**SECURITIES AND EXCHANGE COMMISSION**

**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, 2005**                                                                                                                                                                                                                                                                                                 |
| ** **                                                                                                                                                                                                                                                                                                                                            |
| **o**                                                                                                                                                                                                                                                                                                                                                 | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                                                                                                                                            | ** ** | ** **                                                                                                              |
| **For the  transition period from                          to                           .** |

 

**Commissionfile number 0-19386**

 

----

 

**FISCHER IMAGING CORPORATION**

(Exact name of registrant as specified in itscharter)

 

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

 

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

 

Securities Registered Pursuant to Section 12(b) ofthe Act: **None**

 

Securities Registered Pursuant to Section 12(g) ofthe Act:  **Common Stock, Par Value $0.01 Per Share**

 

----

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.Yes o  No  ý

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or15(d) of the Act.Yes o  No  ý

 

*Note:* Checking the box above will not relieve any registrant required to filereports pursuant to Section 13 or 15(d) of the Exchange Act fromtheir obligations under those Sections.

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor 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 to this Form 10-K. o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large  accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer ý |
|----------------------------|--------|---------------------|--------|------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).Yes o  No  ý

 

The aggregate market valueof the Common stock held by non-affiliates of the registrant as of June 30,2005 was approximately $17.1 million. (Aggregate market value estimatedsolely for the purposes of this report. This shall not be construed as anadmission for the purposes of determining affiliate status.)

 

The number of shares ofregistrant’s Common stock outstanding as of March 24, 2006 was 9,398,817.

 

 

----

 

**TABLE OF CONTENTS**

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

 

i

----

 

# **PART I**

#  

**Forward-looking Statements**

 

This Form 10-K contains or incorporatesby reference “forward-looking statements,” as that term is used in federalsecurities laws, about our financial condition, results of operations andbusiness. These statements include, among others:

 

•                  ouractions with respect to the auction of the RE&S business and/or ProductLines and our intended actions if stockholder approval is required underDelaware law;

•                  ourability to continue to satisfy our Service obligations until the contracttermination dates;

•                  ourability to continue to satisfy RE&S service and warranty obligations;

•      ourexpectations regarding the effects of the Kodak Agreements on our obligationsand cost with respect to the service business;

•                  ability to locate an alternative serviceprovider for RE&S service obligations;

•                  successin building 20 MammoTest tables and generating revenue and cash flow therefrom;and

•                  ability to produce VersaRad units andgenerating revenue and cash flow therefrom;

•                  Philips’ intent to terminate the PhilipsAgreement and potential outcomes regarding the terms and conditions of thetermination including the effect of any payments to Philips and the expense ofdefending any claim on potential distributions to stockholders and creditors;

•     the effect of the loss of key employees oncash position and business;

•     the events or circumstances that could causeus to cease operations and liquidate under applicable law including aliquidation under Chapter 7 or 11 of the Bankruptcy Code;

•     our ability to make distributions tostockholders;

•     our plans with respect to our Europeansubsidiaries;

•                  ourbusiness strategy; and

•                  statementsof our expectations, beliefs, future plans and strategies, anticipateddevelopments and other matters that are not historical facts.

 

These statements may be made expressly in thisdocument or may be incorporated by reference to other documents we will filewith the Securities and Exchange Commission (SEC). You can find many of thesestatements by looking for words such as “believes,” “expects,” “anticipates,” “estimates,”or similar expressions used or incorporated by reference in this report.

 

**These forward-lookingstatements are subject to numerous assumptions, risks and uncertaintiesincluding those discussed in “Risk Factors” in this Form 10-K that may causeour actual results to be materially different from any future results expressedor implied by us in those statements. These risk factors should be consideredin connection with any subsequent written or oral forward-looking statementsthat we or persons acting on our behalf may issue. We do not undertake anyobligation to review or confirm analysts’ expectations or estimates or torelease publicly any revisions to any forward-looking statements to reflectevents or circumstances after the date of this report or to reflect theoccurrence of unanticipated events. Further, the information contained in thisdocument is a statement of our intention as of the date of this filing and isbased upon, among other things, the existing regulatory environment, industryconditions, market conditions and prices, the economy in general and ourassumptions as of such date. We may change our intentions, at any time andwithout notice, based upon any changes in such factors, in our assumptions orotherwise.**

 

Fischer®, Fischer Imaging®, Traumex®,VersaRad®, BloomTM, EPX-60TM, and SPXTM are trademarks of ours. On September 29,2005, we sold the following trademarks and tradenames, although they are stillreferred to in this Annual Report on Form 10-K: MammoTest®, SenoScan®, MammoPlus®, MammoVision®, MammoSound®,MammoTest Plus®, SenoSoundTM, SenoViewTM, and SenoView PlusTM. This Annual Reporton Form 10-K may also include trademarks and

 

1

----

 

tradenamesowned by other parties, and all other trademarks and tradenames mentioned inthis Annual Report on Form 10-K are the property of their respectiveowners.

 

Unless the context otherwise requires,references in this report to “Fischer Imaging,” “Fischer,” “we,” “us,” “our”and the “Company” refer to Fischer Imaging Corporation and its consolidatedsubsidiaries.

 

## **ITEM 1. BUSINESS**

##  

**Business Overview**

 

We currently service mammography and digital imaging products used inthe diagnosis of breast cancer and other diseases and manufacturer and sell theMammoTest to a single distributor in Europe. Our business was significantlyreduced to its current level by the Hologic transaction discussed below. Wealso service and sell products that meet selected needs of the broaderradiology and electrophysiology markets. Our RE&S (Radiology,Electrophysiology and Surgery) product lines consist of film and digitalgeneral radiology systems, an electrophysiology stimulation system,electrophysiology x-ray imaging systems and a specialized surgical C-armsystem.

 

*Changes to Our Business in 2005.*Priorto the consummation of the Hologic transaction*,*our primary business was designing, manufacturing and sellingmammography and digital imaging products and using our digital imagingtechnology in screening and diagnostic mammograms and minimally invasive breastbiopsy to aid in the early identification of breast cancer. Followingsignificant losses and negative cash flows from operations during 2004, whichcontinued into 2005, and delays in the SenoScan redesign program, we obtainedfinancing, as discussed further in Note 6 of the accompanying consolidatedfinancial statements, in an aggregate amount of $7.0 million from ComVestInvestment Partners II LLC (“ComVest”). In May 2005, we announced that we wereconsidering strategic alternatives and retained an international investmentbank to assist us in that process. The $7.0 million of financing was completelyconsumed to fund operations, working capital needs and to repay outstandingloans. Due to difficulties in reducing costs, further delays in the SenoScanredesign program, declines in revenue and other negative developments, we wereleft with insufficient cash reserves to continue operations in June 2005.

 

*Hologic Transaction.*OnJune 22, 2005, we entered into an Asset Purchase Agreement (the “Asset SaleAgreement”) with Hologic, Inc. (“Hologic”) in which we agreed to sell toHologic all of our intellectual property rights related to our mammographybusiness and products, including rights to our SenoScan® digital mammographyand MammoTest® stereotactic breast biopsy systems (the “Mammography Assets”). Weagreed to sell the Mammography Assets, which formed the basis for substantiallyall of our business, to Hologic for a cash purchase price of $32.0 million (the“Asset Sale”). Hologic agreed to grant us a non-exclusive limited license touse certain Mammography Assets necessary for us to continue to service andsupport, and satisfy warranty obligations on the installed base of SenoScan andMammoTest systems (the “Service” business); to fulfill contractual obligationsto provide MammoTest and SenoScan systems to Ethicon Endo-Surgery Europe (asubsidiary of Johnson & Johnson, Inc., “EES”) and Philips Medical SystemsDMC GmbH (“Philips”), respectively; and to carry out certain activities with respectto our RE&S business. In connection with the entry into the Asset SaleAgreement, Hologic loaned us $5.0 million to be used for working capitalpurposes.

 

2

----

 

The Asset Sale Agreement was approved by ourstockholders at a special meeting of stockholders held on September 28, 2005and closing of the Asset Sale transaction occurred on September 29, 2005. Thevalue of the Mammography Assets sold was zero on Fischer’s consolidated balancesheets and therefore the entire $32.0 million proceeds were recognized as Gain onsale of Mammography Assets in the accompanying consolidated statements ofoperations. The proceeds from the Asset Sale were disbursed as follows (inthousands):

 
| Repay $5.0 million loan with Hologic, plus  related interest      |   | $     | 5,114  |   |
|-------------------------------------------------------------------|--------|-------|--------|--------|
| Repay the notes with ComVest, plus related  interest              |   | 7,444 |   |
| Payment of stock warrant obligation to  ComVest                   |   | 1,800 |   |
| Amendment fee to terminate the Lease  discussed below             |   | 4,180 |   |
| Settle certain accounts payable due at  closing of the Asset Sale |   | 931   |   |
|                                                              |   | $     | 19,469 |   |

 

Approximately $8.7 million of the remaining approximately $12.5 millionin proceeds from the Asset Sale were used during the fourth quarter of 2005 tosettle additional accounts payable and other short term obligations and to fundoperations while we continued to explore strategic alternatives for ourRE&S and Service businesses.

 

*Kodak Arrangement.*OnJanuary 23, 2006, we entered into an Intellectual Property License (“KodakLicense Agreement”) and a Services Agreement (“Kodak Services Agreement”, andtogether the “Kodak Agreements”) with Eastman Kodak Company (“Kodak”) thatallows Kodak to act as an authorized service provider and provide service andsupport to the world-wide, excluding Mexico, installed base of our mammographyproducts, specifically the SenoScan® digital mammography and MammoTest®stereotactic breast biopsy systems.  We expect that the Kodak Agreementswill reduce our obligations and costs with respect to our Service business.

 

Under theterms of the Asset Sale, we received a license from Hologic to use theMammography Assets to the extent necessary to provide service and support onthe Service business. We, relative to the Service business and with Hologic’sconsent, granted Kodak a non-exclusive limited license to perform these servicerelated activities in the Kodak License Agreement, which continues for a termof five years.

 

*RE&S Business.*TheRE&S business includes three product lines (collectively the “Product Lines”):

 

(1)                                  TheVersaRad-A and VersaRad-D systems designed for general purpose radiographicimaging (“VersaRad Line”);

 

(2)                                  TheEPX-60 Single Plane EP Imaging System and the SPX Surgical Imaging System (“EPX/SPXLine”); and

 

(3)                                  TheBloom Electrophysiology Stimulator (“Bloom Line”).

 

We currentlysupply our VersaRad-D product to Kodak under an OEM Agreement. The OEMAgreement initially expired on January 12, 2006 and automatically renewed foran additional one-year term. In February 2006, management received a purchaseorder from Kodak for a last time purchase of VersaRad units at an average salesprice of $118,000 with terms of payment of 2% discount if paid within 10 daysof the invoice, or 30 days from invoice date. We have committed to deliver 30units against this purchase order. Therefore, it is expected that no furtherVersaRad units will be sold to Kodak after fulfillment of the last timepurchase order in

 

3

----

 

May 2006, and we expect the OEM Agreement to be terminated afterdelivery of the ordered VersaRad units or substantially modified.

 

Backlog forthe EPX/SPX Line and Bloom Line is zero; we believe this is due to our reducedmarketing efforts and the market’s perception of our financial condition. SinceDecember 31, 2005, we have sold no EPX/SPX units and 16 Bloom units.

 

On March 15,2006, we announced to certain potential bidders and to the public that we werestarting an auction process to sell our RE&S business. In general, theassets to be sold are all of the right, title and interest in and to theVersaRad Line, the EPX/SPX Line and the Bloom Line including related equipment,inventory, general intangibles and intellectual property necessary to design,manufacture, market, sell, distribute, support and repair the Product Lines. Theassets and any liabilities which may be assumed at the option of the bidder foreach Product Line (e.g., service contracts and warranty repair obligations)will be more fully described in and subject to the form asset purchaseagreement that will be delivered to potential bidders.

 

Bidders havebeen asked to submit bids for the entire RE&S business, individual ProductLines or components thereof. Bidders were provided an overview of the biddingand auction procedures for the assets to be sold. Bids are required to besubmitted by May 10, 2006 and an auction is expected to be held on May 15, 2006.As soon as possible after the end of the auction, we intend to finalize andenter into definitive agreements with the party or parties who submit theoffer(s), which in our sole judgment, are the most attractive bid(s) for theRE&S business and Product Lines. There can be no assurance that we will receive any acceptable bids forall or any of the offered assets.

 

Under Delawarelaw, any sale of all or substantially all of our assets requires approval byour stockholders. In the event it is determined that the sale of the assetsrelated to the Product Line(s) to a successful bidder would be considered asale of all or substantially all of our assets, we will either file a petitionunder Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”)and immediately move to close the sale pursuant to §363(b) and (f) of theBankruptcy Code or seek the necessary stockholder approval.

 

Our efforts tosell these Product Lines may be unsuccessful or may not generate significantproceeds. We plan to continue to meet the related service and warrantyobligations until the completion of the sale of the Product Lines. If theeffort to sell these Product Lines is unsuccessful, we will seek an alternativeservice provider to provide continuation of service for warranty and servicecontract obligations.

 

*EES Last Time Purchase Order.*OnMarch 9, 2006, we entered into Amendment No. 2 to Distributor Agreement (the “EESAmendment”) with EES to amend the Distributor Agreement, dated December 9,1998, as amended (the “Distributor Agreement”), between EES and Fischer. TheDistributor Agreement required us to provide MammoTest tables to EES throughOctober 11, 2006. In light of the potential penalties in the DistributorAgreement, our excess inventory on hand, and the pending May 31, 2006termination of the lease on our manufacturing facility, we desired tomanufacture and sell a fixed number of MammoTest tables to EES and to endproduction by May 31, 2006. Under the EES Amendment, which is effective as ofMarch 1, 2006, EES agreed to place a binding order for 20 MammoTest tables(collectively, the “Tables” and each a “Table”). We agreed to deliver theTables no later than May 31, 2006 at a price of US$107,000 per Table, subjectto adjustment for failure to supply all 20 Tables. EES is required to pay forthe first five Tables upon delivery of the 20th Table. EES is required to payfor each subsequent Table delivered upon receipt of the invoice.

 

4

----

 

The price ofeach Table includes applications training available through December 31, 2006and twelve months of warranty support (labor and parts) commencing on theearlier to occur of the date application training is completed for such Tableor December 31, 2006. Applications training and warranty support will beprovided by an alternative service provider since we plan to wind down andliquidate our European subsidiaries in the near future. Our Europeansubsidiaries are in discussions with an alternative service provider but ifthis fails, additional funds may be needed to fund the operations until anappropriate alternative service provider is located. If an alternative serviceprovider cannot be located at a reasonable cost, the projected positive cashcontribution from sale of the EES Tables could be at risk.

 

The EESAmendment and the Distributor Agreement will terminate upon our delivery of allthe Tables or settlement as described above except that the obligations toprovide warranty support and application training survive the termination.

 

**Other Significant Events in 2005**

 

*Change inOfficers.*On July 11, 2005, Steven Durnil was named as president andCEO of Fischer, succeeding Harris Ravine who resigned from the Company as anofficer and member of the board of directors effective July 8, 2005.

 

*Amendment of Lease.*OnSeptember 27, 2005, we entered into an Amendment to Lease Agreement (the “LeaseAmendment”) with JN Properties, our landlord and a company controlled by MorganNields, a substantial stockholder and former director, chair of the Board,chief executive officer and chief technology officer of Fischer. The LeaseAmendment provides for the amendment of the Lease dated July 31, 1992 betweenFischer and JN Properties (the “Lease”) to allow for the early termination ofthe Lease within 60 days of written notice of intent to vacate or May 31, 2006,whichever is earlier. The Lease term was to originally runs through July 2012.  We intend to vacate on May 31, 2006. We willcontinue to pay the current rental rate and comply with other terms andconditions of the Lease during the period prior to termination of the Lease. Inexchange for the above, we agreed to pay to JN Properties $4.0 million pluscertain accrued 2005 property taxes immediately following the closing of theHologic Asset Sale Agreement. In the Lease Amendment, JN Properties granted itsconsent to the transactions contemplated by the Asset Sale Agreement. The $4.0million payment has been recognized as “Lease termination fee” in theaccompanying consolidated statements of operations in accordance with FASBStatement No. 146, “Accounting for Costs Associated with Exit or DisposalActivities.”

 

*Restructuring Expense.*Concurrentwith the Asset Sale, we entered into severance and retention arrangements withcertain senior executive officers and other non-senior executive employees ofFischer for total estimated payments of $3.2 million.  Certain eventssince then have caused us to adjust our estimate of severance and retentionexpenses and charges. As a result the estimated restructuring expense isexpected to be less than the $3.2 million originally approved by theBoard.  The cumulative severance and retention payments for 2005 and 2006are currently estimated to be $2.5 million and are estimated to be recognizedas pre-tax restructuring expense as follows (in thousands):

 
| Year-ended December 31, 2005           |   | $   | 851    |   |
|----------------------------------------|--------|-----|--------|--------|
| Three-months ending March 31, 2006     |   | 900 |   |
| Three-months ending June 30, 2006      |   | 471 |   |
| Three-months ending September 30, 2006 |   | 132 |   |
| Three-months ending December 31, 2006  |   | 132 |   |
| Total                                  |   | $   | 2,486  |   |

 

5

----

 

Therecognition of expense could be accelerated if we terminate the employment ofthe 14 employees who have not received notice that their employment willterminate prior to December 31, 2006.  The amount to be recognized asexpense could be lower if employees accept other employment prior to theirinvoluntary termination dates or if those employees who are party to retentionagreements and who have not already received notification of involuntarytermination are terminated prior to June 30, 2006.

 

Approximately$0.5 million of the cumulative $2.5 million was paid by December 31,2005.  We expect that approximately $0.9 million will be paid during thethree-months ending March 31, 2006 of which $0.6 million is related to amountsplaced into an irrevocable trust.  Approximately $1.1 million is expectedto be paid in the month of April and May 2006.

 

*Sorkin Class Action Lawsuits.*Theclass-action lawsuit filed by The Sorkin, LLC and James K. Harbert against usand three of our former officers and directors, Morgan Nields, Gerald Knudsonand Louis Rivelli, in the United States District Court for the District ofColorado was dismissed without prejudice on June 21, 2005.

 

*Philips Medical Systems*. On October 14, 2004, weannounced a Master Purchasing Agreement with Philips (“Philips Agreement”) tosupply Philips with a digital mammography system based on the SenoScanplatform. Under the Philips Agreement, Philips had non-exclusive worldwidedistribution rights for SenoScan. We received notification on September 2, 2005by Philips that it had ceased sales activities for the present time withrespect to the SenoScan product and that it intended to terminate the PhilipsAgreement should the Asset Sale Agreement be approved by our stockholders andconsummated. We met with Philips in November 2005 to communicate that we hadretained the right to perform our obligations under the Philips Agreement butthat absent additional funding from Philips, we did not have the financialability to perform the Philips Agreement. Philips subsequently offered tosettle the matter without litigation. However, in view of the financialsettlement proposed by Philips, we declined Philips’ offer of settlement andreferred Philips to the dispute resolution provisions of the Philips Agreement.We are unable to predict whether Philips may file a suit or the amount, if any,that may be demanded by Philips, or the expense related to defending any claim.Any payments made by us to or in connection with a claim by Philips maymaterially reduce amounts, if any, that may be available for satisfaction ofcreditor claims and distribution to our stockholders

 

*Note and Warrant Purchase Agreement with ComVest.*OnFebruary 22, 2005, we entered into a Note and Warrant Purchase Agreement(the “Purchase Agreement”) with ComVest, which provided for up to$10 million of senior secured debt financing. At closing, we issued andsold a senior secured promissory note in the principal amount of$5.0 million to ComVest. In connection with the issuance of the this note,we issued to ComVest a warrant (the “Warrant”) to purchase 2,000,000 shares ofCommon Stock at an exercise price of $4.25 per share.

 

OnMarch 29, 2005 we amended the Purchase Agreement and ComVest provided$2.0 million in funding under an additional senior secured promissorynote, bringing their total investment to $7.0 million. Also, in connectionwith the funding of the secondary note, 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, including a change of control, liquidationor dissolution of the Company or any action by us relating to bankruptcy orseeking appointment of a receiver or trustee.

 

On September29, 2005, out of the proceeds of the Asset Sale, we repaid the promisorry noteswith related interest in the sum of $7.4 million and discharged the stockwarrant obligation in the sum of $1.8 million to ComVest.

 

6

----

 

*FDA Auditand Software Recall.*We are subject to periodicinspections by the Food and Drug Administration (“FDA” or the “agency”). Theprimary purpose of these inspections is to verify the compliance of a company’squality system with the requirements of FDA’s Good Manufacturing Practices,also known as the Quality System Regulation, and other FDA regulationsgoverning medical devices. During these inspections, the agency evaluates ourstate of compliance with various FDA regulations and the adequacy of ouractions to correct observations from earlier inspections and Warning Letter(s).In early 2005, the FDA conducted an inspection of our quality system with theabove objectives. On May 13, 2005 the FDA completed the inspection andpresented a Form 483 formally describing observations with respect to ourcompliance with various FDA requirements. This inspection did not resolve theissues described in the Warning Letter issued to the Company in December 2002by the FDA, which as a result, remains in effect. We retained the services of aconsultant and responded to the Form 483 findings. The response described acorrective action plan to address each of the observations included on the Form483. To date, there has been no written response from the FDA regarding theadequacy of our corrective action plan. However, we attended two meetings withthe FDA regarding the status of the corrective actions during which ourcorrective action plan and actions taken have been discussed. We have completedthe corrective action plan defined in the response to the observations and arenow operating according to the changes put into effect.

 

Communication will continue with the FDA regarding our ongoing progressin ensuring the effectiveness of the corrective actions that have been taken. Ourgoal is to address the FDA’s inspectional observations without the agencypursuing additional regulatory or enforcement action. There can be noassurance, however, that our efforts will be successful and that the FDA willnot pursue such actions which could include, but not be limited to, theissuance of another Warning Letter; a court-ordered injunction; productseizures; recall of products; and criminal and/or civil proceedings. If aninjunction is issued, it may preclude us from shipping products or replacementparts until corrective action is taken and verified by the FDA.

 

The FDA has indicated that the 5.2.X versions of the software currentlyrunning on our SenoScan systems should be recalled for a known archiving issue.We have recently developed and are in the process of releasing to the generalmarket, a version 5.2.2 software release to correct the known archiving issueas well as increase functions for servicing the SenoScan unit. We havesubmitted recall plans to the FDA and intend to complete the software upgradesby June 30, 2006 in the U.S. and Europe. We estimate that the costs related tothis will be minimal but costs could become more significant than weanticipate.

 

*Federal Trade Commission (“FTC”)Investigation.*We received in October 2005 a requestfrom the FTC asking that we voluntarily produce certain information and materialto the FTC in connection with the Asset Sale. On January 31, 2006, we receivedadditional information requests from the FTC in the form of a Subpoena DucesTecum and Civil Investigative Demand as part of this ongoing investigation. TheFTC’s requests, which do not allege any wrongdoing, are part of a nonpublicinvestigation to determine whether the Asset Sale may be anticompetitive and aviolation of Sections 7 or 7A of the Clayton Act or Section 5 of the FederalTrade Commission Act. We are in the process of responding to the FTC requests whichcontinues to be expensive and requires significant management time, and we cannotpredict the outcome of the investigation, including whether the FTC will takeany further action against us.

 

**Our Business Strategy**

 

Our goal is to maximize the cash contribution derived from on-goingoperations and minimize expenses and liabilities in order to discharge themaximum amount of obligations and liabilities and distribute any remaining cashto our stockholders, if any is available after we have

 

7

----

 

fulfilled or reserved for, to the extentpossible, all obligations and liabilities to creditors including vendors,customers and others. Our short term strategy is as follows:

 

1.               Continuing our exitfrom our Service business and providing service continuity and warranty supportfor our customers worldwide through alternative service providers such asKodak.

2.               Fulfilling in atimely manner our last time purchase orders for MammoTest from EES and VersaRadfrom Kodak.

3.               Retaining keyemployees and ensuring that we have the necessary resources and capabilities inplace to complete the last time purchase orders.

4.               Liquidating ourEuropean operations after providing a service continuity solution for ourEuropean customers and providing for the obligations in the EES Amendment andDistributor Agreement.

5.               Maintaining thevalue of our RE&S business while we conduct the auction process andsimultaneously exploring alternative RE&S service solutions.

6.               Vacating ourleasehold premises on or before May 31, 2006 and locating appropriatefacilities to continue to operate our RE&S business.

 

Under Delaware law, any sale of all or substantially all of our assetsrequires approval by our stockholders. In the event it is determined that thesale of the assets related to the RE&S business to a successful bidderwould be considered a sale of all or substantially all of our assets, we willeither file a petition under Chapter 11 of the Bankruptcy Code and immediatelymove to close the sale pursuant to §363(b) and (f) of the Bankruptcy Code orseek the necessary stockholder approval. If we run out of cash, determine thatwe will not be able to settle all of our known obligations or determine that itis not cost efficient to pursue stockholder approval for the asset sales, wemay be forced to cease operations and liquidate assets pursuant to applicablelaw, which may include filings for bankruptcy protection under Chapter 7 or 11of the Bankruptcy Code.

 

Stockholderswould only receive a distribution after our business is wound down and we havefulfilled or reserved for, to the extent possible, all obligations andliabilities to creditors including vendors, customers and others. Managementcannot accurately estimate the amount of distribution to our stockholders, ifany, until the following are finalized or resolved:

 

•                  theresults of the auction process related to the sale of our RE&S business orProduct Lines,

•                  thestrategy to exit our European market,

•                  theimpact of Philips’ actions with respect to the termination of the PhilipsAgreement, and

•                  theoutcome of certain threatened or potential litigation.

 

Because we continue to suffer recurringlosses from operations and sold substantially all of our assets in the AssetSale, substantial doubt about our ability to continue as a going concernexists. The accompanying consolidated financial statements do not include anyadjustments that might result from the outcome of this uncertainty. Asdiscussed in Note 4 of the accompanying consolidated financial statements,management assessed the recoverability of our long-lived assets and intangiblesand recognized an impairment charge of $2.4 million in 2005, a process whichincluded assumptions regarding estimated future cash flows and other factors,and estimated that the maximum amount of additional non-cash impairment chargesrelated to fixed assets would be $0.3 million.

 

8

----

 

**OurMarket**

** **

We currentlyservice mammography and digital imaging products used in the diagnosis ofbreast cancer and other diseases and manufacturer and sell MammoTest to asingle distributor in Europe. Prior to the Asset Sale, we marketed and sold ourmammography and digital imaging products to public and private hospitals, aswell as specialized private care centers.

 

We continue tosell products that meet selected needs of the broader radiology andelectrophysiology markets. We continue to sell and service a line of film anddigital general radiology systems, an electrophysiology stimulation system,electrophysiology x-ray imaging systems and a specialized surgical C-armsystem. The generalx-ray medical imaging market is mature and new sales are driven by new productinnovation and a migration away from analog to digital modalities.

 

**Our Products**

 

Our productshave addressed two markets: mammography and conventional radiology. Our breastcancer diagnostic product line included the SenoScan digital mammography systemand the MammoTest prone stereotactic breast biopsy system. Our RE&S productline includes offerings for radiology, electrophysiology and surgery.

 

*SenoScan Digital Mammography System*

 

Our SenoScandigital mammography system was developed for screening and diagnosticmammography. We sold 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 site in the fall of 2001. Sales of our SenoScan productconstituted 22%, 40% and 33% of total product revenue for 2005, 2004 and 2003,respectively.

 

Prior to the Asset Sale, wewere engaged in a product redesign and enhancement effort of the SenoScanproduct intended to produce a new model with greater functionality,manufacturability and reliability. Completing this redesign on a timely basisand relaunching the SenoScan product was critical to our ability to compete inthe growing digital radiology market and to achieve our financial objectives. Ourdifficulties in completing this redesign contributed to the decision to acceptthe Asset Sale.

 

### ***MammoTest Systems***

### ** **

We haveproduced the MammoTest stereotactic breast biopsy system since 1988, and salesof this product constituted 50%, 39% and 49% of total product revenues for2005, 2004 and 2003, respectively. Prior to the Asset Sale, we sold theMammoTest product directly in the U.S. and have continued to sell it throughour partnership with EES under terms allowed per the Asset Sale Agreement. TheMammoTest product enables core needle biopsy of the breast for the minimally-invasiveremoval of suspicious tissue. The MammoTest system consists of an elevatingprone-position table, a mammographic x-ray imaging system and a stereotacticneedle guidance system used during the target localization process, biopsyprocedures and placement of a breast applicator set during interstitial therapyprocedures. Stereotactic refers to the technique of locating a lesion in athree-dimensional field using x-ray imaging, and directing the tip of a coreneedle to the site of the lesion for tissue removal. With the MammoTest system,the patient lies prone on the table with the breast hanging pendulant throughan opening in the table. The digital x-ray imaging camera is located beneaththe table where the breast is compressed and two digital x-ray images areacquired at separate angles.

 

9

----

 

*General Radiology Products*

 

Prior to our introduction of the MammoTestsystem in 1988, our business was focused primarily on the manufacture and saleof x-ray products directed to the general radiology market. Beginning in thethird quarter of 2002, we reinitiated efforts to more aggressively market andsell our Electrophysiology and VersaRad products.

 

*Electrophysiology Products(“EP”).*The treatment of cardiac arrhythmia patientstypically involves a diagnostic study of the electrical functioning of theheart with an electrophysiology, or EP, study. We estimate that approximately200,000 EP studies are performed each year by electrophysiologists. When an EPstudy indicates that the patient requires a surgical procedure, theelectrophysiologist will map the electrical activity in the patient’s heart inan effort to locate the precise area of the heart that is causing thearrhythmia. The EP x-ray imaging systems, tilt-tables and Bloom, are used byelectrophysiologists to evaluate the best course of treatment. We introduced asignificant upgrade to the EPX system in 2003 that included a newhigh-resolution digital imaging system along with a generator upgrade providinga 300% increase in power output, thus enabling the clinician to better imagelarger patients without a significant increase in x-ray dose to the patient orstaff. In August of 2005 we ceased to market and sell EPX systems eitherdirectly or through our network of dealers. Bloom is used byelectrophysiologists in the treatment of patients with cardiac arrhythmia, aswell as when patients receive pacemakers and implantable defibulators. We sellBloom directly worldwide, as well as through a distribution arrangement with GEMedical Systems.

 

*SPX (Special Procedure Imaging System).*Over 20 million people in the U.S. sufferfrom some form of peripheral vascular disease. SPX is designed for the specialrequirements of peripheral radiology, such as mobility and dose control. SPXoffers customers a range of software and hardware options and upgrades to meetspecific physician requirements. We ceased to market and sell the SPX system inJuly 2005 either directly or through our network of dealers.

 

*VersaRad Line.*VersaRad capitalizes on unique positioning capabilities requiringminimal patient movement, making it well suited for emergency roomapplications. It is also a versatile general radiographic system, allowingx-ray of every bone and joint in the body. The VersaRad is available for usewith a traditional x-ray film cassette as well as a digital array. We ceased tosell the VersaRad system directly in July 2005, but it continues to beavailable through our network of dealers. In addition, we supply the VersaRadproduct to Kodak under an OEM Agreement. In February 2006, managementreceived a purchase order from Kodak for a last time purchase of VersaRad.Therefore, we expect that no further VersaRad units will be sold to Kodak afterfulfillment of the last time purchase order in May 2006.

 

*Auction Process*. InMarch 15, 2006, we announced that we had started an auction process to sell theRE&S business. Bidders were asked to submit bids for the entire RE&Sbusiness, individual Product Lines or components thereof. The auction isexpected to be held on May 15, 2006. As soon as possible after the end of theauction, we intend to finalize and enter into definitive agreements with theparty or parties who submit the offer(s), if any, which in our sole judgment,are the most attractive bid(s) for the RE&S business and Product Lines.

 

Under Delawarelaw, any sale of all or substantially all of our assets requires approval byFischer’s stockholders. In the event it is determined that the sale of theRE&S assets to a successful bidder would be considered a sale of all orsubstantially all of our assets, we will either file a petition under Chapter11 of title 11 of the Bankruptcy Code and immediately move to close the salepursuant to §363(b) and (f) of the Bankruptcy Code or seek the necessarystockholder approval.

 

10

----

 

**Backlog**

 

Subsequent to year-end, wereceived last time purchase orders for 20 MammoTest units under the EESAmendment and VersaRad units with Kodak under our OEM Agreement, of which wehave committed to produce 30 units. As of today, the only other product linesare the EPX/SPX Line and Bloom Line. Backlog for the EPX/SPX and Bloom productlines is zero; we believe this is due to our reduced marketing efforts and themarket’s perception of our financial condition. We have sold no EPX/SPX unitsand 16 Bloom units since December 31, 2005.

 

**Research and Development**

 

Prior to the Asset Sale, weemployed development engineers who were dedicated to the enhancement of ourexisting products and the development of next generation products for thediagnosis and treatment of breast cancer and the general radiology market. Significanteffort was expended on engineering, designing systems and software developmentto enhance the SenoScan digital imaging system. Subsequent to the Asset Sale,our significantly reduced engineering staff has supported changes necessary forcompliance with FDA requirements and production.

 

Our researchand product development expenses were approximately $5.2 million,$6.5 million and $4.7 million in 2005, 2004 and 2003, respectively. Duringthe fourth quarter of 2005, our research and product development expenses wereapproximately $0.5 million.

 

**Sales and Marketing**

 

Prior to the Asset Sale, wesold our products worldwide primarily through a direct sales force augmented byselected channel partners. Our marketing activities also previously includedtrade shows, advertising in professional journals, conferences and physiciantraining programs. All marketing efforts were terminated on June 30, 2005 whenwe eliminated the marketing department as a result of the pending Asset Sale.

 

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

 

The market forMammoTest in the U.S. is mature, as the use of stereotactic breast biopsy is awell-established diagnostic procedure. Furthermore, customer requirements andthe competitive landscape are much better known in the physician community forbreast biopsy than for digital imaging. Our marketing effort for MammoTestprior to the Asset Sale focused on existing customers as well as the emergingcorporate healthcare buyers, such as Health Trust Purchasing, AmeriNet andBroadlane. We also sold and continue to sell our MammoTest products to EES fordistribution in Europe; however, in March 2006, we made arrangements with EESfor a final purchase order.

 

We marketedour RE&S products through several channels including direct salespersonnel, partnering and other marketing efforts. Prior to the third quarterof 2005, we had two direct sales personnel who would call on hospitals with ourEPX, SPX and VersaRad product

 

11

----

 

lines. In addition, we sell ourVersaRad product to Kodak for resale but in February 2006, we received a lasttime buy purchase order. We also sell our Bloom Stimulator directly to end userphysicians as well as to GE Medical Systems for resale. Sales to GE MedicalSystems has declined. We believe this is due to the market’s perception of ourfinancial condition.

 

Prior to the Asset Sale, wesold our products worldwide primarily through a direct sales force augmented byselected channel partners. As of December 31, 2004, we had 22 direct salespeople whose territories were mainly composed of large metropolitan areas. Inaddition, we had a limited number of dealers in the United States. All ourinternational sales and service operations were confined to United Kingdom,France, Italy and Germany and were supported by the European headquarters atFischer Imaging International, Geneva, Switzerland.

 

**Service**

 

Our serviceorganization is responsible for installing our products, providing warranty andrepair services, applications training and biomedical training. Products soldby our direct sales force typically carry limited warranties covering parts andlabor for twelve months. Products sold through dealers also carry limitedwarranties, with terms that are normally for twelve months and covering onlyparts or components. Service personnel offer maintenance service either undercontracts or at hourly rates. In many foreign countries outside of Europe, weuse dealers and third parties to provide maintenance service for our products.

 

In January2006, we signed the Kodak Agreements. As a result, we notified all our Servicecontract customers in the United States and Europe that their service contractshave been terminated effective April 21, 2006 and May 12, 2006, respectively. Inaddition, we notified all customers with remaining warranty obligations that weplan to purchase a service contract from Kodak to meet their warranty needsuntil the end of the warranty period. We plan to continue to meet our Serviceobligations until the applicable contract termination dates. We plan tocontinue to meet our service and warranty obligations for the RE&S ProductLines until the completion of the sale of the RE&S business.

 

There can beno assurance that all customers to which we have warranty and serviceobligations will be satisfied or accept Kodak as their alternative serviceprovider. If they do not, such customers may assert claims for damages againstus. We cannot determine the potential impact or outcome if this were to occur.

 

If the timenecessary to complete the sale of the RE&S business extends beyond areasonable period of time, we may not have sufficient funds to continue theseservice operations. If the effort to sell the RE&S business isunsuccessful, management will seek appropriate alternative service providers toprovide continuation of service for RE&S warranty and service contractobligations. If we are unable to find appropriate alternative serviceproviders, we may not have sufficient funds to reimburse our customers forservice and warranty obligations for the RE&S business.

 

Applicationstraining and warranty support committed to be provided under the EES Amendmentwill be provided by an alternative service provider since management plans towind down and liquidate our European subsidiaries in the near future. OurEuropean subsidiaries are in discussions with an alternative service providerbut if this fails, additional funds may need to be used to fund the operationsuntil an appropriate alternative service provider is located. If an alternativeservice provider cannot be located at a reasonable cost, the projected positivecash contribution from the sale of Tables under the EES Amendment could be atrisk.

 

12

----

 

As ofDecember 31, 2005, we employed 37 field and technical support engineers, 6applications training personnel, and 5 customer service personnel,administrative and management personnel in our worldwide service organization. Asof March 10, 2006, we employed 29 field and technical support engineers, 4applications training personnel, and 3 customer service personnel,administrative and management personnel in our worldwide service organization.

 

**Manufacturing**

 

Our productsare manufactured in our production facility in Denver, Colorado. Themanufacturing process is primarily assembly, integration, testing, and qualitycontrol of parts, components and assemblies, the majority of which arepurchased or outsourced from vendors.

 

Many parts andcomponents for our systems are generally readily available from several supplysources. However, for several critical components, including cameras andautoguides used in our MammoTest product, we rely on one supplier. Themanufacture of these components is highly complex and requires a precise, highquality manufacturing process from our suppliers. We have experiencedperformance issues with several of these suppliers in meeting our supply chainand quality requirements. As a result, we have experienced unanticipatedproduction problems that have caused us to miss customer shipment requestdates, delay production and incur additional costs related to manufacturing,shipping and installation. A significant delay in production in 2006 could havea significant impact on our ability to meet the requirements of the last timepurchase orders received from EES and Kodak. We, relative to the Servicebusiness and with Hologic’s consent, granted Kodak a non-exclusive limitedlicense to perform these service related activities in the Kodak LicenseAgreement. As a result, we are in the process of transferring all suppliers ofcomponents for the MammoTest and SenoScan product lines to Kodak.

 

As ofDecember 31, 2005, we employed 34 employees in our manufacturingorganization, including 26 in production and 8 in quality and regulatoryaffairs.  As of March 10,2006 we employed 34 employees in our manufacturing organization, including 27in production and 7 in quality and regulatory affairs.

 

**Intellectual Property**

 

We seek toprotect our proprietary rights through a combination of technical experience,patent, trade secret and trademark protection and nondisclosure agreements. Welicense certain intellectual property from Hologic relating to the MammographyAssets sold to Hologic, which we use primarily to manufacture the MammoTeststereotactic breast biopsy system for EES and to continue to fulfill ourobligations in the Service business**.**Inaddition, we hold issued patents covering, among other things, certain featuresof our SPX and EPX products and related technologies and processes. We alsorely on trade secrets and proprietary knowledge that we seek to protect, inpart, through appropriate confidentiality and proprietary informationagreements. These agreements generally provide that all confidentialinformation developed or made known to an individual during the course of hisor her relationship with us is not to be disclosed to third parties, except inspecific circumstances. They also generally provide that all inventionsconceived by the individual in the course of his or her services to us are ourexclusive property. The value of the RE&S business will depend in part onour ability to protect and preserve our RE&S related intellectual propertyrights.

 

13

----

 

**Competition**

 

The medicaldevice industry is intensely competitive and had a significant impact on our2005 results. Most of our competitors had substantially greater financial andother resources, larger research and development staffs, and more extensivemarketing and manufacturing organizations than we did.

 

We facedsignificant competition in digital imaging from large companies that werepursuing the same digital mammography market. In 2000 the FDA cleared theSenographe 2000D from General Electric, in 2002 the FDA cleared a digitalmammography system from Hologic and in 2004 FDA cleared the Mammomat Novationsystem from Siemens. Additional companies had announced plans to developdigital mammography systems, including Fuji, PlanMed and Kodak.

 

We also havesignificant competition in our RE&S business from many companies that arepursuing the same market. EPMed manufacturers a product similar to Bloom. GE,Siemens, Phillips Electronics and Omega Medical Systems each manufacture andsell products similar to EPX. SwissRay is a primary competitor for our VersaRadproduct line.

 

## **Regulation**

##  

The medicaldevices manufactured and marketed by us are subject to regulation by the FDAand, in many instances, by foreign governments. Under the U.S. Federal Food,Drug and Cosmetic Act, known as the FD&C Act, manufacturers of medicaldevices must 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 System Regulation(“QSR”), administered by the FDA. The majority of our products are also subjectto the Radiation Control for Health and Safety Act, administered by the FDA,which imposes performance standards and record keeping, reporting, producttesting and product labeling requirements for devices that emit radiation, suchas x-rays.

 

Our productsare also subject to approval by certain foreign regulatory and safety agencies,including the European Union (EU), where we market our products under theMedical Device Directive. Two key elements for marketing approval in theEU and many other foreign countries are:

 

1.               The complianceof our products to relevant international standards and the associatedmanufacturer’s Declaration of Conformity 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.

 

Our quality system iscertified by our Notified Body, TUV Product Services and all ourEuropean-marketed products carry the required CE Mark. There may be otherrequirements for registration or approval in other countries, but these twoelements are typically the foundation of many foreign countries’ registrationand approval to sell.

 

The FDA and foreignregulatory agencies can withdraw previously issued clearances or requireus to change a product or its manufacturing process or labeling, to supplyadditional proof of its safety and effectiveness, or to recall, repair, replaceor refund the cost of the medical device, if it is shown to be hazardous ordefective.

 

14

----

 

As statedabove, we are subject to additional FDA regulations, including the RadiationControl for Health and Safety Act of 1968, which specifically regulatesradiation-emitting products. In addition, our manufacturing processes andfacilities are subject to the Quality system Regulation and continuing reviewby FDA. Most U.S. states and many other foreign countries monitor and requirelicensing of X-ray devices.

 

FDAregulations require manufacturers of medical devices to adhere to the QSR,which includes testing, quality control, quality assurance, corrective action,preventive action, and documentation procedures for design, manufacturing,installation and servicing. Our manufacturing facilities are subject toperiodic inspections by the FDA.

 

As previously discussed, theFDA inspection that ended May 2005 resulted in the FDA’s issuance of a Form 483detailing aspects of nonconformity with the QSR. Our goal is to address the FDA’sinspectional observations without the agency pursuing additional regulatory orenforcement action. There can be no assurance, however, that our efforts willbe successful and that the FDA will not pursue such actions which couldinclude, but not be limited to, the issuance of another Warning Letter; acourt-ordered injunction; product seizures; recall of products; and criminaland/or civil proceedings. If an injunction is issued, it may preclude usfrom shipping products or replacement parts until corrective action is takenand verified by the FDA.

 

We are alsosubject to other federal, state, local and international laws and regulationsrelated to worker health and safety, environmental protection and exportcontrols. Some of our technology is governed by the International Traffic inArms Regulations of the United States Department of State. As a result, theexport of some of our systems to some countries may be limited or prohibited.We believe we are in compliance, in all material respects, with these otherlaws and regulations and that maintaining such compliance will not have amaterial financial impact on future capital expenditures or results ofoperations.

 

**Employees**

 

As ofDecember 31, 2005, we had 112 employees, including 93 in our U.S.operations and 19 in our international operations. As of December 31, 2005, weemployed 48 people in service, 34 in manufacturing, 15 in engineering and 15 inadministration. None of our employees are parties to a collective bargainingagreement. We consider relations with our employees to be satisfactory. InDecember 2005, we entered into independent contractor agreements with our Presidentand Chief Executive Officer and our Chief Financial Officer, which officersceased to be employees. On an as-needed basis we sub-contract for personnel toaugment our needs. As of March 10, 2006, we had 88 employees, including 75 inour U.S. operations and 13 in our international operations. All but 14 of ourU.S. employees have received 60-day notice of their departure date. We estimateapproximately 35 of our U.S. employees will leave on or after April 7, 2006 andapproximately 26 will leave in May 2006.

 

We enteredinto termination and retention arrangements from June 2005 through March 2006with approximately 102 employees in the U.S. and Europe. All areas of theCompany were impacted. Retention payments under these agreements are earnedover the periods July 1, 2005 through December 31, 2005 and January 1, 2006through June 30, 2006 and are currently estimated to be $0.7 million and $0.5million, respectively. Severance payments, earned upon involuntary termination,are estimated to be $1.3 million. We believe retention of the remainingemployees is absolutely critical as they each have irreplaceable skill sets. Ifany of these key employees voluntarily terminate, we may not be able tocomplete the last time

 

15

----

 

purchase orders from Kodak andEES which could have a significant impact on our cash projections and on ourability to continue to operate our business.

 

**Website Access**

 

Our websiteaddress is www.fischerimaging.com. You may obtain free electronic copies of ourannual reports on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K, and all amendments to those reports at our websiteunder the heading “Investor Relations” or at the SEC’s website address, whichis www.sec.gov. The SEC website also contains proxy and information statementsand other Company information. These reports are available on our website assoon as reasonably practicable after we electronically file them with the SEC.The reference to our website does not constitute incorporation by reference ofthe information contained on the website, and the information contained on thewebsite is not part of this document.

 

**Other Sources**

 

The public mayread and copy any materials we file 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.

 

**ITEM 1A. Risk Factors**

 

The materialrisks and uncertainties that may affect our operations and financial resultsare described below. Additional risks and uncertainties not presently known tous or 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 trading price of our common stock could decline,and you may lose all or part of your investment.

 

## **Risks Related to Our Business**

##  

**Wecontinue to incur substantial losses and reductions in cash and our ability toexecute our business strategy is uncertain.**

** **

As of March 17, 2006, we had$1.7 million and $0.3 million in cash in the U.S. and Europe, respectively,excluding $0.6 million placed into an irrevocable trust to fundemployee-related obligations. We expect to receive approximately $6.9 millionin revenues from the Kodak and EES last time purchase orders and other ordersfilled since December 31, 2005 or on hand as of March 2006, but these amountswill be offset by continuing claims, liabilities and expenses from operations(such as operating costs, salaries, retention and severance payments, leasepayments, insurance, and local taxes, legal and accounting fees andmiscellaneous office expenses). We continue to experience significant expenseand demands for management resources in connection with continuing litigationand the ongoing FTC investigation. In addition, we continue to negotiate withcreditor, vendors, suppliers and others to mitigate our potential liabilitiesto these parties; however, we are unable to predict our success in this regardand additional claims and liabilities are likely to arise. Our strategy tomaintain sufficient liquidity to enable an orderly wind up of the business andeffectively fulfill or settle outstanding claims and obligations may bejeopardized if we are unable to substantially complete the last time purchaseorders or if substantial claims and liabilities are asserted against us. Ifthis occurs, we may be forced to cease

 

16

----

 

operations and liquidate assets pursuant toapplicable law, which may include filings for bankruptcy protection underChapter 7 or 11 of the Bankruptcy Code.

 

**Wemay be unable to fulfill last time purchase orders from Kodak and EES at all orin a timely manner.**

** **

Our business plan isdependent on substantially completing the last time purchase orders from Kodakand EES in a timely manner. Adverse regulatory action, failure to obtain thenecessary component parts, or failure to retain key employees may prevent usfrom fulfilling these purchase orders, at all or timely, which would adverselyaffect our ability to remain in operation.

 

**Ourvendors and suppliers may fail to deliver components for our products.**

** **

We rely on a limited numberof suppliers for several critical components needed to manufacture our products.In addition, we have experienced performance and quality issues with respect tosome of our component parts and delays in product shipments. Also, several ofour suppliers require payment in advance of delivery or cash on delivery, andothers may do so in the future. We may have additional difficulties withrespect to our ability to obtain components on a timely and cost-effectivebasis in order to manufacture our products and may not be able to obtain suchcomponents at all. Our inability to obtain the requisite parts could cause usto be unable to complete the final Kodak and EES purchase orders and thereforewould have a substantial adverse impact on our ability to continue ouroperations.

 

**Weare continuing to negotiate with our creditors including vendors and customersand may face additional claims in the future.**

** **

We continue to negotiatewith our creditors including vendors and customers to mitigate and settle ourknown liabilities to them or their claims of liabilities. We may incuradditional liabilities if our liquidity situation deteriorates further and mayface additional claims from creditors seeking to protect their interests inlight of our announcements regarding our financial condition and businessplans. We are unable to predict our success in attempting to negotiate withthese parties nor the expense related to defending any such claim. If theService business customers do not sign replacement service agreements by April2006 or the customers do not accept Kodak as a service provider, we may nothave reduced our obligations or costs.

 

With respect to Philips, inlate 2005 we had discussions with Philips as to the settlement of potentialclaims under the Philips Agreement. We declined Philips offer to settle thematter and referred Philips to the dispute resolution provisions of theagreement. We are unable to predict whether Philips may file suit or theamount, if any, that Philips may demand, or the expense related to defendingany such claim. If substantial additional claims are asserted against us, wemay be forced to seek protection under the Bankruptcy Code.

 

**Regulatoryagencies could take adverse action which could have an adverse impact on ourability to continue in operation.**

** **

We are subject to regulationby the FDA and foreign regulatory agencies. We have responded to the Form 483issued by the FDA in May 2005 and will continue to communicate with the FDAregarding our compliance; however, there can be no assurance that our effortswill be successful or that the FDA will not pursue regulatory or enforcementaction with respect to this or other matters. FDA action could include issuanceof another Warning Letter, a court-ordered

 

17

----

 

injunction, product seizures, productrecalls, and criminal and/or civil proceedings. An injunction or similar actionmay prevent us from shipping products to fulfill final purchase orders untilcorrective action is taken and verified by the FDA.

 

We are also subject toregulation by foreign government authorities in Europe and such authorities maywithdraw approval or require us to change a product or its manufacturingprocess or labeling, to supply additional proof of its safety andeffectiveness, or to recall, repair, replace or refund the cost of the device,if it is shown to be hazardous or defective. Such authorities in Europe couldalso prevent us from transitioning our European Service business to analternative service provider.

 

Any of these actions by theFDA or foreign regulatory authorities would have a material adverse impact andon our ability to continue to operate and may cause us to seek protection underthe Bankruptcy Code.

 

**Potentialproduct defects or related performance issued could result in product recallsand significant liability and legal costs.**

** **

Complex medical devices suchas we have produced and continue to produce on a limited basis can experienceperformance problems in the field that require review and possible correctiveaction by the manufacturer. Some of the issues may in the future be addressedby alternative service providers; however, some product problems could resultin market withdrawals or product recalls which could result in significantliability and legal costs.

 

Our business exposes us topotential 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 of products.We have been a defendant, from time to time, in product liability actions. Although,we currently have product liability insurance, our claims-made policy coverageends as of May 1, 2006, and we have been unable to find commercially reasonablereplacement coverage. Consequently, a product liability claim or other claimprior to May 1, 2006 in excess of insured liabilities or any claim after May 1,2006 could have a material adverse effect on us.

 

**Ourplans to liquidate and wind-up our European subsidiaries may require additionalcash or may prevent us from meeting our EES obligations**

** **

In December2005, the Board of Directors approved the liquidation and wind-up of ourEuropean subsidiaries. After the Asset Sale, the only remaining recurring Europeanrevenue is related to service contracts. We anticipate that applicationstraining and warranty support due under the EES Amendment and DistributorAgreement will be provided by an alternative service provider in Europe. OurEuropean subsidiaries are in discussions with an alternative service providerbut if this fails, additional funds may be needed to fund the operations untilan appropriate alternative service provider is located. If an alternativeservice provider cannot be located at a reasonable cost, the projected positivecash contribution from the sale of the EES Tables could be at risk.

 

As our Europeansubsidiary liquidate, additional cash may be required to ensure the transitionto an alternative service provider is completed. We may not be able to providecash from the U.S. depending on our cash availability. If this were to happen,the projected positive cash contribution from the sale of the EES Tables couldbe at risk. As of December 31, 2005, the Board of Directors approved theforgiveness of the receivables from the European subsidiary since we deemed ituncollectible. If the European 

 

18

----

 

subsidiaries cannot secureadditional cash when necessary, each may be required to cease operations andrequest receivership proceedings under applicable Swiss or German insolvencylaw.

 

**Wemay be unable to retain key employees.**

** **

Our key employees are vitalto our business plan over the coming months. If we are unable to retain theseemployees, we may be unable to complete our business strategy and may be forcedto cease operations and liquidate under applicable law including a liquidationunder Chapter 7 or 11 of the Bankruptcy Code.

 

**Failure to collect accounts receivable on a timelybasis would materially adversely affect us.**

** **

**Our accounts receivable balance was $4.0 million, net ofthe allowance for doubtful accounts of $0.4 million, as of December 31, 2005. Approximately,$2.3 million of this relates to our Service business, which we may havedifficulty collecting as a result of the exiting the Service business. Inaddition, currently we have two primary customers, Kodak, in connection withthe VersaRad last time purchase order, and EES, in connection with theMammoTest last time purchase order. If we have difficulties or delays incollecting receivable due from either of Kodak or EES, or on our Servicebusiness related receivables, our business will be materially adverselyeffected and we may be forced to cease operations and liquidate underapplicable law including a liquidation under Chapter 7 or 11 of the BankruptcyCode.**

** **

**TheRE&S auction process may not be successful.**

** **

Our efforts to sell theRE&S business and product lines may be unsuccessful or may not generatesignificant proceeds to pay unknown creditor claims or contribute cash todistribute to stockholders. If the RE&S business is not sold in itsentirety, we would be left with continuing obligations in connection withRE&S related service and warranty obligations. We would seek alternativeservice providers to provide continuation of service for warranty and servicecontract obligations; however, if we were unsuccessful, we could be left withpotential liability in connection with these continuing service and warrantyobligations. If a potential strategic transaction with respect to the RE&Sservice and warranty obligations could not be completed in a reasonable periodof time, we may not have sufficient funds to continue to RE&S serviceoperations.

 

**Weare the subject of a continuing FTC investigation, and the FTC may elect tobring further action against us.**

** **

We are the subject of aninvestigation by the FTC into whether our transaction with Hologic violatedfederal antitrust laws. We are in the process of responding to the FTCrequests, which continues to be expensive and require significant managementtime, and we cannot predict the outcome of the investigation, including whetherthe FTC will take any further actions against us.

 

**Theremay be no value to distribute to stockholders.**

** **

The amount, if any, availablefor distributions to stockholders will primarily depend on our ability tocomplete the EES and Kodak last-time purchase orders, our ability to sell theRE&S business, control expenses and minimize liabilities in the comingmonths. Stockholders will only receive distributions after our business iswound down and we have fulfilled or reserved for, to the extent possible, allobligations and liabilities to creditors including vendors, customers andothers. This

 

19

----

 

process may take a considerable amount oftime and we are unable to predict whether stockholders will receivedistributions or the timing of any potential distributions.

 

**Risks Related to OurCommon Stock**

 

**Our common stock trades on the Pink Sheetsand the market for our common stock is limited.**

 

Our common stock is thinly traded and occurs in the over-the-countermarket called the “Pink Sheets.” Consequently, selling our common stock can bedifficult because smaller quantities of shares can be bought and sold,transactions can be delayed and security analyst and news media coverage of usmay be reduced. These factors could result in lower prices and larger spreadsin the bid and ask prices for shares of our common stock as well as lowertrading volume. Our common stock is also subject to the “penny stock”regulations, including Rule 15g-9 under the Securities Exchange Act of1934. That rule imposes additional sales practice requirements on broker-dealersthat sell low-priced securities to persons other than established customers andinstitutional accredited investors. For transactions covered by this rule, abroker-dealer must make a special suitability determination for the purchaserand have received the purchaser’s written consent to the transaction prior tosale. 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.

 

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

 

Fiveinstitutional investors, Hologic and a single individual stockholder, combined,beneficially, own approximately 59.7% of our common stock as ofDecember 31, 2005. As a result, a few stockholders are able to exercisesignificant influence on the election of our board of directors and couldthereby direct our policies.

 

## **ITEM 1B.UNRESOLVED STAFF COMMENTS**

##  

None.

 

## **ITEM 2. PROPERTIES**

##  

We maintain aleased office for our headquarters and manufacturing facility in Denver,Colorado. This facility includes approximately 120,000 square feet of officeand manufacturing space and is leased from JN Properties. Under the terms ofthe Lease, the Lease may be terminated within 60 days of written notice ofintent to vacate or May 31, 2006, whichever is earlier. We intend to vacate onMay 31, 2006 and to search for a suitable facility to lease to continue theRE&S business during the auction process. We also lease office space inSwitzerland on a month-to-month basis.

 

## **ITEM 3. LEGALPROCEEDINGS**

##  

On December20, 2005, University Health Network (“UHN”) and Mount Sinai Hospital (“MountSinai”) filed a Statement of Claim in Ontario, Canada against Fischer andHorizon Medical Services Ltd. (“Horizon”) and asserted claims seeking torecover damages relating to their purchase of two SenoScan units from us. Insummary, UHN and Mount Sinai allege, among

 

20

----

 

other things, that the SenoScanunits, which were manufactured by us and sold by Horizon, an entity authorizedto sell these types of machines in Canada, were defective and did not conformto certain agreed specifications. The suit seeks Canadian $1 million indamages, plus interest, attorneys’ fees and expenses. We have denied theallegations advanced by UHN and Mount Sinai and asserted breach of contractcounterclaims against UHN and Mount Sinai for failing to pay approximately Canadian$450,000 in connection with the sale of the two SenoScan units. Also, Horizonhas denied the core allegations advanced by UHN and Mount Sinai. Horizon alsoasserted breach of contract counterclaims against UHN and Mount Sinai forfailing to pay amounts due relating to the sale of the two SenoScan units andasserted cross-claims for repayment of attorney fees against us forindemnification based on, among other things, its contention that Horizon actedas our agent in the underlying transaction and we must indemnify its agentunder applicable law. We believe the suit and counterclaim are without meritand intend to vigorously defend the case, as well as assert counterclaimsagainst Horizon for nonpayment.

 

We received inOctober 2005 a request from the FTC asking that we voluntarily produce certaininformation and material to the FTC in connection with the Asset Sale. OnJanuary 31, 2006, we received additional information requests from the FTC inthe form of a Subpoena Duces Tecum and Civil Investigative Demand as part ofthis ongoing investigation. The FTC’s requests, which do not allege any wrongdoing,are part of a nonpublic investigation to determine whether the Asset Sale maybe anticompetitive and a violation of Sections 7 or 7A of the Clayton Act orSection 5 of the Federal Trade Commission Act. We are in the process ofresponding to the FTC requests which continues to be expensive and requiresignificant management time, and we cannot predict the outcome of theinvestigation, including whether the FTC will take any further action againstus.

 

On December21, 2005, we filed a complaint and jury demand against Cedara SoftwareCorporation (“Cedara”) seeking damages arising from Cedara’s breach of acontract to sell software applications products. Cedara answered the complainton January 30, 2006 and filed a counterclaim for unpaid invoices and otherrelief. We do not expect any liability in addition to amounts recognized as ofDecember 31, 2005 for the counterclaim and will vigorously defend thecounterclaim while pursuing our case. At this time, management cannot determinethe possible outcome of the lawsuit.

 

We are also a defendant invarious lawsuits incidental to the operation of our business. We do not believethat any of those pending legal proceedings would have a material, adverseeffect on our consolidated financial position or results of our operations.

 

## **ITEM 4. SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

##  

None

 

21

----

 

# **PART II**

#  

## **ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

##  

In July 2003,our stock was delisted from the Nasdaq National Market where it was tradedunder the symbol “FIMG.”  At that timeour trading symbol changed to “FIMG.PK” and our common stock is now availablefor trading 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 bid prices per share of our common stock as reported by the Pink SheetsLLC. The high and low bid quotations reflect inter-dealer prices, withoutretail mark up, mark down or commission and may not represent actualtransactions.

 
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **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    |       |
|           |       |     |       |    |       |
| **2005**       |       |     |       |    |       |
| First Quarter  |       | $        | 7.00       |    | $          | 3.50 |   |
| Second Quarter |       | 6.30     |       | 2.00    |       |
| Third Quarter  |       | 2.00     |       | 0.13    |       |
| Fourth Quarter |       | 0.36     |       | 0.05    |       |

 

As ofDecember 31, 2005, there were approximately 188 holders of record of ourcommon stock. We believe that we actually have in excess of 1,500 beneficialowners. The closing sale price of our common stock on March 24, 2006 asreported by Pink Sheets, LLC was $0.08 per share. We have not declared or paidany cash dividends on our common stock in the last five years. As discussedabove, we intend to wind up our business, satisfy or provide for ourliabilities and distribute amounts, if any, remaining to stockholders. We areunable to predict whether any amounts will be available to distribute tostockholders under these circumstances and the amounts of any potentialdistributions.

 

**Recent Sales of Unregistered Securities**

 

During January and June 2005, we issued24,333 shares of common stock upon the exercise of options held by threeformer officers of the Company for an aggregate price of $55,124. The shares wereissued in reliance on the exemption from registration requirements provided inSection 4(2) of the Securities Act of 1933, as amended.

 

22

----

 

## **ITEM 6.SELECTED CONSOLIDATED FINANCIAL DATA**

##  

You should read the following SelectedConsolidated Financial Data with the consolidated financial statements andrelated notes and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” appearing elsewhere in this report.

 
| ** **                                             | ** ** | **2005**                                                           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| **Consolidated Statement of Operations Data**          |       |                                                               |       |     |       |     |       |     |       |     |       |
| Revenues:                                              |       |                                                               |       |     |       |     |       |     |       |     |       |
| Products (5)                                           |       | $                                                                  | 32,254     |     | $          | 48,645   |       | $        | 32,814     |     | $          | 30,630 |   | $ | 28,055 |   |
| Services                                               |       | 15,014                                                             |       | 15,395   |       | 13,348   |       | 14,480   |       | 13,860   |       |
| Total revenues                                         |       | 47,268                                                             |       | 64,040   |       | 46,162   |       | 45,110   |       | 41,915   |       |
| Cost of sales:                                         |       |                                                               |       |     |       |     |       |     |       |     |       |
| Products (2)                                           |       | 31,181                                                             |       | 33,648   |       | 25,109   |       | 28,180   |       | 17,984   |       |
| Services (2)                                           |       | 18,467                                                             |       | 17,523   |       | 13,629   |       | 11,887   |       | 7,307    |       |
| Total                                                  |       | 49,648                                                             |       | 51,171   |       | 38,738   |       | 40,067   |       | 25,291   |       |
| Gross profit                                           |       | (2,380                                                             | )          | 12,869   |       | 7,424    |       | 5,043    |       | 16,624   |       |
| Operating expenses:                                    |       |                                                               |       |     |       |     |       |     |       |     |       |
| Research and development                               |       | 5,233                                                              |       | 6,531    |       | 4,654    |       | 4,559    |       | 3,257    |       |
| Selling and marketing                                  |       | 5,913                                                              |       | 10,469   |       | 9,376    |       | 7,981    |       | 7,278    |       |
| General and administrative                             |       | 10,509                                                             |       | 7,917    |       | 8,754    |       | 7,697    |       | 5,028    |       |
| Impairment of long-lived assets (3)                    |       | 2,350                                                              |       | —   |       | —   |       | —   |       | —   |       |
| Lease termination fee (4)                              |       | 4,000                                                              |       | —   |       | —   |       | —   |       | —   |       |
| Total operating expenses                               |       | 28,005                                                             |       | 24,917   |       | 22,784   |       | 20,237   |       | 15,563   |       |
| (Loss) income from operations                          |       | (30,385                                                            | )          | (12,048  | )          | (15,360  | )          | (15,194  | )          | 1,061    |       |
|                                                   |       |                                                               |       |     |       |     |       |     |       |     |       |
| Interest expense                                       |       | (3,066                                                             | )          | (66      | )          | (49      | )          | (81      | )          | (138     | )          |
| Interest income                                        |       | 66                                                                 |       | 4        |       | 62       |       | 119      |       | 77       |       |
| Patent settlement income (1)                           |       | —                                                             |       | 5,150    |       | 900      |       | 24,950   |       | —   |       |
| Gain on sale of Mammography Assets (5)                 |       | 32,000                                                             |       | —   |       | —   |       | —   |       | —   |       |
| Other (expense) income                                 |       | (151                                                               | )          | 39       |       | 34       |       | (74      | )          | (118     | )          |
| Total other income (expense)                           |       | 28,849                                                             |       | 5,127    |       | 947      |       | 24,914   |       | (179     | )          |
| (Loss) income before income taxes                      |       | (1,536                                                             | )          | (6,921   | )          | (14,413  | )          | 9,720    |       | 882      |       |
| Provision (benefit) for income taxes                   |       | 71                                                                 |       | —   |       | —   |       | —   |       | —   |       |
| Net (loss) income                                      |       | $                                                                  | (1,607     | )        | $          | (6,921   | )          | $        | (14,413    | )        | $          | 9,720 |   | $ | 882 |   |
| Net (loss) income per common share:                    |       |                                                               |       |     |       |     |       |     |       |     |       |
| Basic                                                  |       | $                                                                  | (0.17      | )        | $          | (0.74    | )          | $        | (1.55      | )        | $          | 1.06 |   | $ | 0.10 |   |
| Diluted                                                |       | $                                                                  | (0.17      | )        | $          | (0.74    | )          | $        | (1.55      | )        | $          | 1.00 |   | $ | 0.09 |   |
| Shares used to calculate net (loss) income  per share: |       |                                                               |       |     |       |     |       |     |       |     |       |
| Basic                                                  |       | 9,392                                                              |       | 9,353    |       | 9,319    |       | 9,204    |       | 8,643    |       |
| Diluted                                                |       | 9,392                                                              |       | 9,353    |       | 9,319    |       | 9,692    |       | 9,352    |       |
| **Balance Sheet Data (at end of period):**             |       |                                                               |       |     |       |     |       |     |       |     |       |
| Working capital                                        |       | $                                                                  | 4,473      |     | $          | 4,169    |       | $        | 9,405      |     | $          | 23,199 |   | $ | 14,061 |   |
| Total assets                                           |       | 14,698                                                             |       | 31,374   |       | 32,348   |       | 41,079   |       | 31,552   |       |
| Total long-term debt (credit facility)                 |       | —                                                             |       | 1,454    |       | 454      |       | 1,181    |       | 1,003    |       |
| Total stockholders’ equity                        |       | 5,012                                                              |       | 6,593    |       | 13,075   |       | 27,493   |       | 17,669   |       |

 

23

----

 

----

(1)          Duringthe second quarter of 2002, we settled a patent infringement lawsuit that wehad filed against 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. InJune 2004, we received an accelerated final settlement payment of $4.3million.

(2)          During2005, the provision for excess and obsolete inventories increased by $7.8million as a result of a reduction in forecasted sales and service usageresulting from the sale of the Mammography Assets to Hologic, the arrangementmade with Kodak, and the lack of sales generated from the Philips Agreement. Approximately$2.0 million is reported as services cost of sales and $5.8 million is reportedas product cost of sales.

(3)          Animpairment of long-lived assets of $2.4 million was recorded during 2005 asdiscussed in Note 4 of the consolidated financial statements.

(4)          Inexchange for early release from the long-term lease with JN Properties, weagreed to pay to JN Properties $4.0 million plus certain accrued 2005 propertytaxes as discussed in Note 5 of the consolidated financial statements.

(5)          Weagreed to sell our intellectual property rights related to our mammographybusiness and products, including rights to our SenoScan digital mammography andMammoTest stereotactic breast biopsy systems as described in Note 1 of theaccompanying consolidated financial statements. As a result of the Asset Sale,sales of the SenoScan and MammoTest during the fourth quarter were $0.0 millionand $1.4 million, respectively.

 

## **ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

##  

You should read the following “Management’sDiscussion and Analysis” with the consolidated financial statements and relatednotes and “Selected Consolidated Financial Data” appearing elsewhere in thisForm 10-K.

 

**Overview**

 

We servicemammography and digital imaging products used in the diagnosis of breast cancerand other diseases and manufacture and sell the MammoTest to a singledistributor in Europe. Our primary focus prior to the consummation of theHologic Asset Sale on September 29, 2005 (as discussed below) was designing,manufacturing and selling mammography and digital imaging products and usingour digital imaging technology in screening and diagnostic mammograms andminimally invasive breast biopsy to aid in the early identification of breastcancer. We also continue to service and sell products that meet selected needsof the broader radiology and electrophysiology markets.

 

Followingsignificant losses and negative cash flows from operations during 2004, whichcontinued into 2005, and delays in the SenoScan redesign program, we obtainedfinancing, as discussed further in Note 6 of the accompanying consolidatedfinancial statements in an aggregate amount of $7.0 million. In May 2005, weannounced that we were considering strategic alternatives and retained aninternational investment bank to assist it in that process. The $7.0 million offinancing was completely consumed to fund operations, working capital needs andto repay outstanding loans. Due to difficulties in reducing costs, furtherdelays in the SenoScan redesign program, declines in revenue and other negativedevelopments, we were left with insufficient cash reserves to continueoperations in June 2005.

 

On June 22,2005, we entered into the Asset Sale Agreement in which we agreed to sell toHologic all of our intellectual property rights related to our MammographyAssets, which formed the basis for substantially all of our business, for acash purchase price of $32.0 million. The value of the Mammography Assets soldwas zero on our consolidated balance sheets and therefore the

 

24

----

 

entire $32.0 million proceedswere recognized as Gain on sale of Mammography Assets in the accompanyingconsolidated statements of operations.

 

Under theAsset Sale Agreement, Hologic agreed to grant us a non-exclusive limitedlicense to use certain Mammography Assets necessary for us to continue ourService business; to fulfill contractual obligations to provide MammoTest andSenoScan systems to EES and Philips, respectively; and to carry out certainactivities with respect to our RE&S business. In connection with the entryinto the Asset Sale Agreement, Hologic loaned us $5.0 million to be used forworking capital purposes.

 

The Asset Sale Agreement was approved by our stockholders at a specialmeeting of stockholders held on September 28, 2005 and closing of the AssetSale transaction occurred on September 29, 2005. As a result, revenuesrecognized from MammoTest and SenoScan after September 29, 2005 were $1.4million and $0.0 million, respectively. Our plans with respect to each of theretained assets/businesses is discussed further in the “Liquidity and CapitalResources” section.

 

As discussedfurther in Note 14 of the accompanying consolidated financial statements, onMarch 15, 2006, we announced that we were starting an auction process to sellthe RE&S business. Bidders have been asked to submit bids for the entireRE&S business, individual Product Lines or components thereof.

 

Under Delawarelaw, any sale of all or substantially all of our assets requires approval byour stockholders. In the event it is determined that the sale of the assetsrelated to the Product Line(s) to a successful bidder would be considered asale of all or substantially all of our assets, we will either file a petitionunder Chapter 11 of title 11 of the the Bankruptcy Code and immediately move toclose the sale pursuant to §363(b) and (f) of the Bankruptcy Code or seek thenecessary stockholder approval.

 

The factors listed above, among others, raisesubstantial doubt about our ability to continue as a going concern. Theconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty. As discussed in Note 4, managementassessed the recoverability of our long-lived assets and intangibles andrecognized an impairment charge of $2.4 million in 2005, a process whichincluded assumptions regarding estimated future cash flows and other factors,and estimated that the maximum amount of additional non-cash impairment chargesrelated to fixed assets would be $0.3 million.

 

25

----

 

**Results of Operations**

 

The followingtable sets forth the percentage relationship to revenues represented by certaindata included in our statements of operations for the years endedDecember 31:

 
| ** **                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Revenues:                          |       |     |       |     |       |     |       |
| Products                           |       | 68.2     | %          | 76.0     | %          | 71.1     | %          |
| Services                           |       | 31.8     |       | 24.0     |       | 28.9     |       |
| Total revenues                     |       | 100.0    |       | 100.0    |       | 100.0    |       |
| Cost of sales:                     |       |     |       |     |       |     |       |
| Products                           |       | 66.0     |       | 52.5     |       | 54.4     |       |
| Services                           |       | 39.1     |       | 27.4     |       | 29.5     |       |
| Total cost of sales                |       | 105.1    |       | 79.9     |       | 83.9     |       |
| Gross margin                       |       | (5.1     | )          | 20.1     |       | 16.1     |       |
| Operating expenses:                |       |     |       |     |       |     |       |
| Research and development           |       | 11.1     |       | 10.2     |       | 10.1     |       |
| Selling and marketing              |       | 12.5     |       | 16.3     |       | 20.3     |       |
| General and administrative         |       | 22.2     |       | 12.4     |       | 19.0     |       |
| Impairment of long-lived assets    |       | 5.0      |       | —   |       | —   |       |
| Lease termination fee              |       | 8.4      |       | —   |       | —   |       |
| Total operating expenses           |       | 59.2     |       | 38.9     |       | 49.4     |       |
| Loss from operations               |       | (64.3    | )          | (18.8    | )          | (33.3    | )          |
| Interest expense                   |       | (6.5     | )          | (0.1     | )          | (0.1     | )          |
| Interest income                    |       | 0.1      |       | 0.1      |       | 0.1      |       |
| Patent settlement                  |       | —   |       | 7.9      |       | 2.0      |       |
| Gain on sale of Mammography Assets |       | 67.7     |       | —   |       | —   |       |
| Other income (expense), net        |       | (0.2     | )          | 0.1      |       | 0.1      |       |
| Income (loss) before income taxes  |       | (3.2     | )          | (10.8    | )          | (31.2    |       |
| Provision for income taxes         |       | (0.2     | )          | —   |       | —   |       |
| Net income (loss)                  |       | (3.4     | )%         | (10.8    | )%         | (31.2    | )%         |

 

**Year Ended December 31, 2005 Compared toYear Ended December 31, 2004**

 

**Product Revenues**

 

Total revenuesdecreased 26.2% to $47.3 million for the year ended December 31, 2005 from$64.0 million for the year ended December 31, 2004. Product revenues decreased33.7% to $32.3 million in 2005 from $48.6 million in 2004.

 

•                  SenoScandigital mammography product revenue decreased 63.3% or $12.2 million to $7.1million in 2005 from $19.3 million in 2004. Revenues for the year endedDecember 31, 2004 included $8.4 million related to a non-domestic sale that wasshipped in December 2003 and installed during 2004. Without this non-domesticsale, SenoScan digital mammography product revenue decreased 35.1% or $3.8million in 2005 from 2004. As a result of the Asset Sale, SenoScan sales duringthe fourth quarter of 2005 were $0.0 million. Prior to the Asset Sale in 2005,we sold fewer units due to our inability to provide upgrades and enhancementsto our workflow management software and to introduce alternative workflowsolutions and other performance enhancements.

•                  Revenuesfrom our MammoTest breast biopsy products decreased 14.9% or $2.8 million to$16.1 million during the year ended December 31, 2005 from $18.9 million duringthe year ended December 31, 2004. This is primarily attributable to the AssetSale as

 

26

----

 

MammoTest sales during the fourth quarter of2005 were $1.4 million compared to $5.4 million in the fourth quarter of 2004. Themajority of the sales in the fourth quarter of 2005 were related to open orderson September 29, 2005 that were specifically approved by Hologic. This decreasein MammoTest product revenue was partially offset by sales volume increasesprior to the Asset Sale due to stronger demand for the product in the U.S.

 

•                  RE&Sproducts revenues decreased $1.4 million to $9.1 million during the year endedDecember 31, 2005 from $10.5 million during the year ended December 31, 2004primarily due to sales volume decreases in the VersaRad and Bloom product linesand decreases in pricing due to higher mix of OEM sales.

 

After theAsset Sale, we can only sell the MammoTest to EES through the term of theDistributor Agreement. As a result of the EES Amendment and orders on hand atDecember 31, 2005, we expect to sell a total of 23 MammoTest units in 2006. Asa result of the last time purchase order and other orders from Kodak for theVersaRad product, we expect to sell 36 VersaRad units in 2006. As of March 16,2006, there is no backlog for the EPX/SPX and Bloom and we have only sold 16Blooms through March 16, 2006. Management believes this is due to our reducedmarketing efforts and the market’s perception of our financial condition.

 

**Service Revenues**

 

Our service revenues for theyear ended December 31, 2005 decreased 2.5% to $15.0 million from $15.4 millionduring the year ended December 31, 2004. The decrease in service revenues isprimarily due to a decline in installation revenue due to lower product salesand lower time and material revenues, partially offset by higher number ofMammoTest and SenoScan units under service contracts in both the U.S. andEurope leading to an increase in contract revenue. Approximately 17% of servicerevenues were from the sale of disposables and parts during 2005. Approximately15% of service revenues were from time and material billings mainly related tothe MammoTest and SenoScan. Service revenues for the RE&S businesswere $0.5 million in 2005.

 

As a result ofthe announcement of the Asset Sale, we have experienced declining servicecontract sales in the SenoScan and MammoTest area. In addition, the KodakAgreements and the related terminations of all of our service contracts meansthat service revenues will continue to decline to zero by the end of April 2006.After April 2006 service revenues will only be related to the RE&Sbusiness.

 

**Cost of Sales—Products**

 

Cost of sales for productsconsists of fixed and variable costs incurred for purchased components forproducts, 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 products in the year ended December 31, 2005 was $31.2 million or 96.7% ofproduct revenues compared to $33.6 million or 69.2% of product revenues in theyear ended December 31, 2004. As a result of a reduction in forecasted saleswhich resulted from the Asset Sale and changes in market conditions, theprovision for excess and obsolete inventories increased by $5.7 million in theyear ended December 31, 2005. In addition, cost of sales increased by $0.8million in the year ended December 31, 2005 for additional customer commitmentobligations. The cost of sales for products in the year ended December 31, 2005

 

27

----

 

excluding the charges relatedto these reserves would have been $24.6 million or 76.3% of product revenues. Thecost of sales for products in the year ended December 31, 2004 excluding theimpact of a higher, extended warranty provision amounting to $1.0 millionassociated with a non-domestic sale would have been 67.1%. The overall remainingincrease in cost of product sales as a percentage of product revenues isprimarily due to the impact of lower average sales prices and higher materialprices offset by a decrease in the warranty provision because of lower salesand better product performance.

 

**Cost of Sales—Service**

 

Cost of sales for ourservices consists primarily of parts cost, salaries, commissions and travelcosts for personnel in field service, customer service, applications trainingand testing and service administration and management.

 

Cost of salesfor services for the year ended December 31, 2005 increased 5.4% to $18.5million from $17.5 million in the year ended December 31, 2004. As a percent ofservice revenues, cost of service sales increased to 123.0% in the year endedDecember 31, 2005 from 113.8% in the year ended December 31, 2004. As a resultof the Kodak Agreements, inventory related service usage was forecasted todecline significantly leading to an increase of the provision for excess andobsolete inventories by $2.0 million in the year ended December 31, 2005. Thecost of sales for services in the year ended December 31, 2005 excluding thisprovision would have been $16.4 million or 109.5% of services revenues. Approximately$1.1 million of the decrease in cost of sales is due to reductions in headcountand related employee benefits partially offset by higher commissions due tohigher rates to induce increased sales and restructuring expense of approximate$0.5 million.

 

**Research and Development Expenses**

 

Prior to the Asset Sale, weincurred research and development expenses in efforts to redesign and developnew products as well as develop significant enhancements to our existingproducts. We currently incur a small amount of expenses related to sustainingengineering related to managing safety and FDA issues related to our products. Theseexpenses consist primarily of compensation and overhead costs for staff engagedin research and development activities, software development, consulting costs,and costs for materials and supplies consumed while performing research anddevelopment activities. We also offset our research and development costs withincome from research grants we receive.

 

Research anddevelopment expenses decreased 19.9% to $5.2 million in the year ended December31, 2005 from $6.5 million in the year ended December 31, 2004. We spent 11.1%of revenue on research and development in the year ended December 31, 2005compared to 10.2% in the year ended December 31, 2004. Our efforts in the firsthalf of 2005 and prior were focused on redesigning older products for improvedreliability and serviceability and enhancing the features, functionality andreliability of our SenoScan product. Management halted these redesign effortsand terminated related individuals from September 30, 2005 through the end ofthe year. We recognized expense related to the employee terminations of $0.3million during the year ended December 31, 2005.

 

**Selling and Marketing Expenses**

 

Prior to the Asset Sale, ourselling and marketing expenses consisted primarily of salaries, commissions,travel and other overhead costs for employees and activities in the areas of

 

28

----

 

sales, marketing, sales support, and salesadministration. Expenses associated with advertising, trade shows, conferences,promotional and training costs related to marketing our products are classifiedas selling and marketing expenses.

 

Selling andmarketing expenses decreased 43.5% to $5.9 million in the year ended December 31,2005 from $10.5 million in the year ended December 31, 2004. We spent 12.5% ofrevenue on selling and marketing expenses in the year ended December 31, 2005compared to 16.3% in the year ended December 31, 2004. Effective June 30, 2005we terminated marketing activity and associated personnel, which resulted in$1.8 million reduction in costs in the year ended December 31, 2005. Shortlybefore closing the Asset Sale, all sales personnel were terminated as part of arestructuring plan. The total restructuring expense related to these headcountreductions was $0.2 million in 2005. The remaining reduction in selling andmarketing expenses was a direct result of adjustments made during 2004 to thedistribution and coverage of sales territories, which resulted in a lowernumber of sales representatives, and the reduction of commissions as a resultof lower sales.

 

**General and Administrative Expenses**

 

Our general andadministrative expenses consist primarily of compensation and overhead costsfor employees and activities in the areas of finance, information technology,human resources and administration. General and administrative expenses alsoinclude fees for attorneys, independent auditors, and consultants.

 

General andadministrative expenses increased 32.8% to $10.5 million in the year endedDecember 31, 2005 from $7.9 million in the year ended December 31, 2004. Ourspending for legal and financial advisory fees was $1.1 million higher in theyear ended December 31, 2005 as compared to the year ended December 31, 2004mainly due to work related to the Asset Sale, defending threatened and pendinglawsuits and the FTC investigation. In addition, we incurred $0.6 million baddebt expense during the year ended December 31, 2005 as a result of aninability to collect on certain accounts receivable and $0.2 million higherinsurance costs due to renewal of our policies. Termination and retentionaccruals were recognized in the year ended December 31, 2005 for approximately$0.8 million.

 

**Impairment of Long-Lived Assets**

 

As discussedin Note 4 of the accompanying consolidated financial statements and CriticalAccounting Policies, we recognized $2.4 million of impairment of long-livedassets in the year ended December 31, 2005.

 

**Lease Termination Fee**

 

As discussedin Note 5 of the accompanying consolidated financial statements, we recognizedthe $4.0 million payment as “Lease termination fee” in the year ended December31, 2005.

 

**Interest Expense/Interest Income**

 

Interest expense for the year ended December31, 2005 increased to $3.1 million from $0.1 million for the year endedDecember 31, 2004. The majority of the increase is due to the interest expenserelated to the ComVest Notes entered into in the first quarter of 2005,interest expense related to the note with Hologic, and amortization of therelated debt issue costs.

 

29

----

 

**Patent Settlement Income**

 

As discussed in Note 13 of the accompanyingconsolidated financial statements, we recognized $5.2 million of patent settlementincome in 2004.

 

**Gain on sale of Mammography Assets**

 

On September28, 2005 at a special meeting of stockholders, our stockholders approved theAsset Sale Agreement and the Asset Sale. Upon closing of the transaction, werecognized a $32.0 million gain from the cash sale to Hologic of ourMammography Assets.

 

**Income Taxes**

 

We recognizedcurrent tax expense for state taxes and foreign taxes of approximately $0.1million during 2005. No income tax benefit or provision was recorded in 2004. AtDecember 31, 2005 we had available a domestic net operating loss carry-forwardof $32.1 million and $0.7 million of foreign net operating loss carry-forwards.As of December 31, 2005 we had recorded a 100% valuation allowance against ourdeferred tax assets that resulted in a net deferred tax asset of $0. We expectour future income taxes to be less than $0.1 million per year. See Note 7 ofthe accompanying consolidated financial statements for a reconciliation of thestatutory tax rate to the domestic effective tax rate.

 

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

 

**Product Revenues**

 

Total revenues increased 38.7% to $64.0 million for 2004 from $46.2million for 2003. Product revenues increased 48.2% to $48.6 million in2004 from $32.8 million in 2003. SenoScan product revenue increased 79.4%or $8.5 million to $19.3 million in 2004 from $10.8 million in 2003. Revenuesfor year ended December 31, 2004 include a $8.4 million non-domestic salethat was shipped in December 2003. During the fourth quarter 2003, weshipped all the SenoScan systems to a non-domestic customer, one unit met ourrevenue recognition criteria in 2003 and the remaining units met our revenuerecognition criteria in 2004. The non-domestic sale accounts for $7.5 millionor 87.8% of the $8.5 million increase in SenoScan sales in 2004 compared with2003. The remaining $1.0 million increase in SenoScan sales in 2004 comparedwith 2003 reflects a 15.8% or $1.5 million price increase partially offset by a4.8% or $0.5 million volume decrease. Excluding the non-domestic sale, ourSenoScan sales volumes decreased 4.8% in 2004, as compared to 2003, reflectinga 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 2004we experienced difficulties with material availability, assembly andinstallation of SenoScan systems, which affected our revenues and liquidity.

 

Our MammoTest product revenue increased 17.1% or $2.8 million to$18.9 million in 2004 from $16.1 million in 2003. The 17.1% increasein MammoTest product revenue reflects a 23.7% or $3.8 million volume increaseoffset by a 5.3% or $1.0 million pricing decrease. The increase in MammoTestunits sold, is due to a promotional program to upgrade the installed base thatran though September 2004 coupled with increased customer demand in thesecond half of the year for the product. The decrease in pricing is primarilydue to the promotional program. The RE&S product sales during 2004increased $4.6 million, or 76.0%, to $10.5 million from $5.9 million in 2003. Thesales increase in the RE&S products in 2004, as compared to 2003 was

 

30

----

 

primarily due to 137.9% or $3.6 millionvolume increase in VersaRad x-ray products and $0.7 million higher volume forthe other RE&S products.

 

**Service Revenues**

 

Our service revenues for2004 increased 15.3% to $15.4 million from $13.3 million compared to 2003. Theincrease in 2004 as compared to 2003 is primarily due to higher number ofMammoTest and SenoScan units on service contracts in both the US and Europe,which was driven by successful conversion of installed units to service contractsafter the warranty period.

 

**Cost of Sales—Products**

 

Cost of sales for productsin 2004 was $33.6 million or 69.2% of product revenues compared to$25.1 million or 76.5% of product revenues in 2003. The overall decreasein cost of product sales, as a percentage of product revenues is primarily dueto a $1.8 million decrease in manufacturing and repair costs and a $2.1 milliondecrease in inventory write offs due to improved inventory management andcontrol. These decreases were partially offset by a $0.5 million increase inwarranty provision. The warranty provision increased $0.9 million for theSenoScan non-domestic sale because the product warranty provided to thecustomer is longer than the 12-month standard 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 historicalexperience.

 

**Cost ofSales—Services**

 

Cost of sales for servicesfor 2004 increased 28.6% to $17.5 million from $13.6 million in 2003.As a percent of service revenues, cost of service sales increased to 113.8% in2004 from 102.1% in 2003. Of this increase, $2.2 million relates to parts costsand $1.4 million relates to staffing additions to support and service our increasedinstalled base. The US MammoTest and SenoScan units under warranty and servicecontract support increased 26.8% and 144.9%, respectively, in 2004 compared to2003.

 

**Researchand Development Expenses**

 

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 costsincreased $0.4 million or 14.2% as we increased our staffing levels in softwaredevelopment and engineering to focus on redesigning our products for improvedreliability and serviceability, as well as enhancing the features,functionality and reliability of our SenoScan product. To support theseredesign and product development efforts currently underway, contractengineering services increased $1.2 million and expenditures for research anddevelopment materials increased $0.2 million. These increases in our operatingcosts during 2004 were partially offset by $0.3 million increase inreimbursement of funding from research grants.

 

**Sellingand Marketing Expenses**

 

Selling and marketingexpenses increased 11.7% to $10.5 million in 2004 from $9.4 millionin 2003. Our selling and marketing expenses, as a percent of sales decreased to16.3% of revenues in 2004 from 20.3% of revenues in 2003. Of the total spendingincrease, $1.3 million relates to commission

 

31

----

 

on higher domestic sales and $0.3 million relates toincreased marketing and promotional efforts. These spending increases werepartially offset by $0.5 million decrease in salaries and wages due to lowersales personnel headcount in 2004 as compared to 2003.

 

**Generaland Administrative Expenses**

 

General andadministrative expenses decreased 9.6% to $7.9 million in 2004 from$8.8 million in 2003. Our general and administrative expenses, as apercent of revenues decreased to 12.4% from 19.0% in 2003. Of the totalspending decrease, $0.7 million related to reduced audit fees and $0.3 millionrelated to a reduction in expenditures for consultants as the effort to restatethe financial statement that commenced in the first quarter of 2003 wascompleted in April 2004. In addition, as a result of cost containmentefforts, travel expenses decreased $0.2 million and personnel costs decreasedby $0.3 million. These decreases in spending were partially offset by $0.4million in higher legal costs associated with the class action lawsuit and theSEC investigation and $0.4 million in higher insurance costs associated withthe renewal of our policies.

 

**InterestExpense/Income**

 

Interest expense during2004 increased to $66,000 from $49,000 for 2003 due to borrowings on the creditfacility. Interest income during 2004 decreased to $4,000 from $62,000 in 2003due to the lower cash balances in 2004.

 

**PatentSettlement Income**

 

As discussed in Note 13 of the accompanyingconsolidated financial statements, we recognized $5.2 million and $0.9 millionof patent settlement income in 2004 and 2003, respectively.

 

**IncomeTaxes**

 

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 ofDecember 31, 2004 we had a 100% valuation allowance against our deferredtax asset of $17.8 million because management concluded that the deferredtax asset would not be realized through generation of future taxable income.

 

**Liquidity and Capital Resources**

 

As of December 31,2005, we had $4.5 million in cash and $4.5 million in working capitalcompared to $1.9 million in cash and $4.2 million in working capitalat December 31, 2004. The $2.3 million net decrease in working capital,excluding cash, is mainly caused by the following:

 

•                  a $11.7 million decrease in net inventoriesmainly due to increases in excess and obsolescence reserves of $7.8 million andlower purchases,

•                  a decrease in accounts receivable as a resultof lower revenues,

•                  a decrease in our accrued warranties due tolower revenues and better product performance, and

 

32

----

 

•                  a decrease in accounts payable as a result ofutilizing cash received from the Asset Sale to pay vendors.

 

We used $0.5 million of cashin our investing activities during 2005 for capital expenditures to supportefforts in manufacturing and research and development, offset by $0.5 millionwhich became available due to redemption of a certificate of deposit that hadbeen restricted. In order to maintain liquidity, all capital expenditures havebeen stopped.

 

We used proceeds from thesenior secured promissory notes to repay the line of credit with Silicon ValleyBank as discussed further in Note 6 of the accompanying consolidated financialstatements.

 

The Asset Sale Agreement wasapproved by our stockholders at a special meeting of stockholders held onSeptember 28, 2005 and closing of the Asset Sale transaction occurred onSeptember 29, 2005. A portion ofthe $32.0 million in proceeds from the Asset Sale was disbursed as follows (inthousands):

 
| Repay $5.0 million loan with Hologic, plus  related interest      |   | $     | 5,114  |   |
|-------------------------------------------------------------------|--------|-------|--------|--------|
| Repay the ComVest Notes, plus related  interest                   |   | 7,444 |   |
| Payment of stock warrant obligation to  ComVest                   |   | 1,800 |   |
| Amendment fee to terminate the Lease plus  certain property taxes |   | 4,180 |   |
| Settle certain accounts payable due at  closing of the Asset Sale |   | 931   |   |
|                                                              |   | $     | 19,469 |   |

 

Approximately $8.7 millionof the remaining approximately $12.5 million in proceeds from the Asset Salewere used during the fourth quarter to settle additional accounts payable andother short term obligations and to fund operations while we continued toexplore strategic alternatives for our RE&S and Service businesses.

 

We continue to use cash tofund operations. Management has taken and will continue to take steps to reduceour operating costs by reducing the number of employees to the minimum numberneeded to conduct our remaining businesses, terminating certain contracts, andnegotiating releases from remaining contractual arrangements. As discussedfurther in Note 15 of the accompanying consolidated financial statements, ourlosses during the fourth quarter of $5.9 million were made up of $1.6 millionof impairment of long-lived assets, an increase of $2.7 million for excess andobsolete inventories, and $0.7 million of expense for retention and severanceagreements. The remaining $0.9 million in loss from operations is a significantreduction from prior periods. In addition, all but 14 U.S. employees havereceived notice that their employment with Fischer will terminate between nowand May 12, 2006.

 

As a result of the Asset Sale, revenues recognized from the MammoTestand SenoScan after September 29, 2005 were $1.4 million and $0.0 million,respectively. The following is management’s plans with respect to each of theretained assets/businesses:

 

*Service business.*Aspreviously discussed on January 23, 2006, we entered into the Kodak Agreements.These Agreements will allow Kodak to act as an authorized service provider andprovide service and support to the world-wide, excluding Mexico, installed baseof our mammography products. We expect that the Kodak Agreements will reduceour obligations and costs with respect to the Service business.

 

33

----

 

*Contractual obligation to EES.*Aspreviously discussed, on March 9, 2006, we entered into an EES Amendment to theDistributor Agreement. EES agreed to place a binding order with us for 20Tables to be shipped to various locations in Europe. After completion of theTables, the Distributor Agreement and EES Amendment will terminate and nofurther MammoTest tables will be sold. As of December 31, 2005, we had on handa significant portion of the inventories required to produce this order. As aresult, we expect projected positive the cash contribution margin to be higherthan the reported gross margin.

 

*Contractual obligation to Philips.*Thestatus of the Philips Agreement is still unresolved as discussed further inNote 12 in the accompanying consolidated financial statements. As a result,management believes no revenues will be generated from this contract.

 

*RE&S Business.*TheRE&S business includes three Product Lines:

 

(1)                                                   *The VersaRad Line*. Substantially all ofthe sales of this product are sold to Kodak under an OEM Agreement. Asdiscussed further in Note 14, management received a significant last timepurchase order from Kodak in February 2006. Therefore, management expects thatno further VersaRad units will be sold to Kodak after fulfillment of the lasttime purchase order in May 2006. As of December 31, 2005, we had on hand asignificant portion of the inventories required to produce this order. As aresult, we expect the projected positive cash contribution margin to be higherthan the reported gross margin.

 

(2)                                                   *The EPX/SPX Line.*Management expects thatno further EPX/SPX units will be sold due to the departure of our salespersonnel.

 

(3)                                                   *Bloom Line.*Sales of this product havebeen declining and backlog is currently zero. We believe this is due to themarket’s perception of our financial condition.

 

As previously discussed, onMarch 15, 2006, we announced to certain potential bidders and to the publicthat we started an auction process to sell the RE&S business. Bidders havebeen asked to submit bids for the entire RE&S business, individual ProductLines or components thereof.

 

Under Delawarelaw, any sale of all or substantially all of our assets requires approval byour stockholders. In the event it is determined that the sale of the assetsrelated to the Product line(s) to a successful bidder would be considered asale of all or substantially all of our assets, Fischer will either file apetition under Chapter 11 of title 11 of the Bankruptcy Code and immediatelymove to close the sale pursuant to §363(b) and (f) of the Bankruptcy Code orseek the necessary stockholder approval.

 

*Europe.*In December2005, the Board of Directors approved the liquidation and wind-up of ourEuropean subsidiaries. After the Asset Sale, the only remaining recurringrevenue is related to service contracts. Applications training and warrantysupport due under the EES Amendment and Distributor Agreement will be providedby an alternative service provider in Europe. Our European subsidiaries are indiscussions with an alternative service provider but if this fails, additionalfunds may be needed to fund the operations until an appropriate an alternativeservice provider is located. If an alternative service provider cannot belocated at a reasonable cost, the projected positive cash contribution from thesale of the EES Tables could be at risk.

 

34

----

 

*Additional uses.*In addition, proceeds from the last time purchase orders from EES andKodak will also be used as follows:

 

•                  Settle recurring accounts payable, purchasecommitments and certain customer disputes,

•                  Pay amounts due under termination and retentionarrangements of approximately $2.0 million and other employee obligations,

•                  Purchase appropriate and available insurancecoverage and other run-off coverage for approximately $1.2 million, ifavailable,

•                  Pay remaining obligations under our buildinglease and related facilities expenses of approximately $0.5 million through May31, 2006,

•                  Pay significant legal costs related to publiccompany reporting requirements, defending various lawsuits, responding to theFTC subpoena and responding to any further FDA requests, and

•                  Fund operations while we continue to satisfyour Service business obligations until the termination of our Service businessand RE&S service obligations during the auction process of our RE&Sbusiness.

 

A portion of the payments to be made under the termination andretention arrangements will be paid from the irrevocable Fischer ImagingEmployee Trust (the “Trust”). This Trust was established for the specificpurpose of paying amounts owed under termination and retention arrangements orgeneral wages to employees. The Trust was funded on January 2, 2006 with$600,000 of cash as authorized by the Board of Directors.

 

Managements plans and expectations can be significantly impactedby the following, items identified above under “Risk Factors”, as well as otherfactors that may arise:

 

•                  Our vendors may require that we pay inadvance due to our financial condition or may not supply the requested goods atall, which could have a significant impact on our ability to complete the lasttime purchase orders from Kodak and EES.

•                  As discussed further in Note 12 of theaccompanying consolidated financial statements, we have pending legalproceedings that could have a material adverse effect on our cash flow if theoutcomes are collectively unfavorable.

•                  As discussed further in Note 12 of theaccompanying consolidated financial statements, we are unable to predictwhether Philips may file a suit or the amount, if any, that may be demanded byPhilips, or the expense related to defending any claim. Any payments we make toor in connection with a claim by Philips may materially reduce amounts, if any,that may be available for satisfaction of creditor claims and distribution toour stockholders.

•                  As discussed further in Note 12 of theaccompanying consolidated financial statements, an injunction or other responseby the FDA may preclude us from shipping products or replacement parts, whichwould have a significant impact on our ability to complete the last timepurchase orders from Kodak and EES and it may prevent us from maximizing thevalue of the remaining businesses until they are sold, if that occurs.

•      Our key employees are vital to ourbusiness plan over the coming months. If we are unable to retain theseemployees, we may be unable to complete our business strategy.

 

 

Our efforts to sell the RE&S businesses may beunsuccessful or may not generate significant proceeds or the buyers may notassume service and warranty obligations. our plans to continue to meet ourservice and warranty obligations until the completion of the sale of theRE&S businesses. If the time necessary to complete the sale extends beyonda reasonable period of time, we may not have sufficient funds to continue theseservice operations. If the

 

35

----

 

effortto sell the RE&S businesses is unsuccessful, management will seekalternative service providers to provide continuation of service for warrantyand service contract obligations. If we are unable to find appropriatealternative service providers, we may not have sufficient funds to reimburseour customers for service and warranty obligations for the RE&S businesses.

 

Under Delawarelaw, any sale of all or substantially all of our assets requires approval byour stockholders. In the event it is determined that the sale of the assetsrelated to the Product Line(s) to a successful bidder would be considered asale of all or substantially all of our assets, we will either file a petitionunder Chapter 11 of title 11 of the Bankruptcy Code and immediately move toclose the sale pursuant to §363(b) and (f) of the Bankruptcy Code or seek thenecessary stockholder approval.

 

We do not intend to pursueadditional equity or debt financing and any such financing would likely not beavailable to us on acceptable terms, or at all.

 

If we run out of cash, determine that we willnot be able to settle all of our known obligations or determine that it is notcost efficient to pursue stockholder approval for the asset sales, we may beforced to cease operations and liquidate assets pursuant to applicable law,which may include filings for bankruptcy protection under Chapter 7 or 11 ofthe Bankruptcy Code.

 

These factors, among others, raisesubstantial doubt about our ability to continue as a going concern.  In addition, stockholders would only receive adistribution after our business is wound down and we have fulfilled or reservedfor, to the extent possible, all obligations and liabilities to creditorsincluding vendors, customers, and others. Management cannot accurately estimatethe amount of distribution to our stockholders, if any, until the following arefinalized or resolved.

 

•                  the results of the auction process related tothe sale of our RE&S business or Product Lines,

•                  the strategy to exit our European market,

•                  the impact of Philips actions with respect tothe termination of the Philips Agreement, and

•                  the outcome of certain threatened orpotential litigation.

 

**Off-Balance Sheet Arrangements**

 

We do not haveany off-balance sheet arrangements that have, or are reasonably likely to have,a current 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**

 

AtDecember 31, 2005 our commitments under contractual obligations were asfollows (in thousands):

 
| **Payments Due by Period:** | ** ** | **Total** | ** ** | **Less  Than  1 Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
|--------------------------------------------|------------|-----------|------------|-----------------------------|------------|----------------|------------|----------------|------------|-------------------------|------------|
| Purchase commitments                       |       | $         | 1,997      |                        | $          | 1,997          |       | $              | —     |                    | $          | — |   | $ | — |   |
| Operating leases                           |       | 461       |       | 412                         |       | 46             |       | 3              |       | —                  |       |
| Total contractual cash obligations         |       | $         | 2,458      |                        | $          | 2,409          |       | $              | 46         |                    | $          | 3 |   | $ | — |   |

 

36

----

 

**CRITICAL ACCOUNTING POLICIES**

 

Criticalaccounting policies are those that are most important to the portrayal of ourfinancial condition and operating results, and require management to make itsmost difficult 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 dateof this filing, our critical accounting policies include:

 

**Revenue Recognition**

 

We follow theprovisions of Staff Accounting Bulletin 104, “Revenue Recognition in FinancialStatements” (SAB104) which provides for revenue recognition when persuasiveevidence of an arrangement exists, delivery has occurred, the fee is fixed anddeterminable and collectibility is probable. We recognize product revenue uponeffective delivery for our large, direct-sale medical equipment, although wedefer recognition 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 contracts and extended warrantycontracts over the periods for which the contracts are in effect. We bill forservice contracts and extended warranties monthly, quarterly and annually inadvance, and record deferred revenue, which is then recognized over the serviceperiod. We also sell replacement parts to customers, and record revenue at thetime of shipment when title transfers. Certain replaced parts may be returnedfor partial credit, and we make estimates to reduce current revenue to accountfor the future effect of those returns.

 

We carryaccounts receivable at original invoice amounts less an estimate for doubtfulaccounts and sales returns based on a periodic review of outstandingreceivables. We provide allowances for known and anticipated credit losses inthe course of regularly evaluating individual customer receivables. Thisevaluation takes into consideration a customer’s financial condition and credithistory as well as current economic conditions. Accounts receivable are writtenoff when deemed uncollectible. Recovery of accounts receivable previouslywritten off are recorded when received.

 

**Inventories**

 

We value inventory at thelower of cost or market using the first-in, first-out (FIFO) method. Managementassesses the recoverability of inventory based on obsolescence or overstockedinventory equal to the difference between the cost of inventory and theestimated market value based upon historical experience and assumptions aboutfuture demand and changes in market conditions. These assessments requirejudgments and estimates, and valuation adjustments for excess and obsoleteinventory may be recorded based on these periodic assessments.

 

**Product Warranty**

 

We accrue forthe estimated cost of product warranties into product cost of sales at the timerevenue is recognized. Although we engage in extensive product quality programsand

 

37

----

 

processes, our warrantyobligation is affected by product failure rates and service delivery costsincurred in correcting a product failure. Should actual product failure ratesor service costs differ from our estimates, which are based on historical data,and engineering estimates, where applicable, revisions to the estimatedwarranty liability would be required. The typical standard warranty term is for12 months starting from the date of installation. We also sell extendedwarranties ranging from 12 to 60 months.

 

**Income Taxes**

 

As part of theprocess of preparing our financial statements, we are required to estimate ourincome taxes in each of the jurisdictions in which we operate. This processinvolves estimating actual current tax exposure together with assessingtemporary differences resulting from different treatment of items for tax andaccounting purposes. These differences result in deferred tax assets andliabilities, which are included within the balance sheet. We must then assessthe likelihood that the deferred tax assets will be recovered from futuretaxable income and, to the extent that recovery is not likely, a valuationallowance must be established. To the extent a valuation allowance isestablished, we must include an expense within the tax provision in thestatement of operations. In the event that actual results differ from theseestimates, the provision for income taxes could be materially impacted. We havefully reserved for our deferred tax assets.

 

## **Impairment of Long-Lived Assets**

##  

Our policy is to evaluatewhether there has been a permanent impairment in the value of long-livedassets, of certain identifiable intangibles and of goodwill when certain eventshave taken place that indicate that the remaining balance may not berecoverable. We evaluate the carrying value of our property and equipment atthe consolidated level since we believe that is the lowest identifiable levelof cash flows for these assets. We evaluate the carrying value of the intangiblesat the consolidated level since there are no components that constitute abusiness for which discrete financial information is available below thesegment level. As a result of the Asset Sale, Lease Amendment and furtherdeclines in the stock price, management determined a recoverability test shouldbe completed as of September 30, 2005 and December 31, 2005.

 

Since thefuture estimated cash outflows are currently estimated to be near zero, thecarrying amounts of the assets exceeded the estimated undiscounted cash flows. Managementestimated the fair value of the assets by reviewing the value of the remainingbusinesses and other long-lived assets and determined an impairment hadoccurred. Fair value of the long-lived assets was determined through inquiry ofadvisors and comparison to other sales of fixed assets. Therefore, animpairment of long-lived assets of $2.4 million was recognized during the yearended December 31, 2005.

 

If theestimates of fair value change in the future, we may be required to recordadditional impairment charges for the long-lived assets and intangibles. Basedupon the minimum fair value estimates, the maximum amount of impairment chargesrelated to property and equipment would be $0.3 million.

 

## **ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

##  

Market riskrepresents the risk of loss that may impact the financial position, results ofoperations or cash flows due to adverse changes in financial and commoditymarket prices and

 

38

----

 

rates. We are exposed to marketrisk in the areas of changes in United States interest rates and changes inforeign currency exchange rates as measured against the United States dollar.These exposures are directly related to our normal operating and fundingactivities. Historically and as of December 31, 2005, we have not usedderivative instruments or engaged in hedging activities.

 

**Foreign Currency Risk**

 

We attempt to minimize ourexposure to foreign currency and other international business risks by: (1)generally requiring payments in U.S. dollars; (2) using letters of credit; and(3) requiring advance deposits and through other means. We may not successfullyminimize associated risks.

 

We are exposed to foreigncurrency risks through our subsidiary operations in Switzerland and Germany. AtDecember 31, 2005 we had cash and receivables less than current liabilitiescausing a working capital deficit of U.S. $0.6 million denominated in Euros. Wedo not employ any risk mitigation or hedging techniques with respect to amountsexposed to fluctuations in foreign currency exchange rates.

 

**Interest Rate Risk**

 

AtDecember 31, 2005, we had approximately $1.4 million in certificate ofdeposits and $2.0 million in money market accounts that earn interest atvariable interest rates and are therefore subject to interest rate fluctuations.At times, cash balances with our financial institution exceed FDIC insurancelimits.

 

## **ITEM 8. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

##  

Our auditedfinancial statements and notes thereto described in Item 15(a) of thisreport on Form 10-K and appearing on pages F-1 through F-32 of thisreport are incorporated by reference herein. See also “Quarterly Financial Data(unaudited)” appearing in Note 15 of our audited financial statements,which is incorporated herein by reference.

 

## **ITEM 9. CHANGES INAND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

##  

None

 

## **ITEM 9A. CONTROLSAND PROCEDURES**

##  

We carried outan evaluation, 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, 2005. Our disclosurecontrols and procedures are designed with the objective of ensuring thatinformation required to be disclosed in our reports filed under the SecuritiesExchange Act of 1934 is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms. The evaluationincluded certain control areas in which we have made, and are continuing tomake, changes to improve and enhance controls. Based on this evaluation, ourChief Executive Officer and Chief Financial Officer concluded that, as ofDecember 31, 2005, our disclosure controls and procedures are effective inall material respects in alerting them to material information required to beincluded in our periodic SEC reports. In designing and evaluating thedisclosure controls and procedures,

 

39

----

 

management recognized that eventhe most well designed and operated control systems are subject to inherentlimitations and assumptions about the likelihood of future events and canprovide only reasonable assurance of achieving the desired control objectives.

 

**ITEM 9B – OTHER INFORMATION**

 

None.

 

40

----

 

# **PART III**

#  

## **ITEM 10. DIRECTORSAND EXECUTIVE OFFICERS OF THE 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) BeneficialOwnership Reporting Compliance.” The information required by this Itemconcerning our executive officers is incorporated by reference to theinformation set forth in the section of the Proxy Statement entitled “ExecutiveOfficers and Key Employees.”

 

## **ITEM 11. EXECUTIVECOMPENSATION**

##  

Theinformation required by this Item regarding executive compensation isincorporated by reference to the information set forth in the section ofthe Proxy Statement entitled “Executive Compensation.”

 

## **ITEM 12. SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

##  

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 “SecurityOwnership of Certain Beneficial Owners and Management.” The informationrequired by this Item regarding our equity compensations plans is incorporatedby reference to the information set forth in the section of the ProxyStatement entitled “Equity Compensation Plan Information.”

 

## **ITEM 13. CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

##  

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. PRINCIPALACCOUNTANT FEES AND SERVICES**

##  

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

----

 

# **PART IV**

# ** **

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

 

**(a)****                                  Documents filed aspart of this report:**

 

1.                                       FinancialStatements.

 

See pages F-1 through F-32 of thisForm 10-K.

 

2.                                       FinancialStatement Schedules.

 

Other than aslisted below, there were no other financial statement schedules requiredbecause the information is either provided in the financial statements or isnot required under the related instructions or is inapplicable.

 

Schedule II—Valuation accounts.

 
| **Fiscal Year** | ** ** | **Description**                  | ** ** | **Balance at  beginning  of year** | ** ** | **Charged  to  expense** | ** ** | **Write-offs  charged to  allowance** | ** ** | **Balance at  the end of  year** | ** ** |
|----------------------|------------|----------------------------------|------------|-----------------------------------------|------------|--------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **           | ** ** | ** **                       | ** ** | **(in  thousands)**                     | ** ** |
| 2005                 |       | Allowance  for doubtful accounts |       | $                                       | 650        |                     | $          | 573                                        |       | $                                               | (840       | ) | $ | 383 |   |
| 2004                 |       | Allowance  for doubtful accounts |       | 942                                     |       | 37                       |       | (329                                       | )          | 650                                             |       |
| 2003                 |       | Allowance  for doubtful accounts |       | 528                                     |       | 486                      |       | (72                                        | )          | 942                                             |       |
|                      |            |                                  |            |                                         |            |                          |            |                                            |            |                                                 |            |  |  |  |  |

 
| **Fiscal Year** | ** ** | **Description**    | ** ** | **Balance at  beginning  of year** | ** ** | **Charged  to  expense** | ** ** | **Write-offs  charged to  reserve** | ** ** | **Balance at  the end of  year** | ** ** |
|----------------------|------------|--------------------|------------|-----------------------------------------|------------|--------------------------|------------|------------------------------------------|------------|-------------------------------------------------|------------|
| ** **           | ** ** | ** **         | ** ** | **(in  thousands)**                     | ** ** |
| 2005                 |       | Inventory  Reserve |       | $                                       | 1,784      |                     | $          | 7,758                                    |       | $                                               | (2,411     | ) | $ | 7,131 |   |
| 2004                 |       | Inventory  Reserve |       | 3,320                                   |       | 592                      |       | (2,128                                   | )          | 1,784                                           |       |
| 2003                 |       | Inventory  Reserve |       | 3,637                                   |       | 1,149                    |       | (1,466                                   | )          | 3,320                                           |       |
|                      |            |                    |            |                                         |            |                          |            |                                          |            |                                                 |            |  |  |  |  |

 

3.                                       Exhibits.

 

(b)                                 Thefollowing are filed 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(3)                                                                                                                            |
|                    |       |                                                                                                                                                                               |
| 10.3                    |       | Stock Option Plan(1)                                                                                                                                                               |
|                    |       |                                                                                                                                                                               |
| 10.4                    |       | Amended and Restated 2004 Stock Incentive  Plan (7)                                                                                                                                |
|                    |       |                                                                                                                                                                               |
| 10.5                    |       | Lease Agreement, dated July 31, 1992,  between the Company and JN Properties(2)                                                                                               |
|                    |       |                                                                                                                                                                               |
| 10.6                    |       | Amendment to Lease dated September 27, 2005  between Fischer and JN Properties (14)                                                                                                |
|                    |       |                                                                                                                                                                               |
| 10.7                    |       | Voting and Support Agreement dated  September 27, 2005 among Fischer, Morgan Nields, the Robert L. Nields Trust  and the Florence Wesson Nields Trust (14)                         |
|                    |       |                                                                                                                                                                               |
| 10.8                    |       | Agreement dated October 10, 1997,  between the Company and Ethicon Endo-Surgery, Inc. with Addendum dated  January 28, 1998(3)                                      |
|                    |       |                                                                                                                                                                               |
| 10.9                    |       | Addendum, dated February 2, 2002, to  Agreement dated October 10, 1997 between the Company and Ethicon Endo-Surgery, Inc.(4)                                        |
|                    |       |                                                                                                                                                                               |
| 10.10                   |       | Distributor Agreement dated  December 9, 1998, between the Company and Ethicon  Endo-Surgery, Inc.(5)                                                                    |
|                    |       |                                                                                                                                                                               |
| 10.11                   |       | Addendum No. 1, dated December 9,  2000, to Distributor Agreement dated December 9, 1998 between the  Company and Ethicon Endo-Surgery, Inc.(5)                |
|                    |       |                                                                                                                                                                               |
| 10.12                   |       | Addendum No. 2, dated  February 21, 2003, to Distributor Agreement dated December 9, 1998  between the Company and Ethicon Endo-Surgery, Inc.(5)               |
|                    |       |                                                                                                                                                                               |
| 10.13                   |       | Amendment No. 2 to Distributor Agreement,  dated March 9, 2006, between the Company and Ethicon Endo-Surgery, Inc. (18)                                                            |
|                    |       |                                                                                                                                                                               |
| 10.14                   |       | Non-Exclusive Distributorship Agreement  dated October 10, 2002, between the Company and Ethicon  Endo-Surgery, Inc.(5)                                                  |
|                    |       |                                                                                                                                                                               |
| 10.15                   |       | Form of Indemnification Agreement,  dated September 1999, between the Company and Morgan W. Nields (5)                                                                   |
|                    |       |                                                                                                                                                                               |
| 10.16                   |       | 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(5) |

 

42

----

 
| **Exhibit Number** | ** ** | **Description of Exhibit**                                                                                                                             |
|-------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                                                             |
| 10.17                   |       | Separation agreement with Morgan W. Nields  dated December 19, 2003(6)                                                                            |
|                    |       |                                                                                                                                                   |
| 10.18                   |       | Master Purchasing Agreement between the  Company and Philips Medical Systems DMC GmbH dated October 14, 2004(8)                                   |
|                    |       |                                                                                                                                                   |
| 10.19                   |       | Note and Warrant Purchase Agreement dated February 22, 2005  between the Company and ComVest Investment Partners II LLC(9)                        |
|                    |       |                                                                                                                                                   |
| 10.20                   |       | Senior Secured Promissory Note dated  February 22, 2005 between the Company and ComVest Investment Partners II  LLC(9)                            |
|                    |       |                                                                                                                                                   |
| 10.21                   |       | Warrant dated February 22, 2005  between the Company and ComVest Investment Partners II LLC(9)                                                    |
|                    |       |                                                                                                                                                   |
| 10.22                   |       | Registration Rights Agreement dated February 22, 2005 between  the Company and ComVest Investment Partners II LLC(9)                              |
|                    |       |                                                                                                                                                   |
| 10.23                   |       | Security Agreement Company dated  February 22, 2005 between the Company and ComVest Investment Partners II  LLC(9)                                |
|                    |       |                                                                                                                                                   |
| 10.24                   |       | Accounts Receivable Financing Modification  Agreement dated December 7, 2004 between the Company and Silicon Valley  Bank (10)                    |
|                    |       |                                                                                                                                                   |
| 10.25                   |       | Amendment No. 1 to Note and Warrant  Purchase Agreement dated March 29, 2005 between the Company and ComVest  Investment Partners II LLC(10) |
|                    |       |                                                                                                                                                   |
| 10.26                   |       | Amended and Restated Warrant dated as of  February 22, 2005 between the Company and ComVest Investment Partners II  LLC(10)                       |
|                    |       |                                                                                                                                                   |
| 10.27                   |       | Forbearance Agreement dated as of May 20,  2005 by and between the Company and ComVest Investment Partners II LLC(11)                                  |
|                    |       |                                                                                                                                                   |
| 10.28                   |       | Asset Purchase Agreement, dated as of  June 22, 2005 by and between Fischer and Hologic(12)                                                       |
|                    |       |                                                                                                                                                   |
| 10.29                   |       | Loan Agreement dated as of June 22,  2005 by and between Fischer and Hologic(12)                                                                  |
|                    |       |                                                                                                                                                   |
| 10.30                   |       | Promissory Note dated June 22, 2005  issued by Fischer to Hologic(12)                                                                             |
|                    |       |                                                                                                                                                   |
| 10.31                   |       | Security Agreement dated June 22, 2005 by  and between the Company and Hologic, Inc.(12)                                                               |
|                    |       |                                                                                                                                                   |
| 10.32                   |       | Trademark Security Agreement dated as of  June 22, 2005 by and between Fischer and Hologic(12)                                                    |
|                    |       |                                                                                                                                                   |
| 10.33                   |       | Patent Security Agreement dated as of  June 22, 2005 by and between Fischer and Hologic(12)                                                       |
|                    |       |                                                                                                                                                   |
| 10.34                   |       | Subordination and Intercreditor Agreement  dated June 22, 2005 by and among Fischer, Hologic and ComVest Investment  Partners II LLC(12)          |

 

43

----

 
| **Exhibit Number** | ** ** | **Description of Exhibit**                                                                                                                                        |
|-------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **              | ** ** | ** **                                                                                                                                                        |
| 10.35                   |       | Retention and Severance Benefits Agreement  for Steven Durnil dated June 29, 2005(13)                                                                        |
|                    |       |                                                                                                                                                              |
| 10.36                   |       | Retention and Severance Benefits Agreement  for David Kirwan dated June 29, 2005(13)                                                                         |
|                    |       |                                                                                                                                                              |
| 10.37                   |       | Separation and Release Agreement, effective  as of December 2, 2005, between the Company and Steven L. Durnil.(15)                                           |
|                    |       |                                                                                                                                                              |
| 10.38                   |       | Separation and Release Agreement, effective  as of December 2, 2005, between the Company and David Kirwan(15)                                                |
|                    |       |                                                                                                                                                              |
| 10.39                   |       | Independent Contractor Agreement, effective  as of December 2, 2005, between the Company and Steven L. Durnil(15)                                            |
|                    |       |                                                                                                                                                              |
| 10.40                   |       | Independent Contractor Agreement, effective  as of December 2, 2005, between the Company and David Kirwan.(15)                                               |
|                    |       |                                                                                                                                                              |
| 10.41                   |       | Amendment to Independent Contractor  Agreement, dated March 7, 2006, between the Company and Steven L. Durnil(17)                                                 |
|                    |       |                                                                                                                                                              |
| 10.42                   |       | Amendment to Independent Contractor  Agreement, dated March 7, 2006, between the Company and David Kirwan(17)                                                     |
|                    |       |                                                                                                                                                              |
| 10.43                   |       | Intellectual Property License Agreement,  dated January 23, 2006, issued by the Company to Eastman Kodak Company and  approved and accepted by Hologic, Inc. (16) |
|                    |       |                                                                                                                                                              |
| 10.44                   |       | Services Agreement, dated January 23, 2006,  between the Company and Eastman Kodak Company(16)                                                                    |
|                    |       |                                                                                                                                                              |
| 14                      |       | Employee Ethics and Business Conduct  Policy(5)                                                                                                                   |
|                    |       |                                                                                                                                                              |
| 21                      |       | List of Subsidiaries(10)                                                                                                                                          |
|                    |       |                                                                                                                                                              |
| 23.1                    |       | Consent of Ehrhardt Keefe  Steiner & Hottman PC (19)                                                                                                     |
|                    |       |                                                                                                                                                              |
| 23.2                    |       | Consent of Ernst and Young LLP(19)                                                                                                                                |
|                    |       |                                                                                                                                                              |
| 31.1                    |       | Certification of Steven Durnil, Chief  Executive Officer and President, pursuant to Rule 13a-14(a) under  the Securities Exchange Act of 1934(19)       |
|                    |       |                                                                                                                                                              |
| 31.2                    |       | Certification of David Kirwan, Chief  Financial Officer, pursuant to Rule 13a-14(a) under the Securities  Exchange Act of 1934(19)                      |
| 32.1                    |       | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002(19)                            |
|                    |       |                                                                                                                                                              |
| 32.2                    |       | Certification pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002(19)                            |

 

44

----

 

----

| (1)    |   | Incorporated by reference to the Company’s  Registration Statement on Form S-1, File No. 33-41537, as filed  with the Securities and Exchange Commission (the “Commission”) on  July 3, 1991. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                        |
| (2)    |   | Incorporated by reference to the Company’s  Form 10-K for the year ended December 31, 1992, as filed with the  Commission.                                                                                   |
|   |   |                                                                                                                                                                                                                        |
| (3)    |   | Incorporated by reference to the Company’s  Form 10-K for the year ended December 31, 1997, as filed with the  Commission on March 31, 1998.                                                            |
|   |   |                                                                                                                                                                                                                        |
| (4)    |   | Incorporated by reference to the Company’s  Form 10-K for the year ended December 31, 2001, as filed with the  Commission on April 1, 2002.                                                             |
|   |   |                                                                                                                                                                                                                        |
| (5)    |   | Incorporated by reference to the Company’s  Form 10-K for the year ended December 31, 2002, as filed with the  Commission on April 15, 2004.                                                            |
|   |   |                                                                                                                                                                                                                        |
| (6)    |   | Incorporated by reference to the Company’s Form 10-K for the  year ended December 31, 2003, as filed with the Commission on  April 15, 2004                                                             |
|   |   |                                                                                                                                                                                                                        |
| (7)    |   | Incorporated by reference to the Company’s Form 10-Q for the  quarter ended June 30, 2004, as filed with the Commission on  August 15, 2004                                                             |
|   |   |                                                                                                                                                                                                                        |
| (8)    |   | Incorporated by reference to the Company’s Form 10-Q for the  quarter ended September 30, 2004, as filed with the Commission on  November 15, 2004.                                                     |
|   |   |                                                                                                                                                                                                                        |
| (9)    |   | Incorporated by reference to the Company’s  Form 8-K dated February 23, 2005, as filed with the Commission  February 28, 2005.                                                                          |
|   |   |                                                                                                                                                                                                                        |
| (10)   |   | Incorporated by reference to the Company’s Form 10-K for the year  ended December 31, 2004, as filed with the Commission March 31, 2005.                                                                               |
|   |   |                                                                                                                                                                                                                        |
| (11)   |   | Incorporated by reference to the Company’s  Form 10-Q for the quarter ended March 31, 2005, as filed with the  Commission on May 20, 2005.                                                                   |
|   |   |                                                                                                                                                                                                                        |
| (12)   |   | Incorporated by reference to the Company’s  Form 8-K, as filed with the Commission June 23, 2005.                                                                                                            |
|   |   |                                                                                                                                                                                                                        |
| (13)   |   | Incorporated by reference to the Company’s  Form 10-Q for the quarter ended June 30, 2005, as filed with the  Commission on August 15, 2005.                                                                      |
|   |   |                                                                                                                                                                                                                        |
| (14)   |   | Incorporated by reference to the Company’s  Form 8-K, as filed with the Commission September 28, 2005.                                                                                                            |
|   |   |                                                                                                                                                                                                                        |
| (15)   |   | Incorporated by reference to the Company’s  Form 8-K, as filed with the Commission December 15, 2005.                                                                                                             |

 

45

----

 
| (16)   |   | Incorporated by reference to the Company’s  Form 8-K, as filed with the Commission on January 27, 2006. |
|--------|--------|--------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                         |
| (17)   |   | Incorporated by reference to the  Company’s Form 8-K, as filed with the Commission on March 7, 2006.    |
|   |   |                                                                                                         |
| (18)   |   | Incorporated by reference to the Company’s Form 8-K, as filed with  the Commission on March 15, 2006.   |
|   |   |                                                                                                         |
| (19)   |   | Filed herewith.                                                                                              |

 

**c)****                                      Exhibits**

 

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

 

46

----

 

**SIGNATURES**

 

Pursuant tothe requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signedMarch 31, 2006 on its behalf by the undersigned, thereunto duly authorized.

 
|   | FISCHER IMAGING CORPORATION |
|--------|-----------------------------|
|   | Registrant                  |
|   |                        |
|   | By:                         | /s/ STEVEN DURNIL |   |
|   |                        | Steven Durnil |
|   |                        | *President and Chief Executive Officer* |
|   |                        | *(Principal Executive Officer)* |

 

Pursuant tothe requirements 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 | Chair of the Board                    | March 31,  2006 |
| Gail S.  Schoettler     |                                  |                 |
|                    |                                  |                 |
| /s/ STEVEN  DURNIL      | President and Chief Executive Officer | March 31,  2006 |
| Steven  Durnil          | (Principal Executive Officer)         |                 |
|                    |                                  |                 |
|                    | Senior Vice President-Finance, Chief  |                 |
| /s/ DAVID  KIRWAN       | Financial Officer, Secretary          | March 31,  2006 |
| David Kirwan            | (Principal Financial and Accounting   |                 |
|                    | Officer)                              |                 |
|                    |                                  |                 |
| /s/ TODGER  ANDERSON    | Director                              | March 31,  2006 |
| Todger  Anderson        |                                  |                 |
|                    |                                  |                 |
| /s/  CHARLOTTE PETERSEN | Director                              | March 31,  2006 |
| Charlotte  Petersen     |                                  |                 |
|                    |                                  |                 |
| /s/ J.  TAYLOR SIMONTON | Director                              | March 31,  2006 |
| J. Taylor  Simonton     |                                  |                 |

 

47

----

 

**FISCHER IMAGING CORPORATION**

 

**CONSOLIDATEDFINANCIAL STATEMENTS**

 

**INDEX**

 
| Report of Ehrhardt Keefe Steiner & Hottman PC                                                                |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                  |   |
| Report of Ernst  and Young LLP                                                                                        |   |
|                                                                                                                  |   |
| Consolidated Financial  Statements:                                                                                   |   |
|                                                                                                                  |   |
| Consolidated Balance  Sheets—December 31, 2005 and 2004                                                     |   |
|                                                                                                                  |   |
| Consolidated  Statements of Operations—For the Years Ended December 31, 2005, 2004 and  2003                |   |
|                                                                                                                  |   |
| Consolidated  Statements of Stockholders’ Equity—For the Years Ended December 31,  2005, 2004 and 2003 |   |
|                                                                                                                  |   |
| Consolidated  Statements of Cash Flows—For the Years Ended December 31, 2005, 2004 and  2003                |   |
|                                                                                                                  |   |
| Notes to  Consolidated Financial Statements                                                                           |   |

 

F-1

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Board of Directors and Stockholders

Fischer Imaging Corporation

Denver, Colorado

 

We have audited the accompanying consolidated balance sheetsof the Fischer Imaging Corporation and subsidiaries as of December 31,2005 and 2004, and the related consolidated statements of operations, changesin stockholders’ equity and cash flows for the years then ended. Our auditsalso included the financial statement schedules II for the years ended December 31,2005 and 2004. These consolidated financial statements and schedules are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements and schedules based on ouraudits.

 

We conducted our audits in accordance with auditing standardsof the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assuranceabout whether the consolidated financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the consolidated financial statements.An audit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall consolidatedfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

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 31,2005 and 2004, and the results of their operations and their cash flows for theyears then ended in conformity with accounting principles generally accepted inthe United States of America. Also, in our opinion, the related financialstatement schedules II for the years ended December 31, 2005 and 2004,when considered in relation to the basic financial statements taken as a whole,present fairly in all material respects the information set forth therein.

 

The accompanying financial statements have been preparedassuming that the Company will continue as a going concern. As discussed inNote 1 to the financial statements, the Company has suffered recurring lossesfrom operations and sold substantially all of its assets in September 2005.This combination raises substantial doubt about its ability to continue as agoing concern. Management’s plans in regard to these matters are also describedin Note 1. The financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 
|   |   | /s/ Ehrhardt Keefe Steiner & Hottman PC |
|--------|--------|--------------------------------------------------|

 

March 8,2006

Denver, Colorado

 

F-2

----

 

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Stockholders and Board of Directors of

FischerImaging Corporation

 

Wehave audited the accompanying consolidated balance sheets of Fischer ImagingCorporation and subsidiaries as of December 31, 2003, and the relatedconsolidated statements of operations, shareholders’ equity, and cash flows forthe year then ended. Our audit also included the financial statement schedulesincluded in Item 15(a)(2). These financial statements and schedules are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and schedules based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. We were not engagedto perform an audit of the Company’s internal control over financialreporting. Our audit included consideration of internal control over financialreporting as a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the Company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit also includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Fischer ImagingCorporation and subsidiaries at December 31, 2003, and the consolidatedresults of their operations and their cash flows for the year then ended, inconformity with U.S. generally accepted accounting principles. Also, in ouropinion, the related financial statement schedules, when considered in relationto the basic financial statements taken as a whole, present fairly, in allmaterial respects, the information set forth therein.

 
|                                   | /s/ Ernst & Young LLP |   |
|----------------------------------------|--------------------------------|--------|
| Denver, Colorado   April 14, 2004 |                           |

 

F-3

----

 

**FISCHER IMAGINGCORPORATION**

 

**CONSOLIDATED BALANCE SHEETS**

 

**(Amounts inthousands except share data)**

 
| ** **                                                                                                                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                              |       |                  |       |   |   |
| Current  Assets:                                                                                                                                                                        |       |                  |       |   |   |
| Cash and  cash equivalents                                                                                                                                                              |       | $                     | 4,499      |   | $ | 1,939 |   |
| Certificate  of deposit, restricted cash                                                                                                                                                |       | —                |       | 514 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $383 and $650 at December 31,  2005 and 2004, respectively                                                         |       | 4,026                 |       | 7,286 |   |
| Inventories,  net                                                                                                                                                                       |       | 4,329                 |       | 16,034 |   |
| Prepaid  expenses and other current assets                                                                                                                                              |       | 1,305                 |       | 751 |   |
| Total  current assets                                                                                                                                                                   |       | 14,159                |       | 26,524 |   |
| Property and  equipment:                                                                                                                                                                |       |                  |       |   |   |
| Manufacturing  equipment                                                                                                                                                                |       | 331                   |       | 5,129 |   |
| Office  equipment and leasehold improvements                                                                                                                                            |       | 208                   |       | 6,300 |   |
| Total  property and equipment                                                                                                                                                           |       | 539                   |       | 11,429 |   |
| Less:  accumulated depreciation                                                                                                                                                         |       | —                |       | (7,612 | ) |
| Property and  equipment, net                                                                                                                                                            |       | 539                   |       | 3,817 |   |
| Intangible  assets, net                                                                                                                                                                 |       | —                |       | 1,033 |   |
| Total assets                                                                                                                                                                            |       | $                     | 14,698     |   | $ | 31,374 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                          |       |                  |       |   |   |
| Current  Liabilities:                                                                                                                                                                   |       |                  |       |   |   |
| Accounts  payable                                                                                                                                                                       |       | $                     | 2,722      |   | $ | 10,666 |   |
| Current  maturities under capital lease obligation                                                                                                                                      |       | —                |       | 224 |   |
| Accrued  salaries and wages                                                                                                                                                             |       | 665                   |       | 1,617 |   |
| Customer  deposits                                                                                                                                                                      |       | 1,009                 |       | 3,123 |   |
| Accrued  warranties                                                                                                                                                                     |       | 1,040                 |       | 3,013 |   |
| Deferred  service revenue                                                                                                                                                               |       | 1,667                 |       | 1,121 |   |
| Other  current liabilities                                                                                                                                                              |       | 2,583                 |       | 2,591 |   |
| Total  current liabilities                                                                                                                                                              |       | 9,686                 |       | 22,355 |   |
| Long-term  debt                                                                                                                                                                         |       | —                |       | 1,454 |   |
| Non-current  deferred revenue                                                                                                                                                           |       | —                |       | 972 |   |
| Total  liabilities                                                                                                                                                                      |       | 9,686                 |       | 24,781 |   |
| 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; 9,398,817 and 9,374,484  shares issued and outstanding at December 31, 2005 and December 31,  2004, respectively |       | 94                    |       | 94 |   |
| Paid-in  capital                                                                                                                                                                        |       | 49,455                |       | 49,400 |   |
| Accumulated  deficit                                                                                                                                                                    |       | (44,240               | )          | (42,633 | ) |
| Accumulated  other comprehensive loss                                                                                                                                                   |       | (297                  | )          | (268 | ) |
| Total  stockholders’ equity                                                                                                                                                        |       | 5,012                 |       | 6,593 |   |
| Total  liabilities and stockholders’ equity                                                                                                                                        |       | $                     | 14,698     |   | $ | 31,374 |   |

 

The accompanying notes are an integral part ofthese consolidated financial statements.

 

F-4

----

 

**FISCHERIMAGING CORPORATION**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(Amounts inthousands except per share data)**

 
| ** **                                                     | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                                      |       |                                                          |       |   |   |   |   |
| Products                                                       |       | $                                                             | 32,254     |   | $ | 48,645 |   | $ | 32,814 |   |
| Services                                                       |       | 15,014                                                        |       | 15,395 |   | 13,348 |   |
| Total  revenues                                                |       | 47,268                                                        |       | 64,040 |   | 46,162 |   |
| Cost of  sales:                                                |       |                                                          |       |   |   |   |   |
| Products                                                       |       | 31,181                                                        |       | 33,648 |   | 25,109 |   |
| Services                                                       |       | 18,467                                                        |       | 17,523 |   | 13,629 |   |
| Total cost  of sales                                           |       | 49,648                                                        |       | 51,171 |   | 38,738 |   |
| Gross margin                                                   |       | (2,380                                                        | )          | 12,869 |   | 7,424 |   |
| Operating  expenses:                                           |       |                                                          |       |   |   |   |   |
| Research and  development                                      |       | 5,233                                                         |       | 6,531 |   | 4,654 |   |
| Selling and  marketing                                         |       | 5,913                                                         |       | 10,469 |   | 9,376 |   |
| General and  administrative                                    |       | 10,509                                                        |       | 7,917 |   | 8,754 |   |
| Impairment  of long-lived assets                               |       | 2,350                                                         |       | — |   | — |   |
| Lease  termination fee                                         |       | 4,000                                                         |       | — |   | — |   |
| Total  operating expenses                                      |       | 28,005                                                        |       | 24,917 |   | 22,784 |   |
| Loss from  operations                                          |       | (30,385                                                       | )          | (12,048 | ) | (15,360 | ) |
| Other income  (expense):                                       |       |                                                          |       |   |   |   |   |
| Interest  expense                                              |       | (3,066                                                        | )          | (66 | ) | (49 | ) |
| Interest  income                                               |       | 66                                                            |       | 4 |   | 62 |   |
| Patent  settlement income                                      |       | —                                                        |       | 5,150 |   | 900 |   |
| Gain on sale  of Mammography Assets                            |       | 32,000                                                        |       | — |   | — |   |
| Other                                                          |       | (151                                                          | )          | 39 |   | 34 |   |
| Total other  income                                            |       | 28,849                                                        |       | 5,127 |   | 947 |   |
| Loss before  income taxes                                      |       | (1,536                                                        | )          | (6,921 | ) | (14,413 | ) |
| Provision  for income taxes                                    |       | 71                                                            |       | — |   | — |   |
| Net loss                                                       |       | $                                                             | (1,607     | ) | $ | (6,921 | ) | $ | (14,413 | ) |
| Net loss per  share:                                           |       |                                                          |       |   |   |   |   |
| Basic                                                          |       | $                                                             | (0.17      | ) | $ | (0.74 | ) | $ | (1.55 | ) |
| Diluted                                                        |       | $                                                             | (0.17      | ) | $ | (0.74 | ) | $ | (1.55 | ) |
| Weighted  average shares used to calculate net loss per share: |       |                                                          |       |   |   |   |   |
| Basic                                                          |       | 9,392                                                         |       | 9,353 |   | 9,319 |   |
| Diluted                                                        |       | 9,392                                                         |       | 9,353 |   | 9,319 |   |

 

The accompanying notes are an integral part ofthese consolidated statements.

 

F-5

----

 

**FISCHERIMAGING CORPORATION**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

 

**(Amounts inthousands except share data)**

 
| ** **                                              | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                              | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**              | ** ** | **Total**  | ** ** |
| ** **                                              | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                              | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** |
| ** **                                              | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | ** **             | ** ** | ** ** | ** ** |
| 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                               |       | —                |       | —      |       | —          |       | —            |       | —                 |       | (6,539     | )          |
| Exercise of  stock options                              |       | 26,000                |       | —      |       | 57              |       | —            |       | —                 |       | 57         |       |
| Balances, December 31,  2004                       |       | 9,374,484             |       | 94          |       | 49,400          |       | (42,633           | )          | (268                   | )          | 6,593      |       |
| Comprehensive  loss:                                    |       |                  |       |        |       |            |       |              |       |                   |       |       |       |
| Net loss                                                |       | —                |       | —      |       | —          |       | (1,607            | )          |                   |       | (1,607     | )          |
| Foreign  currency translation adjustments               |       | —                |       | —      |       | —          |       | —            |       | (29                    | )          | (29        | )          |
| Total  comprehensive loss                               |       | —                |       | —      |       | —          |       | —            |       | —                 |       | (1,636     | )          |
| Exercise of  stock options                              |       | 24,333                |       | —      |       | 55              |       | —            |       | —                 |       | 55         |       |
| Balances, December 31,  2005                       |       | 9,398,817             |       | $           | 94         |            | $          | 49,455            |       | $                      | (44,240    | )          | $          | (297 | ) | $ | 5,012 |   |

 

The accompanying notes are an integral part ofthese consolidated statements.

 

F-6

----

 

**FISCHERIMAGING CORPORATION**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 

**(Amounts inthousands)**

 
| ** **                                                                                 | ** ** | **For the Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cash flows  from operating activities:                                                     |       |                                                          |       |   |   |   |   |
| Net loss                                                                                   |       | $                                                             | (1,607     | ) | $ | (6,921 | ) | $ | (14,413 | ) |
| Adjustments  to reconcile net loss to net cash (used in) provided by operating activities: |       |                                                          |       |   |   |   |   |
| Depreciation                                                                               |       | 1,284                                                         |       | 1,154 |   | 1,109 |   |
| Amortization  of intangible assets                                                         |       | 44                                                            |       | 44 |   | 44 |   |
| Amortization  of debt issue costs                                                          |       | 2,272                                                         |       | — |   | — |   |
| Bad debt  expense                                                                          |       | 573                                                           |       | 29 |   | — |   |
| Impairment  of long-lived assets                                                           |       | 2,350                                                         |       | — |   | — |   |
| Gain on sale  of Mammography Assets                                                        |       | (32,000                                                       | )          | — |   | — |   |
| Gain on sale  of investment                                                                |       | —                                                        |       | (123 | ) | — |   |
| Loss on  disposal of property and equipment                                                |       | 180                                                           |       | — |   | — |   |
| Other                                                                                      |       | 226                                                           |       | — |   | 31 |   |
| Foreign  exchange (gains) losses                                                           |       | —                                                        |       | — |   | (33 | ) |
| Change in  operating assets and liabilities                                                |       |                                                          |       |   |   |   |   |
| Accounts  receivable, net                                                                  |       | 2,687                                                         |       | 2,056 |   | (686 | ) |
| Inventories,  net                                                                          |       | 11,705                                                        |       | (1,116 | ) | 3,035 |   |
| Prepaid  expenses and other current assets                                                 |       | (554                                                          | )          | 886 |   | (1,222 | ) |
| Accounts  payable                                                                          |       | (7,944                                                        | )          | 2,288 |   | 3,658 |   |
| Customer  deposits                                                                         |       | (2,114                                                        | )          | (968 | ) | 2,861 |   |
| Accrued  warranty                                                                          |       | (1,973                                                        | )          | 1,026 |   | 311 |   |
| Deferred  service revenue                                                                  |       | 546                                                           |       | 666 |   | 161 |   |
| Other                                                                                      |       | (1,307                                                        | )          | 1,272 |   | (497 | ) |
| Net cash  (used in) provided by operating activities                                       |       | (25,632                                                       | )          | 293 |   | (5,641 | ) |
| Cash flows  provided by (used in) investing activities:                                    |       |                                                          |       |   |   |   |   |
| Redemption  of certificate of deposit (restricted cash)                                    |       | 514                                                           |       | — |   | — |   |
| Purchases of  property and equipment                                                       |       | (483                                                          | )          | (1,561 | ) | (1,268 | ) |
| Proceeds  from sale of property and equipment                                              |       | 84                                                            |       | — |   | — |   |
| Proceeds  from sale of investment                                                          |       | —                                                        |       | 148 |   | — |   |
| Purchase of  certificate of deposit (restricted cash)                                      |       | —                                                        |       | — |   | (514 | ) |
| Proceeds  from sale of Mammography Assets                                                  |       | 32,000                                                        |       | — |   | — |   |
| Net cash  provided by (used in) investing activities                                       |       | 32,115                                                        |       | (1,413 | ) | (1,782 | ) |
| Cash flows  (used in) provided by financing activities:                                    |       |                                                          |       |   |   |   |   |
| Proceeds  from sale of common stock                                                        |       | 55                                                            |       | 57 |   | 182 |   |
| Proceeds  from sale/leaseback                                                              |       | —                                                        |       | — |   | 514 |   |
| Proceeds  from senior secured promissory notes                                             |       | 7,000                                                         |       | — |   | — |   |
| Repayment of  senior secured promissory notes                                              |       | (7,000                                                        | )          | — |   | — |   |
| Proceeds  from junior secured promissory notes                                             |       | 5,000                                                         |       | — |   | — |   |
| Repayment of  junior secured promissory notes                                              |       | (5,000                                                        | )          | — |   | — |   |
| Payment of  stock warrant obligation                                                       |       | (1,800                                                        | )          | — |   | — |   |
| Payment of  debt issue costs                                                               |       | (471                                                          | )          | — |   | — |   |
| Proceeds  from line of credit                                                              |       | 3,311                                                         |       | 4,108 |   | — |   |
| Repayments  on line of credit                                                              |       | (4,765                                                        | )          | (2,654 | ) | — |   |
| Payments on  capital lease obligation                                                      |       | (224                                                          | )          | (230 | ) | (60 | ) |
| Net cash  (used in) provided by financing activities                                       |       | (3,894                                                        | )          | 1,281 |   | 636 |   |
| Effect of  exchange rate changes on cash                                                   |       | (29                                                           | )          | 382 |   | (218 | ) |
| Net increase  (decrease) in cash and cash equivalents                                      |       | 2,560                                                         |       | 543 |   | (7,005 | ) |
| Cash and  cash equivalents, beginning of year                                              |       | 1,939                                                         |       | 1,396 |   | 8,401 |   |
| Cash and  cash equivalents, end of year                                                    |       | $                                                             | 4,499      |   | $ | 1,939 |   | $ | 1,396 |   |
| Supplemental  cash flow disclosures:                                                       |       |                                                          |       |   |   |   |   |
| Cash  interest payments                                                                    |       | $                                                             | 816        |   | $ | 61 |   | $ | 51 |   |
| Cash income  tax payments                                                                  |       | 130                                                           |       | 14 |   | 15 |   |

 

The accompanying notes are an integral part ofthese consolidated statements.

 

F-7

----

 

**FISCHERIMAGING CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**For thethree years ended December 31, 2005, 2004 and 2003**

 

**(1) BUSINESS OPERATIONS**

 

**Organization**

 

Fischer Imaging Corporation, together with itswholly owned subsidiaries, (“Fischer” or the “Company”) services mammographyand digital imaging products used in the diagnosis of breast cancer and otherdiseases and manufacture and sell the MammoTest to a single distributor inEurope. The Company’s primary focus prior to the consummation of the Hologictransaction on September 29, 2005 (as discussed below) was designing,manufacturing and selling mammography and digital imaging products and usingits digital imaging technology in screening and diagnostic mammograms andminimally invasive breast biopsy to aid in the early identification of breastcancer. The Company also continues to sell products that meet selected needs ofthe broader radiology and electrophysiology markets.

 

The consolidated financial statements include theaccounts of Fischer Imaging Corporation and all subsidiaries. All significantinter-company accounts and transactions have been eliminated in consolidation. Certainamounts in 2004 and 2003 have been reclassified in the consolidated financialstatements to conform to the 2005 presentation.

 

**Hologic Transaction and****Management Plans**

 

Following significant losses and negative cash flowsfrom operations during 2004, which continued into 2005, and delays in theSenoScan redesign program, Fischer obtained financing, as discussed further inNote 6 in an aggregate amount of $7.0 million from ComVest Investment PartnersII LLC (“ComVest”). In May 2005, the Company stated that it wasconsidering strategic alternatives and retained an international investmentbank to assist it in that process. The $7.0 million of financing was completelyconsumed to fund operations, working capital needs and to repay outstandingloans. Due to difficulties in reducing costs, further delays in the SenoScanredesign program, declines in revenue and other negative developments, theCompany was left with insufficient cash reserves to continue operations in June 2005.

 

On June 22, 2005, Fischer entered into an AssetPurchase Agreement (the “Asset Sale Agreement”) with Hologic, Inc. (“Hologic”)in which Fischer agreed to sell to Hologic all of Fischer’s intellectualproperty rights related to its mammography business and products, includingrights to Fischer’s SenoScan® digital mammography and MammoTest® stereotacticbreast biopsy systems (the “Mammography Assets”). Fischer agreed to sell theMammography Assets, which formed the basis for substantially all of Fischer’sbusiness, to Hologic for a cash purchase price of $32.0 million (the “AssetSale”). The Mammography Assets also represented substantially all of Fischer’sassets for purposes of Delaware law. Hologic agreed to grant Fischer anon-exclusive limited license to use certain Mammography Assets necessary forFischer to continue to service and support, and satisfy warranty obligations onthe installed base of SenoScan and MammoTest systems (the “Service” business);to fulfill contractual obligations to provide MammoTest and SenoScan systems toEthicon Endo-Surgery Europe (a subsidiary of Johnson & Johnson, Inc.,“EES”) and Philips Medical Systems DMC GmbH (“Philips”), respectively; and tocarry out certain activities with respect to Fischer’s radiology,electrophysiology and surgical (“RE&S”) business. In 

 

F-8

----

 

connectionwith the entry into the Asset Sale Agreement, Hologic loaned Fischer $5.0million to be used for working capital purposes.

 

The Asset Sale Agreement was approved by Fischer’sstockholders at a special meeting of stockholders held on September 28,2005 and closing of the Asset Sale transaction occurred on September 29,2005. The value of the Mammography Assets sold was zero on Fischer’sconsolidated balance sheets and therefore the entire $32.0 million proceedswere recognized as Gain on sale of Mammography Assets in the accompanyingconsolidated statements of operations. The proceeds from the Asset Sale weredisbursed as follows (in thousands):

 
| Repay loan  with Hologic, plus related interest (Note 6)                   |   | $     | 5,114  |   |
|----------------------------------------------------------------------------|--------|-------|--------|--------|
| Repay ComVest  Notes plus related interest (Note 6)                        |   | 7,444 |   |
| Payment of  stock warrant obligation to ComVest (Note 6)                   |   | 1,800 |   |
| Amendment  fee to terminate the Lease plus certain property taxes (Note 5) |   | 4,180 |   |
| Settle  certain accounts payable due at closing of the Asset Sale          |   | 931   |   |
|                                                                       |   | $     | 19,469 |   |

 

Approximately $8.7 million of the approximately$12.5 million in proceeds from the Asset Sale were used during the fourthquarter of 2005 to settle additional accounts payable and other short termobligations and to fund operations while Fischer continued to explore strategicalternatives for its RE&S and Service businesses.

 

Effective with the AssetSale, Hologic is the beneficiary of any future earnings and growth in revenuesfrom the Mammography Assets except for activities related to the retainedassets/businesses. Therefore, revenues recognized from the MammoTest andSenoScan after September 29, 2005 were $1.4 million and $0.0 million,respectively. The following is management’s plans with respect to each of theretained assets/businesses:

 

*Servicebusiness.*On January 23,2006, Fischer entered into an Intellectual Property License Agreement (the “KodakLicense Agreement”) and Services Agreement ( the “Kodak Services Agreement, andtogether, the “Kodak Agreements”) with Eastman Kodak Company (“Kodak”). TheseAgreements will allow Kodak to act as an authorized service provider andprovide service and support to the world-wide, excluding Mexico, installed baseof Fischer’s mammography products. Fischer expects that these Agreements withKodak will reduce Fischer’s obligations and costs with respect to the Servicebusiness. See Note 14 for further discussion of the impact of this subsequentevent.

 

*Contractualobligation to EES.*OnMarch 9, 2006, Fischer entered into an amendment (the “EES Amendment”) tothe Distributor Agreement, dated December 9, 1998, as amended (the “DistributorAgreement”) between EES and Fischer. EES agreed to place a binding order withFischer for 20 MammoTest tables (collectively, the “Tables” and each a “Table”)to be shipped to various locations in Europe. As discussed further in Note 14,after completion of the Tables, the Distributor Agreement and EES Amendmentwill terminate and no further MammoTest tables will be sold.

 

*Contractualobligation to Philips.*Thestatus of the Master Purchasing Agreement (“Philips Agreement”) between Fischerand Philips is still unresolved as discussed further in Note 12. As a result,management believes no revenues will be generated from this contract.

 

F-9

----

 

*RE&Sbusiness.*TheRE&S business includes three product lines (collectively the “Product Lines”):

 

(1)                 The VersaRad-A and VersaRad-D systemsdesigned for general purpose radiographic imaging (“VersaRad Line”). Substantiallyall of the sales of this product are sold to Kodak under an OEM Agreement. Asdiscussed further in Note 14, management received a significant last timepurchase order from Kodak in February 2006. Therefore, management expectsthat no further VersaRad units will be sold to Kodak after fulfillment of thelast time purchase order in May 2006.

 

(2)                 The EPX-60 Single Plane EP Imaging System andthe SPX Surgical Imaging System (“EPX/SPX Line”). Management expects that nofurther EPX/SPX units will be sold due to the departure of sales personnel.

 

(3)                 The Bloom Electrophysiology Stimulator (“BloomLine”). Sales of this product have been declining and backlog is currentlyminimal. Fischer believes this is due to the market’s perception of Fischer’sfinancial condition.

 

As discussed further in Note 14, on March 15,2006, Fischer announced to certain potential bidders and to the public that itis starting an auction process to sell the RE&S business. Bidders have beenasked to submit bids for the entire RE&S business, individual Product Linesor components thereof.

 

Under Delaware law, any sale of all or substantiallyall of Fischer’s assets requires approval by Fischer’s stockholders. In theevent it is determined that the sale of the assets related to the ProductLine(s) to a successful bidder would be considered a sale of all or substantiallyall of Fischer’s assets, Fischer will either file a petition under Chapter 11of title 11 of the United States Code (the “Bankruptcy Code”) and immediatelymove to close the sale pursuant to §363(b) and (f) of the BankruptcyCode or seek the necessary stockholder approval.

 

*Europe.*In December 2005, the Board of Directorsapproved the liquidation and wind-up of Fischer’s European subsidiaries. Afterthe Asset Sale, the only remaining recurring revenue is related to servicecontracts. Applications training and warranty support due under the EES Amendmentand Distributor Agreement will be provided by an alternative service providerin Europe. Fischer’s European subsidiaries are in discussions with analternative service provider but if this fails, additional funds may beneeded to fund the operations until an appropriate alternative service provideris located. If an alternative service provider cannot be located at areasonable cost, the projected positive cash contribution from sale of the EESTables could be at risk.

 

The cash and cash equivalents available as of December 31,2005 is made up of $4.2 million in the United States and $0.3 million invarious countries in Europe. The remaining cash as of December 31, 2005will be used to pay outstanding obligations, to satisfy operationalresponsibilities in respect of other obligations as discussed above; and tocontinue operations until the sale of the RE&S business is complete. Managementexpects that amounts, if any, remaining after completing the last time purchaseorders with Kodak and EES and after making adequate reserves for contingentliabilities such as outstanding litigation, would be distributed tostockholders.

 

Thefactors listed above, among others, raise substantial doubt about Fischer’sability to continue as a going concern. The consolidated financial statementsdo not include any adjustments that might result from the outcome of thisuncertainty. As discussed in Note 4,

 

F-10

----

 

management assessed therecoverability of its long-lived assets and intangibles and recognized animpairment charge of $2.4 million in 2005, a process which included assumptionsregarding estimated future cash flows and other factors, and estimated that themaximum amount of additional non-cash impairment charges related to fixedassets would be $0.3 million.

 

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

 

**Use of Estimates in the Preparation of FinancialStatements**

 

The Company uses estimates and assumptions in preparingfinancial statements in accordance with accounting principles generallyaccepted in the United States. Those estimates and assumptions affect thereported amounts of assets and liabilities, the disclosure of contingent assetsand contingent liabilities, and the reported revenue and expenses. Actualresults could vary from the estimates that were used.

 

**Revenue Recognition**

 

The Company follows the provisions of SEC Staff Accounting Bulletin No. 104,“Revenue Recognition in Financial Statements” (“SAB 104”) which provides forrevenue recognition when persuasive evidence of an arrangement exists, deliveryhas occurred, the price is fixed and determinable and collectibility isreasonably assured. The Company’s standard business practice requires thatsales transactions be supported by an executed sales agreement or an executedpurchase order. The Company recognizes product revenue for its medicalequipment when title and risk of loss have transferred to the customer and theCompany has no post-shipment performance obligations other than installation ortraining. Where 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 wherethe sales agreement prescribes additional consequential performance obligationsor requires specific 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 extendedwarranty agreements in advance either monthly, quarterly, annually or at thetime of the product sale, depending upon the customers’ request. The amountsbilled are recorded as deferred revenue and recognized as revenue ratablyduring the period for which the contracts are in effect. The Company recognizesrevenue from services billed on a time and material basis when the services areperformed. The Company also sells replacement parts to customers and recordsrevenue at the time of shipment when title transfers. Certain replaced parts may bereturned for partial credit, and the Company records sales allowances based onhistorical experience to account for the future effect of those returns.

 

Accounts receivable are carried at original invoiceamounts less an estimate for doubtful accounts and sales returns based on aperiodic review of outstanding receivables. Allowances are provided for knownand anticipated credit losses as determined by management in the course ofregularly evaluating individual customer receivables. This evaluation takesinto consideration a customer’s financial condition and credit history as wellas current economic conditions. Accounts receivable are written off when deemeduncollectible. Recovery of accounts receivable previously written off arerecorded when received.

 

F-11

----

 

**Cash and Cash Equivalents**

 

Cash and cash equivalents include cash on hand,demand deposits, and short-term investments with an original maturity of threemonths or less. Cash and cash equivalents include financial instruments thatpotentially subject the Company to a concentration of credit risk. The Companyplaces its cash and temporary cash investments with high credit qualityinstitutions. At times, cash held in the Company’s primary bank may be inexcess of the FDIC insurance limits. As support for a capital lease obligation,the Company held $514,000 in restricted cash in a certificate of deposit as of December 31,2004. Upon payment of the capital lease obligation, the restrictions werereleased.

 

**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 recordedbased on these periodic assessments. As a result of a reduction in forecastedsales and service usage resulting from the Asset Sale, Kodak Agreements, lackof sales generated from the Philips Agreement and changes in market conditions,the provision for excess and obsolete inventories increased by $7.8 million inthe year ended December 31, 2005. Approximately $2.0 million is reportedas services cost of sales in the consolidated statements of operations as itrelates directly to the Kodak Agreements; the remaining $5.8 million isreported as product cost of sales.

 

Inventories consist of the following components (inthousands) as of December 31:

 
| ** **                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Raw  materials                               |       | $        | 5,120      |     | $          | 8,952 |   |
| Work in  process and finished goods          |       | 6,340    |       | 8,866    |       |
| Reserve for  excess and obsolete inventories |       | (7,131   | )          | (1,784   | )          |
| Inventories,  net                            |       | $        | 4,329      |     | $          | 16,034 |   |

 

During 2005, approximately one-third of inventoryreceived was purchased from three suppliers. Obtaining alternative sources ofsupply of components or systems that are available from only one or a limitednumber of suppliers could involve significant delays and other costs, and thesesupplies may not be available on reasonable terms, if at all.

 

**Property and Equipment**

 

Property and equipment is stated at the lower ofdepreciated cost or net realizable value. Significant additions andimprovements are capitalized at cost, while maintenance and repairs that do notimprove or extend the life of the respective assets are charged to expense asincurred.

 

Manufacturing and office equipment are depreciatedor amortized on a straight-line basis, over the estimated useful lives (rangingfrom 3 to 8 years) of the respective assets. Leasehold improvements areamortized, on a straight-line basis, over the lesser of the estimated usefullife or the remaining term of the related lease. Once an impairment of propertyand equipment is recognized, depreciation is estimated based upon the remaininglife of the asset but will not be 

 

F-12

----

 

recognizedin an amount which would lower the net book value below net realizable value. Therefore,management believes depreciation expense will be negligible in 2006.

 

**Intangible Assets**

 

Intangible assets consist of identifiable intangibleassets and goodwill. Identifiable intangible assets consist of a non-competeagreement and a patent license, which are stated at cost. Identifiable assetsare amortized on straight-line basis over their expected useful lives rangingfrom 8 to 10 years. Goodwill is the excess of the purchase price over thefair value of net assets acquired related to acquisitions. Effective December 31,2005, an impairment of intangible assets was recognized as discussed further inNote 4.

 

**Long-Lived Assets including Identifiable IntangibleAssets Subject to Amortization**

 

Long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. In performing the review forrecoverability, the Company estimates the future cash flows expected to resultfrom the use of the asset and its eventual disposition. If the sum of theexpected future cash flows (undiscounted and without interest charges) is lessthan the carrying amount of the asset, the asset is written down to itsestimated fair value. During 2005, impairments of long-lived assets wererecognized as discussed further in Note 4.

 

**Financial Instruments**

 

The fair market value of accounts receivable,accounts payable, debt and other financial instruments approximates theircarrying values in the accompanying consolidated balance sheets. The fair valueof debt was determined based upon current interest rates available to Fischer.

 

**Product Warranty**

 

The Company provides for the estimated cost ofproduct warranties at the time revenue is recognized. Although the Companyengages in extensive product quality programs and processes, its warrantyobligation is affected by product failure rates and service delivery costsincurred in correcting a product failure. Should actual product failure ratesor service costs differ from the Company’s estimates, which are based onhistorical data, and engineering estimates, where applicable, revisions to theestimated warranty liability would be required. The typical standard warrantyterm is for 12 months starting from the date of installation. The Companyalso sells extended warranties ranging from 12 to 60 months.

 

Activity in the product warranty accrual for theyears ended December 31, 2005 and 2004 follows (in thousands):

 
| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Beginning  balance       |       | $        | 3,013      |     | $          | 1,987 |   |
| Add:  Warranty provision |       | 1,486    |       | 4,078    |       |
| Less: Cost  incurred     |       | (3,459   | )          | (3,052   | )          |
| Ending  balance          |       | $        | 1,040      |     | $          | 3,013 |   |

 

F-13

----

 

**Translation of Foreign Currencies**

 

The assets and liabilities of the Company’sconsolidated foreign subsidiaries, whose cash flows are primarily in theirlocal currencies, have been translated into U.S. dollars using the currentexchange rates at each balance sheet date. The operating results of theseforeign 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.

 

## **Research and Development Costs**

## ** **

Research and product development costs are expensedas incurred and include primarily engineering salaries, overhead and materialsused in connection with research and development and sustaining engineeringprojects.

 

**Advertising Costs**

 

The Company expenses advertising costs as incurred.Advertising costs of $99,000, $400,000 and $320,000 were expensed in 2005, 2004and 2003, respectively.

 

**Stock-Based Compensation Plans:**

 

**Employee Stock Option Plan and Employee Stock PurchasePlan**

 

The Company’s stock option grants are accounted forunder the intrinsic value recognition and measurement principles of AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations (“APB No. 25”). No stock-basedemployee compensation cost is recognized in net income or loss, unless theoption price is less than the current market price at the grant date. Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of SFAS No. 123“Accounting for Stock-Based Compensation,” to employee stock benefits.

 

For purposes of this pro forma disclosure, the estimated fair value ofthe options are assumed to be amortized to expense over the options’ vesting periods(in thousands, except per share amounts).

 
| ** **                                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net loss:                                                               |       |     |       |     |       |     |       |
| As reported                                                             |       | $        | (1,607     | )        | $          | (6,921   | )          | $ | (14,413 | ) |
| Add stock  options issued below market value                            |       | —   |       | —   |       | 31       |       |
| Stock based  compensation benefit (expense) under the fair value method |       | 788      |       | (1,005   | )          | (1,412   | )          |
| Pro forma                                                               |       | $        | (819       | )        | $          | (7,926   | )          | $ | (15,794 | ) |
| Net loss per  common share, basic and diluted:                          |       |     |       |     |       |     |       |
| As reported                                                             |       | $        | (0.17      | )        | $          | (0.74    | )          | $ | (1.55 | ) |
| Pro forma                                                               |       | $        | (0.09      | )        | $          | (0.85    | )          | $ | (1.69 | ) |

 

F-14

----

 

Thestock based compensation benefit in 2005 relates to significant forfeituresoccurring during the year and a lack of options granted.

 

The weighted average fair value of each option granthas been estimated as of the date of grant using the Black-Scholes option-pricingmodel and the following weighted average assumptions:

 
| ** **                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend  rate            |       | 0.0      | %          | 0.0      | %          | 0.0      | %          |
| Expected  volatility      |       | 102.6    | %          | 94.0     | %          | 94.9     | %          |
| Risk-free  interest rate  |       | 3.9      | %          | 3.8      | %          | 2.5      | %          |
| Expected  life (in years) |       | 5.0      |       | 5.0      |       | 5.0      |       |

 

The weighted average fair value of options grantedduring the 2005, 2004 and 2003 fiscal years were $3.59, $2.47 and $3.96,respectively.

 

**Net Loss Per Share**

 

Basic earnings or loss per share is computed bydividing the net earnings or loss by the weighted average number of shares ofcommon stock outstanding at the reporting date. Diluted earnings or loss pershare is determined by dividing the net earnings or loss by the sum of theweighted average number of common shares outstanding, and if not anti-dilutive,the effect of outstanding stock options determined utilizing the treasury stockmethod.

 

Common stock equivalents excluded from dilutedearnings per share because their effect is anti-dilutive are as follows (inthousands):

 
| ** **                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Anti-dilutive  effect of stock options |       | 608      |       | 1,373    |       | 1,483    |       |

 

**Comprehensive Income (Loss)**

 

Components of comprehensive income include netincome (loss) and certain transactions that have generally been reported in theconsolidated statements of stockholders’ equity. Other comprehensive incomeincludes foreign currency translation adjustments.

 

**Recently Issued Accounting Pronouncements**

 

The FASB has issued SFAS No. 123 (revised 2004)(“SFAS No. 123R”), “Share-BasedPayment” which supersedes APB No. 25. Under SFAS No. 123R, allshare-based payments would be treated as other forms of compensation byrecognizing the costs, generally measured as the fair value at the date ofgrant, in the income statement. Fischer will be required to adopt SFAS No. 123Rfor its fiscal year beginning January 1, 2006. Fischer is evaluating therequirements of SFAS No. 123R and has not yet determined which method ofadoption it will employ or the impact on its results of operations, financialposition or liquidity.

 

The FASB has issued Statement of FinancialAccounting Standards No. 151, “Inventory Costs – an amendment of ARB No. 43,Chapter 4” (“SFAS No. 151”). The provisions of SFAS 151 are intendedto eliminate narrow differences between the existing accounting standards ofthe FASB and the International Accounting Standards Board (IASB) relatedto inventory costs, in particular, the treatment of abnormal idle facilityexpense, freight, handling costs and spoilage.

 

F-15

----

 

SFASNo. 151 requires that these costs be recognized as current period chargesregardless of the extent to which they are considered abnormal. The provisionsof SFAS 151 are effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. The adoption of SFAS 151 is not expected tohave a material impact on the Company’s results of operations, financialposition or liquidity.

 

**(3) INTANGIBLE ASSETS**

 

During the year ended December 31, 2005, animpairment of intangible assets was recognized as discussed further in Note 4. Intangibleassets consist of the following as of December 31, 2004 (in thousands):

 
| Non-compete  agreement              |   | $      | 3,569  |   |
|-------------------------------------|--------|--------|--------|--------|
| License                             |   | 350    |   |
|                                |   | 3,919  |   |
| Less—accumulated  amortization |   | (3,744 | )      |
| Identifiable  intangibles, net      |   | 175    |   |
| Goodwill,  net                      |   | 858    |   |
| Total  intangibles, net             |   | $      | 1,033  |   |

 

The estimated lives used to amortize the non-competeagreement and license through December 31, 2005 were 10 and 8 years,respectively.

 

**(4) IMPAIRMENT OF LONG-LIVED ASSETS**

** **

The Company’s policy is to evaluate whether there has been a permanentimpairment in the value of long-lived assets, of certain identifiableintangibles and of goodwill when certain events have taken place that indicatethat the remaining balance may not be recoverable. Fischer evaluates thecarrying value of its property and equipment at the consolidated level sincethe Company believes that is the lowest identifiable level of cash flows forthese assets. Fischer evaluates the carrying value of the intangibles at theconsolidated level since there are no components that constitute a business forwhich discrete financial information is available below the segment level. As aresult of the Asset Sale, Lease Amendment and further declines in the stockprice, management determined a recoverability test should be completed as of September 30,2005 and December 31, 2005.

 

Since the future estimated cash inflows arecurrently estimated to be near zero, the carrying amounts of the assetsexceeded the estimated undiscounted cash flows. Management estimated the fairvalue of the assets by reviewing the value of the remaining businesses andother long-lived assets and determined an impairment had occurred. Fair valueof the long-lived assets was determined through inquiry of advisors andcomparison to other sales of fixed assets. Therefore, an impairment oflong-lived assets of $2.4 million was recognized during the year ended December 31,2005.

 

F-16

----

 

 

 

If the estimates of fair value change in the future, the Company may berequired to record additional impairment charges for the long-lived assets. Basedupon the minimum fair value estimates, the maximum amount of impairment chargesrelated to property and equipment would be $0.3 million.

 

**(5)LEASE TERMINATION FEE AND RESTRUCTURING EXPENSE**

** **

The Company entered into termination and retention arrangements fromJune 2005 through March 2006 with approximately 102 employees in the U.S. andEurope. All areas of the Company were impacted. Retention payments under theseagreements are earned over the periods July 1, 2005 through December 31, 2005and January 1, 2006 through June 30, 2006 and are currently estimated to be$0.7 million and $0.5 million, respectively. Severance payments, earned uponinvoluntary termination, are estimated to be $1.3 million. Retention paymentsare being recognized as expense over the period earned, and severance paymentswill be expensed over the period beginning with the date of signing through theearlier of the communicated involuntary termination dates or December 31, 2006.The Company recognized restructuring expense in the amount of $0.9 millionrelated to these arrangements during the year ended December 31, 2005.

 

A portion of the payments to be made under the termination andretention arrangements will be paid from the irrevocable Fischer ImagingEmployee Trust (the “Trust”). This Trust was established in 2006 for thespecific purpose of paying amounts owed under termination and retentionarrangements or general wages to employees. The Trust was funded by the Companyon January 2, 2006 with $600,000 of cash as authorized by the Board ofDirectors.

 

All other employees not under termination or retention arrangementsthat were involuntarily terminated received termination benefits ofapproximately $1.1 million, of which all but $0.2 million has been paid as ofDecember 31, 2005.

 

The majority of restructuring expense related to termination andretention arrangements has been recorded as “Services cost of sales” and“General and administrative” in the accompanying consolidated statements ofoperations.

 

On September 27, 2005, Fischer entered into an Amendment to LeaseAgreement (the “Lease Amendment”) with JN Properties, Fischer’s landlord and acompany controlled by Morgan Nields, a substantial stockholder and formerdirector, chair of the Board, chief executive officer and chief technologyofficer of Fischer. The Lease Amendment provides for the amendment of the Leasedated July 31, 1992 between Fischer and JN Properties (the “Lease”) to allowfor the early termination of the Lease within 60 days of written notice fromFischer of intent to vacate or May 31, 2006, whichever is earlier. The Leaseterm was to originally run through July 2012. Fischer will continue to pay thecurrent rental rate and comply with other terms and conditions of the Leaseduring the period prior to termination of the Lease. In exchange for the above,Fischer agreed to pay to JN Properties $4.0 million plus certain accrued 2005property taxes immediately following the closing of the Hologic transaction. Inthe Lease Amendment, JN Properties granted its consent to the transactionscontemplated by the Asset Sale Agreement. The $4.0 million payment has beenrecognized as “Lease termination fee” in the accompanying consolidatedstatements of operations in accordance with FASB Statement No. 146, “Accountingfor Costs Associated with Exit or Disposal Activities.”

 

F-17

----

 

The following is a roll forward of the restructuring accrual (inthousands):

 
| ** **                   | ** ** | **Termination  Benefits** | ** ** | **Lease  Termination  Fee** | ** ** | **Total** | ** ** |
|------------------------------|------------|---------------------------|------------|-----------------------------|------------|-----------|------------|
| Balance at December 31, 2004 |       | $                         | —     |                        | $          | —    |       | $ | — |   |
| Expense                      |       | 1,974                     |       | 4,000                       |       | 5,974     |       |
| Payments                     |       | (1,435                    | )          | (4,000                      | )          | (5,435    | )          |
| Balance at December 31, 2005 |       | $                         | 539        |                        | $          | —    |       | $ | 539 |   |

 

The restructuring accrual is included in “Other Current Liabilities” inthe accompanying consolidated balance sheet.

 

**(6) BORROWINGS AND WARRANTS**

 

In June 2003, the Company entered intoan $8.0 million credit facility with Silicon Valley Bank, subject torestrictions based on eligible receivables. The outstanding balance as ofDecember 31, 2004 was $1.5 million. On February 22, 2005, the Companyrefinanced the $2.5 million then outstanding under this credit facility on along-term debt basis with ComVest and terminated this credit facility. TheCompany accounted for the refinanced debt as long-term in the accompanyingconsolidated balance sheet as of December 31, 2004 pursuant to FASB StatementNo. 6, “Classification of Short-term Obligations Expected to be Refinanced.”

 

The Company entered into a Note and WarrantPurchase Agreement with ComVest on February 22, 2005 (the “PurchaseAgreement”), which provided for the issuance of up to $10.0 million in seniorsecured promissory notes and a warrant to purchase up to 2,000,000 shares ofFischer common stock. At closing, Fischer issued and sold a senior securedpromissory note in the principal amount of $5.0 million to ComVest. Inconnection with the issuance of this note, Fischer issued to ComVest a warrant(the “Warrant”) to purchase 2,000,000 shares of Common Stock at an exerciseprice of $4.25 per share.

 

On March 29, 2005 the Company and ComVestamended the Purchase Agreement and the Company issued and sold an additional$2.0 million senior secured promissory note to ComVest, bringing the totalamount borrowed from ComVest to $7.0 million. Also in connection with thefunding of the secondary note, the Company 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 $5.0 million of loan proceeds receivedfrom ComVest in February 2005 and the $2.0 million loan proceeds received fromComVest in March 2005, were completely consumed to fund operations, workingcapital needs and to repay the outstanding balance of $2.5 million under theline of credit with Silicon Valley Bank. In connection with the closing of theAsset Sale, ComVest exercised its put option, and at closing, Fischer paid $1.8million in satisfaction of the stock warrant obligation. In addition, amountsdue under the ComVest promissory notes were paid upon the closing of the AssetSale.

 

In connection with the execution of the AssetSale Agreement, Fischer entered into a $5.0 million interest bearing securedterm loan with Hologic. Hologic deducted all amounts outstanding under thepromissory note from the purchase price payable at the closing of the AssetSale.

 

F-18

----

 

The capital lease obligation as of December31, 2004 was a two-year obligation for primarily computer equipment andsoftware. The capital lease was secured by computer equipment. As of December31, 2005, all long-term debt and capital lease obligations had been paid and nofurther funding was available through those sources.

 

Long-term debt and capital lease obligationas of December 31, 2004 consist of the following (in thousands):

 
| Long-term (Credit facility refinanced to  long-term debt) |   | $     | 1,454  |   |
|-----------------------------------------------------------|--------|-------|--------|--------|
| Capital lease obligation                                  |   | 224   |   |
| Total                                                     |   | 1,678 |   |
| Less—Current maturities                              |   | 224   |   |
| Long-term debt                                            |   | $     | 1,454  |   |

 

**(7) INCOME TAXES**

 

The provision (benefit) for income taxesincludes the following (in thousands) as of December 31,

 
| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current                  |       |     |       |     |       |     |       |
| Federal                  |       | $        | —     |     | $          | —   |       | $ | — |   |
| State                    |       | 50       |       | —   |       | —   |       |
| Foreign                  |       | 21       |       | —   |       | —   |       |
| Total current provision  |       | 71       |       | —   |       | —   |       |
| Deferred                 |       |     |       |     |       |     |       |
| Federal                  |       | (1,508   | )          | (1,394   | )          | (4,509   | )          |
| State                    |       | (142     | )          | (131     | )          | (429     | )          |
| Foreign                  |       | 1,151    |       | (878     | )          | (417     | )          |
| Total deferred provision |       | (499     | )          | (2,403   | )          | (5,355   | )          |
| Valuation Allowance      |       | 499      |       | 2,403    |       | 5,355    |       |
| Total deferred provision |       | —   |       | —   |       | —   |       |
| Total provision          |       | $        | 71         |     | $          | —   |       | $ | — |   |

 

The domestic versus foreign component of theCompany’s income (loss) before income taxes is as follows (in thousands):

 
| ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Domestic   |       | $        | (6,133     | )        | $          | (4,176   | )          | $ | (13,109 | ) |
| Foreign    |       | 4,597    |       | (2,745   | )          | (1,304   | )          |
| Total      |       | $        | (1,536     | )        | $          | (6,921   | )          | $ | (14,413 | ) |

 

During 2005, the domestic parent forgave theoutstanding debt from its foreign subsidiaries and recognized bad debt expensein its financial statements of $6.5 million. The foreign subsidiariesrecognized $6.5 million of income related to the forgiveness of debt. There wasno impact on the consolidated financial statements as these transactionseliminate in consolidation.

 

F-19

----

 

During 2005, the Company utilizedapproximately $4.2 million and $0.3 million of its net operating losscarry-forward to offset taxable income in the year in the U.S. and Europe,respectively. A valuation allowance was previously provided against these losscarry-forwards.

 

The statutory federal income tax rate was 35%for the years ended December 31, 2005, 2004 and 2003. Reasons for thedifference between income tax expense reported in the statements of operationsand the amount computed by applying the statutory federal income tax rate toearnings before income taxes are as follows:

 
| ** **                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Domestic Operations:**           |       |     |       |     |       |     |       |   |   |   |
| Statutory tax rate                 |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| Increase (decrease) due to:        |       |     |       |     |       |     |       |
| State income taxes                 |       | 2.8      |       | 1.9      |       | 3.0      |       |
| Non-deductible expenses            |       | (0.6     | )          | (1.0     | )          | (0.3     | )          |
| Non-deductible goodwill impairment |       | (4.9     | )          | —   |       | —   |       |
| Other                              |       | (0.8     | )          | (1.2     | )          | (0.3     | )          |
| Valuation allowance                |       | (32.3    | )          | (34.7    | )          | (37.4    | )          |
| Effective tax rate                 |       | (0.8     | )%         | —   | %          | —   | %          |
|                                    |            |          |            |          |            |          |            |  |  |  |

 

Components of net deferred tax assets(liabilities) as of December 31, 2005 and 2004 are as follows (inthousands):

 
| ** **                        | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Current—                     |       |       |       |     |       |     |       |
| Inventory reserves                |       |       |       |     | $          | 2,758    |       | $ | 1,226 |   |
| Bad debt reserves                 |       |       |       | 104      |       | 235      |       |
| Accrued compensation              |       |       |       | 236      |       | 434      |       |
| Other accrued liabilities         |       |       |       | 326      |       | 103      |       |
| Warranty reserves                 |       |       |       | 500      |       | 928      |       |
| Amortization of investments       |       |       |       | 51       |       | —   |       |
| Other                             |       |       |       | 271      |       | —   |       |
| Less—Valuation allowance     |       |       |       | (4,246   | )          | (2,926   | )          |
| Net current deferred tax asset    |       |       |       | $        | —     |     | $          | — |   |
|                              |       |       |       |     |       |     |       |
| Noncurrent—                  |       |       |       |     |       |     |       |
| Amortization of investments       |       |       |       | $        | —     |     | $          | 249 |   |
| Depreciation                      |       |       |       | 756      |       | 293      |       |
| Net operating loss carryforward   |       |       |       | 12,484   |       | 13,379   |       |
| Tax credits                       |       |       |       | 740      |       | 740      |       |
| Other                             |       |       |       | 50       |       | 190      |       |
| Less—Valuation allowance     |       |       |       | (14,030  | )          | (14,851  | )          |
| Net noncurrent deferred tax asset |       |       |       | $        | —     |     | $          | — |   |
|                                   |            |            |            |          |            |          |            |  |  |  |

 

The Company has approximately$32.1 million of domestic net operating loss carry-forwards, and$0.7 million of foreign net operating loss carry-forwards that expire atvarious dates through 2024. The Company also has available research anddevelopment 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 allowance against its deferred tax assets because ofthe uncertainty of realizing such assets. A valuation allowance ofapproximately $2.0 million relates

 

F-20

----

 

to operating losses totaling $5.1 million attributable todeductions on stock option exercises that, if reversed, will be additions toadditional paid in capital.

 

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

 

**2004 Equity Incentive Plan**

 

The Company adopted the 2004 Equity Incentive Plan at the 2004 annualstockholders’ meeting on June 29, 2004. The Plan provides for the grant ofincentive stock options to employees and non-qualified stock options tonon-employee directors and consultants. Seven hundred thousand shares of CommonStock are reserved for issuance upon exercise of options granted under thePlan, of which 280,000 have been granted through December 31, 2005.

 

**1993 Director Plan**

 

The Company’s Non-employee Director StockOption Plan (the “Director Plan”), adopted in 1993 and amended inJune 1998, authorizes the granting of nonqualified options to acquire upto 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 Option Plan (the“1991 Plan”) adopted June 1991 and subsequently amended, authorized thegranting of incentive and nonqualified stock options to acquire up to 1,750,000shares of common stock by employees and consultants. Exercise terms for theoptions granted were determined by the Board of Directors at the time of grant.Incentive stock options may be granted at an exercise price not less than fairmarket value on the date of grant with a maximum option term of ten years. The1991 Plan also permitted the granting of stock appreciation rights, althoughnone were granted. The ability to grant options under the 1991 Plan expired in2001.

 

Certain of the options granted under the 1991Plan vest upon attainment of performance objectives as well as over time.Outstanding as of December 31, 2004 are 80,000 options granted inDecember 1995 that vest when the market price of the Company’s stock hasreached targeted price levels for a period of 45 consecutive trading days ornine years and eleven months from the date of original grant, whichever isearlier. These 80,000 options were cancelled in 2005. Other options grantedunder the 1991 Plan vest ratably over time, generally over a four-year period.

 

**Non-Plan Grants**

 

During the period from the expiration of theability to make grants under the 1991 Plan until September 6, 2003, theCompany’s Board of Directors authorized grants to various officers and employeesof options to purchase a total of 1,076,500 shares of common stock. Outstandingas of December 31, 2005 were 219,250 exercisable options so granted.

 

F-21

----

 

**Employee Stock Purchase Plan**

 

Under the Employee Stock Purchase Plan, orEmployee Plan, adopted in December 1991 and as amended in June 1998,the Company is authorized to issue up to 400,000 shares of common stock to itsfull-time employees, nearly all of whom are eligible to participate. Underterms of the Employee Plan, employees can have from 2% to 5% of their salarywithheld to purchase common stock. The purchase price of the stock is 85% ofthe lower of its beginning-of-year or end-of-year market price. Under theEmployee Plan, Fischer issued 25,408 shares for the year endedDecember 31, 2003 relating to employee withholdings. Shares issued in 2003were for the year ended December 31, 2002. There were no stock purchasesin 2004 and 2005 and there are no shares available for purchase under theEmployee Plan.

 

**Other**

 

During 2003, $31,000 was recorded as non-cashcompensation expense related to 25,000 options granted to certain directors fortheir service on the Board of Directors at a $4.00 exercise price, which at thetime of issuance was below the quoted market price.

 

A combined summary of the status of the aboveplans, including the non-plan grants follows:

 
| ** **                        | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-----------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Outstanding at January 1     |       | 1,373,500 |       | 1,483,500 |       | 1,556,560 |       |
| Granted                           |       | 105,000   |       | 195,000   |       | 298,500   |       |
| Exercised                         |       | (24,333   | )          | (26,000   | )          | (16,500   | )          |
| Canceled                          |       | (846,417  | )          | (279,000  | )          | (355,060  | )          |
| Outstanding at December 31   |       | 607,750   |       | 1,373,500 |       | 1,483,500 |       |
| Exercisable at December 31   |       | 589,000   |       | 975,750   |       | 835,125   |       |
|                              |       |      |       |      |       |      |       |
| Weighted average exercise prices: |       |      |       |      |       |      |       |
| At beginning of year              |       | $         | 6.06       |      | $          | 6.58      |       | $ | 6.90 |   |
| At end of year                    |       | 5.71      |       | 6.06      |       | 6.58      |       |
| Exercisable at end of year        |       | 5.75      |       | 6.23      |       | 6.27      |       |
| Options granted                   |       | 4.80      |       | 2.47      |       | 5.61      |       |
| Options exercised                 |       | 2.27      |       | 2.19      |       | 3.18      |       |
| Options canceled                  |       | 6.15      |       | 6.76      |       | 6.10      |       |
|                                   |            |           |            |           |            |           |            |  |  |  |

 

F-22

----

 

Following isinformation about options outstanding and exercisable under the 2004, 1993 and1991 Plans, as well as the non-plan grants as of December 31, 2005:

 
| **Range of exercise prices**                                          | ** ** | **Shares** | ** ** | **Price**  | ** ** |
|--------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Weighted average exercise price for options  outstanding:**                        |       |       |       |       |       |
| $1.00 - $3.05                                                                        |       | 87,750     |       | $          | 2.30       |   |
| $3.06 - $4.99                                                                        |       | 297,250    |       | 3.95       |       |
| $5.00 - $5.99                                                                        |       | 14,750     |       | 5.07       |       |
| $6.00 - $7.99                                                                        |       | 90,250     |       | 6.47       |       |
| $8.00 - $11.00                                                                       |       | 51,000     |       | 10.75      |       |
| $11.01 - $16.64                                                                      |       | 66,750     |       | 13.23      |       |
|                                                                                 |       | 607,750    |       | $          | 5.71       |   |
| **Weighted average exercise price for options  exercisable:**                        |       |       |       |       |       |
| $1.00 - $3.05                                                                        |       | 87,750     |       | $          | 2.30       |   |
| $3.06 - $4.99                                                                        |       | 282,250    |       | 3.95       |       |
| $5.00 - $5.99                                                                        |       | 12,250     |       | 5.09       |       |
| $6.00 - $7.99                                                                        |       | 89,000     |       | 6.48       |       |
| $8.00 - $11.00                                                                       |       | 51,000     |       | 10.75      |       |
| $11.01 - $16.64                                                                      |       | 66,750     |       | 13.23      |       |
|                                                                                 |       | 589,000    |       | $          | 5.75       |   |
|                                                                                 |       |       |       |       |       |
| ** **                                                                           | ** ** | **Shares** | ** ** | **Years**  | ** ** |
| **Weighted average remaining contractual life  for options outstanding (in years):** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $1.00 - $3.05                                                                        |       | 87,750     |       | 6.2        |       |
| $3.06 - $4.99                                                                        |       | 297,250    |       | 6.3        |       |
| $5.00 - $5.99                                                                        |       | 14,750     |       | 6.9        |       |
| $6.00 - $7.99                                                                        |       | 90,250     |       | 7.0        |       |
| $8.00 - $11.00                                                                       |       | 51,000     |       | 5.7        |       |
| $11.01 - $14.00                                                                      |       | 66,750     |       | 5.9        |       |
|                                                                                 |       | 607,750    |       | 6.3        |       |

 

**(9) BENEFIT PLANS**

 

**401(k) Plan**

 

In 1985, the Company established The FischerImaging Employee Capital Accumulation Plan (“Plan”), which is governed bySection 401(k) of the Internal Revenue Code. Employees are eligible toparticipate in the plan upon completion of one month of service. Investments inthe 401(k) plan are primarily made in independently managed mutual funds. FromJanuary 2004 through August 17, 2005, the Company matched 50% of employees’contributions up to 6% of their respective annual compensation and during 2003the Company matched 25% of employees’ compensation up to 6% of their respectivecompensation. In addition, the Plan allows the Company to make discretionarycontributions. These matching and discretionary contributions ratably vest overa four-year period. During 2005 the Plan was partially terminated and as aresult all active participants as of August 1, 2005 and those participantsinvoluntarily terminated from Fischer from May 1, 2005 through August 1, 2005became fully vested in matching contributions. Effective January 31, 2006, thePlan was terminated and all remaining participants became fully vested. TheCompany made $225,000, $254,000 and $132,000 of matching contributions for theyears ended December 31, 2005, 2004 and 2003, respectively. The Companydid not make a discretionary contribution in the years ended December 31,2005, 2004 and 2003.

 

F-23

----

 

**(10) RELATED PARTY TRANSACTIONS**

 

Long-term debt prior to 2003 consisted ofloans borrowed on cash values of life insurance policies by a former employee,who was previously a director of the Company, Chairman of the Board, ChiefExecutive Officer and Chief Technology Officer. This individual is a 6.2% stockholder.On May 12, 2003, the Company reached agreement with this individual, toeffect the transfers of and responsibility for, the insurance policies. TheCompany subsequently released its assignments on the related policies inAugust 2003. This individual assumed all cash values totaling $1.1 millionand borrowings totaling $1.2 million related to the split-dollar arrangements.Effective December 31, 2003, this individual resigned as an employee anddirector of the Company and received deferred compensation totaling $200,000,which was paid in 2004.

 

As discussed in Note 5, the Company paida Lease Termination Fee of $4.0 million to JN Properties. A former employee, asof December 31, 2003, who was also previously a director of the Company,Chairman of the Board, Chief Executive Officer and Chief Technology Officer,and a 6.2% stockholder is a general partner in JN Properties. The Companymade total lease payments of $796,000 in each of the following years: 2005,2004 and 2003 in addition to the Lease Termination Fee and prepaid $66,000 ofrent on December 30, 2005.

 

During 1999, the Company extended a loan inthe amount of $252,000 to a former President and Chief Executive Officer anddirector pursuant to his employment agreement, in consideration for hisagreement to relocate to Colorado immediately. At December 31, 2003,$100,000 of the loan was outstanding and was repaid in full inSeptember 2004.

 

**(11) SEGMENT AND CUSTOMER INFORMATION**

 

TheCompany operates in a single industry segment: the manufacture and service ofspecialty digital imaging systems and other medical devices primarily used inscreening, diagnostic and interventional procedures. The Company manufacturesits products in the United States and distributes them in the United States,Europe and elsewhere. The Company’s chief operating decision makers useconsolidated results 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. International long-lived assets are located inSwitzerland. The following table represents a summary of revenues andlong-lived assets (in thousands):

 
| ** **          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------|------------|--------------------------------------------|------------|
| ** **          | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:           |       |                                       |       |   |   |   |   |
| United States       |       | $                                          | 41,171     |   | $ | 46,640 |   | $ | 37,966 |   |
| Mexico              |       | —                                     |       | 8,406 |   | 562 |   |
| Other International |       | 6,097                                      |       | 8,994 |   | 7,634 |   |
| Total               |       | $                                          | 47,268     |   | $ | 64,040 |   | $ | 46,162 |   |

 
| ** **              | ** ** | **As of December 31,** | ** ** |
|-------------------------|------------|---------------------------------------|------------|
| ** **              | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Long-lived assets, net: |       |                                  |       |   |   |
| United States           |       | $                                     | 469        |   | $ | 3,599 |   |
| International           |       | 70                                    |       | 218 |   |
| Total                   |       | $                                     | 539        |   | $ | 3,817 |   |

 

F-24

----

 

The Company’s revenues generally are concentrated among customers inthe healthcare industry and consist of healthcare organizations, governmentfacilities and dealers. The Company establishes an allowance for uncollectibleaccounts based upon factors surrounding the credit risk of specific customers,historical trends and other information. Accounts receivable are generallyunsecured.

 

During 2005, 2004 and 2003, the following customers represented greaterthan 10% of the Company’s revenues:

 
| ** **                                                                       | ** ** | **Year Ended  December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| Ethicon-Endo Surgery, Inc (a division of  Johnson & Johnson, Inc.) |       | 8.1                                    | %          | 10.1 | % | 10.9 | % |
| Mexican Social Security Institute                                                |       | —                                 |       | 13.1 |   | 1.2 |   |
| Eastman Kodak Company                                                            |       | 12.4                                   |       | 9.8 |   | — |   |

 

As of December 31, 2005 and 2004, the following customers representedgreater than 10% of the Company’s accounts receivable, net of allowance fordoubtful accounts:

 
| ** **                                                                       | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Ethicon-Endo Surgery, Inc (a division of  Johnson & Johnson, Inc.) |       | 8.2                                   | %          | 29.4 | % |
| Eastman Kodak Company                                                            |       | 14.0                                  |       | 7.3 |   |

 

The following are sales by product line:

 
| ** **                 | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------|------------|--------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Product Revenue:           |       |                                       |       |   |   |   |   |
| Digital Mammography        |       | $                                          | 7,090      |   | $ | 19,326 |   | $ | 10,772 |   |
| Stereotactic Breast Biopsy |       | 16,056                                     |       | 18,857 |   | 16,099 |   |
| RE&S Products          |       | 9,108                                      |       | 10,462 |   | 5,943 |   |
| Service Revenue            |       | 15,014                                     |       | 15,395 |   | 13,348 |   |
| Total                      |       | $                                          | 47,268     |   | $ | 64,040 |   | $ | 46,162 |   |

 

**(12) COMMITMENTS AND CONTINGENCIES**

 

**Litigation**

 

On December 20, 2005, University Health Network (“UHN”) and Mount SinaiHospital (“Mount Sinai”) filed a Statement of Claim in Ontario Canada againstFischer and Horizon Medical Services Ltd. (“Horizon”) and asserted claimsseeking to recover damages relating to their purchase of two SenoScan unitsfrom Fischer. In summary, UHN and Mount Sinai allege, among other things, thatthe SenoScan units, which were manufactured by Fischer and sold by Horizon, anentity authorized to sell these types of machines in Canada, were defective anddid not conform to certain agreed specifications. The suit seeks Canadian $1million in damages, plus interest, attorneys’ fees and expenses. Fischer hasdenied the allegations advanced by UHN and Mount Sinai and asserted breach ofcontract counterclaims against UHN and Mount Sinai for failing to payapproximately Canadian $450,000 in connection with the sale of the two SenoScanunits. Also, Horizon has denied the core allegations advanced by UHN and MountSinai.

 

F-25

----

 

Horizon also asserted breach of contract counterclaims against UHN andMount Sinai for failing to pay amounts due relating to the sale of the twoSenoScan units and asserted cross-claims for repayment of attorney fees againstFischer for indemnification based on, among other things, its contention thatHorizon acted as Fischer’s agent in the underlying transaction and Fischer mustindemnify its agent under applicable law. The Company believes the suit andcounterclaim are without merit and intend to vigorously defend the case, aswell as assert counterclaims against Horizon for nonpayment.

 

On December 21, 2005, Fischer filed a complaint and jury demand againstCedara Software Corporation (“Cedara”) seeking damages arising from Cedara’sbreach of a contract to sell software applications products. Cedara answeredthe complaint on January 30, 2006 and filed a counterclaim for unpaid invoicesand other relief. The Company does not expect any liability in addition to theamount recognized as of December 31, 2005 for the counterclaim and willvigorously defend the counterclaim while pursuing its case. At this time,management cannot determine the possible outcome of the lawsuit.

 

The Company is also a defendant in variouslawsuits brought by vendors, suppliers and others incident to the operation ofits business. The Company does not believe that any one of these pending legalproceedings would have a material adverse effect on the consolidated financialposition or results of operations of the Company. However, in the aggregate thepotential liability and management distraction resulting from managing numerouslawsuits simultaneously could have a material adverse effect on the financialcondition and cash flow of the Company if the outcomes are collectivelyunfavorable.

 

**Federal Trade Commission**

 

Fischer received in October 2005 a requestfrom the Federal Trade Commission (“FTC”) asking that Fischer voluntarilyproduce certain information and material to the FTC in connection with theAsset Sale. On January 31, 2006, Fischer received additional information requestsfrom the FTC in the form of a Subpoena Duces Tecum and Civil InvestigativeDemand as part of this ongoing investigation. The FTC’s requests, which do notallege any wrongdoing, are part of a nonpublic investigation to determinewhether the Asset Sale may be anticompetitive and a violation of Sections 7 or7A of the Clayton Act or Section 5 of the Federal Trade Commission Act. Fischeris in the process of responding to the FTC requests and cannot predict theoutcome of the investigation or its effect, if any, on Fischer’s business.

 

**Regulatory Actions**

 

The Company is subject to periodic inspections by the Food and DrugAdministration (“FDA” or the “agency”). The primary purpose of theseinspections is to verify the compliance of a company’s quality system with therequirements of FDA’s Good Manufacturing Practices, also known as the QualitySystem Regulation, and other FDA regulations governing medical devices. Duringthese inspections, the agency evaluates a company’s state of compliance withvarious FDA regulations and the adequacy of the company’s actions to correctobservations from earlier inspections and Warning Letter(s). In early 2005, theFDA conducted an inspection of the Company’s Quality System with the aboveobjectives. On May 13, 2005 the FDA completed the inspection and presented aForm 483 formally describing observations with respect to the Company’scompliance with various FDA requirements. This inspection did not resolve theissues described in the Warning Letter issued to the Company in December 2002by the FDA, which, as a result, remains in effect. The Company retained theservices of a consultant and responded to the Form 483 findings. The responsedescribed a corrective action plan to address each of the

 

F-26

----

 

observations included on the Form 483. To date, there has been nowritten response from the FDA regarding the adequacy of the Company’scorrective action plan. However, the Company has attended two meetings with theFDA regarding the status of the corrective actions during which the Company’scorrective action plan and actions taken have been discussed. The Company hascompleted the corrective action plan defined in the response to theobservations and is now operating according to the changes put into effect.

 

Communication will continue with the FDA regarding the Company’songoing progress in ensuring the effectiveness of the corrective actions thathave been taken. The Company’s goal is to address the FDA’s inspectionalobservations without the agency pursuing additional regulatory or enforcementaction. There can be no assurance, however, that the Company’s efforts will besuccessful and that the FDA will not pursue such actions which could include,but not be limited to, the issuance of another Warning Letter; a court-orderedinjunction; product seizures; recall of products; and criminal and/or civilproceedings. If an injunction is issued, it may preclude the Company fromshipping products or replacement parts until corrective action is taken andverified by the FDA.

 

The FDA has indicated that the 5.2.X versions of the software currentlyrunning on Fischer’s SenoScan systems should be recalled for a known archivingissue. Fischer has recently developed and is in the process of releasing to thegeneral market, a version 5.2.2 software release to correct the known archivingissue as well as increase functions for servicing the SenoScan unit. Fischersubmitted recall plan to the FDA and intends to complete the software upgradesby June 30, 2006 in the U.S. and Europe. Management estimate that the costsrelated to this will be minimal but costs could become more significant thanFischer anticipates.

 

**Philips**

 

Fischer received notification on September 2,2005 by Philips that it had ceased sales activities for the present time withrespect to the SenoScan product and that it intended to terminate the PhilipsAgreement, should the Asset Sale Agreement be approved by the Company’s stockholdersand consummated. Fischer met with Philips in November 2005 to communicate thatFischer had retained the right to perform its obligations under the PhilipsAgreement but that, absent additional funding from Philips, it did not have thefinancial ability to perform the Philips Agreement. Philips subsequentlyoffered to settle the matter without litigation. However, in view of thefinancial settlement proposed by Philips, Fischer declined Philips’ offer ofsettlement and referred Philips to the dispute resolution provisions of thePhilips Agreement. Fischer is unable to predict whether Philips may file a suitor the amount, if any, that may be demanded by Philips, or the expense relatedto defending any claim. Fischer has recognized a liability for a customerdeposit made by Philips in advance of shipping the SenoScan product in theamount of $0.3 million. Any payments made by Fischer to or in connection with aclaim by Philips may materially reduce amounts, if any, that may be availablefor satisfaction of creditor claims and distribution to Fischer’s stockholders.

 

F-27

----

 

**Operating Leases**

 

The Company leases a building and equipmentunder various operating lease agreements that provide for the following minimumfuture lease payments (in thousands) for the years ending December 31:

 
| 2006  |   | $  | 412    |   |
|-------|--------|----|--------|--------|
| 2007  |   | 32 |   |
| 2008  |   | 14 |   |
| 2009  |   | 2  |   |
| 2010  |   | 1  |   |
| Total |   | $  | 461    |   |

 

Of the abovetotal lease commitments, $332,000 relates to the JN properties building lease(see Note 10—Related Party Transactions). Total rent expense was approximately$1,214,000, $1,210,000 and $936,000 in 2005, 2004 and 2003, respectively. Thetotal rent expense includes rent expense for JN properties of $796,000 for eachof 2005, 2004 and 2003.

 

**(13) PATENT LITIGATION SETTLEMENT**

 

Duringthe second quarter of 2002, the Company settled a patent infringement lawsuit for $32.3 million, theCompany recognized $25.0 million as income in 2002 and $7.2 million of thesettlement was scheduled to be received in equal annual installments of $0.9million over the remaining eight-year life of the associated patents. TheCompany recognized an other income itemin the amount of $0.9 million during both the second quarter of 2003 and 2004.On June 2, 2004 the Companyamended the settlement agreement, received a one-time accelerated paymenttotaling $4.3 million in lieu of the six remaining $0.9 million payments thatwere due annually through 2010 and recognized the one-time payment as an otherincome item.

 

**(14) SUBSEQUENT EVENTS**

** **

Kodak Agreements

 

As discussed in Note 1, on January 23, 2006,Fischer entered into the Kodak Agreements. The Kodak Agreements will allowKodak to act as an authorized service provider and provide service and supportto the world-wide, excluding Mexico, installed base of Fischer’s mammographyproducts, specifically the Service business. Fischer expects that the KodakAgreements will reduce Fischer’s obligations and costs with respect to theService business. The Service Agreements continue for a term of five yearsunless terminated earlier in accordance with the Service Agreement. Fischer,relative to the Service business and with Hologic’s consent, granted Kodak anon-exclusive limited license to perform these service related activities inthe Kodak License Agreement, which continues for a term of five years.

 

Under the terms of the Services Agreement,Fischer has agreed to provide to Kodak certain licenses, deliverables, trainingand assistance to enable Kodak to service the installed SenoScan and MammoTestequipment under new service agreements that Kodak intends to offer to currentowners of SenoScan and MammoTest systems. The Services Agreement includes thefollowing major provisions:

 

•      Fischerwill provide Kodak with its SenoScan and MammoTest customer list and makeappropriate introductions of Kodak as an authorized service provider.

 

F-28

----

 

Kodak will contact customers to offercustomers the ability to enter into new service contracts directly with Kodakand terminate their service agreements with Fischer with no penalty.

•      Fischerwill provide training classes to Kodak. In addition, Fischer will reimburseKodak $75,000 for out-of-pocket expenses related to training payable uponsigning the Services Agreement.

•      Fischerwill provide three SenoScan and three MammoTest units free of charge fortraining purposes.

•      Fischerhas agreed during the first 90 days of the Services Agreement to provide laboron a sub-contract basis to Kodak to enable the Service business to betransitioned to Kodak. Fischer will be paid $250 per hour with a minimumcommitment of certain hours. Hours over the minimum commitments will bereimbursed at $150 per hour.

•      Fischerwill provide service parts free of charge for all service performed throughMarch 31, 2006 as of which all remaining spare parts inventory will betransferred to Kodak as an incentive to enter into the arrangement. Kodakagrees to purchase certain critical parts in an amount up to $750,000 out ofthe remaining spare parts inventory. A portion of the cash received will beused to arrange for customers in the United States with warranty periodsremaining as of March 31, 2006 to receive a Kodak service agreement for theremaining warranty period and a portion of the cash received will be used toreimburse customers with pre-paid long-term service contracts.

•      Fischerwill reimburse Kodak for $60,000 of out-of-pocket expenses in order toimplement the Services Agreement payable upon signing the Services Agreement;

 

As a result of signing these Agreements,management determined that the value of its spare parts inventory for theMammoTest and SenoScan products had a value of $750,000 as of December 31, 2005and recorded a provision for excess and obsolete inventories of approximately$2.0 million. This amount is reported as services cost of sales in theconsolidated statements of operations for the year ended December 31, 2005.

 

EES Last Time Purchase Order

 

On March 9, 2006, Fischer entered into theEES Amendment to amend the Distributor Agreement.  The Distributor Agreement had provided forFischer to provide MammoTest tables to EES through October 11, 2006. In lightof the potential penalties in the Distributor Agreement, Fischer’s excessmanufacturing inventory on hand, and the pending May 31, 2006 termination of thelease on its manufacturing facility, Fischer desired to manufacture and sell afixed number of MammoTest tables to EES and to end production by May 31, 2006. Underthe EES Amendment, which is effective as of March 1, 2006, EES has agreed toplace a binding order with Fischer for 20 Tables. Fischer has agreed to deliverthe Tables no later than May 31, 2006 at a price of $107,000 per Table, subjectto adjustment for failure to supply all 20 Tables as discussed below. EES isrequired to pay for the first five Tables upon delivery of the 20th Table. EESis required to pay for each subsequent Table delivered upon receipt of theinvoice.

 

The price of each Table includes applicationstraining available through December 31, 2006 and twelve months of warranty support(labor and parts) commencing on the earlier to occur of the date applicationtraining is completed for such Table or December 31, 2006.

 

F-29

----

 

If Fischer fails to supply all 20 Tables, thetotal price for the delivered Tables will be determined using the followingequation:

 

Total price = ($142,000 x total number ofTables delivered) - $700,000.

 

If, using the above equation, the total priceis less than zero (i.e., Fischer delivers 4 or fewer Tables), Fischer will payEES the balance within 45 days of Fisher’s notification to EES of a failure tosupply. If the total price is greater than zero, Fisher will invoice EES forthe adjusted total price upon delivery of the last Table. If EES has paidFischer for any Tables, Fischer shall deduct the amount paid by EES from theamount otherwise due to Fischer.

 

The EES Amendment and the DistributorAgreement will terminate upon Fischer’s delivery of all the Tables orsettlement as described above except that the obligations to provide warrantysupport and application training survive the termination.

 

Kodak Last Time Purchase Order

 

Fischer currently supplies its VersaRad-Dproduct to Kodak under an OEM Agreement. The OEM Agreement initially expired onJanuary 12, 2006 and automatically renewed for an additional one-year term. InFebruary 2006, management received a purchase order from Kodak for a last timepurchase of VersaRad units at an average sales price of $118,000 with terms ofpayment of 2% discount if paid within 10 days of the invoice, or 30 days frominvoice date. Management has committed to deliver 30 units against thispurchase order.

 

Auction Process to Sell RE&S Business

 

On March 15, 2006, Fischer announced tocertain potential bidders and to the public that it is starting an auctionprocess to sell its RE&S business. The RE&S business includes threeproduct lines: the VersaRad Line, EPX/SPX Line and Bloom Line.

 

In general, the assets to be sold are all ofFischer’s right, title and interest in and to the VersaRad Line, the EPX/SPXLine and the Bloom Line including related equipment, inventory, generalintangibles and intellectual property necessary to design, manufacture, market,sell, distribute, support and repair the Product Lines. The assets and anyliabilities which may be assumed at the option of the bidder for each ProductLine (e.g., service contracts and warranty repair obligations) will be morefully described in and subject to the form asset purchase agreement that willbe delivered to potential bidders.

 

Bidders have been asked to submit bids forthe entire RE&S business, individual Product Lines or components thereof. Bidderswere provided an overview of the bidding and auction procedures for the assetsto be sold. Bids are required to be submitted by May 10, 2006 and an auction isexpected to be held on May 15, 2006. As soon as possible after the end of theauction, Fischer intends to finalize and enter into one or more definitiveagreements with the party or parties who submit the offer(s), which inFischer’s sole judgment, are the most attractive bid(s) for the RE&Sbusiness and Product Lines.

 

F-30

----

 

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

 

(in thousands, except per share data):

 
| ** **                                          | ** ** | **First  Quarter  2005** | ** ** | **Second  Quarter  2005** | ** ** | **Third  Quarter  2005** | ** ** | **Fourth  Quarter  2005** | ** ** | **Year  Ended  2005** | ** ** |
|-----------------------------------------------------|------------|--------------------------|------------|---------------------------|------------|--------------------------|------------|---------------------------|------------|-----------------------|------------|
| Revenues                                            |       | $                        | 14,454     |                      | $          | 11,189                   |       | $                         | 13,439     |                  | $          | 8,186 |   | $ | 47,268 |   |
| Gross profit                                        |       | 1,942                    |       | (3,500                    | )          | 282                      |       | (1,104                    | )          | (2,380                | )          |
| Net (loss) income                                   |       | (6,577                   | )          | (9,107                    | )          | 19,948                   |       | (5,871                    | )          | (1,607                | )          |
| Basic (loss) income per share                       |       | $                        | (0.70      | )                         | $          | (0.97                    | )          | $                         | 2.12       |                  | $          | (0.62 | ) | $ | (0.17 | ) |
| Diluted (loss) income per share |       | $                        | (0.70      | )                         | $          | (0.97                    | )          | $                         | 2.12       |                  | $          | (0.62 | ) | $ | (0.17 | ) |

 
| ** **                      | ** ** | **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 | ) |

 

In each of the following quarters, theCompany recorded items that were material in relation to the results of thequarter:

 

During the fourth quarter of 2005, managementrecorded $1.6 million of impairment of long-lived assets as more fullydiscussed in Note 4 and an increase of $2.7 million for excess and obsoleteinventories as a result of the Kodak Agreements and change in estimates relatedto the Philips Contract. In addition, $0.7 million of restructuring expense forretention and severance payments was recorded in the fourth quarter of 2005.

 

During the third quarter of 2005, as a result of the Asset Sale andLease Amendment, the following adjustments were recorded:

 

•      $0.8 million ofimpairment of long-lived assets as more fully discussed in Note 4,

•      $4.0 million ofexpense related to the Lease Amendment as more fully discussed in Note 5,

•      an increase of$0.7 million for excess and obsolete inventories as a result of a reduction inforecasted sales resulting from the Asset Sale and changes in marketconditions,

•      restructuringexpenses for retention and severance payments of $0.9 million,

•      expenses forlegal and financial advisory fees related to the Asset Sale in the amount of$0.6 million, and

•      a gain on saleof Mammography Assets of $32.0 million.

 

During the second quarter of 2005, theCompany recorded the following adjustments:

 

•      anincrease of $4.2 million to the reserve for excess and obsolete inventories asmore fully discussed in Note 2,

•      anincrease to cost of sales of $0.6 million for purchase commitments thatmanagement estimates it is contractually liable to pay related to excessinventories, and

•      expensesfor legal and financial advisory fees related to the Asset Sale in the amountof $0.4 million.

 

F-31

----

 

During the first quarter of 2005, the Companyrecorded $2.5 million of other financing expense related to the fair value ofthe warrants. As discussed in Note 6 of the consolidated financial statements,Fischer is required to recognize the fair value of the warrants as a stockwarrant obligation.

 

During the fourth quarter of 2004, theCompany recorded a $0.4 million reduction in the warranty provision to adjustthe related obligation to reflect historical warranty experience. The Companyalso recorded a $0.3 million reduction in services cost of sales to moreaccurately reflect the timing of the four-year warranty obligation associatedwith the December 2003 non-domestic shipment to the government of Mexicowhich was recognized as revenue prior to year end 2004. The Company recorded a$0.3 million charge in the fourth quarter of 2004 to properly record accumulateddepreciation related to the amortization of leasehold improvements over theshorter of the useful life of the asset or the term of the related leasedproperty. In addition, the Company recorded $0.6 million higher marketingexpenses in the fourth quarter of 2004 related to a national trade show.

 

In the second quarter of 2004, the Companyreached an agreement with Thermo Electron Corporation that accelerated theremaining $5.4 million owed the Company from a 2002 patent settlement intoa single payment of $4.3 million. As a result, the Company recorded $4.3of other income in the quarter ending June 30, 2004. The $5.4 millionwas scheduled to be received in equal annual installments of $900,000 over theremaining six-year life of the patents for continued sales of the breast-biopsyimaging system now being sold by Hologic, Inc. The $5.4 million settlementowed to the Company is now paid in full.

 

F-32

----