | (329       | )  | $ | 650 |   |
| 2003            |       | Allowance  for doubtful accounts |       | 528                                 |       | 486                      |       | (72                                   | )     | 942                               |       |
| 2002            |       | Allowance  for doubtful accounts |       | 878                                 |       | 252                      |       | (602                                  | )     | 528                               |       |
|            |       |                             |       |                                |       |                     |       |                                  |       |                              |       |
|            |       |                             |       |                                |       |                     |       |                                  |       |                              |       |
| **Fiscal Year** | ** ** | **Description**                  | ** ** | **Balance  at  beginning  of year** | ** ** | **Charged  to  expense** | ** ** | **Write-offs  charged to  reserve**   | ** ** | **Balance  at  the end of  year** | ** ** |
| ** **      | ** ** | ** **                       | ** ** | **(in  thousands)**                 | ** ** |
| 2004            |       | Inventory  Reserve               |       | $                                   | 3,320      |                     | $          | 592                                   |       | $                                 | (2,128     | ) | $ | 1,784 |   |
| 2003            |       | Inventory  Reserve               |       | 3,637                               |       | 1,149                    | (1)        | (1,466                                | )(1)       | 3,320                             |       |
| 2002            |       | Inventory  Reserve               |       | 7,014                               |       | 9,813                    |       | (13,190                               | )          | 3,637                             |       |
|                 |            |                                  |            |                                     |            |                          |            |                                       |            |                                   |            |  |  |  |  |  |

 

(1)RECLASSIFIED

 

3.             Exhibits.

 

(b)           The following arefiled as part of this report:

 
| **Exhibit Number** | ** ** | **Description of Exhibit**                                                                                                                                          |
|-------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                     |       | Certificate of Incorporation of the  Company(1)                                                                                                                     |
| 3.2                     |       | Bylaws of  the Company(1)                                                                                                                                           |
| 10.1                    |       | Agreement,  dated October 5, 1990, between the Company and Dornier Medizintechnik  GmbH(1)                                                                     |
| 10.2                    |       | Non-employee  Director Stock Option Plan, as amended(5)                                                                                                             |
| 10.3                    |       | Stock Option  Plan(1)                                                                                                                                               |
| 10.4                    |       | Retention  Bonus Plan(3)                                                                                                                                            |
| 10.5                    |       | Lease  Agreement, dated July 31, 1992, between the Company and JN Properties(2)                                                                                |
| 10.6                    |       | Agreement  dated October 10, 1997, between the Company and Ethicon  Endo-Surgery, Inc. with Addendum dated January 28, 1998(5)                       |
| 10.7                    |       | Addendum,  dated February 2, 2002, to Agreement dated October 10, 1997 between  the Company and Ethicon Endo-Surgery, Inc.(6)                        |
| 10.8                    |       | Distributor  Agreement dated December 9, 1998, between the Company and Ethicon  Endo-Surgery, Inc.(9)                                                     |
| 10.9                    |       | Addendum  No. 1, dated December 9, 2000, to Distributor Agreement dated  December 9, 1998 between the Company and Ethicon Endo-Surgery, Inc.(9) |

 

 

42

----

 
| **Exhibit Number** | ** ** | **Description of Exhibit**                                                                                                                                                         |
|-------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10                   |       | Addendum No. 2, dated  February 21, 2003, to Distributor Agreement dated December 9, 1998  between the Company and Ethicon Endo-Surgery, Inc.(9)               |
| 10.11                   |       | Non-Exclusive Distributorship  Agreement dated October 10, 2002, between the Company and Ethicon  Endo-Surgery, Inc.(9)                                                  |
| 10.12                   |       | Form of Indemnification Agreement,  dated September 1999, between the Company and Morgan W. Nields(9)                                                                    |
| 10.13                   |       | Form of Indemnification Agreement,  dated January 2003 between the Company and each of Harris S. Ravine, J.  Taylor Simonton, Todger Anderson, and Gail S. Schoettler(9) |
| 10.16                   |       | Employee Ethics and Business Conduct  Policy(9)                                                                                                                                    |
| 10.17                   |       | Separation agreement with Morgan W. Nields  dated December 19, 2003(10)                                                                                                       |
| 10.19                   |       | Amended and Restated 2004 Stock Incentive Plan  (11)                                                                                                                               |
| 10.21                   |       | Master Purchasing Agreement between the  Company and Philips Medical Systems DMC GmbH dated October 14, 2004(12)                                                              |
| 10.22                   |       | Note and Warrant Purchase Agreement dated February 22, 2005  between the Company and ComVest Investment Partners II LLC(13)                                                   |
| 10.23                   |       | Senior Secured Promissory Note dated  February 22, 2005 between the Company and ComVest Investment Partners II  LLC(13)                                                       |
| 10.24                   |       | Warrant dated February 22, 2005  between the Company and ComVest Investment Partners II LLC(13)                                                                               |
| 10.25                   |       | Registration Rights Agreement dated February 22, 2005 between  the Company and ComVest Investment Partners II LLC(13)                                                         |
| 10.26                   |       | Security Agreement Company dated  February 22, 2005 between the Company and ComVest Investment Partners II  LLC(13)                                                           |
| 10.27                   |       | Accounts Receivable Financing Modification  Agreement dated December 7, 2004 between the Company and Silicon Valley  Bank (14)                                                |
| 10.28                   |       | Amendment No. 1 to Note and Warrant  Purchase Agreement dated March 29, 2005 between the Company and ComVest  Investment Partners II LLC(14)                             |
| 10.29                   |       | Amended and Restated Warrant dated as of  February 22, 2005 between the Company and ComVest Investment Partners II  LLC(14)                                                   |
| 21                      |       | List of Subsidiaries(14)                                                                                                                                                           |
| 23.1                    |       | Consent of Ehrhardt Keefe  Steiner & Hottman PC (14)                                                                                                                      |
| 23.2                    |       | Consent of Ernst and Young LLP(14)                                                                                                                                                 |
| 24.1                    |       | Power of Attorney by Todger Anderson(14)                                                                                                                                           |
| 24.2                    |       | Power of Attorney by Larry E. Lenig Jr.(14)                                                                                                                                        |
| 24.3                    |       | Power of Attorney by Charlotte Petersen(14)                                                                                                                                        |
| 24.4                    |       | Power of Attorney by Gail S. Schoettler(14)                                                                                                                                        |
| 24.5                    |       | Power of Attorney by Taylor Simonton(14)                                                                                                                                           |
| 31.1                    |       | Certification of Harris Ravine, Chief  Executive Officer and President, pursuant to Rule 13a-14(a) under  the Securities Exchange Act of 1934(14)                        |
| 31.2                    |       | Certification of David Kirwan, Chief  Financial Officer, pursuant to Rule 13a-14(a) under the  Securities Exchange Act of 1934(14)                                       |
| 32.1                    |       | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002(14)                                             |
| 32.2                    |       | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002(14)                                             |
| 99.1                    |       | Audit Committee Charter(10)                                                                                                                                                        |

__________________________

(1)                                  Incorporated byreference to the Company’s Registration Statement on Form S-1, FileNo. 33-41537, as filed with the Securities and Exchange Commission(the “Commission”) on July 3, 1991.

 

(2)                                  Incorporated byreference to the Company’s Form 10-K for the year endedDecember 31, 1992, as filed with the Commission.

 

 

43

----

 

(3)                                  Incorporated byreference to the Company’s Form 10-K for the year endedDecember 31, 1994, as filed with the Commission on April 14, 1995.

 

(4)                                  Incorporated byreference to the Company’s Form 8-K, as filed with the Commission onJuly 3, 1995.

 

(5)                                  Incorporated byreference to the Company’s Form 10-K for the year endedDecember 31, 1997, as filed with the Commission on March 31, 1998.

 

(6)                                  Incorporated byreference to the Company’s Form 10-K for the year ended December 31,2001, as filed with the Commission on April 1, 2002.

 

(7)                                  Incorporated byreference to the Company’s Form 8-K/A, as filed with the Commissionon November 9, 2001.

 

(8)                                  Incorporated byreference to the Company’s Form 10-Q/A Amendment No. 1 for thequarter ended June 30, 2002, as filed with the Commission onSeptember 17, 2002.

 

(9)                                  Incorporated byreference to the Company’s Form 10-K for the year endedDecember 31, 2002, as filed with the Commission on April 15, 2004.

 

(10)                          Incorporatedby reference to the Form 10-K for the year ended December 31,2003, as filed with the Commission on April 15, 2004

 

(11)                          Incorporatedby reference to the Form 10-Q for the quarter ended June 30,2004, as filed with the Commission on August 15, 2004

 

(12)                            Incorporated by reference to the Form 10-Q for the quarter endedSeptember 30, 2004, as filed with the Commission on November 15,2004.

 

(13)                             Incorporated by referenceto the Form 8-K dated February 23, 2005, as filed with theCommission February 28, 2005.

 

(14)                            Filed herewith.

 

**c)****                                      Exhibits**

 

                See Item 15(a)(3) ofthis Form 10-K.

 

44

----

** **

**SIGNATURES**

 

                Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed March 31,2005 on its behalf by the undersigned, thereunto duly authorized.

 
|   | FISCHER  IMAGING CORPORATION

Registrant |
|--------|------------------------------------------|
|   |                                     |   |
|   | By:                                      | /s/  HARRIS RAVINE

Harris  Ravine*President, Chief Executive Officer  (Principal Executive Officer)* |

 

                Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned by the following persons on behalf of the Registrant, in the capacitiesand on the dates indicated.

 
| **Signature**                                    | ** ** | **Title**                                                                                                        | ** ** | **Date**            |
|--------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|---------------------|
| /s/  GAIL S. SCHOETTLER

Gail S. Schoettler |       | Chair of the Board                                                                                               |       | March 31, 2005 |
| /s/  HARRIS RAVINE

Harris Ravine           |       | President, Chief Executive Officer and a  Director  (Principal Executive Officer)                                |       | March 31, 2005 |
| /s/  DAVID KIRWAN

David Kirwan             |       | Senior Vice President-Finance, Chief  Financial Officer, Secretary  (Principal Financial and Accounting Officer) |       | March 31, 2005 |
| /s/  TODGER ANDERSON
Todger Anderson        |       | Director                                                                                                         |       | March 31, 2005 |
| /s/  LARRY LENIG

Larry Lenig               |       | Director                                                                                                         |       | March 31, 2005 |
| /s/  CHARLOTTE PETERSEN

Charlotte Petersen |       | Director                                                                                                         |       | March 31, 2005 |
| /s/  J. TAYLOR SIMONTON

J. Taylor Simonton |       | Director                                                                                                         |       | March 31, 2005 |

 
| *By: | /s/   HARRIS RAVINE

Harris Ravine

(Attorney-in-Fact by Power of

Attorney filed herewith) |   |   |
|------|--------------------------------------------------------------------------------------------------|--------|--------|

 

 

45

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** **

**FISCHER IMAGING CORPORATION**

**CONSOLIDATED FINANCIAL STATEMENTS**

**INDEX**

** **

 
|                                                                                                                  |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|
| Report  of Ehrhardt Keefe Steiner & Hottman PC                                                               | F-2    |
| Report  of Ernst and Young LLP                                                                                        | F-3    |
| Consolidated  Financial Statements:                                                                                   |   |
| Consolidated Balance  Sheets—December 31, 2004 and 2003                                                     | F-4    |
| Consolidated  Statements of Operations—For the Years Ended December 31, 2004, 2003 and  2002                | F-5    |
| Consolidated  Statements of Stockholders’ Equity—For the Years Ended December 31,  2004, 2003 and 2002 | F-6    |
| Consolidated  Statements of Cash Flows—For the Years Ended December 31, 2004, 2003 and  2002                | F-7    |
| Notes to  Consolidated Financial Statements                                                                           | F-8    |

 

 

F-1

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

** **

Board of Directors and Stockholders

Fischer Imaging Corporation

Denver, Colorado

 

We have audited the accompanyingconsolidated balance sheet of the Fischer Imaging Corporation and subsidiariesas of December 31, 2004, and the related consolidated statements ofoperations, changes in stockholders’ equity and cash flows for the year thenended. Our audit also included the financial statement schedule II for theyear ended December 31, 2004. These consolidated financial statements and schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements and schedule basedon our audit.

 

We conducted our audit in accordance with auditing standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the consolidated financial statements are free ofmaterial misstatement. **The Company is not required to have, nor were we engaged to perform, anaudit of its internal control over financial reporting. Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion.******An auditalso includes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall consolidated financial statementpresentation. We believe that our audit provides a reasonable basis for ouropinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Fischer Imaging Corporation and subsidiaries as of December 31,2004, and the results of their operations and their cash flows for the yearthen ended in conformity with accounting principles generally accepted in theUnited States of America. Also, in our opinion, the related financial statementschedule II for the year ended December 31, 2004, when considered inrelation to the basic financial statements taken as a whole, presents fairly inall material respects the information set forth therein.

 
|   |   | /s/  Ehrhardt Keefe Steiner & Hottman P.C. |
|--------|--------|-----------------------------------------------------|

 

March 4,2005, except for the matters discussed in Notes 1 and 5, as to which thedate is March 30, 2005.

 

Denver, Colorado

 

 

F-2

----

 

 

**Reportof Independent Registered Public Accounting Firm**

 

To the Stockholders and Board of Directors of

Fischer Imaging Corporation

 

We have audited the accompanying consolidatedbalance sheets of Fischer Imaging Corporation and subsidiaries as of December31, 2003, and the related consolidated statements of income, shareholders’equity, and cash flows for each of the two years in the period ended December31, 2003.  These financial statements arethe responsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. We were not engaged to perform an audit of the Company’s internalcontrol over financial reporting. Our audit included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion.  An audit also includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In our opinion, the financial statementsreferred to above present fairly, in all material respects, the consolidatedfinancial position of Fischer Imaging Corporation and subsidiaries at December31, 2003, and the consolidated results of their operations and their cash flowsfor each of the two years in the period ended December 31, 2003, in conformitywith U.S. generally accepted accounting principles.

 
|                                  | /s/ Ernst & Young LLP |
|---------------------------------------|--------------------------------|
| Denver, Colorado

April 14, 2004 |                           |

 

 

F-3

----

** **

**FISCHER IMAGING CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(Amounts in thousands except share data)**

 
| ** **                                                                                                                                                                             | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                                                                             |       |                  |       |   |   |
| Current Assets:                                                                                                                                                                        |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                              |       | $                     | 1,939      |   | $ | 1,396 |   |
| Certificate of deposit, restricted cash                                                                                                                                                |       | 514                   |       | 514 |   |
| Accounts receivable, net of allowance for doubtful accounts of $650  and $942 at December 31, 2004 and 2003, respectively                                                         |       | 7,286                 |       | 9,371 |   |
| Inventories, net                                                                                                                                                                       |       | 16,034                |       | 14,918 |   |
| Prepaid expenses and other current assets                                                                                                                                              |       | 751                   |       | 1,637 |   |
| Total current assets                                                                                                                                                                   |       | 26,524                |       | 27,836 |   |
| Property and equipment:                                                                                                                                                                |       |                  |       |   |   |
| Manufacturing equipment                                                                                                                                                                |       | 5,129                 |       | 4,415 |   |
| Office equipment and leasehold improvements                                                                                                                                            |       | 6,300                 |       | 5,453 |   |
| Total property and equipment                                                                                                                                                           |       | 11,429                |       | 9,868 |   |
| Less: accumulated depreciation                                                                                                                                                         |       | (7,612                | )          | (6,458 | ) |
| Property and equipment, net                                                                                                                                                            |       | 3,817                 |       | 3,410 |   |
| Intangible assets, net                                                                                                                                                                 |       | 1,033                 |       | 1,077 |   |
| Other                                                                                                                                                                                  |       | —                |       | 25 |   |
| Total assets                                                                                                                                                                           |       | $                     | 31,374     |   | $ | 32,348 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                         |       |                  |       |   |   |
| Current Liabilities:                                                                                                                                                                   |       |                  |       |   |   |
| Accounts payable                                                                                                                                                                       |       | $                     | 10,666     |   | $ | 8,378 |   |
| Current maturities under capital lease obligation                                                                                                                                      |       | 224                   |       | 231 |   |
| Accrued salaries and wages                                                                                                                                                             |       | 1,617                 |       | 1,630 |   |
| Customer deposits                                                                                                                                                                      |       | 3,123                 |       | 4,091 |   |
| Accrued warranties                                                                                                                                                                     |       | 3,013                 |       | 1,987 |   |
| Deferred service revenue                                                                                                                                                               |       | 1,121                 |       | 455 |   |
| Other current liabilities                                                                                                                                                              |       | 2,591                 |       | 1,659 |   |
| Total current liabilities                                                                                                                                                              |       | 22,355                |       | 18,431 |   |
| Long-term debt                                                                                                                                                                         |       | 1,454                 |       | 223 |   |
| Non-current deferred revenue                                                                                                                                                           |       | 972                   |       | 619 |   |
| Total liabilities                                                                                                                                                                      |       | 24,781                |       | 19,273 |   |
| Commitment and contingencies                                                                                                                                                           |       | —                |       | — |   |
| Stockholders’ Equity:                                                                                                                                                             |       |                  |       |   |   |
| Preferred Stock, 5,000,000 shares authorized:                                                                                                                                          |       |                  |       |   |   |
| Series C Junior participating preferred stock, $.01 par value,  500,000 shares authorized, no shares issued and outstanding                                                       |       | —                |       | — |   |
| Series D Convertible preferred stock, $.01 par value, 506,667  shares authorized, no shares issued and outstanding                                                                |       | —                |       | — |   |
| Common stock, $.01 par value, 25,000,000 shares authorized; 9,374,484  and 9,348,484 shares issued and outstanding at December 31, 2004 and December 31,  2003, respectively |       | 94                    |       | 94 |   |
| Paid-in capital                                                                                                                                                                        |       | 49,400                |       | 49,343 |   |
| Accumulated deficit                                                                                                                                                                    |       | (42,633               | )          | (35,712 | ) |
| Accumulated other comprehensive loss                                                                                                                                                   |       | (268                  | )          | (650 | ) |
| Total stockholders’ equity                                                                                                                                                        |       | 6,593                 |       | 13,075 |   |
| Total liabilities and stockholders’ equity                                                                                                                                        |       | $                     | 31,374     |   | $ | 32,348 |   |
|                                                                                                                                                                                   |       |                  |       |   |   |
|                                                                                                                                                                                        |            |                       |            |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

 

F-4

----

** **

**FISCHERIMAGING CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Amounts in thousands except per share data)**

 
| ** **                                                              | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                              | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:                                                               |       |                                      |       |   |   |   |   |
| Products                                                                |       | $                                         | 48,645     |   | $ | 32,814 |   | $ | 30,630 |   |
| Services                                                                |       | 15,395                                    |       | 13,348 |   | 14,480 |   |
| Total revenues                                                          |       | 64,040                                    |       | 46,162 |   | 45,110 |   |
| Cost of sales:                                                          |       |                                      |       |   |   |   |   |
| Products                                                                |       | 33,648                                    |       | 25,109 |   | 28,180 |   |
| Services                                                                |       | 17,523                                    |       | 13,629 |   | 11,887 |   |
| Total cost of sales                                                     |       | 51,171                                    |       | 38,738 |   | 40,067 |   |
| Gross profit                                                            |       | 12,869                                    |       | 7,424 |   | 5,043 |   |
| Operating expenses:                                                     |       |                                      |       |   |   |   |   |
| Research and development                                                |       | 6,531                                     |       | 4,654 |   | 4,559 |   |
| Selling and marketing                                                   |       | 10,469                                    |       | 9,376 |   | 7,981 |   |
| General and administrative                                              |       | 7,917                                     |       | 8,754 |   | 7,697 |   |
| Total operating expenses                                                |       | 24,917                                    |       | 22,784 |   | 20,237 |   |
| Loss from operations                                                    |       | (12,048                                   | )          | (15,360 | ) | (15,194 | ) |
| Other income (expense):                                                 |       |                                      |       |   |   |   |   |
| Interest expense                                                        |       | (66                                       | )          | (49 | ) | (81 | ) |
| Interest income                                                         |       | 4                                         |       | 62 |   | 119 |   |
| Patent settlement income                                                |       | 5,150                                     |       | 900 |   | 24,950 |   |
| Other                                                                   |       | 39                                        |       | 34 |   | (74 | ) |
| Total other income (expense)                                            |       | 5,127                                     |       | 947 |   | 24,914 |   |
| (Loss) income before income taxes                                       |       | (6,921                                    | )          | (14,413 | ) | 9,720 |   |
| Provision for income taxes                                              |       | —                                    |       | — |   | — |   |
| Net (loss) income                                                       |       | $                                         | (6,921     | ) | $ | (14,413 | ) | $ | 9,720 |   |
| Net (loss) income per share:                                            |       |                                      |       |   |   |   |   |
| Basic                                                                   |       | $                                         | (0.74      | ) | $ | (1.55 | ) | $ | 1.06 |   |
| Diluted                                                                 |       | $                                         | (0.74      | ) | $ | (1.55 | ) | $ | 1.00 |   |
| Weighted average shares used to calculate net (loss) income per  share: |       |                                      |       |   |   |   |   |
| Basic                                                                   |       | 9,353                                     |       | 9,319 |   | 9,204 |   |
| Diluted                                                                 |       | 9,353                                     |       | 9,319 |   | 9,692 |   |
|                                                                    |       |                                      |       |   |   |   |   |
|                                                                         |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedstatements.

 

 

F-5

----

 

**FISCHERIMAGING CORPORATION**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**(Amounts in thousands except share data)**

 
| ** **                                             | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
| **Shares**                                             | ** ** | **Amount**        | ** ** |
| ** **                                             | ** ** | ** **        | ** ** | ** **                       | ** ** | ** **               | ** ** | ** **                                           | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Balances, December 31, 2001                       |       | 9,176,929         |       | $                                | 91         |                     | $          | 48,798                                               |       | $                                     | (31,019    | ) | $ | (201 | ) | $ | 17,669 |   |
| Comprehensive income:                                  |       |              |       |                             |       |                     |       |                                                 |       |                                  |       |   |   |
| Net income                                             |       | —            |       | —                           |       | —                   |       | 9,720                                                |       | —                                |       | 9,720 |   |
| Foreign currency translation adjustments               |       | —            |       | —                           |       | —                   |       | —                                               |       | (231                                  | )          | (231 | ) |
| Total comprehensive income                             |       | —            |       | —                           |       | —                   |       | —                                               |       | —                                |       | 9,489 |   |
| Exercise of stock options                              |       | 129,647           |       | 2                                |       | 333                      |       | —                                               |       | —                                |       | 335 |   |
| Balances, December 31, 2002                       |       | 9,306,576         |       | 93                               |       | 49,131                   |       | (21,299                                              | )          | (432                                  | )          | 27,493 |   |
| Comprehensive loss:                                    |       |              |       |                             |       |                     |       |                                                 |       |                                  |       |   |   |
| Net loss                                               |       | —            |       | —                           |       | —                   |       | (14,413                                              | )          | —                                |       | (14,413 | ) |
| Foreign currency translation adjustments               |       | —            |       | —                           |       | —                   |       | —                                               |       | (218                                  | )          | (218 | ) |
| Total comprehensive loss                               |       | —            |       | —                           |       | —                   |       | —                                               |       | —                                |       | (14,631 | ) |
| Shares purchased under an Employee Stock Purchase Plan |       | 25,408            |       | —                           |       | 129                      |       | —                                               |       | —                                |       | 129 |   |
| Stock options issued below market value                |       | —            |       | —                           |       | 31                       |       | —                                               |       | —                                |       | 31 |   |
| Exercise of stock options                              |       | 16,500            |       | 1                                |       | 52                       |       | —                                               |       | —                                |       | 53 |   |
| Balances, December 31, 2003                       |       | 9,348,484         |       | 94                               |       | 49,343                   |       | (35,712                                              | )          | (650                                  | )          | 13,075 |   |
| Comprehensive loss:                                    |       |              |       |                             |       |                     |       |                                                 |       |                                  |       |   |   |
| Net loss                                               |       | —            |       | —                           |       | —                   |       | (6,921                                               | )          | (6,921                                | )          |   |   |
| Foreign currency translation adjustments               |       | —            |       | —                           |       | —                   |       | —                                               |       | 382                                   |       | 382 |   |
| Total comprehensive loss                               |       | —            |       | —                           |       | —                   |       | —                                               |       | —                                |       | (6,536 | ) |
| Exercise of stock options                              |       | 26,000            |       | —                           |       | 57                       |       | —                                               |       | —                                |       | 57 |   |
| Balances, December 31, 2004                       |       | 9,374,484         |       | $                                | 94         |                     | $          | 49,400                                               |       | $                                     | (42,633    | ) | $ | (268 | ) | $ | 6,593 |   |
|                                                   |       |              |       |                             |       |                     |       |                                                 |       |                                  |       |   |   |
|                                                        |            |                   |            |                                  |            |                          |            |                                                      |            |                                       |            |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedstatements.

 

 

F-6

----

 

**FISCHERIMAGING CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Amounts in thousands)**

 
| ** **                                                                                       | ** ** | **For the Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Cash flows from operating activities:                                                            |       |                                      |       |   |   |   |   |
| Net (loss) income                                                                                |       | $                                         | (6,921     | ) | $ | (14,413 | ) | $ | 9,720 |   |
| Adjustments to reconcile net (loss) income to net cash provided  (used) by operating activities: |       |                                      |       |   |   |   |   |
| Depreciation                                                                                     |       | 1,154                                     |       | 1,109 |   | 674 |   |
| Amortization of intangible assets                                                                |       | 44                                        |       | 44 |   | 509 |   |
| Gain on sale of investment                                                                       |       | (123                                      | )          | — |   | — |   |
| Loss on sales and retirements of assets                                                          |       | —                                    |       | — |   | 191 |   |
| Non-cash compensation expense                                                                    |       | —                                    |       | 31 |   | — |   |
| Foreign exchange (gains) losses                                                                  |       | —                                    |       | (33 | ) | 31 |   |
| Change in operating assets and liabilities                                                       |       |                                      |       |   |   |   |   |
| Accounts receivable, net                                                                         |       | 2,085                                     |       | (686 | ) | (1,362 | ) |
| Inventories, net                                                                                 |       | (1,116                                    | )          | 3,035 |   | 291 |   |
| Prepaid expenses and other current assets                                                        |       | 886                                       |       | (1,222 | ) | (274 | ) |
| Accounts payable and accrued liabilities                                                         |       | 3,207                                     |       | 2,612 |   | (1,031 | ) |
| Customer deposits                                                                                |       | (968                                      | )          | 2,861 |   | (1,312 | ) |
| Accrued warranty                                                                                 |       | 1,026                                     |       | 311 |   | 985 |   |
| Deferred service revenue                                                                         |       | 666                                       |       | 161 |   | (60 | ) |
| Other                                                                                            |       | 353                                       |       | 549 |   | 942 |   |
| Net cash provided (used) by operating activities                                                 |       | 293                                       |       | (5,641 | ) | 9,304 |   |
| Cash flows from investing activities:                                                            |       |                                      |       |   |   |   |   |
| Purchases of property and equipment                                                              |       | (1,561                                    | )          | (1,268 | ) | (2,197 | ) |
| Proceeds from sale of investment                                                                 |       | 148                                       |       | — |   | — |   |
| Purchase of certificate of deposit (restricted cash)                                             |       | —                                    |       | (514 | ) | — |   |
| Other                                                                                            |       | —                                    |       | — |   | (103 | ) |
| Net cash used in investing activities                                                            |       | (1,413                                    | )          | (1,782 | ) | (2,300 | ) |
| Cash flows from financing activities:                                                            |       |                                      |       |   |   |   |   |
| Proceeds from sale of common stock                                                               |       | 57                                        |       | 182 |   | 335 |   |
| Proceeds from sale/leaseback                                                                     |       | —                                    |       | 514 |   | — |   |
| Proceeds from line of credit                                                                     |       | 4,108                                     |       | — |   | — |   |
| Repayments on line of credit                                                                     |       | (2,654                                    | )          | — |   | — |   |
| (Repayments on) proceeds from long-term debt, net                                                |       | (230                                      | )          | (60 | ) | 60 |   |
| Net cash provided by financing activities                                                        |       | 1,281                                     |       | 636 |   | 395 |   |
| Effect of exchange rate changes on cash                                                          |       | 382                                       |       | (218 | ) | (231 | ) |
| Net increase (decrease) in cash and cash equivalents                                             |       | 543                                       |       | (7,005 | ) | 7,168 |   |
| Cash and cash equivalents, beginning of year                                                     |       | 1,396                                     |       | 8,401 |   | 1,233 |   |
| Cash and cash equivalents, end of year                                                           |       | $                                         | 1,939      |   | $ | 1,396 |   | $ | 8,401 |   |
| Supplemental cash flow disclosures:                                                              |       |                                      |       |   |   |   |   |
| Cash interest payments                                                                           |       | $                                         | 61         |   | $ | 51 |   | $ | 81 |   |
| Cash income tax payments                                                                         |       | 14                                        |       | 15 |   | 32 |   |

 

The accompanying notes are an integral part of these consolidatedstatements.

 

 

F-7

----

 

**FISCHERIMAGING CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**For the three years ended December 31, 2004, 2003and 2002**

 

**(1) BUSINESS OPERATIONS**

 

**Organization**

 

                Fischer Imaging Corporation,together with its wholly owned subsidiaries, (“Fischer” or “the Company”)designs, manufactures and sells innovative mammography and digital imagingproducts used to diagnose breast cancer and other diseases. The Company’sprimary focus is on using its digital imaging technology in screening anddiagnostic mammograms and minimally invasive breast biopsy to aid in the earlyidentification of breast cancer. The Company sells high-resolution digitalmammography products, enabling radiologists, surgeons and other healthcaretreatment professionals to diagnose or rule out disease early and treatpatients with less-invasive procedures. The Company has also refocused itsefforts to market and sell products that meet selected needs of the broaderradiology and electrophysiology markets. The consolidated financial statementsinclude the accounts of Fischer Imaging Corporation and all subsidiaries. Allsignificant inter-company accounts and transactions have been eliminatedin consolidation.

 

**Management Plans**

 

                Managementhas developed an operating plan intended to return the Company to positive cashflow from operations. Key components to this plan include increasing revenues,improving operating efficiencies and supply chain costs in order to reduce costof sales and to improve gross margins and lowering overall operating costs as apercentage of revenues. Management is undertaking a number of steps to improvethe performance and reliability and to enhance the image processing, workflowand connectivity features of its SenoScan product. Management is taking stepsto redesign parts and components for its products and is planning to completethe redesign of its SenoScan product in 2005 at which time the SenoScan productwill be relaunched. Management expects that US service revenues will increase,provided that the installed base for its products continues to grow, such thatservice revenues will fall more in line with the service cost infrastructureand that parts usage costs will decline, provided that component reliabilityimprovement initiatives underway succeed, such that the US service businesswill see a return to positive gross margins. Management has begun the processof restructuring its sales and service operations in Europe with the goal oftransferring its European service business and addressing the European marketthrough a strategic distribution agreement, thereby eliminating the need forthe current European infrastructure. Management has taken steps to develop andestablish Corporate Relationships to augment its direct sales force such thatit expects to broaden its product reach and increase revenues and also intendsto acquire complementary products to integrate with its existing products andofferings for sale through its existing sales channels to its customer base.

 

**(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Use of Estimates in the Preparation of Financial Statements**

 

                The Company uses estimates andassumptions in preparing financial statements in accordance with accountingprinciples generally accepted in the United States. Those estimates andassumptions affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and contingent liabilities, and the reportedrevenue and expenses. Actual results could vary from the estimates that wereused.

 

**Revenue Recognition**

 

                The Company follows theprovisions of SEC Staff Accounting Bulletin No. 104, “Revenue Recognitionin Financial Statements” (“SAB 104”) which provides for revenue recognitionwhen persuasive evidence of an arrangement exists, delivery has occurred, theprice is fixed and determinable and collectibility is reasonably assured. TheCompany’s standard business practice requires that sales transactions aresupported by an executed sales agreement or an executed purchase order. TheCompany recognizes product revenue for its medical equipment when title andrisk of loss have transferred to the customer and the Company has nopost-shipment performance obligations other than installation or training.Where

 

 

F-8

----

 

installation and/or training services are provided in a salesagreement and they have not been completed at the time product revenue isrecognized, the fair value of these services is deferred and subsequentlyrecognized as revenue when each of the services are performed. In cases where the sales agreementprescribes additional consequential performance obligations or requiresspecific performance criteria be met for customer acceptance, the Companydefers revenue recognition on the product sale until such conditions aresatisfied.

 

The Company bills service contracts and extended warranty agreements inadvance either monthly, quarterly, annually or at the time of the product sale,depending upon the customers’ request. The amounts billed are recorded asdeferred revenue and recognized as revenue ratably during the period for whichthe contracts are in effect. The Company recognizes revenue from services billed on a time andmaterial basis when the services are performed. The Company also sellsreplacement parts to customers and records revenue at the time of shipment whentitle transfers. Certain replaced parts may be returned for partial credit, andthe Company records sales allowances based on historical experience to accountfor the future effect of those returns.

 

Accountsreceivable are carried at original invoice amounts less an estimate for doubtfulaccounts and sales returns based on a periodic review of outstandingreceivables. Allowances are provided for known and anticipated credit losses asdetermined by management in the course of regularly evaluating individualcustomer receivables. This evaluation takes into consideration a customer’sfinancial condition and credit history as well as current economic conditions.Accounts receivable are written off when deemed uncollectible. Recovery ofaccounts receivable previously written off are recorded when received.

 

**Cash and Cash Equivalents**

 

Cash and cash equivalents include cash on hand, demand deposits, andshort-term investments with an original maturity of three months or less. Cashand cash equivalents include financial instruments that potentially subject theCompany to a concentration of credit risk. The Company places its cash andtemporary cash investments with high credit quality institutions. At times,cash held in the Company’s primary bank may be in excess of the FDIC insurancelimits.

 

**Inventories**

 

The Company values inventory at the lower of cost or market using thefirst-in, first-out (FIFO) method. The Company assesses the recoverability ofinventory based on obsolescence or overstocked inventory equal to thedifference between the cost of inventory and the estimated market value basedupon historical experience and assumptions about future demand and changes inmarket conditions. These assessments require judgments and estimates, andvaluation adjustments for excess and obsolete inventory may be recorded basedon these periodic assessments.

 

Inventories consist of the following components (in thousands) as of December 31,:

 

| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Raw materials                               |       | $        | 8,952      |     | $          | 8,925 |   |
| Work in process and finished goods          |       | 8,866    |       | 9,313    |       |
| Reserve for excess and obsolete inventories |       | (1,784   | )          | (3,320   | )          |
| Inventories, net                            |       | $        | 16,034     |     | $          | 14,918 |   |
|                                        |       |     |       |     |       |

 

**Property and Equipment**

 

Property and equipment is stated at the lower of depreciated cost ornet realizable value. Significant additions and improvements are capitalized atcost, while maintenance and repairs that do not improve or extend the life ofthe respective assets are charged to expense as incurred.

 

Manufacturing and office equipment are depreciated or amortized on astraight-line basis, over the estimated useful lives (ranging from 3 to8 years) of the respective assets. Leasehold improvements are amortized,on a straight-line basis, over the lesser of the estimated useful life or theremaining term of the related lease.

 

 

F-9

----

 

**Intangible Assets**

 

                Intangible assets consist ofidentifiable intangible assets and goodwill. Identifiable intangible assetsconsist of a non-compete agreement and a patent license, which are stated atcost. Identifiable assets are amortized on straight-line basis over theirexpected useful lives ranging from 8 to 10 years. Goodwill is the excessof the purchase price over the fair value of net assets acquired related toacquisitions. Goodwill is recorded net of accumulated amortization through December 31,2001. In accordance with the Statement of Financial Accounting Standards (SFAS)No. 142, “Goodwill and Other Intangible Assets”, effective January 1,2002, goodwill is no longer amortized, but is subject to an annual impairmentanalysis.

 

**Long-Lived Assets including Identifiable Intangible AssetsSubject to Amortization**

 

                In August 2001, theFinancial Accounting Standards Board (“FASB”), issued SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 appliesto all long-lived assets (including discontinued operations) and requires thatlong-lived assets be evaluated for impairment if indicators of impairment arepresent and if necessary written down to estimated fair value. SFAS No. 144also develops an accounting model for long-lived assets that are to be disposedof by sale and requires the measurement to be the lower of book value or fairvalue, less the cost to sell the assets. Additionally, SFAS No. 144expands the scope of discontinued operations to include all components of anentity with operations that can be distinguished from the rest of the entityand will be eliminated from the ongoing operations of the entity in a disposaltransaction.

 

                Long-lived assets are reviewedfor impairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. In performing the reviewfor recoverability, the Company estimates the future cash flows expected toresult from the use of the asset and its eventual disposition. If the sum ofthe expected future cash flows (undiscounted and without interest charges) isless than the carrying amount of the asset, the asset is written down to itsestimated fair value. The Company has determined that no long-lived assets wereimpaired at December 31, 2004.

 

**Financial Instruments**

 

                The fair market value ofaccounts receivable, accounts payable, debt and other financial instrumentsapproximates their carrying values in the accompanying consolidated balance sheets.The fair value of debt was determined based upon current interest ratesavailable to Fischer.

 

**Product Warranty**

 

                The Company provides for theestimated cost of product warranties at the time revenue is recognized.Although the Company engages in extensive product quality programs andprocesses, its warranty obligation is affected by product failure rates andservice delivery costs incurred in correcting a product failure. Should actualproduct failure rates or service costs differ from the Company’s estimates,which are based on historical data, and engineering estimates, whereapplicable, revisions to the estimated warranty liability would be required.The typical standard warranty term is for 12 months starting from the dateof installation. The Company also sells extended warranties ranging from 12 to60 months.

 

                Activity in the product warrantyaccrual for the years ended December 31, 2004 and 2003 follows (inthousands):

 

| ** **              | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Beginning balance       |       | $        | 1,987      |     | $          | 1,676 |   |
| Add: Warranty provision |       | 4,078    |       | 2,557    |       |
| Less: Cost incurred     |       | (3,052   | )          | (2,246   | )          |
| Ending balance          |       | $        | 3,013      |     | $          | 1,987 |   |
|                    |       |     |       |     |       |

 

**Translation of Foreign Currencies**

 

                The assets and liabilities ofthe Company’s consolidated foreign subsidiaries, whose cash flows are primarilyin their local currencies, have been translated into U.S. dollars using thecurrent exchange rates at each balance sheet date. The operating results ofthese foreign subsidiaries have been translated at average exchange rates thatprevailed during each reporting period. Adjustments resulting from translationof foreign currency financial statements are reflected as accumulated othercomprehensive income in the consolidated balance sheets. Exchange gains andlosses resulting from foreign currency transactions (transactions denominatedin a currency other than that of the entity’s primary cash flow) are includedin operations in the period in which they occur.

 

 

F-10

----

 

**Research and Development Costs**

 

                Research and product developmentcosts are expensed as incurred and include primarily engineering salaries,overhead and materials used in connection with research and developmentprojects.

 

**Advertising Costs**

 

                The Company expenses advertisingcosts as incurred. Advertising costs of $400,000, $320,000 and $408,000 wereexpensed in 2004, 2003 and 2002, respectively.

 

**Stock-Based Compensation Plans:**

 

**Non-employee Director Stock Option Plan**

 

                At December 31, 2004, theCompany’s Non-employee Director Stock Option Plan (the “Director Plan”),adopted in 1993 and amended in June 1998, authorizes the granting ofnonqualified options to acquire up to 300,000 shares of common stock. TheDirector Plan allows for automatic annual grants upon each year of director’sservice, and for discretionary grants on such terms and conditions as are setby the Board at the time of grant. The stock options issued under the DirectorPlan may be exercised at any time from date of grant, with a maximum optionterm of ten years.

 

**Employee Stock Option Plan and Employee Stock Purchase Plan**

 

                At December 31, 2004, theCompany had an employee stock option plan and an employee stock purchase plan,which are described more fully in Note 7. The Company has elected toaccount for stock-based compensation arrangements using the intrinsicvalue method under the provisions of Accounting Principles Board Opinion No. 25(“APB 25”), “Accounting for Stock Issued to Employees”. Under this method,stock compensation is recognized to the extent that the exercise price is lessthan the market price for the underlying stock on the date of grant.

 

                The following table illustratesthe effect on net income (loss) and net income (loss) per share if the Companyhad applied the fair value recognition provisions of Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-BasedCompensation,” to stock-based employee compensation (in thousands exceptshare data) for the years ended December 31,:

 
| ** **                                                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net (loss) income:                                        |       |     |       |     |       |     |       |
| As reported                                               |       | $        | (6,921     | )        | $          | (14,413  | )          | $ | 9,720 |   |
| Add stock options issued below market value               |       | —   |       | 31       |       | —   |       |
| Less stock based compensation under the fair value method |       | (1,005   | )          | (1,412   | )          | (1,560   | )          |
| Pro forma                                                 |       | $        | (7,926     | )        | $          | (15,794  | )          | $ | 8,160 |   |
| Net (loss) income per common share, basic:                |       |     |       |     |       |     |       |
| As reported                                               |       | $        | (0.74      | )        | $          | (1.55    | )          | $ | 1.06 |   |
| Pro forma                                                 |       | $        | (0.85      | )        | $          | (1.69    | )          | $ | 0.89 |   |
| Net (loss) income per common share, diluted:              |       |     |       |     |       |     |       |
| As reported                                               |       | $        | (0.74      | )        | $          | (1.55    | )          | $ | 1.00 |   |
| Pro forma                                                 |       | $        | (0.85      | )        | $          | (1.69    | )          | $ | 0.84 |   |
|                                                           |            |          |            |          |            |          |            |  |  |  |  |  |

 

                The weighted average fair valueof each option grant has been estimated as of the date of grant using the Black-Scholesoption-pricing model and the following weighted average assumptions:

 
| ** **               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend rate            |       | 0.0      | %          | 0.0      | %          | 0.0      | %          |
| Expected volatility      |       | 94.0     | %          | 94.9     | %          | 104.3    | %          |
| Risk-free interest rate  |       | 3.8      | %          | 2.5      | %          | 2.5      | %          |
| Expected life (in years) |       | 5.0      |       | 5.0      |       | 5.0      |       |

 

 

Theweighted average fair value of options granted during the 2004, 2003 and 2002was $2.47, $3.96 and $5.51,

 

 

F-11

----

 

respectively.

 

**Net Earnings or Loss Per Share**

 

                Basic earnings or loss per shareis computed by dividing the net earnings or loss by the weighted average numberof shares of common stock outstanding at the reporting date. Diluted earningsor loss per share is determined by dividing the net earnings or loss by the sumof the weighted average number of common shares outstanding, and if notanti-dilutive, the effect of outstanding stock options determined utilizing thetreasury stock method. Dilutive securities consist of the following (inthousands):

 

| ** **                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Weighted average common shares   |       | 9,353    |       | 9,319    |       | 9,204    |       |
| Dilutive effect of stock options |       | —   |       | —   |       | 488      |       |
| Total                            |       | 9,353    |       | 9,319    |       | 9,692    |       |
|                             |       |     |       |     |       |     |       |

 

                Common stock equivalentsexcluded from diluted earnings per share because their effect is anti-dilutiveare as follows (in thousands):

 

| ** **                            | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Anti-dilutive effect of stock options |       | 1,373    |       | 1,483    |       | 1,068    |       |

 

**Comprehensive Income (Loss)**

 

                Components of comprehensiveincome include net income (loss) and certain transactions that have generallybeen reported in the consolidated statements of stockholders’ equity. Othercomprehensive income includes foreign currency translation adjustments.

 

**Recently Issued Accounting Pronouncements**

 

                In November 2002, the FASBissued SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.” SFAS No. 150 improves theaccounting for certain financial instruments that, under previous guidance,issuers could account for as equity and requires that those instruments beclassified as liabilities (or assets in certain circumstances) in statements offinancial position. SFAS No. 150 also requires disclosures aboutalternative ways of settling the instruments and the capital structure ofentities, all of whose shares are mandatorily redeemable. SFAS No. 150 isgenerally effective for all financial instruments entered into or modifiedafter May 31, 2003, and otherwise is effective at the beginning of thefirst interim period beginning after June 15, 2003. The adoption of SFAS No. 150did not have a material impact on its financial position or results ofoperations.

 

                In January 2003, the FASBissued Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities.” FIN 46 requires an investor with a majority of thevariable interests in a variable interest entity to consolidate the entity andalso requires majority and significant variable interest investors to providecertain disclosures. A variable interest entity is an entity in which theequity investors do not have a controlling interest or the equity investment atrisk is insufficient to finance the entity’s activities without receivingadditional subordinated financial support from the other parties. The adoptionof FIN 46 did not have any impact on the Company's financial position orresults of operations.

 

                In April 2003, the FASBissued SFAS No. 149, “Amendment of Statement No. 133 on DerivativeInstruments and Hedging Activities.” SFAS No. 149 amends and clarifiesaccounting for derivative instruments, including certain derivative instrumentsembedded in other contracts and for hedging activities under SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149is generally effective for derivative instruments, including derivativeinstruments embedded in certain contracts, entered into or modified after June 30,2003, and for hedging relationships designated after June 30, 2003. The adoptionof SFAS No. 149 did not have a material impact on its financial positionor results of operations.

 

                InDecember 2004, the FASB issued SFAS No. 123 (revised), “Share-BasedPayment” which supersedes Accounting Principles Board (“APB”) No. 25, “Accountingfor Stock Issued to Employees” and its related implementation guidance. Under

 

 

F-12

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SFAS No. 123 (revised), all share-basedpayments would be treated as other forms of compensation by recognizing the costs,generally measured as the fair value at the date of grant, in the incomestatement. Fischer will be required to adopt SFAS No. 123 (revised) forits fiscal year beginning July 1, 2005. Management expects that the impactof the adoption of SFAS No. 123 (revised) will be that the share-basedpayment expense amounts historically disclosed as required by SFAS No. 123will now be recognized as an expense on the statement of operations.

 

**(3) INTANGIBLE ASSETS**

 

                Intangible assets consist of thefollowing (in thousands) as of December 31,

 

| ** **                         | ** ** | **Estimated  Lives** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------|------------|----------------------|------------|----------|------------|----------|------------|
| Non-compete agreement              |       | 10 years        |       | $        | 3,569      |     | $          | 3,569 |   |
| License                            |       | 8  years             |       | 350      |       | 350      |       |
|                               |       |                 |       | 3,919    |       | 3,919    |       |
| Less—accumulated amortization |       |                 |       | (3,744   | )          | (3,700   | )     |
| Identifiable intangibles, net      |       |                 |       | 175      |       | 219      |       |
| Goodwill, net                      |       | N/A                  |       | 858      |       | 858      |       |
| Total intangibles, net             |       |                 |       | $        | 1,033      |     | $          | 1,077 |   |
|                               |       |                 |       |     |       |     |       |
|                                    |            |                      |            |          |            |          |            |  |  |  |

 

                Amortization expense foridentifiable intangible assets is projected to be approximately $44,000 peryear for the next four years.

 

**(4) OTHER CURRENT LIABILITIES**

 

                Other current liabilitiesconsist of the following (in thousands) as of December 31,

 

| ** **                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| Accrued sales, property, and other state and local taxes |       | $        | 444        |     | $          | 288 |   |
| Customer refunds                                         |       | 938      |       | —   |       |
| Accrued legal                                            |       | 168      |       | 284      |       |
| Other                                                    |       | 1,041    |       | 1,087    |       |
| Total other current liabilities                          |       | $        | 2,591      |     | $          | 1,659 |   |
|                                                     |       |     |       |     |       |

 

**(5) BORROWINGS**

 

                In June 2003, the Company entered into an$8.0 million credit facility with Silicon Valley Bank, subject torestrictions based on eligible receivables. The amount available under thecredit facility at December 31, 2004 was approximately $3.4 million. Borrowingsunder the line of credit agreement accrued interest at the bank’s prime rate,plus 2.75%, with a minimum total interest rate of 7%. The credit facilityrequired the Company to comply with a tangible net worth covenant. As amended on July 27,2004, the tangible net worth covenant was modified to $4.0 million from $10.0million, effective April 1, 2004, and the bank waived the Company’snon-compliance with this covenant through March 31, 2004. The outstanding balances as of December 31,2004 and December 31, 2003, are $1.5 million and $0, respectively. On February 23,2005, the Company refinanced the credit facility on a long-term debt basis withComVest Investment Partners II, LLC (“ComVest”) and terminated this creditfacility. The Company has accounted for the refinanced debt as long-term in theaccompanying balance sheet pursuant to FASB Statement No. 6,Classification of Short-term Obligations Expected to be Refinanced.

 

                On February 23, 2005, theCompany entered into a Note and Warrant Purchase Agreement (the “PurchaseAgreement”) with ComVest, which provides for up to $10 million of seniorsecured debt financing to the Company. At closing, the Company issued and solda senior secured promissory note in the principal amount of $5.0 million (the “InitialNote”) to ComVest. OnMarch 30, 2005 the Company and ComVest amended the Purchase Agreement andWarrant and ComVest provided $2.0 million in funding, bringing their totalinvestment to $7.0 million. In connection with this amendment we agreed toamend the warrant to provide ComVest with a put option, exercisable at $0.90per warrant share, upon the occurrence of a Change of Control or liquidation ordissolution of the Company. The remaining $3.0 million

 

 

F-13

----

 

availableunder the commitment may be borrowed by Fischer from time to time, subject tothe satisfaction of certain conditions, including completion of an FDAexamination, through November 15, 2005. The Initial Note and anyadditional notes issued under the Purchase Agreement will bear interest at perannum 8.5% with a maturity of the earlier of (i) August 15, 2008 or (ii) asale of the company and are secured by all of the assets of the Company, asprovided in a Security Agreement between the Company and ComVest. Accruedinterest on the Initial Note is payable, commencing on November 15, 2005and quarterly thereafter on each February 15, May 15, August 15and November 15. Principal on the Initial Note is payable in ten equalquarterly installments, each in an amount equal to one (1%) of the originalprincipal amount of the note, with a final payment of the remaining principaloutstanding under the Initial Note due on August 15, 2008. The firstinstallment of principal is payable on February 15, 2006, with successiveinstallments continuing on each May 15, August 15, November 15and February 15 thereafter. In connection with the issuance of the InitialNote, Fischer issued to ComVest a warrant (the “Warrant”) to purchase 2,000,000shares of Common Stock at an exercise price of $4.25 per share. The Warrant isexercisable from August 23, 2005 until February 22, 2010. Thewarrants also provide the holders with registration rights that will requirethat the Company re-list its stock on the NASDAQ exchange and file aregistration statement sufficient to cover the common shares underlying thewarrants. Fischer expects to begin this process during the second quarter of2005.

 

The $5.0 million proceedsfrom the sale of the Initial Note were used to retire $2.5 million of seniorindebtedness which was outstanding as of February 23, 2005 under the $8.0million credit facility and the remainder was used for working capital to fundoperations, research and development and marketing initiatives.

 

                The capital lease obligation isa two year obligation for primarily computer equipment and software. Thecapital lease is secured by computer equipment. Long-term debt and capitallease obligation as of December 31, 2004 and 2003 consist of the following(in thousands):

 

| ** **                                               | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| Long-term (Credit facility refinanced to long-term debt) |       | $        | 1,454      |     | $          | — |   |
| Capital lease obligation                                 |       | 224      |       | 454      |       |
| Total                                                    |       | 1,678    |       | 454      |       |
| Less—Current maturities on capital lease obligation |       | 224      |       | 231      |       |
| Long-term debt                                           |       | $        | 1,454      |     | $          | 223 |   |
|                                                     |       |     |       |     |       |

 

**(6) INCOME TAXES**

 

                The provision (benefit) forincome taxes includes the following (in thousands) as of December 31,

 

| ** **               | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current                  |       |     |       |     |       |     |       |
| Federal                  |       | $        | —     |     | $          | —   |       | $ | — |   |
| State                    |       | —   |       | —   |       | —   |       |
| Foreign                  |       | —   |       | —   |       | —   |       |
| Total current provision  |       | —   |       | —   |       | —   |       |
| Deferred                 |       |     |       |     |       |     |       |
| Federal                  |       | (1,394   | )          | (4,509   | )          | 4,256    |       |
| State                    |       | (131     | )          | (429     | )          | 358      |       |
| Foreign                  |       | (878     | )          | (417     | )          | (295     | )          |
| Total deferred provision |       | (2,403   | )          | (5,355   | )          | 4,319    |       |
| Valuation Allowance      |       | 2,403    |       | 5,355    |       | (4,319   | )          |
| Total deferred provision |       | —   |       | —   |       | —   |       |
| Total provision          |       | $        | —     |     | $          | —   |       | $ | — |   |
|                     |       |     |       |     |       |     |       |
|                          |            |          |            |          |            |          |            |  |  |  |  |

 

                During 2002, the Companyutilized approximately $9.1 million of its net operating loss carry-forwardto offset taxable income in that year. A valuation allowance was previouslyprovided against these loss carry-forwards.

 

 

F-14

----

 

Thestatutory federal income tax rate was 35% for the years ended December 31,2004, 2003 and 2002. Reasons for the difference between income tax expensereported in the statements of operations and the amount computed by applyingthe statutory federal income tax rate to earnings before income taxes are asfollows:

 

| ** **                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Domestic Operations:**    |       |     |       |     |       |     |       |
| Statutory tax rate          |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| Increase (decrease) due to: |       |     |       |     |       |     |       |
| State income taxes          |       | 1.9      |       | 3.0      |       | 3.7      |       |
| Non-deductible expenses     |       | (1.0     | )          | (0.3     | )          | 0.7      |       |
| Other                       |       | (1.2     | )          | (0.3     | )          | 5.0      |       |
| Valuation allowance         |       | (34.7    | )          | (37.4    | )          | (44.4    | )          |
| Effective tax rate          |       | —   | %          | —   | %          | —   | %          |
|                        |       |     |       |     |       |     |       |

 

                The domestic versus foreigncomponent of the Company’s income (loss) before income taxes is as follows (inthousands):

 

| ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Domestic   |       | $        | (4,176     | )        | $          | (13,109  | )          | $ | 10,643 |   |
| Foreign    |       | (2,745   | )          | (1,304   | )          | (923     | )          |
| Total      |       | $        | (6,921     | )        | $          | (14,413  | )          | $ | 9,720 |   |
|       |       |     |       |     |       |     |       |
|            |            |          |            |          |            |          |            |  |  |  |  |  |

 

                Components of net deferred taxassets (liabilities) as of December 31, 2004 and 2003 are as follows (inthousands):

 

| ** **                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Current—                     |       |     |       |     |       |
| Inventory reserves                |       | $        | 1,226      |     | $          | 1,241 |   |
| Bad debt reserves                 |       | 235      |       | 356      |       |
| Accrued compensation              |       | 434      |       | 493      |       |
| Other accrued liabilities         |       | 103      |       | 169      |       |
| Warranty reserves                 |       | 928      |       | 656      |       |
| Less—Valuation allowance     |       | (2,926   | )          | (2,915   | )          |
| Net current deferred tax asset    |       | $        | —     |     | $          | — |   |
| Noncurrent—                  |       |     |       |     |       |
| Amortization of investments       |       | $        | 249        |     | $          | 295 |   |
| Depreciation                      |       | 293      |       | 324      |       |
| Net operating loss carryforward   |       | 13,379   |       | 11,722   |       |
| Tax credits                       |       | 740      |       | 792      |       |
| Other                             |       | 190      |       | 154      |       |
| Less—Valuation allowance     |       | (14,851  | )          | (13,287  | )          |
| Net noncurrent deferred tax asset |       | $        | —     |     | $          | — |   |
|                              |       |     |       |     |       |
|                                   |            |          |            |          |            |  |  |  |

 

                The Company has approximately$31.4 million of domestic net operating loss carry-forwards, and$4.4 million of foreign net operating loss carry-forwards thatexpire at various dates through 2024. The Company also has available researchand development tax credits of approximately $571,000 expiring at various datesthrough 2018, and alternative minimum tax credits of $169,000. Realization isdependent on generating sufficient taxable income prior to the expiration datesof the respective carry-forward periods and tax credits. The Company hasprovided a full valuation against its deferred tax assets because theuncertainty of realizing such assets. A valuation allowance of approximately$1.8 million relates to operating losses totaling $5.2 millionattributable to deductions on stock option exercises that, if reversed, will beadditions to additional paid in capital.

 

 

F-15

----

 

**(7) STOCK-BASED COMPENSATION PLANS**

 

**2004 Equity Incentive Plan**

 

The Company adopted the 2004Equity Incentive Plan at the 2004 annual stockholders’ meeting on June 29,2004. The Plan provides for the grant of incentive stock options to employeesand non-qualified stock options to non-employee directors and consultants. Sevenhundred thousand shares of Common Stock are reserved for issuance upon exerciseof options granted under the Plan, of which 175,000 have been granted at December 31,2004.

 

**1993 Director Plan**

 

                The Company’s Non-employeeDirector Stock Option Plan (the “Director Plan”), adopted in 1993 and amendedin June 1998, authorizes the granting of nonqualified options to acquireup to 300,000 shares of common stock. The Director Plan allows for automaticannual grants upon each year of director’s service, and for discretionarygrants on such terms and conditions as are set by the Board at the time ofgrant. The stock options issued under the Director Plan may be exercised at anytime from date of grant, with a maximum option term of ten years.

 

**1991 Stock Option Plan**

 

                The Company’s 1991 Stock OptionPlan (the “1991 Plan”) adopted June 1991 and subsequently amended,authorized the granting of incentive and nonqualified stock options to acquireup to 1,750,000 shares of common stock by employees and consultants. Exerciseterms for the options granted were determined by the Board of Directors at thetime of grant. Incentive stock options may be granted at an exercise price notless than fair market value on the date of grant with a maximum option term often years. The 1991 Plan also permitted the granting of stock appreciationrights, although none were granted. The ability to grant options under the 1991Plan expired in 2001.

 

                Certain of the options grantedunder the 1991 Plan vest upon attainment of performance objectives as well asover time. Outstanding as of December 31, 2004 are 80,000 options grantedin December 1995 that vest when the market price of the Company’s stockhas reached targeted price levels for a period of 45 consecutive trading daysor nine years and eleven months from the date of original grant, whichever isearlier. Other options granted under the 1991 Plan vest ratably over time,generally over a four-year period.

 

**Non-Plan Grants**

 

                During the period from theexpiration of the ability to make grants under the 1991 Plan until September 6,2003, the Company’s Board of Directors authorized grants to various officersand employees of options to purchase a total of 1,076,500 shares of commonstock. Outstanding as of December 31, 2004 were 596,250 exercisableoptions so granted.

 

**Employee Stock Purchase Plan**

 

                Under the Employee StockPurchase Plan, or Employee Plan, adopted in December 1991 and as amendedin June 1998, the Company is authorized to issue up to 400,000 shares ofcommon stock to its full-time employees, nearly all of whom are eligible toparticipate. Under terms of the Employee Plan, employees can have from 2% to 5%of their salary withheld to purchase common stock. The purchase price of thestock is 85% of the lower of its beginning-of-year or end-of-year market price.Under the Employee Plan, Fischer issued 25,408 shares for the year ended December 31,2003 relating to employee withholdings. Shares issued in 2003 were for the yearended December 31, 2002. There were no stock purchases in 2004 and thereare no shares available for purchase under the Employee Plan.

 

**Other**

 

                During 2003, $31,000 wasrecorded as non-cash compensation expense related to 25,000 options granted tocertain directors for their service on the Board of Directors at a $4.00exercise price, which at the time of issuance was below the quoted marketprice.

 

 

F-16

----

 

                A combined summary of the statusof the above plans, including the non-plan grants follows:

 
| ** **                        | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|-----------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Outstanding at January 1     |       | 1,483,500 |       | 1,556,560 |       | 1,524,590 |       |
| Granted                           |       | 195,000   |       | 298,500   |       | 509,000   |       |
| Exercised                         |       | (26,000   | )          | (16,500   | )          | (129,647  | )          |
| Canceled                          |       | (279,000  | )          | (355,060  | )          | (347,383  | )          |
| Outstanding at December 31   |       | 1,373,500 |       | 1,483,500 |       | 1,556,560 |       |
| Exercisable at December 31   |       | 975,750   |       | 835,125   |       | 743,135   |       |
|                              |       |      |       |      |       |      |       |
| Weighted average exercise prices: |       |      |       |      |       |      |       |
| At beginning of year              |       | $         | 6.58       |      | $          | 6.90      |       | $ | 5.75 |   |
| At end of year                    |       | 6.06      |       | 6.58      |       | 6.90      |       |
| Exercisable at end of year        |       | 6.23      |       | 6.27      |       | 6.38      |       |
| Options granted                   |       | 2.47      |       | 5.61      |       | 7.28      |       |
| Options exercised                 |       | 2.19      |       | 3.18      |       | 2.59      |       |
| Options canceled                  |       | 6.76      |       | 6.10      |       | 4.05      |       |
|                                   |            |           |            |           |            |           |            |  |  |  |

 

                Following is information aboutoptions outstanding and exercisable under the 2004, 1993 and 1991 Plans, aswell as the non-plan grants as of December 31, 2004:

 
| **Range of exercise prices**                                                         | ** ** | **Shares** | ** ** | **Price**                                       | ** ** |
|--------------------------------------------------------------------------------------|------------|------------|------------|-------------------------------------------------|------------|
| **Weighted average exercise price for options  outstanding:**                        |       |       |       |                                            |       |
| $1.00 - $3.05                                                                        |       | 307,458    |       | $       2.28 |       |
| $3.06 - $4.99                                                                        |       | 335,542    |       | 3.95                                            |       |
| $5.00 - $5.99                                                                        |       | 213,250    |       | 5.65                                            |       |
| $6.00 - $7.99                                                                        |       | 216,500    |       | 6.40                                            |       |
| $8.00 - $11.00                                                                       |       | 121,000    |       | 9.51                                            |       |
| $11.01 - $16.64                                                                      |       | 179,750    |       | 14.21                                           |       |
|                                                                                 |       | 1,373,500  |       | $       6.06 |       |
| **Weighted average exercise price for options  exercisable:**                        |       |       |       |                                            |       |
| $1.00 - $3.05                                                                        |       | 172,458    |       | $       2.30 |       |
| $3.06 - $4.99                                                                        |       | 265,792    |       | 3.88                                            |       |
| $5.00 - $5.99                                                                        |       | 194,500    |       | 5.67                                            |       |
| $6.00 - $7.99                                                                        |       | 124,750    |       | 6.42                                            |       |
| $8.00 - $11.00                                                                       |       | 77,250     |       | 9.68                                            |       |
| $11.01 - $16.64                                                                      |       | 141,000    |       | 14.15                                           |       |
|                                                                                 |       | 975,750    |       | $       6.23 |       |
|                                                                                 |       |       |       |                                            |       |
| **Weighted average remaining contractual life for  options outstanding (in years):** | ** ** | **Shares** | ** ** | **Years**                                       | ** ** |
| $1.00 - $3.05                                                                        |       | 307,458    |       | 7.6                                             |       |
| $3.06 - $4.99                                                                        |       | 335,542    |       | 6.7                                             |       |
| $5.00 - $5.99                                                                        |       | 213,250    |       | 3.2                                             |       |
| $6.00 - $7.99                                                                        |       | 216,500    |       | 8.0                                             |       |
| $8.00 - $11.00                                                                       |       | 121,000    |       | 7.1                                             |       |
| $11.01 - $14.00                                                                      |       | 179,750    |       | 6.9                                             |       |
|                                                                                 |       | 1,373,500  |       | 6.60                                            |       |
|                                                                                 |       |       |       |                                            |       |

 

 

F-17

----

 

**(8) BENEFIT PLANS**

 

**401(k) Plan**

 

                In 1985, the Company establishedThe Fischer Imaging Employee Capital Accumulation Plan, which is governed by Section 401(k)of the Internal Revenue Code. Employees are eligible to participate in the planupon completion of one month of service. Investments in the 401(k) plan areprimarily made in independently managed mutual funds. During 2004, the Companymatched 50% of employees’ contributions up to 6% of their respective annualcompensation and during 2003 and 2002 the Company matched 25% of employees’compensation up to 6% of their respective compensation. In addition, the Planallows the Company to make discretionary contributions. These matching anddiscretionary contributions ratably vest over a four-year period. The Companymade $254,000, $132,000 and $64,000 of matching contributions for the yearsended December 31, 2004, 2003 and 2002, respectively. The Company did notmake a discretionary contribution in the years ended December 31, 2004,2003 and 2002.

 

**(9) RELATED PARTY TRANSACTIONS**

 

                Long-term debt prior to 2003consisted of loans borrowed on cash values of life insurance policies by aformer employee, who was previously a director of the Company, Chairman of theBoard, Chief Executive Officer and Chief Technology Officer. This individual isa 11.8% shareholder. On May 12, 2003, the Company reached agreement withthis individual, to effect the transfers of and responsibility for, theinsurance policies. The Company subsequently released its assignments on therelated policies in August 2003. This individual assumed all cash valuestotaling $1.1 million and borrowings totaling $1.2 million related to the split-dollararrangements. Effective December 31, 2003, this individual resigned as anemployee and director of the Company and received deferred compensationtotaling $200,000, which was paid in 2004.

 

                The Company’s Denverheadquarters and manufacturing facility is leased from JN Properties under alease effective August 1, 1992, which expires July 31, 2012. A formeremployee, as of December 31, 2003, who was also previously a director ofthe Company, Chairman of the Board, Chief Executive Officer and ChiefTechnology Officer, and a 11.8% shareholder is a general partner inJN Properties. The lease requires Fischer to pay all taxes, insurance,operating and maintenance expenses for the facility, and provides for an annualbase rent which is subject to adjustment at the beginning of the 8th, 13th and18th lease year based on the then current market rent for similar premises,provided that the base rent may not be increased at any one time by more than7%. The Company made total lease payments of $796,000 in each of the followingyears: 2004, 2003 and 2002.

 

                On December 1, 2001, theCompany entered into a consulting agreement with a former Chief ExecutiveOfficer and director of the Company prior to his appointment to thesepositions. Under the terms of the consulting agreement, which expired on April 18,2002, this individual received compensation of $15,000 per month, or a total of$60,000 in 2002 for his consulting services. The individual resigned hisposition of Chief Executive Officer effective April 24, 2003 and resignedfrom the Board of Directors effective December 26, 2003.

 

                During 2002, the Company enteredinto a consulting agreement with another director, which expired on December 31,2002. For the year ended December 31, 2002, this director received $59,000in consulting fees. This director resigned from the Board of Directorseffective October 29, 2003.

 

                During 1999, the Companyextended a loan in the amount of $252,000 to a former President and ChiefExecutive Officer and director pursuant to his employment agreement, inconsideration for his agreement to relocate to Colorado immediately. At December 31,2003, $100,000 of the loan was outstanding and was repaid in full in September 2004.

 

**(10) SEGMENT AND CUSTOMER INFORMATION**

 

                The Company operates in a singleindustry segment: the design, manufacture and marketing of specialty digitalimaging systems and other medical devices primarily used in screening,diagnostic and interventional procedures. The Company manufactures its productsin the United States and distributes them in the United States, Europe andelsewhere. The Company’s chief operating decision maker uses consolidatedresults to make operating and strategic decisions.

 

Internationally,the Company markets and supports its products primarily through it subsidiariesand various dealers. Revenues are attributed to geographic areas based on thelocation of the customer. No material amount of revenue was derived from oneforeign country other than Mexico. International long-lived assets are locatedin Switzerland. The Company incurred significant losses totalling $2.8 millionfrom European operations in 2004. Management has begun the process of restructuring

 

 

F-18

----

 

its sales and serviceoperations in Europe with the goal of transferring its European servicebusiness and addressing the European market through a strategic distributionagreement, thereby eliminating the need for the current Europeaninfrastructure. The cost of winding down the European operationsare not considered to be significant.

 

Thefollowing table represents a summary of revenues and long-lived assets (inthousands):

                

| ** **          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------|------------|----------------------------------|------------|
| ** **          | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Revenues:           |       |                             |       |   |   |   |   |
| United States       |       | $                                | 46,640     |   | $ | 37,966 |   | $ | 42,916 |   |
| Mexico              |       | 8,406                            |       | 562 |   | — |   |
| Other International |       | 8,994                            |       | 7,634 |   | 2,194 |   |
| Total               |       | $                                | 64,040     |   | $ | 46,162 |   | $ | 45,110 |   |
|                     |            |                                  |            |  |  |  |  |  |  |  |  |  |  |

 

| ** **              | ** ** | **As of December 31,** | ** ** |
|-------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Long-lived assets, net: |       |                        |       |   |   |   |   |
| United States           |       | $                           | 3,599      |   | $ | 3,260 |   | $ | 3,064 |   |
| International           |       | 218                         |       | 150 |   | 153 |   |
| Total                   |       | $                           | 3,817      |   | $ | 3,410 |   | $ | 3,217 |   |
|                         |            |                             |            |  |  |  |  |  |  |  |  |

 

The Company’s revenuesgenerally are concentrated among customers in the healthcare industry andconsist of healthcare organizations, government facilities and dealers. TheCompany establishes an allowance for uncollectible accounts based upon factorssurrounding the credit risk of specific customers, historical trends and otherinformation. Accounts receivable are generally unsecured.

 

During 2004, 2003 and 2002,the following customers represented greater than 10% of the Company’s revenues:

 

| ** **                                                                      | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Ethicon-Endo Surgery, Inc (a division of Johnson & Johnson, Inc.) |       | 10.1                             | %          | 10.9 | % | 11.4 | % |
| Mexican Social Security Institute                                               |       | 13.1                             | %          | 1.2 | % | — |   |
|                                                                            |       |                             |       |   |   |   |   |

 

                The following are sales byproduct line:

 

| ** **                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **2004**                         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Product Revenue:           |       |                             |       |   |   |   |   |
| Digital Mammography        |       | $                                | 19,326     |   | $ | 10,772 |   | $ | 3,571 |   |
| Stereotactic Breast Biopsy |       | 18,857                           |       | 16,099 |   | 19,050 |   |
| RE&S Products          |       | 10,462                           |       | 5,943 |   | 8,009 |   |
| Service Revenue            |       | 15,395                           |       | 13,348 |   | 14,480 |   |
| Total                      |       | $                                | 64,040     |   | $ | 46,162 |   | $ | 45,110 |   |

 

** (11) COMMITMENTS ANDCONTINGENCIES**

 

**Litigation**

 

In April 2003, theCompany reported to the Securities and Exchange Commission that it wouldrestate its financial results for the reporting periods beginning January 1,2000 and ending September 30, 2002. On June 9, 2003, the

 

F-19

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Company received notice of a formal order ofinvestigation and subpoena from the Securities and Exchange Commission. Thisrequest followed the voluntary disclosures that the Company made to the SECbeginning in April 2003 and the creation of an independent board committeeto review the facts and circumstances underlying the Company’s decision torestate financial results. On November 15, 2004, the Company entered intoa settlement agreement with the U.S. Securities and Exchange Commission arisingout of the Commission’s investigation of the Company’s reported financialresults for the periods beginning January 1, 2000 and ending September 30,2002, which have since been restated by the Company. In the settlement, theCompany has agreed, without admitting or denying the allegations in theCommission’s complaint, to the entry of a cease and desist order against futureviolations of the antifraud, reporting, recordkeeping and internal controlsprovisions of the federal securities laws. The Commission’s complaint allegesthat the company violated Section 17(a) of the Securities Act of1933, Sections 10 (b), 13 (a), 13 (b) (2) (A), 13 (b) (2) (B) and13 (b)(5) of the Securities Exchange Act of 1934, and Rules 10b-5,12b-20, 13a-1, 13a-13, and 13b2-1 thereunder. TheCompany is not required to pay any civil penalties or fines as part of thesettlement. The Commission’s investigation against other persons or entitieswho may have been involved is ongoing. The administrative order containing theCommission’s allegations and the terms of the settlement with the Company isavailable at www.sec.gov/litigation/admin.shtml.  In addition, we have been informed by the U.S.Department of Justice of their intention to investigate the matters cited inthe SEC order.

 

 

On April 10, 2003 andon June 3, 2003, The Sorkin, LLC and James K. Harbert filed punitive classaction lawsuits against us and three of our former officers and directors,Morgan Nields, Gerald Knudson and Louis Rivelli, in the United States DistrictCourt for the District of Colorado. The complaints are purportedly brought onbehalf of purchasers of shares of the Company’s common stock during the period February 14,2001 to April 1, 2003 and allege that, among other things, during theputative class period, the Company and the individual defendants madematerially false statements in violation of Section 10(b) of theExchange Act, Rule 10b-5 promulgated under the Exchange Act, and Section 20(a) ofthe Exchange Act. The complaints seek unspecified compensatory damages andother relief. On August 7, 2003, the Company, and Messrs. Nields andKnudson moved to dismiss all claims asserted by The Sorkin, LLC and Harbert. OnAugust 18, 2003, Mr. Rivelli moved to dismiss all claims asserted inthose lawsuits. On October 20, 2003, Mr. Harbert moved to dismiss hislawsuit, which the court subsequently granted. On October 21, 2003, theSorkin, LLC and Mr. Harbert filed an amended class action complaint. Theamended complaint contains the same claims for relief against us and Messrs. Nieldsand Rivelli, but does not assert any claims against Mr. Knudson. Inaddition, the amended complaint seeks to recover unspecified compensatorydamages and other relief on behalf of purchasers of shares of our common stockduring the period February 14, 2001 to July 17, 2003. The Company, Mr. Nieldsand Mr. Rivelli have filed motions to dismiss all claims asserted in theamended complaint. In September 2004 we entered into an agreement inprinciple to settle this litigation with plaintiffs’ attorneys and our directorand officer liability insurance provider, Chubb Insurance Company. Thissettlement proposal was submitted to the U.S. District Court for approval, andon March 3, 2005 Judge Richard Matsch declined to approve the proposal. Asa result, litigation will continue in this matter. A hearing on the motions todismiss is scheduled for May 6, 2005.

 

The Company is a defendantin a breach of contract suit brought by International Surgical Systems in thefederal District Court of Arizona. The suit claims that Fischer Imagingwrongfully breached an agreement to supply product to ISS, notwithstanding ISS’nonpayment, and that such breach caused the failure and bankruptcy of ISS. Thesuit seeks $1.0 million in damages, plus attorneys’ fees and expenses. TheCompany believes the suit is without merit and intends to vigorously defend thecase, as well as assert counterclaims against ISS for nonpayment.

 

The Company is also a defendant in various lawsuitsincident to the operation of its business. We do not believe that any of thosepending legal proceedings would have a material, adverse effect on theconsolidated financial position or results of operations of the Company.

 

**Regulatory Actions**

 

TheCompany is subject to periodic inspections by the Food and Drug Administration(“FDA”) whose primary purpose is to audit the Company’s compliance with GoodManufacturing Practices. These practices include testing, quality control anddocumentation of procedures. In December 2002, following an earlierperiodic inspection that resulted in the FDA issuing a Form 483, the FDAissued a Warning Letter regarding deficiencies in the way the Company’s qualitysystem satisfies the FDA’s Quality System Regulation (QSR). The Companyresponded to the Warning Letter findings and observations and institutedcorrective actions. During January 2005 FDA began an inspection to verifythe effectiveness of the Company’s corrective actions. This inspection isongoing. There have been a number of informal observations of potential deficiencies,focusing primarily on the Company’s Corrective and Preventive Action (CAPA)system, complaint system, and Design Control system. The outcome of thisinspection will be either the issuance of a FDA form 483, a FDA Warning Letter,or a court-ordered injunction. If an injunction is the outcome, it may precludecompany shipment of products until corrective action is taken and verified bythe FDA. In addition, FDA enforcement actions could include, among otherthings, product seizure and/or criminal or civil proceedings being initiatedwithout further

 

 

F-20

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notice.We expect that the FDA audit will conclude during the next 60 days.

 

                The Company’s stock was delistedfrom NASDAQ on July 7, 2003 due to failure to meet the financial reportingfiling requirements established by the NASDAQ for annual and quarterly reports.

 

**Operating Leases**

 

                The Company leases buildings andequipment under various operating lease agreements that provide for thefollowing minimum future lease payments (in thousands) for the years ending December 31,:

 

| 2005       |   | $      | 925    |   |
|------------|--------|--------|--------|--------|
| 2006       |   | 934    |   |
| 2007       |   | 936    |   |
| 2008       |   | 852    |   |
| 2009       |   | 852    |   |
| Thereafter |   | 2,320  |   |
| Total      |   | $      | 6,819  |   |
|       |   |   |   |

 

                Of the above total leasecommitments, $6,546,000 relates to the JN properties building lease (seeNote 9—Related Party Transactions). Total rent expense was approximately$1,210,000, $936,000 and $834,000 in 2004, 2003 and 2002, respectively. Thetotal rent expense includes rent expense for JN properties of $796,000 for eachof 2004, 2003 and 2002.

 

**(12) PATENT LITIGATION SETTLEMENT**

 

During the second quarter of 2002, the Company settled a patent infringement lawsuit for$32.3 million, the Company recognized $25.0 million as income in 2002and $7.2 million of the settlement was scheduled to be received in equal annualinstallments of $0.9 million over the remaining eight-year life of theassociated patents. The Company recognized an other income item in the amount of $0.9million during both the second quarter of 2003 and 2004. On June 2, 2004 the Company amended the settlement agreement,received a one-time accelerated payment totaling $4.3 million in lieu of thesix remaining $0.9 million payments that were due annually through 2010 andrecognized the one-time payment as an other income item.

 

**(13) QUARTERLY FINANCIAL DATA—UNAUDITED**

 

                (in thousands, except per sharedata):

 
| ** **                                          | ** ** | **First  Quarter  2004** | ** ** | **Second  Quarter  2004** | ** ** | **Third  Quarter  2004** | ** ** | **Fourth  Quarter  2004** | ** ** | **Year  Ended  2004** | ** ** |
|-----------------------------------------------------|------------|--------------------------|------------|---------------------------|------------|--------------------------|------------|---------------------------|------------|-----------------------|------------|
| Revenues                                            |       | $                        | 12,006     |                      | $          | 19,779                   |       | $                         | 17,801     |                  | $          | 14,454 |   | $ | 64,040 |   |
| Gross profit                                        |       | 1,846                    |       | 3,994                     |       | 4,109                    |       | 2,920                     |       | 12,869                |       |
| Net (loss) income                                   |       | (4,478                   | )          | 3,154                     |       | (1,745                   | )          | (3,852                    | )          | (6,921                | )          |
| Basic (loss) income per share                       |       | $                        | (0.48      | )                         | $          | 0.34                     |       | $                         | (0.19      | )                     | $          | (0.41 | ) | $ | (0.74 | ) |
| Diluted (loss) income per share |       | $                        | (0.48      | )                         | $          | 0.33                     |       | $                         | (0.19      | )                     | $          | (0.41 | ) | $ | (0.74 | ) |
|                                                |       |                     |       |                      |       |                     |       |                      |       |                  |       |
| ** **                                          | ** ** | **First  Quarter  2003** | ** ** | **Second  Quarter  2003** | ** ** | **Third  Quarter  2003** | ** ** | **Fourth  Quarter  2003** | ** ** | **Year  Ended  2003** | ** ** |
| Revenues                                            |       | $                        | 9,492      |                      | $          | 12,057                   |       | $                         | 11,649     |                  | $          | 12,964 |   | $ | 46,162 |   |
| Gross profit                                        |       | 2,046                    |       | 2,671                     |       | 2,984                    |       | (277                      | )          | 7,424                 |       |
| Net (loss) income                                   |       | (2,385                   | )          | (2,399                    | )          | (2,045                   | )          | (7,584                    | )          | (14,413               | )          |
| Basic (loss) income per share                       |       | $                        | (0.26      | )                         | $          | (0.26                    | )          | $                         | (0.22      | )                     | $          | (0.81 | ) | $ | (1.55 | ) |
| Diluted (loss) income per share                     |       | $                        | (0.26      | )                         | $          | (0.26                    | )          | $                         | (0.22      | )                     | $          | (0.81 | ) | $ | (1.55 | ) |
|                                                |       |                     |       |                      |       |                     |       |                      |       |                  |       |
| ** **                                          | ** ** | **First  Quarter  2002** | ** ** | **Second  Quarter  2002** | ** ** | **Third  Quarter  2002** | ** ** | **Fourth  Quarter  2002** | ** ** | **Year  Ended  2002** | ** ** |
| Revenues                                            |       | $                        | 11,568     |                      | $          | 10,054                   |       | $                         | 12,946     |                  | $          | 10,542 |   | $ | 45,110 |   |
| Gross profit                                        |       | 3,026                    |       | (912                      | )          | 2,450                    |       | 479                       |       | 5,043                 |       |
| Net (loss) income                                   |       | (887                     | )          | 18,532                    |       | (2,145                   | )          | (5,780                    | )          | 9,720                 |       |
| Basic (loss) income per share                       |       | $                        | (0.10      | )                         | $          | 2.01                     |       | $                         | (0.23      | )                     | $          | (0.62 | ) | $ | 1.06 |   |
| Diluted (loss) income per share                     |       | $                        | (0.10      | )                         | $          | 1.95                     |       | $                         | (0.23      | )                     | $          | (0.62 | ) | $ | 1.00 |   |
|                                                     |            |                          |            |                           |            |                          |            |                           |            |                       |            |  |  |  |  |  |  |

 

Note: Theaggregate of certain of the above amounts differs from that reported for thefull fiscal year due to the effects of rounding.

 

 

F-21

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In each of the following quarters, the Company recorded unusual orinfrequently occurring items that were material in relation to the results ofthe quarter:

 

During the fourth quarter of 2004, the Company recorded a $0.4 millionreduction in the warranty provision to adjust the related obligation to reflecthistorical warranty experience. The Company also recorded a $0.3 millionreduction in services cost of sales to more accurately reflect the timing ofthe four-year warranty obligation associated with the December 2003non-domestic shipment to the government of Mexico which was recognized asrevenue prior to year end 2004. The Company recorded a $0.3 million charge inthe fourth quarter of 2004 to properly record accumulated depreciation relatedto the amortization of leasehold improvements over the shorter of the usefullife of the asset or the term of the related leased property. In addition, theCompany recorded $0.6 million higher marketing expenses in the fourth quarterof 2004 related to a national trade show.

 

Inthe second quarter of 2004, the Company reached an agreement with ThermoElectron Corporation that accelerated the remaining $5.4 million owed theCompany from a 2002 patent settlement into a single payment of$4.3 million. As a result, the Company recorded $4.3 of other income inthe quarter ending June 30, 2004. The $5.4 million was scheduled tobe received in equal annual installments of $900,000 over the remainingsix-year life of the patents for continued sales of the breast-biopsy imagingsystem now being sold by Hologic, Inc. The $5.4 million settlement owed tothe Company is now paid in full.

 

During the fourth quarter of2003, the Company recorded a $2.6 million charge related to inventory ofwhich $1.6 million was due to inventory discrepancies identified in the fourthquarter of 2003, $0.7 million was due to a higher reserve requirement forexcess and obsolete inventory, and $0.3 million was due to an increase ininventory reserves to value the inventory at lower of cost or market. Inaddition, the fourth quarter of 2003 results reflect a $0.4 million charge forcommitments made to provide existing customers with upgraded systems, $0.3million increase in receivable reserves for potentially uncollectible accountsbased on a specific analysis of accounts receivable, $0.5 million increase inspending to support the restatement efforts that were underway, $0.4 millionincrease in sales commissions associated with higher sales backlog, and a $0.3million increase in spending associated with national trade show attendedduring the fourth quarter.

 

Duringthe fourth quarter of 2002 operating expenses increased $1.7 million to $6.3million from $4.6 million during the third quarter of 2002. The increase inoperating expenses was due to $0.6 million increase in spending associated with national tradeshow attended during the fourth quarter of 2002; $0.5 millionyear-end bonus accrual and $0.4 million increase in commissions due to strongfourth quarter bookings.

 

During the second quarter of 2002 the Company received and recognizedas income $25.0 million for a patent infringement lawsuit settlement. Thisincome was partially offset by a $9.7 million charge identified uponcompletion of a comprehensive analysis of the inventoryand a physical inventory during the second quarter of 2002. Of this $9.7million charge, $6.4 million related to inventory discrepancies betweenthe physical inventories and the general ledger due to inaccurate reporting oftransactions and $3.3 million was an increase in the excess and obsoleteinventory reserve due to a change in the business direction the RE&Sproduct line.

 

** **

**F-22**

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