**FORM 10-Q**

 

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

| **(Mark One)** |
|----------------|
| ý         | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE** |
|           |   | **SECURITIES EXCHANGE ACT OF 1934** |
|           |   |   |
|           |   | **For the Quarter Ended March 31,  2006** |
|           |   |   |
|           |   | **or** |
|           |   | ** ** |
| o              |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE** |
|           |   | **SECURITIES EXCHANGE ACT OF 1934** |
|           |   | ** ** |
|           |   | **For the transition period  from                  to                  ** |

 

 

**Commission file number 0-19386**

 

**FISCHER IMAGING CORPORATION**

(Exact name of Registrantas specified in its charter)

 

| **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 area code: |
| **(303) 452-6800**                                   |

 

Indicate by check markwhether the Registrant (i) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports) and (ii) has been subject to such filingrequirements for the past 90 days.

 

Yes ý  No o

 

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

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

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o  No ý

 

The number of shares of Registrant’s Common Stockoutstanding as of May 5, 2006 was 9,398,817.

 

 

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**FISCHER IMAGING CORPORATION**

 

**FORM 10-Q**

 

**INDEX**

 
| **PART I.**   | **FINANCIAL  INFORMATION**                                                                           |       |
|---------------|------------------------------------------------------------------------------------------------------|------------|
|          |                                                                                                 |       |
| Item 1.       | Consolidated  Financial Statements                                                                   |       |
|          | Consolidated  Balance Sheets—March 31, 2006 (unaudited) and December 31, 2005                   |       |
|          | Consolidated  Statements of Operations (unaudited)—Three months ended March 31, 2006 and  2005  |       |
|          | Consolidated  Statements of Cash Flows (unaudited)— Three months ended March 31, 2006 and  2005 |       |
|          | Notes  to Consolidated Financial Statements (unaudited)                                              |       |
|          |                                                                                                 |       |
| Item  2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations          |       |
|          |                                                                                                 |       |
| Item  3.      | Quantitative  and Qualitative Disclosures About Market Risk                                          |       |
|          |                                                                                                 |       |
| Item  4.      | Controls  and Procedures                                                                             |       |
|          |                                                                                                 |       |
| **PART  II.** | **OTHER  INFORMATION**                                                                               | ** ** |
|          |                                                                                                 |       |
| Item 1.       | Legal Proceedings                                                                                    |       |
|          |                                                                                                 |       |
| Item 1A.      | Risk Factors                                                                                         |       |
| Item 2.       | Unregistered Sales of Equity  Securities and Use of Proceeds                                         |       |
| Item 3.       | Defaults Upon Senior  Securities                                                                     |       |
| Item 4.       | Submission of Matters to a Vote  of Security Holders                                                 |       |
| Item 5.       | Other Information                                                                                    |       |
| Item 6.       | Exhibits                                                                                             |       |
|          |                                                                                                 |       |
| SIGNATURES    |                                                                                                 |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**FISCHER IMAGING CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(amounts in thousands exceptshare data)**

 
| ** **                                                                                                                                    | ** ** | **March 31,  2006** | ** ** | **December 31,****2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|--------------------------|------------|
| ** **                                                                                                                                    | ** ** | **(Unaudited)**     | ** ** | ** **               | ** ** |
| **ASSETS**                                                                                                                                    |       |                |       |                     |       |
| Current Assets:                                                                                                                               |       |                |       |                     |       |
| Cash and cash  equivalents                                                                                                                    |       | $                   | 1,785      |                     | $          | 4,499 |   |
| Restricted cash                                                                                                                               |       | 603                 |       | —                   |       |
| Accounts  receivable, net of allowance for doubtful accounts of $385 and $383 at March  31, 2006 and December 31, 2005, respectively          |       | 3,175               |       | 4,026                    |       |
| Inventories, net                                                                                                                              |       | 3,784               |       | 4,329                    |       |
| Prepaid expenses  and other current assets                                                                                                    |       | 1,691               |       | 1,305                    |       |
| Total current assets                                                                                                                          |       | 11,038              |       | 14,159                   |       |
| Property and equipment:                                                                                                                       |       |                |       |                     |       |
| Manufacturing  equipment                                                                                                                      |       | 161                 |       | 331                      |       |
| Office equipment  and leasehold improvements                                                                                                  |       | 90                  |       | 208                      |       |
| Total property  and equipment                                                                                                                 |       | 251                 |       | 539                      |       |
| Less:  accumulated depreciation                                                                                                               |       | —              |       | —                   |       |
| Property and equipment, net                                                                                                                   |       | 251                 |       | 539                      |       |
| Total assets                                                                                                                                  |       | $                   | 11,289     |                     | $          | 14,698 |   |
|                                                                                                                                          |       |                |       |                     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                 |       |                |       |                     |       |
| Current  Liabilities:                                                                                                                         |       |                |       |                     |       |
| Accounts payable                                                                                                                              |       | $                   | 2,696      |                     | $          | 2,722 |   |
| Accrued salaries  and wages                                                                                                                   |       | 578                 |       | 665                      |       |
| Customer  deposits                                                                                                                            |       | 789                 |       | 1,009                    |       |
| Accrued  warranties                                                                                                                           |       | 1,000               |       | 1,040                    |       |
| Deferred service  revenue                                                                                                                     |       | 808                 |       | 1,667                    |       |
| Other current  liabilities                                                                                                                    |       | 3,130               |       | 2,583                    |       |
| Total current  liabilities                                                                                                                    |       | 9,001               |       | 9,686                    |       |
| Commitments 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 shares issued and  outstanding at March 31, 2006 and December 31, 2005 |       | 94                  |       | 94                       |       |
| Paid-in capital                                                                                                                               |       | 49,455              |       | 49,455                   |       |
| Accumulated  deficit                                                                                                                          |       | (46,958             | )          | (44,240                  | )          |
| Accumulated  other comprehensive loss                                                                                                         |       | (303                | )          | (297                     | )          |
| Total  stockholders’ equity                                                                                                              |       | 2,288               |       | 5,012                    |       |
| Total  liabilities and stockholders’ equity                                                                                              |       | $                   | 11,289     |                     | $          | 14,698 |   |

 

The accompanying notesare an integral part of these consolidated financial statements

 

3

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**FISCHER IMAGING CORPORATION**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

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

**(Unaudited)**

 
| ** **                                                       | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                       | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Revenues:                                                        |       |                   |       |   |   |
| Products                                                         |       | $                      | 3,937      |   | $ | 10,744 |   |
| Services                                                         |       | 3,049                  |       | 3,710 |   |
| Total revenues                                                   |       | 6,986                  |       | 14,454 |   |
| Cost of sales:                                                   |       |                   |       |   |   |
| Products                                                         |       | 3,842                  |       | 8,106 |   |
| Services                                                         |       | 3,470                  |       | 4,406 |   |
| Total cost of  sales                                             |       | 7,312                  |       | 12,512 |   |
| Gross margin                                                     |       | (326                   | )          | 1,942 |   |
| Operating  expenses:                                             |       |                   |       |   |   |
| Research and  development                                        |       | —                 |       | 1,940 |   |
| Selling and  marketing                                           |       | —                 |       | 1,977 |   |
| General and  administrative                                      |       | 1,981                  |       | 1,831 |   |
| Impairment of  long-lived assets                                 |       | 230                    |       | — |   |
| Total operating  expenses                                        |       | 2,211                  |       | 5,748 |   |
| Loss from  operations                                            |       | (2,537                 | )          | (3,806 | ) |
| Other (expense)  income:                                         |       |                   |       |   |   |
| Other financing  (expense)                                       |       | —                 |       | (2,532 | ) |
| Interest expense                                                 |       | (66                    | )          | (318 | ) |
| Interest income                                                  |       | 22                     |       | 1 |   |
| Other (expense)  income                                          |       | (137                   | )          | 78 |   |
| Net loss                                                         |       | $                      | (2,718     | ) | $ | (6,577 | ) |
| Net loss per  share:                                             |       |                   |       |   |   |
| Basic and  diluted                                               |       | $                      | (0.29      | ) | $ | (0.70 | ) |
| Weighted average  shares used to calculate net (loss) per share: |       |                   |       |   |   |
| Basic and  diluted                                               |       | 9,399                  |       | 9,383 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

4

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**FISCHER IMAGING CORPORATION**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(amounts in thousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                   | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Cash flows from  operating activities:                                       |       |                   |       |   |   |
| Net (loss)                                                                   |       | $                      | (2,718     | ) | $ | (6,577 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                   |       |   |   |
| Depreciation and  amortization                                               |       | —                 |       | 320 |   |
| Amortization of  debt issue costs                                            |       | —                 |       | 200 |   |
| Other financing  (expense)                                                   |       | —                 |       | 2,532 |   |
| Other                                                                        |       | 21                     |       | — |   |
| Impairment of  long-lived assets                                             |       | 230                    |       | — |   |
| Change in  current assets and liabilities                                    |       |                   |       |   |   |
| Accounts  receivable, net                                                    |       | 851                    |       | (2,136 | ) |
| Inventories, net                                                             |       | 545                    |       | 1,778 |   |
| Prepaid expenses  and other current assets                                   |       | (386                   | )          | 104 |   |
| Accounts payable                                                             |       | (26                    | )          | (1,631 | ) |
| Accrued  warranties                                                          |       | (40                    | )          | (185 | ) |
| Customer  deposits                                                           |       | 110                    |       | 205 |   |
| Deferred service  revenue                                                    |       | (859                   | )          | 300 |   |
| Other                                                                        |       | 126                    |       | (122 | ) |
| Net cash used in  operating activities                                       |       | (2,146                 | )          | (5,212 | ) |
|                                                                         |       |                   |       |   |   |
| Cash flows used  in investing activities:                                    |       |                   |       |   |   |
| Funding of  Fischer Imaging Employee Trust                                   |       | (600                   | )          | — |   |
| Proceeds from  sale of property and equipment                                |       | 37                     |       | — |   |
| Purchases of  property and equipment                                         |       | —                 |       | (441 | ) |
| Net cash used in  investing activities                                       |       | (563                   | )          | (441 | ) |
|                                                                         |       |                   |       |   |   |
| Cash flows  provided by financing activities:                                |       |                   |       |   |   |
| Proceeds from  sale of common stock                                          |       | —                 |       | 16 |   |
| Proceeds from  senior secured promissory notes                               |       | —                 |       | 7,000 |   |
| Payment of debt  issue costs                                                 |       | —                 |       | (388 | ) |
| Proceeds from  line of credit                                                |       | —                 |       | 3,311 |   |
| Repayments on  line of credit                                                |       | —                 |       | (4,765 | ) |
| Payment on  leases                                                           |       | —                 |       | (13 | ) |
| Net cash  provided by financing activities                                   |       | —                 |       | 5,161 |   |
|                                                                         |       |                   |       |   |   |
| Effect of  exchange rate changes on cash                                     |       | (5                     | )          | 17 |   |
| Net decrease in  cash and cash equivalents                                   |       | (2,714                 | )          | (475 | ) |
| Cash and cash  equivalents, beginning of period                              |       | 4,499                  |       | 1,939 |   |
| Cash and cash  equivalents, end of period                                    |       | $                      | 1,785      |   | $ | 1,464 |   |
|                                                                         |       |                   |       |   |   |
| Supplemental  Cash Flow Information:                                         |       |                   |       |   |   |
| Non-cash change  in stock warrant obligation                                 |       | —                 |       | (4,320 | ) |
| Non-cash  increase in debt issue costs                                       |       | —                 |       | 1,788 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

5

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**FISCHER IMAGING CORPORATION**

**NOTES TO THE CONSOLIDATEDFINANCIAL STATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH31, 2006**

**(UNAUDITED)**

 

**(1)   GENERAL**

 

**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 manufactures and sells the MammoTest stereotactic breast biopsysystem to a single distributor in Europe. The Company’s primary focus prior tothe consummation of the Hologic transaction on September 29, 2005 (as discussedbelow) was designing, manufacturing and selling mammography and digital imagingproducts and using its digital imaging technology in screening and diagnosticmammograms and minimally invasive breast biopsy to aid in the earlyidentification of breast cancer. The Company also continues to sell productsthat meet selected needs of the broader radiology and electrophysiologymarkets.

 

The consolidated financial statements include theaccounts of Fischer Imaging Corporation and all subsidiaries. All significantinter-company accounts and transactions have been eliminated in consolidation.

 

**Hologic Transaction and Management Plans**

 

In September 2005, Fischerconsummated the sale (the “Asset Sale”) of all of its intellectual propertyrights related to its mammography business and products, including its SenoScandigital mammography and MammoTest stereotactic breast biopsy systems (the “MammographyAssets”) to Hologic, Inc. (“Hologic”). Hologic granted Fischer a non-exclusivelimited license to use certain Mammography Assets necessary for Fischer tocontinue to service and support, and satisfy warranty obligations on theinstalled base of SenoScan and MammoTest systems (the “Service” business); tofulfill 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 to carryout certain activities with respect to Fischer’s radiology, electrophysiologyand surgical (“RE&S”) business.

 

The following are developments and management’splans with respect to each of the retained assets/businesses:

 

*Service business.*On January 23, 2006, Fischer entered into anIntellectual Property License Agreement and Services Agreement (together, the “KodakAgreements”) with Eastman Kodak Company (“Kodak”). The Kodak Agreements allowKodak to act as an authorized service provider and provide service and supportto the world-wide, excluding Mexico, installed base of Fischer’s mammographyproducts. Fischer expects that the Kodak Agreements will reduce Fischer’sobligations and costs with respect to the Service business. All mammographyservice contracts have been cancelled as of April 21, 2006 in the U.S. and asof May 8, 2006 in Europe. All disposables and time and material revenue fromthe Service business was terminated as of January 23, 2006 in the U.S. Fischerincurred $135,000 of expense related to payments made to Kodak during the threemonths ended March 31, 2006. Services cost of sales has been reduced due toreimbursement from Kodak of approximately $350,000 during the three monthsended March 31, 2006.

 

*Contractual obligation to EES.*On March 9, 2006, Fischer entered into anamendment (the “EES Amendment”) to the Distributor Agreement, dated December 9,1998, as amended (the “Distributor Agreement”) between EES and Fischer. EESplaced a binding order with Fischer for 20 MammoTest tables (collectively, the “Tables”and each a “Table”) to be shipped to various locations in Europe. Aftercompletion of the Tables, the Distributor Agreement and EES Amendment willterminate and no further MammoTest tables will be sold. Applications trainingand warranty support due under the EES Amendment and Distributor Agreement willbe provided by Kodak in Europe. Fischer has delivered all the Tables.

 

*Contractual obligation to Philips.*The status of theMaster Purchasing Agreement (“Philips Agreement”) between Fischer and Philipsis still unresolved as discussed further in Note 10. As a result, managementbelieves no revenues will be generated from this contract.

 

*RE&S business.*The RE&S business includes three productlines (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. Managementreceived a significant last time purchase order from Kodak in February 2006 and78% of this order has been shipped as of May 5, 2006. Therefore,

 

6

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management expects that no further VersaRadunits will be sold to Kodak after fulfillment of the last time purchase orderin May 2006.

 

(2)  The EPX-60 Single Plane EP ImagingSystem and the SPX Surgical Imaging System (“EPX/SPX Line”). Management expectsthat no further EPX/SPX units will be sold due to the departure of salespersonnel.

 

(3)  The Bloom ElectrophysiologyStimulator (“Bloom Line”). Sales of this product have been declining andbacklog is currently minimal.

 

OnMarch 15, 2006, Fischer announced to certain potential bidders and to thepublic that it was starting an auction process to sell its RE&S business. Ingeneral, the assets to be sold are all of Fischer’s right, title and interestin and to the VersaRad Line, the EPX/SPX Line and the Bloom Line includingrelated equipment, inventory, general intangibles and intellectual propertynecessary to design, manufacture, market, sell, distribute, support and repairthe Product Lines. The assets and any liabilities which may be assumed at theoption of the bidder for each Product Line (e.g., service contracts andwarranty repair obligations) will be more fully described in and subject to theform asset purchase agreement that has been delivered to potential bidders.

 

Bidders were asked to submit bids for the entireRE&S business, individual Product Lines or components thereof. Bids wererequired to be submitted by May 10, 2006. Several bids for the Bloom Line andone bid for the RE&S business were received in accordance with the originaltimeline. Management is completing the analysis of the bids 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 definitive agreements withthe party or parties whose offer(s) are deemed in Fischer’s sole judgment themost attractive bid(s) for the RE&S business and Product Lines orcomponents thereof. Fischer shall have the right to reject any bid if Fischerdetermines, in the reasonable exercise of its fiduciary duties, that the bidsreceived are inadequate or insufficient; or contrary to the best interests ofFischer.

 

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 orsubstantially all of Fischer’s assets, Fischer 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 the BankruptcyCode or seek the necessary stockholder approval.

 

If the RE&S business is not sold in itsentirety, the Company will be left with continuing obligations in connectionwith RE&S related service and warranty obligations. The Company will seekalternative service providers to provide continuation of service for warrantyand service contract obligations. If a potential strategic transaction withrespect to the RE&S service and warranty obligations could not be completedin a reasonable period of time, the Company may not have sufficient funds tocontinue to meet these obligations.

 

*Europe.*  After the Asset Sale, the only expectedremaining recurring revenue in Europe was related to service contracts. InDecember 2005, the Board of Directors approved the liquidation and wind-up ofFischer’s European subsidiaries. Europe started the liquidation process on May4, 2006 and a liquidator has been designated. As a result, Fischer no longerhas control of its European subsidiaries. Management estimates that when thesubsidiaries are deconsolidated in May 2006 the impact on the consolidatedstatement of operations will be immaterial. Selected European balance sheetinformation as of March 31, 2006 are as follows (in thousands):

 
| Cash and cash  equivalents   |   | $      | 193    |   |
|------------------------------|--------|--------|--------|--------|
| Accounts  receivable, net    |   | 436    |   |
| Inventory, net               |   | 573    |   |
| Other assets                 |   | 89     |   |
| Current  liabilities         |   | (1,639 | )      |
| Net working  capital deficit |   | $      | (348   | )      |

 

The cash and cash equivalents available as of April30, 2006 is made up of $1.6 million in the United States and $0.2 million invarious countries in Europe. The remaining cash as of April 30, 2006 will beused to pay outstanding obligations, to satisfy operational responsibilities inrespect of other obligations as discussed above; and to continue operations untilthe sale of the RE&S business is complete. If the RE&S business is notsold in its entirety, the Company may be forced to file a petition underChapter 7 or Chapter 11 of the Bankruptcy Code. The Company expects thatamounts, if any, remaining after completing the last time purchase orders withKodak and EES and after making adequate reserves for contingent liabilitiessuch as outstanding litigation, would be distributed to stockholders. Managementis unable to predict whether any amounts will be available for distribution tostockholders.

 

7

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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, management assessed the recoverability ofits long-lived assets and intangibles and recognized an impairment charge of$0.2 million in the first quarter of 2006, a process which included assumptionsregarding estimated future cash flows and other factors.

 

**Basis of Presentation**

 

In management’s opinion, the accompanying unauditedconsolidated balance sheets, statements of operations and statements of cashflows contain all adjustments necessary to present fairly in all materialrespects the financial position of the Company at March 31, 2006, its resultsof operations for the three months ended March 31, 2006 and 2005 and its cashflows for the three months ended March 31, 2006 and 2005. Results of operationsand cash flows for the interim periods may not be indicative of the results ofoperations and cash flows for the full fiscal year.

 

The unaudited condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements and footnotes thereto included in the Company’s Annual Report onForm 10-K for the year ended December 31, 2005.

 

**Stock Based Compensation**

 

During the first quarter of 2006, the Company adoptedthe provisions of and began accounting for stock-based compensation inaccordance with, the Financial Accounting Standards Board’s Statement ofFinancial Accounting Standards No. 123—revised 2004 (“SFAS 123R”), “Share–BasedPayment” which replaced Statement of Financial Accounting Standards No. 123 (“SFAS123”), “Accounting for Stock–Based Compensation” and supersedes APB Opinion No.25 (“APB 25”), “Accounting for Stock Issued to Employees.”  Under the fair value recognition provisionsof this statement, stock–based compensation cost is measured at the optiongrant date based on the fair value of the award and is recognized as an expenseon a straight–line basis over the requisite service period, which is thevesting period where applicable or in the case of option grants that vestimmediately, over the appropriate period prior to the grant date. The Companyelected the modified–prospective method, under which prior periods are notrevised for comparative purposes. The valuation provisions of SFAS 123R applyto new option grants and to option grants that were outstanding as of January1, 2006 and subsequently modified. Estimated compensation cost for optiongrants that were outstanding as of the effective date and are not expected tobe forfeited will be recognized over the remaining service period using thecompensation cost estimated for the SFAS 123 pro forma disclosures.

 

The adoption of SFAS 123R had no impact on theconsolidated financial position, results of operations and cash flows. As aresult of the restructuring plan, unvested options outstanding as of December31 2005 are not expected to vest. The 2004 Equity Incentive Plan allows forautomatic annual grants upon each year of director’s service of 10,000 perdirector on January 1. The compensation expense related to this annual grant isrecognized over the prior year of service. No further grants under the Company’sstock option plans are expected due to management’s plans.

 

The following table sets forth the pro forma amountsof net income and net income per share, for the three months ended March 31,2005, that would have resulted if Fischer had accounted for the option grantsunder employee stock plans under the fair value recognition provisions of SFAS123 (in thousands, except per share amounts).

 
| ** **                                      | ** ** | **Three Months  Ended March 31,  2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------|------------|
|                                            |       |                                    |       |
| Net loss as  reported                           |       | $                                       | (6,577     | ) |
| Fair value-based  compensation cost, net of tax |       | (75                                     | )          |
| Pro forma net  loss                             |       | $                                       | (6,652     | ) |
|                                            |       |                                    |       |
| Basic and  diluted loss per share:              |       |                                    |       |
| As reported                                     |       | $                                       | (0.70      | ) |
| Pro forma                                       |       | $                                       | (0.71      | ) |

 

8

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**(2)   REVENUE RECOGNITION**

 

The Company follows the provisions of SEC StaffAccounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (“SAB104”) which provides for revenue recognition when persuasive evidence of anarrangement exists, delivery has occurred, the price is fixed and determinableand collectibility is reasonably assured. The Company’s standard businesspractice requires that sales transactions be supported by an executed salesagreement or an executed purchase order. The Company recognizes product revenuefor its medical equipment when title and risk of loss have transferred to thecustomer and the Company has no post-shipment performance obligations otherthan installation or training. Where installation and/or training services areprovided in a sales agreement and they have not been completed at the timeproduct revenue is recognized, the fair value of these services is deferred andsubsequently recognized as revenue when each of the services are performed. Incases where the sales agreement prescribes additional consequential performanceobligations or requires specific performance criteria be met for customeracceptance, the Company defers revenue recognition on the product sale untilsuch conditions are satisfied.

 

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 partsmay be returned for partial credit, and the Company records sales allowancesbased on historical experience to account for the future effect of thosereturns.

 

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.

 

**(3)   INVENTORIES**

 

The Company values inventory at the lower of cost ormarket using the first-in, first-out (FIFO) method. The Company assesses therecoverability of inventory based on obsolescence or overstocked inventoryequal to the difference between the cost of inventory and the estimated marketvalue based upon historical experience and assumptions about future demand andchanges in market conditions. These assessments require judgments andestimates, and valuation adjustments for excess and obsolete inventory may berecorded based on these periodic assessments.

 

Inventories consisted of the following components (inthousands):

 
| ** **                                   | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------|------------|---------------------|------------|------------------------|------------|
| Raw materials                                |       | $                   | 4,082      |                   | $          | 5,120 |   |
| Work in process  and finished goods          |       | 6,343               |       | 6,340                  |       |
| Reserve for  excess and obsolete inventories |       | (6,641              | )          | (7,131                 | )          |
| Inventories, net                             |       | $                   | 3,784      |                   | $          | 4,329 |   |

 

**(4)   IMPAIRMENT OF LONG-LIVEDASSETS**

 

The Company’s policy is to evaluate whether there hasbeen a permanent impairment in the value of long-lived assets, of certainidentifiable intangibles and of goodwill when certain events have taken placethat indicate that the remaining balance may not be recoverable. Fischerevaluates the carrying value of its property and equipment at the consolidatedlevel since the Company believes that is the lowest identifiable level of cashflows for these assets. As a result of further declines in the stock price anda decision to liquidate the remaining long-lived assets in the building,management determined a recoverability test should be completed as of March 31,2006.

 

Since the future estimated cash inflows are currentlyestimated to be near zero, the carrying amounts of the assets exceeded theestimated undiscounted cash flows. Management estimated the fair value of theassets by reviewing the value of

 

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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 $0.2 million was recognized during thequarter ended March 31, 2006.

 

**(5)   RESTRUCTURING EXPENSE**

 

The Company entered into termination and retentionarrangements from June 2005 through March 2006 with approximately 102 employeesin the U.S. and Europe. All areas of the Company were impacted. Retentionpayments under these agreements earned over the period July 1, 2005 throughDecember 31, 2005 were $0.7 million of which $0.3 million were paid in January2006. Retention payments under these agreements earned over the period January1, 2006 through June 30, 2006 are currently estimated to be $0.4 million andare estimated to be paid in the second quarter of 2006. Severance payments,earned upon involuntary termination, are estimated to be $1.4 million. Retentionpayments are being recognized as expense over the period earned, and severancepayments will be expensed over the period beginning with the date of signingthrough the earlier of the communicated involuntary termination dates or June30, 2006.

 

The Company recognized restructuring expense in theamount of $1.2 million related to these arrangements during the three-monthsended March 31, 2006. Restructuring expense was recognized in the consolidatedstatements of operations as $0.3 million in products cost of sales, $0.7 millionin services cost of sales and $0.2 million in general and administrativeexpense.

 

A portion of the payments to be made under thetermination and retention arrangements will be paid from the irrevocableFischer Imaging Employee Trust (the “Trust”). This Trust was established in2006 for the specific purpose of paying amounts owed under termination andretention arrangements or general wages to employees. The Trust was funded bythe Company on January 2, 2006 with $600,000 of cash as authorized by the Boardof Directors.

 

The following is a roll forward of the restructuringaccrual (in thousands):

 
| Balance at  December 31, 2005 |   | $     | 539    |   |
|-------------------------------|--------|-------|--------|--------|
| Expense                       |   | 1,195 |   |
| Payments                      |   | (447  | )      |
| Balance at March  31, 2006    |   | $     | 1,287  |   |

 

The restructuring accrualis included in “Other Current Liabilities” in the accompanying consolidatedbalance sheet.

 

**(6)   OTHER FINANCING EXPENSE**

 

OnFebruary 22, 2005, the Company entered into a Note and Warrant PurchaseAgreement (the “Purchase Agreement”) with ComVest. At closing, Fischer issuedand sold a senior secured promissory note in the principal amount of $5.0million (the “Initial Note”) to ComVest. In connection with the issuance of theInitial Note, Fischer issued to ComVest a warrant (the “Warrant”) to purchase2,000,000 shares of Common Stock at an exercise price of $4.25 per share.

 

OnMarch 29, 2005 the Company amended the Purchase Agreement and ComVest provided$2.0 million in funding under a Secondary Note, bringing their total investmentto $7.0 million (the “Notes”). Also in connection with the funding of theSecondary Note, the Company agreed to amend the Warrant to provide ComVest witha put option, exercisable at $0.90 per warrant share, upon the occurrence ofcertain trigger events.

 

SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of Both Liabilities and Equity,” and EITF 00-19,“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock” each require issuers to classify asliabilities (or assets under certain circumstances) freestanding financialinstruments which, at inception, require or may require an issuer to settle anobligation by transferring assets. SFAS No. 150 required the warrants issuedsubject to a put under the Purchase Agreement to be classified as a liabilityin an amount equal to the estimated fair value.

 

As of February 22, 2005 and March 31, 2005, the stockwarrant obligation fair value was estimated to be $2.9 million and $4.3million, respectively. As required per APB Opinion No. 14, “Accounting forConvertible Debt and Debt Issued with Stock Purchase Warrants,” the issuanceproceeds were allocated between the amount applicable to the debt and theamount applicable to the warrant based upon relative fair values of the debtand the warrants at issuance date. As a result, Fischer increased “Debt issuecosts” by $1.8 million. The difference of $2.5 million between the amountallocated to “Debt issue

 

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costs” of $1.8million and the fair value as of March 31, 2005 of $4.3 million was beenrecognized as a non-cash “Other Financing Expense” in the Consolidated IncomeStatements for the three-months ended March 31, 2005.

 

The fair value of the stock warrant obligation wasestimated using the Black-Scholes option-pricing model. The stock price wasdiscounted by 40% to consider marketability of the common stock itself and theresulting Black-Scholes fair value was discounted by 20% to consider the lackof marketability of the warrant. The following summarizes the significantassumptions:

 
| ** **                    | ** ** | **March 31, 2005** | ** ** | **February 22, 2005** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
|                          |       |               |       |                  |       |
| Stock price  (10-day average) |       | $                  | 6.22       |                  | $          | 4.55 |   |
| Discounted stock  price       |       | $                  | 3.73       |                  | $          | 2.73 |   |
| Volatility                    |       | 94.9               | %          | 94.9                  | %          |
| Dividend yield                |       | 0.00               | %          | 0.00                  | %          |
| Risk-free  interest rate      |       | 4.24               | %          | 3.89                  | %          |
| Expected life  (years)        |       | 5.00               |       | 5.00                  |       |
| Black-Scholes  fair value     |       | $                  | 2.70       |                  | $          | 1.84 |   |
| Fair value per  warrant share |       | $                  | 2.16       |                  | $          | 1.47 |   |

 

In connection with the closing of the Asset Sale,ComVest exercised its put option, and at closing, Fischer paid $1.8 million insatisfaction of the stock warrant obligation. In addition, amounts due underthe ComVest promissory notes were paid upon the closing of the Asset Sale.

 

**(7)  NET EARNINGS PER SHARE**

 

Basic earnings or loss per share is computed bydividing the Company’s net income or loss by the weighted average number ofshares of common stock outstanding at the reporting date. Diluted earnings orloss per share is determined by dividing the net earnings or loss by the sum ofthe weighted average number of common shares outstanding, and if notanti-dilutive, the effect of outstanding stock options determined utilizing thetreasury stock method.

 

For the three months ended March 31, 2006 and2005, 541,000 and 1,345,417, respectively, of options to purchase shares ofcommon stock were outstanding but not included in the computation of dilutedearnings per share because the effect would have been anti-dilutive.

 

**(8)   COMPREHENSIVE LOSS**

 

Comprehensive loss isdefined as the change in equity of an enterprise other than the changeresulting from investments by, or distributions to, its owners. For theCompany, comprehensive loss includes only net loss and foreign currencytranslation adjustments as follows (in thousands):

 
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
|                                      |       |                   |       |   |   |
| Net loss                                  |       | $                      | (2,718     | ) | $ | (6,577 | ) |
| Foreign currency  translation adjustments |       | (5                     | )          | 17 |   |
| Comprehensive  loss                       |       | $                      | (2,723     | ) | $ | (6,560 | ) |

 

**(9)   SEGMENT AND CUSTOMERINFORMATION**

 

The Company has historically operated in a singleindustry segment: the design, manufacture and marketing of specialty digitalimaging systems and other medical devices primarily used in screening,diagnostic and interventional procedures, and the provision of service to itsinstalled base. The Company manufactures its products in the United States anddistributes them in the United States, Europe and elsewhere. The Company’schief operating decision maker uses consolidated results to make operating andstrategic decisions.

 

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Internationally, the Company markets and supports itsproducts primarily through its subsidiaries and various dealers. Revenues areattributed to geographic areas based on the location of the customer. Internationallong-lived assets are located in Switzerland. The following table represents asummary of revenues and long-lived assets (in thousands):

 
| ** **    | ** ** | **Three Months Ended** | ** ** |
|---------------|------------|------------------------|------------|
| ** **    | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Revenues:     |       |                   |       |   |   |
| United States |       | $                      | 5,342      |   | $ | 12,843 |   |
| International |       | 1,644                  |       | 1,611 |   |
| Total         |       | $                      | 6,986      |   | $ | 14,454 |   |

 
| ** **              | ** ** | **As of**           | ** ** |
|-------------------------|------------|---------------------|------------|
| ** **              | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
| Long-lived assets, net: |       |                |       |   |   |
| United States           |       | $                   | 227        |   | $ | 469 |   |
| International           |       | 24                  |       | 70 |   |
| Total                   |       | $                   | 251        |   | $ | 539 |   |

 

The Company’s revenues generally are concentratedamong customers in the healthcare industry and consist of healthcareorganizations, government facilities and dealers. The Company establishes anallowance for uncollectible accounts based upon factors surrounding the creditrisk of specific customers, historical trends and other information. Accountsreceivable are generally unsecured.

 

Customers representing greater than 10% of the Company’srevenue during any of the reporting periods:

 
| ** **                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Ethicon-Endo  Surgery, Inc. |       | 16.6                   | %          | 8.4 | % |
| Eastman Kodak  Company      |       | 38.6                   | %          | 8.3 | % |

 

Revenue grouped by similar products and services (inthousands):

 
| ** **                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Product Revenue:            |       |                   |       |   |   |
| Digital  Mammography        |       | $                      | —     |   | $ | 2,784 |   |
| Stereotactic  Breast Biopsy |       | 1,127                  |       | 5,642 |   |
| RE&S  Products          |       | 2,810                  |       | 2,318 |   |
| Service Revenue             |       | 3,049                  |       | 3,710 |   |
| Total                       |       | $                      | 6,986      |   | $ | 14,454 |   |

 

**(10)   COMMITMENTS ANDCONTINGENCIES**

 

**Litigation**

 

OnDecember 20, 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 Fischer. Insummary, UHN and Mount Sinai allege, among other things, that the SenoScanunits, which were manufactured by Fischer and sold by Horizon, an entityauthorized to sell these types of machines in Canada, were defective and didnot 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

 

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failing to pay approximately Canadian $450,000 in connection with thesale of the two SenoScan units. Also, Horizon has denied the core allegationsadvanced by UHN and Mount Sinai. Horizon also asserted breach of contractcounterclaims against UHN and Mount Sinai for failing to pay amounts duerelating to the sale of the two SenoScan units and asserted cross-claims forrepayment of attorney fees against Fischer for indemnification based on, amongother things, its contention that Horizon acted as Fischer’s agent in theunderlying transaction and Fischer must indemnify its agent under applicablelaw. The Company believes the suit and counterclaim are without merit andintends to vigorously defend the case, as well as assert counterclaims againstHorizon for nonpayment.

 

OnDecember 21, 2005, Fischer filed a complaint and jury demand against CedaraSoftware Corporation (“Cedara”) seeking damages arising from Cedara’s breach ofa contract to sell software applications products. Cedara answered thecomplaint on January 30, 2006 and filed a counterclaim for unpaid invoices andother 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.

 

TheCompany is also a defendant in various lawsuits brought by vendors, suppliersand others incident to the operation of its business. The Company does notbelieve that any one of these pending legal proceedings would have a materialadverse effect on the consolidated financial position or results of operationsof the Company. However, in the aggregate the potential liability andmanagement distraction resulting from managing numerous lawsuits simultaneouslycould have a material adverse effect on the financial condition and cash flowof the Company if the outcomes are collectively unfavorable.

 

**FederalTrade Commission**

 

Fischerreceived in October 2005 a request from the Federal Trade Commission (“FTC”)asking that Fischer voluntarily produce certain information and material to theFTC in connection with the Asset Sale. On January 31, 2006, Fischer received additionalinformation requests from the FTC in the form of a Subpoena Duces Tecum andCivil Investigative Demand as part of this ongoing investigation. The FTC’srequests, 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. Fischer is in the process of responding to the FTCrequests and cannot predict the outcome of the investigation or its effect, ifany, on Fischer’s business.

 

**RegulatoryActions**

 

TheCompany is subject to periodic inspections by the Food and Drug Administration(“FDA” or the “agency”). The primary purpose of these inspections is to verifythe compliance of a company’s quality system with the requirements of FDA’sGood Manufacturing Practices, also known as the Quality System Regulation, andother FDA regulations governing medical devices. During these inspections, theagency evaluates a company’s state of compliance with various FDA regulationsand the adequacy of the company’s actions to correct observations from earlierinspections and Warning Letter(s). In early 2005, the FDA conducted aninspection of the Company’s Quality System with the above objectives. On May13, 2005 the FDA completed the inspection and presented a Form 483 formallydescribing observations with respect to the Company’s compliance with variousFDA requirements. This inspection did not resolve the issues described in theWarning Letter issued to the Company in December 2002 by the FDA, which, as aresult, remains in effect. The Company retained the services of a consultantand responded to the Form 483 findings. The response described a correctiveaction plan to address each of the observations included on the Form 483. Todate, there has been no written response from the FDA regarding the adequacy ofthe Company’s corrective action plan. However, the Company has attended twomeetings with the FDA regarding the status of the corrective actions duringwhich the Company’s corrective action plan and actions taken have beendiscussed. The Company has completed the corrective action plan defined in theresponse to the observations and is now operating according to the changes putinto effect.

 

Communicationwill continue with the FDA regarding the Company’s ongoing progress in ensuringthe effectiveness of the corrective actions that have been taken. The Company’sgoal is to address the FDA’s inspectional observations without the agencypursuing additional regulatory or enforcement action. There can be noassurance, however, that the Company’s efforts will be successful and that theFDA will not pursue such actions which could include, but not be limited to,the issuance 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 the Company from shipping products orreplacement parts until corrective action is taken and verified by the FDA.

 

TheFDA has indicated that the 5.2.X versions of the software currently running onFischer’s SenoScan systems should be recalled for a known archiving issue. Afterconsultation with the Company’s Notified Body, it was determined that thisissue and its correction did not meet the criteria for a recall in the EU. Fischerhas recently developed and released to the general market, a version 5.2.2software release to correct the known archiving issue as well as increasefunctions for servicing the SenoScan unit. Fischer submitted an initial recallplan to the FDA that indicated the target completion date of the softwareupgrades by June 30, 2006 in the U.S. Due to scheduling conflicts withcustomers to complete the action required to install the

 

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new software version, a revised plan will be submitted with a targetcompletion date of September 30, 2006. Management estimates that the costsrelated to this will be minimal but costs could become more significant thanFischer anticipates.

 

**Philips**

 

Fischerreceived notification on September 2, 2005 by Philips that it had ceased salesactivities for the present time with respect to the SenoScan product and thatit intended to terminate the Philips Agreement should the Asset Sale Agreementbe approved by the Company’s stockholders and consummated. Fischer met withPhilips in November 2005 to communicate that Fischer had retained the rightperform its obligations under the Philips Agreement but that, absent additionalfunding from Philips, it did not have the financial ability to perform thePhilips Agreement. Philips subsequently offered to settle the matter withoutlitigation. However, in view of the financial settlement proposed by Philips,Fischer declined Philips’ offer of settlement and referred Philips to thedispute resolution provisions of the Philips Agreement. Fischer is unable topredict whether Philips may file a suit or the amount, if any, that may bedemanded by Philips, or the expense related to defending any claim. Fischer hasrecognized a liability for a customer deposit made by Philips in advance ofshipping the SenoScan product in the amount of $0.3 million. Any payments madeby Fischer to or in connection with a claim by Philips may materially reduceamounts, if any, that may be available for satisfaction of creditor claims anddistribution to Fischer’s stockholders.

 

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**Item2.    Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

**Cautionary Language**

 

This report containsforward-looking information that involves risk and uncertainties, includingstatements regarding our plans, objectives, expectations, and intentions. Suchstatements include, without limitation:

 

•                  statementsregarding various estimates we have made in preparing our financial statements,

•                  our actionswith respect to the auction of the RE&S business and/or Product Lines andour intended actions if stockholder approval is required under Delaware law;

•                  our abilityto continue to satisfy RE&S service and warranty obligation if the RE&Sbusiness is not sold in its entirety;

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

•                  ability tolocate an alternative service provider for RE&S service obligations;

•                  expectedimpact of deconsolidating Fischer’s European subsidiaries on Fischer’sfinancial statements;

•                  Philips’intent to terminate the Philips Agreement and potential outcomes regarding theterms and conditions of the termination including the effect of any payments toPhilips and the expense of defending any claim on potential distributions tostockholders and creditors;

•                  the eventsor circumstances that could cause us to cease operations and liquidate underapplicable law including a liquidation under Chapter 7 or Chapter 11 of theBankruptcy Code;

•                  our abilityto make distributions to stockholders; and

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

 

These forward-lookingstatements are subject to known and unknown risks and uncertainties that couldcause actual results to differ materially from those anticipated. Factors thatcould cause actual results to materially differ include, without limitation,our ability to execute our business strategy, our ability to negotiate with ourcreditors including vendors and customers, additional claims of whichmanagement is not aware, adverse actions taken by regulatory agencies,potential product defects or related performance resulting in product recallsand significant liability and legal costs, impact of liquidation of ourEuropean subsidiaries which could require additional cash, the outcome of theRE&S auction process, and the outcome of the FTC investigation. Otherfactors that could adversely affect our business are described in our RiskFactors described in our Annual Report on Form 10-K for the year ended December31, 2005 as revised by Part II, Item 1A Risk Factors of this Form 10-Q. Exceptas otherwise required by law, we expressly disclaim any obligation orundertaking to release publicly any updates or revisions to any such statementsto reflect any change in our expectations or any change in events, conditionsor circumstances on which any such statement is based.

 

**Critical Accounting Policies**

 

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

 

The critical accounting policies that we believeaffect the more significant judgments and estimates used in the preparation ofour consolidated financial statements presented in this report are described inthe Management’s Discussion and Analysis of Financial Condition and Results ofOperations included in our Annual Report on Form 10-K for the fiscal yearended December 31, 2005. There have been no material changes to our criticalaccounting policies, as described in that Form 10-K, except for the impairmentof long-lived assets.

 

Our policy is to evaluate whether there has been apermanent impairment in the value of long-lived assets when certain events havetaken place that indicate that the remaining balance may not be recoverable. Weevaluate the carrying value of our property and equipment at the consolidatedlevel since we believe that is the lowest identifiable level of cash flows forthese assets. As a result of further declines in the stock price and a decisionto liquidate the remaining long-lived assets in our building, managementdetermined a recoverability test should be completed as of March 31, 2006

 

Since the future estimated cash outflows are currentlyestimated to be near zero, the carrying amounts of the assets exceeded theestimated undiscounted cash flows. Management estimated the fair value of theassets by reviewing the value of

 

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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 $0.2 million was recognized during thequarter ended March 31, 2006.

 

**Overview**

 

We servicemammography and digital imaging products used in the diagnosis of breast cancerand other diseases and manufacture and sell the MammoTest stereotactic breastbiopsy system to a single distributor in Europe. Our primary focus prior to theconsummation of the Hologic Asset Sale on September 29, 2005 (as discussedbelow) was designing, manufacturing and selling mammography and digital imagingproducts and using our digital imaging technology in screening and diagnosticmammograms and minimally invasive breast biopsy to aid in the earlyidentification of breast cancer. We also continue to service and sell productsthat meet selected needs of the broader radiology and electrophysiologymarkets.

 

InSeptember 2005, we consummated the sale (the “Asset Sale”) of all of itsintellectual property rights related to its mammography business and products,including rights to our SenoScan digital mammography and MammoTest stereotacticbreast biopsy systems to Hologic, Inc. (“Hologic”). Under the Asset SaleAgreement, Hologic granted us a non-exclusive limited license to use certainMammography Assets necessary for us to continue our Service business; tofulfill contractual obligations to provide MammoTest and SenoScan systems toEES and Philips, respectively; and to carry out certain activities with respectto our RE&S business.

 

As aresult, revenues recognized from MammoTest and SenoScan during the quarterended March 31, 2006 were $1.1 million and zero, respectively.

 

Asdiscussed further in Note 1 of the accompanying consolidated financialstatements, on March 15, 2006, we announced that we were starting an auctionprocess to sell the RE&S business. Bidders were asked to submit bids forthe entire RE&S business, individual Product Lines or components thereof. Severalbids for the Bloom Line and one bid for the RE&S business were received inaccordance with the original timeline. Management is completing the analysis ofthe bids and an auction is expected to be held on May 15, 2006. As soon aspossible after the end of the auction, we intend to finalize and enter intodefinitive agreements with the party or parties whose offer(s) are deemed inour sole judgment the most attractive bid(s) for the RE&S business andProduct Lines or components thereof. We shall have the right to reject any bidif we determine, in the reasonable exercise of our fiduciary duties, that thebids received are inadequate or insufficient; or contrary to the best interestsof Fischer.

 

UnderDelaware law, any sale of all or substantially all of our assets requires approvalby our 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.

 

The factorslisted above, among others, raise substantial doubt about our ability to continueas a going concern. The consolidated financial statements do not include anyadjustments that might result from the outcome of this uncertainty.

 

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**Results of Operations**

 

The following table sets forth the percentage ofrevenues represented by certain data included in our statements of operationsfor the periods indicated:

 
| ** **                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| Revenues:                        |       |                   |       |   |   |
| Product revenues                 |       | 56.4                   | %          | 74.3 | % |
| Service revenues                 |       | 43.6                   |       | 25.7 |   |
| Total revenues                   |       | 100.0                  |       | 100.0 |   |
| Cost of sales:                   |       |                   |       |   |   |
| Products                         |       | 55.0                   |       | 56.1 |   |
| Services                         |       | 49.7                   |       | 30.5 |   |
| Research and  development        |       | —                 |       | 13.4 |   |
| Selling and  marketing           |       | —                 |       | 13.7 |   |
| General and  administrative      |       | 28.3                   |       | 12.7 |   |
| Impairment of  long-lived assets |       | 3.3                    |       | — |   |
| Loss from  operations            |       | (36.3                  | )          | (26.4 | ) |
| Other income,  net               |       | (2.6                   | )          | (19.1 | ) |
| Net loss                         |       | (38.9                  | )%         | (45.5 | )% |

 

**Product Revenues**

 

Total revenuesdecreased 51.7% to $7.0 million for the quarter ended March 31, 2006 from $14.5million for the quarter ended March 31, 2005. Product revenues decreased 63.4%to $3.9 million in the first quarter of 2006 from $10.7 million inthe first quarter of 2005.

 

•                  SenoScandigital mammography product revenue during the first quarter of 2005 was $2.8million. As a result of the Asset Sale, there were no sales in the firstquarter of 2006 and there will be no further sales of SenoScan.

•                  Revenuesfrom our MammoTest breast biopsy products decreased 80.0% or $4.5 million to$1.1 million in the first quarter of 2006 from $5.6 million in thefirst quarter of 2005. The decrease in MammoTest product revenue is a directresult of the Asset Sale. We expect MammoTest product revenue to increase toapproximately $1.7 million in the second quarter of 2006 as we complete thelast time purchase order from EES and then discontinue.

•                  TheRE&S products revenues increased $0.5 million to $2.8 million in the firstquarter of 2006 from $2.3 million in the first quarter of 2005. The salesincrease on RE&S products in the first quarter of 2006, as compared to thefirst quarter of 2005 was primarily due to $1.2 million volume increase inVersaRad x-ray products as a result of the last time buy purchase order fromKodak, offset by volume decreases in EPX/SPX and Bloom of $0.7 million.

 

**Service Revenues**

 

Our service revenues for the quarter ended March 31,2006 decreased 17.8% to $3.0 million from $3.7 million during the comparablequarter in 2005. The decreases in the three-month period ended March 31, 2006in relation to the comparable periods in 2005 are primarily due to a reductionof MammoTest and SenoScan units on service contracts in both the U.S. andEurope and a result of cancellation of service contracts in the U.S. ascustomers purchased service contracts from Kodak. In addition, all disposables and time and material revenuefrom the Service business was terminated as of January 23, 2006 in the U.S. Weexpect revenue to decline to near zero since the only remaining servicecontracts and service revenue will be generated from the RE&S product lines.RE&S service revenue in the quarter ended March 31, 2006 was $267,000.

 

**Cost of Sales—Products**

 

Cost of sales for products in the first quarter of2006 was $3.8 million or 97.6% of product revenues compared to$8.1 million or 75.5% of product revenues in the first quarter of 2005.The overall increase in cost of product sales, as a percentage of productrevenues is primarily due to the recognition of $0.3 million in restructuringexpense related to termination and retention arrangements, lower average salesprice of the MammoTest product and higher warranty costs due to outsourcing ofservice.

 

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**Cost of Sales—Service**

 

Cost of sales for services for the quarter ended March31, 2006 decreased 21.2% to $3.5 million from $4.4 million in thequarter ended March 31, 2005. As a percent of service revenues, cost of servicesales decreased to 113.8% in the first quarter of 2006 from 118.8% in the firstquarter of 2005. Approximately $1.5 million of the decrease in cost of sales isdue to reductions in headcount and related employee benefits and reimbursementfrom Kodak for a portion of service costs offset by $0.7 million inrestructuring expense related to termination and retention arrangements. Themajority of service employees employment with Fischer was terminated on April7, 2006 in the U.S. and April 30, 2006 in Europe.

 

**Research and Development Expenses**

 

Research and developmentexpenses decreased to zero in the quarter ended March 31, 2006 from$1.9 million in the quarter ended March 31, 2005. Our efforts prior to theAsset Sale were focused on redesigning older products for improved reliabilityand serviceability and enhancing the features, functionality and reliability ofthe SenoScan product.

 

**Selling and Marketing Expenses**

 

Selling and marketing expenses decreased to zero inthe quarter ended March 31, 2006 from $2.0 million in the quarter endedMarch 31, 2005. Effective June 30, 2005 we terminated marketing activity andassociated personnel, which resulted in $0.5 of the reduction. Shortly beforeclosing the Asset Sale, all sales personnel were terminated as part of therestructuring plan, which accounts for the remaining reduction.

 

**General and Administrative Expenses**

 

General and administrativeexpenses increased 8.2% to $2.0 million in the quarter ended March 31,2006 from $1.8 million in the quarter ended March 31, 2005. During thefirst quarter of 2006, we recognized $0.2 million in restructuring expenserelated to termination and retention arrangements. Our spending for legal costswas $0.1 million higher in the first quarter of 2006 as compared to the firstquarter of 2005 due in part to the FTC investigation and various outstandinglawsuits. In addition, we experienced $0.1 million higher insurance costs inthe quarter due to renewal of our policies in May 2005. The remaining change isdue to headcount reductions which occurred in the last half of 2005.

 

**Impairment of Long-Lived Assets**

 

As discussed in Note 4 of the accompanying consolidatedfinancial statements and Critical Accounting Policies,****werecognized $0.2 million of impairment of long-lived assets in the quarter endedMarch 31, 2006.

 

**Interest Expense/Interest Income**

 

Interest expense for the quarter ended March 31, 2006decreased to $66,000 from $318,000 for the quarter ended March 31, 2005. Theinterest expense in the first quarter of 2005 was related interest on thesecured promissory notes entered into in the first quarter of 2005 with ComVestand amortization of the related debt issue costs. Interest expense in the firstquarter of 2006 is related to interest payments made as a result of settlingcertain state and local sales tax audits.

 

**Other Financing Expense**

 

As discussed in Note 6 of the consolidated financialstatements, we were required to recognize the fair value of the warrants as astock warrant obligation. The amount recognized in the first quarter of 2005was approximately $2.5 million.

 

**Income Taxes**

 

We estimated that we would not owe taxes for thethree-month period ended March 31, 2006 and 2005. Accordingly, no income taxbenefit or provision was recorded. This was determined based upon theanticipated 2006 results of operations and an available domestic net operatingloss carry-forward of $32.1 million and $0.7 million of foreign netoperating loss carry-forwards at December 31, 2005. As of March 31, 2006 we hada 100% valuation allowance against our deferred tax asset that resulted in anet deferred tax asset of $0.

 

**Liquidity and Capital Resources**

 

As of March 31, 2006, we had $1.8 million inunrestricted cash and $2.0 million in working capital compared to $4.5

 

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million in cashand $4.5 million in working capital at December 31, 2005. The $2.5 million netdecrease in working capital is mainly caused by operating losses of which $1.2million is due to restructuring expense recognized during the quarter and theremainder is due to funding operations. During the quarter, we spent $1.0million in cash to purchase directors and officer liability insurance run-offcoverage.

 

A portion of the payments to be made under thetermination and retention arrangements will be paid from the irrevocableFischer Imaging Employee Trust (the “Trust”). This Trust was established in2006 for the specific purpose of paying amounts owed under termination andretention arrangements or general wages to employees. The Trust was funded onJanuary 2, 2006 with $600,000 of cash as authorized by the Board of Directors.

 

We continue to use cash to fund operations. We havetaken and will continue to take steps to reduce our operating costs by reducingthe number of employees to the minimum number needed to conduct our remainingbusinesses, terminating certain contracts, and negotiating releases fromremaining contractual arrangements. All but four U.S. employees have receivednotice that their employment with Fischer will terminate between now and May31, 2006.

 

Our plans and expectations can be significantlyimpacted by the following, as well as other factors that may arise:

 

•                  As discussedfurther in Note 10 of the accompanying consolidated financial statements, wehave pending legal proceedings that could have a material adverse effect on ourcash flow if the outcomes are collectively unfavorable.

•                  As discussedfurther in Note 10 of the accompanying consolidated financial statements, weare 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 we make to or in connection with a claim by Philips may materiallyreduce amounts, if any, that may be available for satisfaction of creditorclaims and distribution to our stockholders.

 

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. We plan 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 effort to sell the RE&S businesses isunsuccessful, management will seek alternative service providers to providecontinuation of service for warranty and service contract obligations. If weare unable to find appropriate alternative service providers, we may not havesufficient funds to reimburse our customers for service and warrantyobligations for the RE&S businesses.

 

Under Delaware law, any sale of all or substantiallyall of our assets requires approval by our stockholders. In the event it isdetermined that the sale of the assets related to the Product Line(s) to asuccessful bidder would be considered a sale of all or substantially all of ourassets, we will either file a petition under Chapter 11 of title 11 of theBankruptcy Code and immediately move to close the sale pursuant to §363(b) and(f) of the Bankruptcy Code or seek the necessary stockholder approval.

 

We do not intend to pursue additional equity or debtfinancing and any such financing would likely not be available to us onacceptable terms, or at all.

 

If we run out of cash, determine that we will not beable to settle all of our known obligations or determine that it is not costefficient to pursue stockholder approval for the asset sales, we may be forcedto cease operations and liquidate assets pursuant to applicable law, which mayinclude filings for bankruptcy protection under Chapter 7 or 11 of theBankruptcy Code.

 

These factors, among others, raise substantial doubtabout our ability to continue as a going concern. In addition, 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:

 

•                  the results ofthe auction process related to the sale of our RE&S business or ProductLines,

•                  liquidation ofEuropean operations,

•                  the impact ofPhilips’ actions with respect to the termination of the Philips Agreement, and

•                  the outcome ofcertain threatened or potential litigation.

 

**Contractual Obligations**

 

SinceDecember 31, 2005, there have not been any significant changes in ourcontractual obligations except that purchase obligations continue to decline aspurchase orders outstanding at December 31, 2005 are completed. New purchase

 

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orders are minimal for 2006 due to minimal needs for inventory as aresult of utilizing inventory on hand or already ordered at December 31, 2005to fulfill the last time purchase orders.

 

**Backlog**

 

As of March 31, 2006, we had backlog of $3.7 millioncompared to a backlog of near zero as of December 31, 2005. The increase inbacklog is primarily due to last time purchase orders from Kodak and EES.

 

**Item3.    Quantitative and Qualitative Disclosures About MarketRisk**

 

**Foreign Currency Risk**

 

We attempt to minimizeour exposure 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. AtMarch 31, 2006 we had cash and receivables less than current liabilitiescausing a working capital deficit of U.S. $0.4 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**

 

At March 31, 2006, we hadapproximately $0.1 million in certificate of deposits and $1.2 million in moneymarket accounts that earn interest at variable interest rates and are thereforesubject to interest rate fluctuations. At times, cash balances with ourfinancial institution exceed FDIC insurance limits.

 

**Item4.    Controls and Procedures**

 

We carried out an evaluation, under the supervisionand with the participation of our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of our disclosure controls and procedures as ofthe end of the period covered by this report. Our disclosure controls andprocedures are designed with the objective of ensuring that informationrequired to be disclosed in our reports filed under the Securities Exchange Actof 1934 is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms. The evaluation included certain controlareas in which we have made, and are continuing to make, changes to improve andenhance controls. Based on this evaluation, our Chief Executive Officer andChief Financial Officer concluded that, as of the end of the period covered bythis report, our disclosure controls and procedures are effective in allmaterial respects in alerting them to material information required to beincluded in our periodic SEC reports. In designing and evaluating thedisclosure controls and procedures, management recognized that even the mostwell designed and operated control systems are subject to inherent limitationsand assumptions about the likelihood of future events and can provide onlyreasonable assurance of achieving the desired control objectives.

 

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**PART II. OTHER INFORMATION**

 

**Item 1.Legal Proceedings:**

 

On December 20, 2005,University Health Network (“UHN”) and Mount Sinai Hospital (“Mount Sinai”)filed a Statement of Claim in Ontario, Canada against Fischer and HorizonMedical Services Ltd. (“Horizon”) and asserted claims seeking to recoverdamages relating to their purchase of two SenoScan units from us. In summary,UHN and Mount Sinai allege, among other things, that the SenoScan units, whichwere manufactured by us and sold by Horizon, an entity authorized to sell thesetypes of machines in Canada, were defective and did not conform to certainagreed specifications. The suit seeks Canadian $1 million in damages, plusinterest, attorneys’ fees and expenses. We have denied the allegations advancedby UHN and Mount Sinai and asserted breach of contract counterclaims againstUHN and Mount Sinai for failing to pay approximately Canadian $450,000 inconnection with the sale of the two SenoScan units. Also, Horizon has deniedthe core allegations advanced by UHN and Mount Sinai. Horizon also assertedbreach of contract counterclaims against UHN and Mount Sinai for failing to payamounts due relating to the sale of the two SenoScan units and assertedcross-claims for repayment of attorney fees against us for indemnificationbased on, among other things, its contention that Horizon acted as our agent inthe underlying transaction and we must indemnify its agent under applicable law.We believe the suit and counterclaim are without merit and intends tovigorously defend the case, as well as assert counterclaims against Horizon fornonpayment.

 

We received in October2005 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 anywrongdoing, are part of a nonpublic investigation to determine whether theAsset Sale may be anticompetitive and a violation of Sections 7 or 7A of theClayton Act or Section 5 of the Federal Trade Commission Act. We are in theprocess of responding to the FTC requests, which continues to be expensive andrequire significant management time, and we cannot predict the outcome of theinvestigation, including whether the FTC will take any further action againstus.

 

On December 21, 2005, wefiled a complaint and jury demand against Cedara Software Corporation (“Cedara”)seeking damages arising from Cedara’s breach of a contract to sell softwareapplications products. Cedara answered the complaint on January 30, 2006 andfiled a counterclaim for unpaid invoices and other relief. We do not expect anyliability in addition to amounts recognized as of December 31, 2005 for thecounterclaim and will vigorously defend the counterclaim while pursuing ourcase. At this time, management cannot determine the possible outcome of thelawsuit.

 

We are also a defendantin various lawsuits incidental to the operation of our business. We do notbelieve that any of those pending legal proceedings would have a material,adverse effect on our consolidated financial position or results of ouroperations.

 

**Item 1A. Risk Factors**

 

Thefollowing risks are no longer considered significant:

 

•                  We may be unable to fulfill last timepurchase orders from Kodak and EES at all or in a timely manner.

•                  Our vendors and suppliers may fail to delivercomponents for our products.

•                  Regulatory agencies could take adverse actionwhich could have an adverse impact on our ability to continue in operation.

•                  We may be unable to retain key employees.

•                  Failure to collect accounts receivable on atimely basis would materially adversely affect us.

 

Allother risks remain unchanged.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds:**   Notapplicable

 

**Item 3.Defaults Upon Senior Securities:**   Notapplicable.

 

**Item 4.Submission of Matters to a Vote of Security Holders:**   Notapplicable.

 

**Item 5.Other Information:**   Not applicable.

 

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**Item 6.Exhibits:**

 

**(a)   Exhibits:**

 

The following is a list of exhibits filed as part ofthis Report on Form 10-Q.

 
| 31.1 |   | Certification of Steven Durnil, Chief Executive  Officer and President, pursuant to Rule 13a-14(a) under the Securities  Exchange Act of 1934. |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification of David Kirwan, Chief Financial  Officer, pursuant to Rule 13a-14(a) under the Securities Exchange Act of  1934.                |
| 32.1 |   | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *                     |
| 32.2 |   | Certification pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *                     |

 

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*As contemplated by SEC Release 33-8212 these exhibitsare furnished with the Quarterly Report on Form 10-Q and are not deemed filedwith the Securities and Exchange Commission and are not incorporated byreference in any filing of Fischer Imaging Corporation under the SecuritiesExchange Act of 1933 or the Exchange Act of 1934, whether made before or afterthe date hereof and irrespective of any general incorporation language in suchfilings.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|   | Date: May 12, 2006 | FISCHER IMAGING CORPORATION             |
|--------|--------------------|-----------------------------------------|
|   |               | /s/  STEVEN DURNIL            |   |
|   |               | Steven Durnil                           |
|   |               | *Chief Executive Officer and President* |
|   | Date: May 12, 2006 |                                    |
|   |               | /s/  DAVID KIRWAN             |   |
|   |               | David Kirwan                            |
|   |               | *Chief Financial Officer*               |

 

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