1

**FORM10-Q**

 

**SECURITIESAND EXCHANGE COMMISSION**

**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 September 30, 2004**                                                                                                                                                                                    |
|            |   |                                                                                                                                                                                                                            |
|            |   | **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**

** **                                                                                                                                                                                  |

 

 

**FISCHERIMAGING CORPORATION**

(Exactname of Registrant as 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 mark whether the Registrant(i) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports)and (ii) has been subject to such filing requirements for the past90 days.

 
| Yes ý  No o |
|--------------------------------------|

 

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

 
| Yes o  No ý |
|--------------------------------------|

 

The number of shares ofRegistrant’s Common Stock outstanding as of November 11, 2004 was 9,374,484.

 

 

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**FISCHER IMAGING CORPORATION**

 

**FORM 10-Q**

 

**INDEX**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                      |   |   |
|--------------|--------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|         |                                                                                                                           |   |   |
| Item 1.      | Consolidated Financial  Statements                                                                                             |   |
|         | Consolidated Balance  Sheets—September 30, 2004 (unaudited) and December 31, 2003                                         |   |
|         | Consolidated  Statements of Operations (unaudited)—Three and nine months ended September  30, 2004 and September 28, 2003 |   |
|         | Consolidated  Statements of Cash Flows (unaudited)— Nine months ended September 30, 2004  and September 28, 2003          |   |
|         | 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**                                                                                                          |   |   |
| ** **   | ** **                                                                                                                     |   |   |
| SIGNATURES   |                                                                                                                           |   |

 

2

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# **PART I. FINANCIALINFORMATION**

**Item 1. Financial Statements**

 

#### **FISCHER IMAGING CORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                    | ** ** | **September 30,  2004** | ** ** | **December 31,****2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                    |       | **(Unaudited)**         |       |                     |       |
| **ASSETS**                                                                                                                                                                    |       | ** **              |       |                     |       |
| Current Assets:                                                                                                                                                               |       |                    |       |                     |       |
| Cash and cash equivalents                                                                                                                                                     |       | $                       | 1,714      |                     | $          | 1,396 |   |
| Certificate of deposit, restricted cash                                                                                                                                       |       | 514                     |       | 514                      |       |
| Accounts receivable, net of allowance for  doubtful accounts of $747 and $942 at   September 30, 2004 and December 31, 2003, respectively                                |       | 10,448                  |       | 9,371                    |       |
| Inventories, net                                                                                                                                                              |       | 14,716                  |       | 14,918                   |       |
| Prepaid expenses and other current assets                                                                                                                                     |       | 1,670                   |       | 1,637                    |       |
| Total current  assets                                                                                                                                                         |       | 29,062                  |       | 27,836                   |       |
| Property and equipment:                                                                                                                                                       |       |                    |       |                     |       |
| Manufacturing equipment                                                                                                                                                       |       | 4,879                   |       | 4,415                    |       |
| Office equipment and leasehold improvements                                                                                                                                   |       | 6,004                   |       | 5,453                    |       |
| Total property and equipment                                                                                                                                                  |       | 10,883                  |       | 9,868                    |       |
| Less: accumulated depreciation                                                                                                                                                |       | (7,224                  | )          | (6,458                   | )          |
| Property and equipment, net                                                                                                                                                   |       | 3,659                   |       | 3,410                    |       |
| Intangible  assets, net                                                                                                                                                       |       | 1,044                   |       | 1,077                    |       |
| Other                                                                                                                                                                         |       | —                  |       | 25                       |       |
| Total assets                                                                                                                                                                  |       | $                       | 33,765     |                     | $          | 32,348 |   |
|                                                                                                                                                                          |       |                    |       |                     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                |       |                    |       |                     |       |
| Current Liabilities:                                                                                                                                                          |       |                    |       |                     |       |
| Accounts payable                                                                                                                                                              |       | $                       | 10,891     |                     | $          | 8,378 |   |
| Current maturities under capital lease  obligation                                                                                                                            |       | 266                     |       | 231                      |       |
| Accrued salaries and wages                                                                                                                                                    |       | 1,926                   |       | 1,630                    |       |
| Customer deposits                                                                                                                                                             |       | 3,779                   |       | 4,091                    |       |
| Accrued warranties                                                                                                                                                            |       | 3,677                   |       | 1,987                    |       |
| Deferred service revenue                                                                                                                                                      |       | 856                     |       | 455                      |       |
| Other current liabilities                                                                                                                                                     |       | 1,165                   |       | 1,659                    |       |
| Total current liabilities                                                                                                                                                     |       | 22,560                  |       | 18,431                   |       |
| Long-term debt                                                                                                                                                                |       | 23                      |       | 223                      |       |
| Non-current deferred revenue                                                                                                                                                  |       | 1,031                   |       | 619                      |       |
| Total liabilities                                                                                                                                                             |       | 23,614                  |       | 19,273                   |       |
| Contingencies                                                                                                                                                                 |       |                    |       |                     |       |
| Stockholders’ Equity:                                                                                                                                                    |       |                    |       |                     |       |
| Preferred Stock, 5,000,000 shares  authorized:                                                                                                                                |       |                    |       |                     |       |
| Series C Junior participating preferred  stock, $.01 par value, 500,000 shares authorized, no shares issued and  outstanding                                                  |       | —                  |       | —                   |       |
| Series D Convertible preferred stock, $.01  par value, 506,667 shares authorized, no shares issued and outstanding                                                            |       | —                  |       | —                   |       |
| Common stock, $.01 par value, 25,000,000  shares authorized; 9,374,484 and 9,348,484 shares issued and outstanding at  September 30, 2004 and December 31, 2003, respectively |       | 94                      |       | 94                       |       |
| Paid-in capital                                                                                                                                                               |       | 49,399                  |       | 49,343                   |       |
| Accumulated deficit                                                                                                                                                           |       | (38,780                 | )          | (35,712                  | )          |
| Accumulated other comprehensive loss                                                                                                                                          |       | (562                    | )          | (650                     | )          |
| Total stockholders’ equity                                                                                                                                               |       | 10,151                  |       | 13,075                   |       |
| Total liabilities and stockholders’ equity                                                                                                                               |       | $                       | 33,765     |                     | $          | 32,348 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements

 

3

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**FISCHER IMAGING CORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                       | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                       | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** |
| Revenues:                                                        |       |                    |       |                    |       |   |   |   |   |
| Products                                                         |       | $                       | 13,710     |                    | $          | 8,469 |   | $ | 38,310 |   | $ | 23,614 |   |
| Services                                                         |       | 4,091                   |       | 3,180                   |       | 11,276 |   | 9,584 |   |
| Total revenues                                                   |       | 17,801                  |       | 11,649                  |       | 49,586 |   | 33,198 |   |
| Cost of sales:                                                   |       |                    |       |                    |       |   |   |   |   |
| Products                                                         |       | 8,890                   |       | 4,420                   |       | 26,623 |   | 15,417 |   |
| Services                                                         |       | 4,802                   |       | 4,245                   |       | 13,014 |   | 10,080 |   |
| Total cost of sales                                              |       | 13,692                  |       | 8,665                   |       | 39,637 |   | 25,497 |   |
| Gross profit                                                     |       | 4,109                   |       | 2,984                   |       | 9,949 |   | 7,701 |   |
| Operating expenses:                                              |       |                    |       |                    |       |   |   |   |   |
| Research and development                                         |       | 1,722                   |       | 947                     |       | 4,302 |   | 3,378 |   |
| Selling and marketing                                            |       | 2,257                   |       | 2,046                   |       | 7,820 |   | 6,291 |   |
| General and administrative                                       |       | 1,868                   |       | 2,090                   |       | 6,048 |   | 5,858 |   |
| Total operating expenses                                         |       | 5,847                   |       | 5,083                   |       | 18,170 |   | 15,527 |   |
| Loss from operations                                             |       | (1,738                  | )          | (2,099                  | )          | (8,221 | ) | (7,826 | ) |
| Other income and (expense):                                      |       |                    |       |                    |       |   |   |   |   |
| Interest expense                                                 |       | (13                     | )          | (5                      | )          | (33 | ) | (18 | ) |
| Interest income                                                  |       | 1                       |       | 3                       |       | 3 |   | 33 |   |
| Patent settlement income                                         |       | —                  |       | —                  |       | 5,150 |   | 900 |   |
| Other income (expense), net                                      |       | 5                       |       | 56                      |       | 33 |   | 82 |   |
| Net (loss)                                                       |       | $                       | (1,745     | )                       | $          | (2,045 | ) | $ | (3,068 | ) | $ | (6,829 | ) |
| Net (loss) per share:                                            |       |                    |       |                    |       |   |   |   |   |
| Basic                                                            |       | $                       | (0.19      | )                       | $          | (0.22 | ) | $ | (0.33 | ) | $ | (0.73 | ) |
| Diluted                                                          |       | $                       | (0.19      | )                       | $          | (0.22 | ) | $ | (0.33 | ) | $ | (0.73 | ) |
| Weighted average shares used to calculate  net (loss) per share: |       |                    |       |                    |       |   |   |   |   |
| Basic                                                            |       | 9,363                   |       | 9,333                   |       | 9,353 |   | 9,321 |   |
| Diluted                                                          |       | 9,363                   |       | 9,333                   |       | 9,353 |   | 9,321 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

4

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**FISCHER IMAGING CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(amounts in thousands)**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Nine Months Ended**   | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                 | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** |
| Cash flows from operating activities:                                                      |       |                    |       |   |   |
| Net loss                                                                                   |       | $                       | (3,068     | ) | $ | (6,829 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |                    |       |   |   |
| Depreciation                                                                               |       | 766                     |       | 910 |   |
| Amortization of intangible assets                                                          |       | 33                      |       | (13 | ) |
| Change in current assets and liabilities                                                   |       |                    |       |   |   |
| Accounts receivable, net                                                                   |       | (1,076                  | )          | (309 | ) |
| Inventories, net                                                                           |       | 202                     |       | 2,788 |   |
| Prepaid expenses and other current assets                                                  |       | (8                      | )          | (60 | ) |
| Accounts payable and accrued liabilities                                                   |       | 2,316                   |       | (2,631 | ) |
| Warranty and extended warranty                                                             |       | 1,690                   |       | (36 | ) |
| Customer deposits                                                                          |       | (313                    | )          | 2,699 |   |
| Deferred service revenue                                                                   |       | 401                     |       | (210 | ) |
| Other  non-current liabilities                                                             |       | 412                     |       | (949 | ) |
| Net cash provided by (used in) operating  activities                                       |       | 1,355                   |       | (4,640 | ) |
|                                                                                       |       |                    |       |   |   |
| Cash flows from investing activities:                                                      |       |                    |       |   |   |
| Purchases of property and equipment                                                        |       | (1,015                  | )          | (1,575 | ) |
| Purchases of certificate of deposit  (restricted cash)                                     |       | —                  |       | (514 | ) |
| Net cash used in investing activities                                                      |       | (1,015                  | )          | (2,089 | ) |
|                                                                                       |       |                    |       |   |   |
| Cash flows from financing activities:                                                      |       |                    |       |   |   |
| Proceeds from sale of common stock                                                         |       | 56                      |       | 176 |   |
| Payment on leases                                                                          |       | (166                    | )          | — |   |
| Proceeds from sale/leaseback                                                               |       | —                  |       | 514 |   |
| Net cash provided by (used in) financing  activities                                       |       | (110                    | )          | 690 |   |
|                                                                                       |       |                    |       |   |   |
| Effect of exchange rate changes on cash                                                    |       | 88                      |       | 70 |   |
|                                                                                       |       |                    |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |       | 318                     |       | (5,969 | ) |
| Cash and cash equivalents, beginning of  period                                            |       | 1,396                   |       | 8,401 |   |
| Cash and cash equivalents, end of period                                                   |       | $                       | 1,714      |   | $ | 2,432 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

5

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**FISCHER IMAGING CORPORATION**

**NOTES TOTHE CONSOLIDATED FINANCIAL STATEMENTS**

**FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004**

**(UNAUDITED)**

 

**(1)****             ****GENERAL**

 

In management’s opinion, theaccompanying unaudited consolidated balance sheets, statements of operationsand statements of cash flows contain all adjustments necessary to presentfairly in all material respects the financial position of Fischer Imaging Corporation(the “Company,” “we” or “our”) at September 30, 2004, its results of operationsfor the three and nine months ended September 30, 2004 and September 28, 2003and its cash flows for the nine months ended September 30, 2004 and September28, 2003.  Results of operations and cashflows for the interim periods may not be indicative of the results ofoperations and cash flows for the full fiscal year.

 

In prior years the Companyclosed its quarter end on the Sunday closest to month-end.  Effective January 1, 2004, the Company closesits quarter ends on the last calendar day of the month.  Certain reclassifications have been made toprior year amounts to conform to current year presentation.

 

**(2)****             ****REVENUE RECOGNITION**

 

The Company follows theprovisions of Staff Accounting Bulletin No. 104, “Revenue Recognition inFinancial Statements” (SAB 104) which provides for revenue recognition whenpersuasive evidence of an arrangement exists, delivery has occurred, the priceis fixed and determinable and collectibility is reasonably assured. Ourstandard business practice requires that sales transactions are supported by anexecuted sales agreement or an executed purchase order.  We recognize product revenue for our medicalequipment when title and risk of loss have transferred to our customer and wehave no post-shipment performance obligations other than installation ortraining.   Where installation and/or trainingservices are provided in a sales agreement and they have not been completed atthe time product revenue is recognized, the fair value of these services isdeferred and subsequently recognized as revenue when each of the services areperformed. In cases where thesales agreement prescribes additional consequential performance obligations orrequires specific performance criteria be met for customer acceptance, we deferrevenue recognition on the product sale until such conditions are satisfied.

 

The Companybills service contracts and extended warranty agreements in advance eithermonthly, quarterly, annually or at the time of the product sale, depending uponthe customers’ request.  The amountsbilled are recorded as deferred revenue and recognized as revenue ratablyduring the period for which the contracts are in effect.  We recognize revenue from services billedon a time and material basis when the services are performed.  We also sell replacement parts tocustomers and record revenue at the time of shipment when title transfers.Certain replaced parts may be returned for partial credit, and we record salesallowances based on historical experience to account for the future effect ofthose returns.

 

**(3)****             ****INVENTORIES**

 

The Company values inventoryat the lower of cost or market using the first-in, first-out (FIFO) method. TheCompany assesses the recoverability of inventory based on obsolescence oroverstocked inventory equal to the difference between the cost of inventory andthe estimated market value based upon historical experience and assumptionsabout future demand and changes in market conditions. These assessments requirejudgments and estimates, and valuation adjustments for excess and obsoleteinventory may be recorded based on these periodic assessments.

 

Inventories consisted of thefollowing components (in thousands): 

 
| ** **                                  | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Raw materials                               |       | $                       | 9,965      |                   | $          | 8,116 |   |
| Work in process and finished goods          |       | 8,453                   |       | 10,068                 |       |
|                                        |       | 18,418                  |       | 18,184                 |       |
| Reserve for excess and obsolete inventories |       | (3,702                  | )          | (3,266                 | )          |
| Inventories, net                            |       | $                       | 14,716     |                   | $          | 14,918 |   |

 

6

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**(4)****             ****LONG-TERM DEBT**

 

Long-term debt atSeptember 30, 2004 and December 31, 2003 consists solely of a two-yearcapital lease obligation for computer equipment and software.  The capital lease is collateralized by acertificate of deposit which is included in restricted cash in the accompanyingbalance sheets.

 

In June 2003, weentered into an $8.0 million credit facility, subject to restrictionsbased on eligible receivables. The amount available under the credit facilityat September 30, 2004 was approximately $6.1 million. As amended, this creditagreement expires on December 9, 2004, and is secured by all of ourassets. Borrowings under the agreement bear interest at the bank’s prime rate,plus 2.75%, with a minimum total interest rate of 7%.  The credit facility requires the Company tocomply with a tangible net worth covenant. As amended on July 27, 2004, the tangible net worth covenant wasmodified to $4.0 million from $10.0 million, effective April 1, 2004, and thebank waived the Company’s non-compliance with this covenant through March 31,2004.  If we do not maintain compliancewith the tangible net worth covenant any outstanding borrowings may beimmediately due, the amount available under the credit facility may be furtherreduced or we may not be permitted to make borrowings against the facility. As of September 30, 2004 andDecember 31, 2003, there are no outstanding borrowings under thefacility.    In November 2004, theCompany drew $1.6 million on the credit facility.

 

**(5)****             ****NET EARNINGS PER SHARE**

 

Basic earnings or loss pershare is computed by dividing the Company’s net income or loss by the weightedaverage number of shares of common stock outstanding at the reporting date.Diluted earnings or loss per share is determined by dividing the net earningsor loss by the sum of the weighted average number of common shares outstanding,and if not anti-dilutive, the effect of outstanding stock options determinedutilizing the treasury stock method.

 

A reconciliation between thenumber of securities used to calculate basic and diluted net loss per share isas follows (in thousands): 

 
| ** **                                      | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September28,  2003** | ** ** |
|                                            |       |                    |       |                    |       |   |   |   |   |
| Weighted average of common shares  outstanding: |       |                    |       |                    |       |   |   |   |   |
| Basic                                           |       | 9,363                   |       | 9,333                   |       | 9,353 |   | 9,321 |   |
| Dilutive effect of stock options                |       | —                  |       | —                  |       | — |   | — |   |
| Diluted                                         |       | 9,363                   |       | 9,333                   |       | 9,353 |   | 9,321 |   |

 

As of September 30, 2004and September 28, 2003, there were outstanding options to purchase 1,448,500and 1,528,500 shares, respectively, of common stock under the Company’s currentstock option plans.  As of September 30,2004, the option exercise prices ranged from $1.87 to $16.64.

 

For the three monthsended September 30, 2004 and September 28, 2003 there were anti-dilutiveoptions to purchase 1,442,924 and 1,465,510 shares, respectively and for thenine months ended September 30, 2004 and September 28, 2003 there wereanti-dilutive options to purchase 1,372,676 and 1,394,526 shares,respectively.  These options wereexcluded from the computation of diluted earnings per share for the quartersended September 30, 2004 and September 28, 2003 and the nine-month periodsended September 30, 2004 and September 28, 2003 because the effect on netearnings per share is anti-dilutive.

 

**(6)****             ****STOCK BASED COMPENSATION**

 

The Company’s stock optiongrants are accounted for under the intrinsic value recognition and measurementprinciples of Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees,” and related interpretations.   No stock-based employee compensation cost isrecognized in net income or loss, unless the option price is less than thecurrent market price at the grant date. The following table illustrates theeffect on net income and earnings per share if the Company had applied the fairvalue recognition provisions of SFAS No. 123 “Accounting for Stock-BasedCompensation, “ to employee stock benefits.

 

7

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For purposes of this proforma disclosure, the estimated fair value of the options are assumed to beamortized to expense over the options’ vesting periods (in thousands, exceptper share amounts).

 
| ** **                                      | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** |
|                                            |       |                    |       |                    |       |   |   |   |   |
| Net (loss) as reported                          |       | $                       | (1,745     | )                       | $          | (2,045 | ) | $ | (3,068 | ) | $ | (6,829 | ) |
| Fair value-based compensation cost, net of  tax |       | (300                    | )          | (277                    | )          | (878 | ) | (1,151 | ) |
| Pro forma net loss                              |       | $                       | (2,045     | )                       | $          | (2,322 | ) | $ | (3,946 | ) | $ | (7,980 | ) |
|                                            |       |                    |       |                    |       |   |   |   |   |
| Basic (loss) per share:                         |       |                    |       |                    |       |   |   |   |   |
| As reported                                     |       | $                       | (0.19      | )                       | $          | (0.22 | ) | $ | (0.33 | ) | $ | (0.73 | ) |
| Pro forma                                       |       | (0.22                   | )          | (0.25                   | )          | (0.42 | ) | (0.86 | ) |
|                                            |       |                    |       |                    |       |   |   |   |   |
| Diluted (loss) per share:                       |       |                    |       |                    |       |   |   |   |   |
| As reported                                     |       | $                       | (0.19      | )                       | $          | (0.22 | ) | $ | (0.33 | ) | $ | (0.73 | ) |
| Pro forma                                       |       | (0.22                   | )          | (0.25                   | )          | (0.42 | ) | (0.86 | ) |

 

**(7)****             ****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. Foreigncurrency translation adjustments for nine months ended September 30, 2004resulted in a currency translation gain due to the strengthening of the UnitedStates Dollar to the Euro during the period.

 

For the Company,comprehensive loss includes only net income (loss) and foreign currencytranslation adjustments as follows (in thousands):

 
| ** **                               | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** |
|                                     |       |                    |       |                    |       |   |   |   |   |
| Net (loss)                               |       | $                       | (1,745     | )                       | $          | (2,045 | ) | $ | (3,068 | ) | $ | (6,829 | ) |
| Foreign currency translation adjustments |       | (39                     | )          | (51                     | )          | 88 |   | 70 |   |
| Comprehensive (loss)                     |       | $                       | (1,784     | )                       | $          | (2,096 | ) | $ | (2,980 | ) | $ | (6,759 | ) |

 

**(8)****             ****SEGMENT AND CUSTOMER INFORMATION**

 

TheCompany operates in a single industry segment: the design, manufacture andmarketing of specialty digital imaging systems and other medical devicesprimarily used in screening, diagnostic and interventional procedures. TheCompany manufactures its products in the United States and distributes them inthe United States, Europe and elsewhere.  The Company’s chief operating decision maker uses consolidated resultsto make operating and strategic decisions.

 

Internationally,the Company markets and supports its products primarily through it subsidiariesand various dealers.  Revenues areattributed to geographic areas based on the location of the customer.  International long-lived assets are locatedin Switzerland.  The following tablerepresents a summary of revenues and long-lived assets (in thousands):

 

8

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| ** **          | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|---------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **          | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** |
|                |       |                    |       |                    |       |   |   |   |   |
| Revenues:           |       |                    |       |                    |       |   |   |   |   |
| United States       |       | $                       | 14,811     |                    | $          | 8,972 |   | $ | 37,328 |   | $ | 28,432 |   |
| Mexico              |       | 562                     |       | —                  |       | 7,306 |   | — |   |
| Other International |       | 2,428                   |       | 2,677                   |       | 4,952 |   | 4,766 |   |
| Total               |       | $                       | 17,801     |                    | $          | 11,649 |   | $ | 49,586 |   | $ | 33,198 |   |

 
| ** **              | ** ** | **As of**               |       | **As of**               |       |
|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** |   |
| Long-lived assets, net: |       |                    |       |                    |       |   |   |   |   |
| United States           |       | $                       | 3,514      |                    | $          | 3,207 |   | $ | 3,514 |   | $ | 3,207 |   |
| International           |       | 145                     |       | 675                     |       | 145 |   | 675 |   |
| Total                   |       | $                       | 3,659      |                    | $          | 3,882 |   | $ | 3,659 |   | $ | 3,882 |   |

 

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

 

Customersrepresenting greater than 10% of the Company’s revenue during any of thereporting periods:

 
| ** **                  | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** |
| Ethicon-Endo Surgery, Inc   |       | 4.7                     | %          | 8.7                     | %          | 4.8 | % | 6.0 | % |
| Intec Mexico,  S.A. de C.V. |       | 3.2                     | %          | 0.0                     | %          | 15.0 | % | 0.0 | % |
| Eastman Kodak               |       | 12.9                    | %          | 3.3                     | %          | 9.2 | % | 5.1 | % |

 

Revenuegrouped by similar products and services (in thousands):

 
| ** **                 | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** |
| Product Revenue:           |       |                    |       |                    |       |   |   |   |   |
| Digital Mammography        |       | $                       | 4,265      |                    | $          | 3,568 |   | $ | 17,461 |   | $ | 8,460 |   |
| Stereotactic Breast Biopsy |       | 6,626                   |       | 3,887                   |       | 13,468 |   | 11,053 |   |
| RE&S Products          |       | 2,819                   |       | 1,014                   |       | 7,381 |   | 4,101 |   |
| Service Revenue            |       | 4,091                   |       | 3,180                   |       | 11,276 |   | 9,584 |   |
| Total                      |       | $                       | 17,801     |                    | $          | 11,649 |   | $ | 49,586 |   | $ | 33,198 |   |

 

**(9)****             ****CONTINGENCIES**

 

**LegalProceedings**

 

In April 2003, FischerImaging Corporation reported to the Securities and Exchange Commission that itwould restate its financial results for the reporting periods beginningJanuary 1, 2000 and ending September 30, 2002. On June 9, 2003,the Company received notice of a formal order of investigation and subpoenafrom the Securities and Exchange Commission. This request followed thevoluntary disclosures that the Company made to the SEC beginning inApril 2003 and the creation of an independent board committee to reviewthe facts and circumstances underlying the Company’s decision to restatefinancial results.

 

9

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On November 15, 2004, theCompany entered into a settlement agreement with the U.S. Securities andExchange Commission arising out of the Commission's investigation of theCompany's reported financial results for the periods beginning January 1,2000 and ending September 30, 2002, which have since been restated by theCompany. In the settlement, the Company has agreed, without admitting or denyingthe allegations in the Commission's complaint, to the entry of a cease anddesist order against future violations of the antifraud, reporting,recordkeeping and internal controls provisions of the federal securities laws.The Commission's complaint alleges that the Company violated Section 17(a)of the Securities Act of 1933, Sections 10(b), 13(a), 13(b)(2)(A),13(b)(2)(B) and 13(b)(5) of the Securities Exchange Act of 1934, andRules 10b-5, 12b-20, 13a-1, 13a-13, and 13b2-1 thereunder. The Company isnot required to pay any civil penalties or fines as part of the settlement. TheCommission's investigation against other persons or entities who may have beeninvolved is ongoing. The administrative order containing the Commission'sallegations and the terms of the settlement with the Company is available atwww.sec.gov/litigation/admin.shtml.

 

OnApril 10, 2003 and on June 3, 2003, The Sorkin, LLC and James K.Harbert filed putative class action lawsuits against us and three of our formerofficers and directors, Morgan Nields, Gerald Knudson and Louis Rivelli, in theUnited States District Court for the District of Colorado. The complaints arepurportedly brought on behalf of purchasers of shares of the Company’s commonstock during the period February 14, 2001 to April 1, 2003 and allegethat, among other things, during the putative class period, the Company and theindividual defendants made materially false statements in violation ofSection 10(b) of the Exchange Act,Rule 10b-5 promulgated under the Exchange Act, andSection 20(a) of the Exchange Act. The complaints seek unspecifiedcompensatory damages and other relief. On August 7, 2003, the Company, andMessrs. Nields and Knudson moved to dismiss all claims asserted by TheSorkin, LLC and Mr. Harbert. On August 18, 2003, Mr. Rivelli moved todismiss all claims asserted in those lawsuits. On October 20, 2003,Mr. Harbert moved to dismiss his lawsuit, which the court subsequentlygranted. On October 21, 2003, The Sorkin, LLC and Mr. Harbert filedan amended class action complaint. The amended complaint contains the sameclaims for relief against us and Messrs. Nields and Rivelli, but does notassert any claims against Mr. Knudson. In addition, the amended complaintseeks to recover unspecified compensatory damages and other relief on behalf ofpurchasers of shares of our common stock during the period February 14,2001 to July 17, 2003. The Company, Mr. Nields and Mr. Rivellihave filed motions to dismiss all claims asserted in the amendedcomplaint.   The parties recently reachedagreement in principle to settle the case, which is subject to finaldocumentation and approval by the parties, court approval and receipt of thenecessary class consents. The Company believes any costs incurred under thissettlement will be covered by insurance.

 

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

 

10

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

 

**CautionaryLanguage**

 

This reportcontains forward-looking information that involves risk and uncertainties,including statements regarding our plans, objectives, expectations, andintentions.  Such statements include,without limitation, statements regarding various estimates we have made inpreparing our financial statements, statements regarding our expectationsrelating to increased digital mammography sales and our geographical mix ofsales, as well as statements regarding expected future trends relating to ourresults of operations and the sufficiency of our liquidity and access toadditional capital resources.  Theseforward-looking statements are subject to known and unknown risks anduncertainties that could cause actual results to differ materially from those anticipated.  Factors that could cause actual results tomaterially differ include, without limitation, our ability to implement ouroperating plan intended to return the company to positive cash flow fromoperations which involves increasing revenues and improving operatingefficiencies; the impact of continuing losses on our liquidity, and our need totake action to enhance liquidity; our reliance on a single source of supply forsome key components of our products as well as the need to comply withespecially high standards for those components in the manufacture of ourSenoScanâ product;uncertainties inherent in the development of new products and the enhancementof existing products, including technical and regulatory risks, cost overrunsand delays; the risk that newly introduced products may contain undetectederrors or defects or otherwise not perform as anticipated; our ability topredict accurately the demand for our products and to develop strategies toaddress our markets successfully; the early stage of market development fordigital X-ray products; risks relating to compliance with financial covenantsunder our line of credit facility; technical innovations that could renderproducts marketed or under development by us obsolete; competition; andreimbursement policies for the use of our products.   Other factors that could adversely affectour business and prospects are described in our filings with Securities andExchange Commission, including our Form 10-K for the year ended December 31,2003.  Except as otherwise required bylaw, we expressly disclaim any obligation or undertaking to release publiclyany updates or revisions to any such statements to reflect any change in ourexpectations or any change in events, conditions or circumstances on which anysuch statement is based.

 

**CriticalAccounting Policies**

 

Critical accounting policiesare those that are most important to the portrayal of our financial conditionand operating results, and require management to make its most difficult andsubjective judgments, often as a result of the need to make estimates onmatters that are inherently uncertain. These judgments are based on ourhistorical experience, terms of existing contracts, our observance of trends inthe industry, information provided by our customers and information availablefrom other outside sources, as appropriate. Actual results may differ fromthese estimates under different assumptions or conditions.

 

The critical accountingpolicies that we believe affect the more significant judgments and estimatesused in the preparation of our consolidated financial statements presented inthis report are described in the Management’s Discussion and Analysis ofFinancial Condition and Results of Operations included in our Annual report onForm 10-K for the fiscal year ended December 31, 2003. There havebeen no material changes to our critical accounting policies, as described inthat Form 10-K.

 

**Overview**

 

We design, manufacture andsell innovative mammography and digital imaging products used in the diagnosisof breast cancer and other diseases. Our two primary breast cancer products areour MammoTestâ stereotactic breast biopsy system, which weintroduced in 1988, and our SenoScanâ digital mammography system, introduced inlate 2001.  MammoTestâ is a mature product, and while we haveintroduced, and intend to continue to introduce, continued improvements to thesystem, it is not expected to provide significant growth in revenue goingforward. We believe SenoScanâ has significant potential for growth asdigital mammography gains acceptance over traditional x-ray film mammography.Our ability to grow SenoScanâ sales and capture market share in thisemerging digital market is critical to our success. SenoScanâ was approved by the Food and DrugAdministration (FDA) for sale in 2001 and since then we have invested, and willcontinue to invest, significant resources to enhance performance and features,as it becomes a more mature product line. We also reinitiated our effortsduring late 2002 to market and sell our Electrophysiology and VersaRad X-rayproducts to the general radiology market.  In addition to our product sales, we provide services for installationand application training at the time our products are installed at the customer’slocation. We also sell parts and provide maintenance services under our limitedwarranties, under long-term contracts, and at hourly rates.

 

The Companyincurred significant losses and had negative cash flows from operations during2003.  We incurred a $8.2 million lossfrom operations and a $3.1 million net loss for the nine-month period endedSeptember 30, 2004.  We are activelypursuing an operating plan intended to return the company to sustainablepositive cash flow from operations.   Keycomponents of this plan include increasing revenues and improving our operatingefficiencies to reduce cost of sales, thereby improving gross margins, andlowering our

 

11

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overall operating costs as apercentage of revenues. Our future revenue growth and success depends largelyupon increasing sales of our SenoScan® product and further expanding the numberof strategic corporate relationships to broaden our products’ reach. We areundertaking a number of steps to improve the performance and reliability of ourSenoScanâ product and to advance our technologyfor digital imaging, which we believe has the potential to foster a significantincrease in product revenues.  Some ofthese steps include redesigning parts and components to our products, providingupgrades and enhancements to our image and workflow management software andintroducing new review workstations.  Wehave also begun implementing manufacturing and supply chain processimprovements that we believe will result in reducing cost of sales on ourproducts.  Although these effortscommenced in early 2004, we do not anticipate that the full impact of theimproved performance and reliability and the resultant increase in productrevenues and improvement in product gross margins will be realized until atleast mid-2005.  We expect our servicerevenue to increase, as the installed base for our products continues toincrease, such that our service revenues become more in line with our servicecost infrastructure.  Gross marginimprovements for our service organization are also dependent upon successfulimplementation of performance and reliability improvements.  Accordingly, the full impact on servicemargin improvements due to performance and reliability enhancements may not berealized until at least mid-2005.  Ouroperating plan includes reducing our overall operating costs as a percentage ofrevenue as we do not expect to continue incurring costs associated with therestatement of our financial statements or costs to further expand our Europeanoperations. We expect to continue investing resources to build anorganizational infrastructure to support our business objectives and continuemeeting corporate governance requirements. We will, if necessary, scale backour expenditures in order to maintain our financial liquidity.  As it will take time to completely executeour strategic and operating initiatives and to realize the positive effect onour business operations, we expect to continue incurring operating losses into2005.  See “Liquidity and CapitalResources” below for a discussion of the implications of continuing losses onour liquidity.

 

Although we have experienced some improvement in the performance andreliability of the SenoScanâ product as a result of the implementation ofsome of our strategic and operational initiatives during 2004, our SenoScanâsales bookings and backlog decreased inthe third quarter.  The decrease inoverall U.S. domestic and European sales backlog at September 30, 2004, to $8.9million from $11.4 million at December 31, 2003 has been influenced byunanticipated program delays in the introduction of performance enhancementsfor the SenoScanâ product.  We have continued to experience sub-component supply difficulties duringthe third quarter of 2004, specifically related to the supplier of detectorsfor our SenoScanâ product. Consequently, we have experienced unanticipated delays in productionthat have prevented us from meeting some of our customer requested deliverydates.  As a result of this issue we haveincurred additional costs in manufacturing, shipping and installation and webelieve we have lost sales opportunities to our competitors.  During the second quarter of 2004, weregained the authorization to CE Mark our MammoTest® units for shipment toEurope.  Shipments resumed in May 2004.

 

We incurred a net loss of$1.7 million for the quarter ended September 30, 2004 compared to a net loss of$2.0 million for the quarter ended September 28, 2003.  The $0.3 million improvement in net incomeduring the third quarter of 2004 compared to the third quarter of 2003 was dueto $1.1 million improvement in product margins, partially offset by $0.8million increase in operating expenses. The $1.1 million gross margin improvement in third quarter of 2004, ascompared to the third quarter of 2003, was attributable to a $6.2 millionincrease in total revenues to $17.8 million in the third quarter of 2004 from$11.6 million in the third quarter of 2003. Due to higher product sales volume in the third quarter of 2004, ascompared to the third quarter of 2003, we generated an additional $0.7 millionproduct gross margin.  Additionally, we incurreda $0.4 million lower negative margin on service operations due to higherservice revenue.  The negative margingenerated by our service operations reflects our continuing issues with productperformance due to parts and components reliability.

 

In April 2004, wecompleted our restatement effort and the associated costs for legal fees, auditfees, consultants and contractors are no longer being incurred.

 

For thenine-month period ended September 30, 2004 we have recognized revenue totaling$7.3 million for a non-domestic sale shipped in December 2003.  Of the total $9.0 million non-domesticshipment in December 2003, $0.6 million was recognized as revenue in 2003, $7.3million was recognized during the nine-month period ended September 30, 2004and $1.1 million has not been recognized as revenue because it does not yetmeet our revenue recognition criteria.

 

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**Results ofOperations**

 

The following table setsforth the percentage of revenues represented by certain data included in ourstatements of operations for the periods indicated:

 
| ** **                 | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **September 30,  2004** | ** ** | **September 28,  2003** | ** ** | **September 30,****2004** | ** ** | **September 28,  2003** | ** ** |
| Revenues:                  |       |                    |       |                    |       |   |   |   |   |
| Product  revenues          |       | 77.0                    | %          | 72.7                    | %          | 77.3 | % | 71.1 | % |
| Service  revenues          |       | 23.0                    |       | 27.3                    |       | 22.7 |   | 28.9 |   |
| Total revenues             |       | 100.0                   |       | 100.0                   |       | 100.0 |   | 100.0 |   |
| Cost of sales:             |       |                    |       |                    |       |   |   |   |   |
| Products                   |       | 49.9                    | %          | 37.9                    | %          | 53.7 | % | 46.4 | % |
| Services                   |       | 27.0                    |       | 36.4                    |       | 26.2 |   | 30.4 |   |
| Research and development   |       | 9.7                     |       | 8.1                     |       | 8.7 |   | 10.2 |   |
| Selling and marketing      |       | 12.7                    |       | 17.6                    |       | 15.8 |   | 18.9 |   |
| General and administrative |       | 10.5                    |       | 17.9                    |       | 12.2 |   | 17.7 |   |
| Loss from operations       |       | (9.8                    | )          | (17.9                   | )          | (16.6 | ) | (23.6 | ) |
| Other income, net          |       | 0.0                     |       | 0.5                     |       | 10.4 |   | 3.0 |   |
| Net (loss) income          |       | (9.8                    | )%         | (17.4                   | )%         | (6.2 | )% | (20.6 | )% |

 

**ProductRevenues**

 

Total revenuesincreased 53.4% to $17.8 million for the quarter ended September 30, 2004 from$11.6 million for the quarter ended September 28, 2003.  Product revenues increased 61.2% to$13.7 million in the third quarter of 2004 from $8.5 million in thethird quarter of 2003. SenoScan® digital mammography product revenueincreased 19.4% or $0.7 million to $4.3 million in the third quarter of 2004from $3.6 million in third quarter of 2003. The increase in sales reflects a 59.4% or $2.1 million price increasepartially offset by a 25.0% or $1.4 million volume decrease.  The price increase in the third quarter of2004 compared to the third quarter of 2003 is due to sales of units in thethird quarter of 2004 that include more favorably priced configurations,options and software.  Third quarter 2004revenues include a $0.6 million non-domestic sale installed during the quarterthat was shipped in December 2003. Revenues from our MammoTest® breast biopsy products increased69.2% or $2.7 million to $6.6 million in the third quarter of 2004 from$3.9 million in the third quarter of 2003. The increase in MammoTest®product revenue is primarily due to 73.9% or $2.8 million volume increase.  The increase in MammoTest® unitssold during the third quarter of 2004 as compared to the third quarter of 2003is primarily due to stronger demand for the product. The RE&S productsincreased $1.8 million to $2.8 million in the third quarter of 2004 from $1.0million in the third quarter of 2003. The sales increase on RE&S products in the third quarter of 2004, ascompared to the third quarter of 2003 was primarily due to 700.0% or $1.8 millionvolume increase in VersaRad® x-ray products as a result ofdistributor agreement entered into during the first quarter of 2004.

 

Total revenuesincreased 49.4% to $49.6 million for the nine-month period ended September 30,2004 from $33.2 million for the nine-month period ended September 28,2003.   Product revenues increased 62.3%to $38.3 million in the nine-month period ended September 30, 2004 from$23.6 million in the nine-month period ended September 28, 2003. SenoScan®product revenue increased 105.9% or $9.0 million to $17.5 million in thenine-month period ended September 30, 2004 from $8.5 million in the nine-monthperiod ended September 28, 2003.  Theincrease in SenoScan® sales in the nine-month period ended September30, 2004 as compared to the nine-month period ended September 28, 2003 reflectsa 55.8% or $4.7 million volume increase coupled with a 32.5% or $2.7 millionprice increase.  The price increase inthe nine-month period ended September 30, 2004 compared to the nine-monthperiod ended September 28, 2003 is due to sales of units in the nine-monthperiod of 2004 that include more favorably priced configurations,  options and software.  Revenues for the nine-month period endedSeptember 30, 2004 include a $7.3 million non-domestic sale installed in theperiod that was shipped in December 2003. The non-domestic sale accounts for 89.7% of the volume increase in thenine-month period ended September 30, 2004 compared with the nine-month periodended September 28, 2003.  The pricing onthis non-domestic sale was more favorable than that of our domestic SenoScan®sales, which increased by 13.5%.   Ourdomestic SenoScan® sales volumes increased 5.8% in the nine-monthperiod ended September 30, 2004, as compared to the nine-month period endedSeptember 28, 2003 reflecting relatively flat market demand.  Of the fourth quarter 2003 shipment to anon-domestic customer, $1.1 million has not yet met our revenue recognitioncriteria and is included in our September 30, 2004 sales backlog.  We continue to experience difficulties withmaterial availability, assembly and installation of SenoScan®systems, which have affected and will continue to affect our revenues andliquidity.   As discussed below, ourbacklog at September 30, 2004 has been adversely affected by these issues.

 

13

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Our MammoTest®product revenue increased 21.6% or $2.4 million to $13.5 million in thenine-month period ended September 30, 2004 from $11.1 million in thenine-month period ended September 28, 2003. The 21.6% increase in MammoTest®product revenue reflects a 29.5% or $3.3 million volume increase offset by a5.9% or $0.7 million pricing decrease. The increase in MammoTest® units sold, as well as the lowerpricing in the nine-month period ended September 30, 2004, as compared to thenine month period ended September 28, 2003 is primarily due to a promotionalprogram in 2004 to upgrade the installed base. The RE&S product salesduring the nine-month period ended September 30, 2004 increased $3.3 million to$7.4 million from $4.1 million in the nine-month period ended September 28,2003.  The sales increase in the RE&Sproducts in the nine month period ended September 30, 2004, as compared to thenine month period ended September 28, 2003 was primarily due to 175.0% or $3.0million volume increase in VersaRad® x-ray products, partiallyoffset by $10.5% or $0.2 million decrease in pricing as a result of distributoragreement entered into during the first quarter of 2004 and $0.3 million highervolume for the EP products.

 

**ServiceRevenues**

 

Our service revenues for thequarter ended September 30, 2004 increased 28.1% to $4.1 million from $3.2million during the comparable quarter in 2003. Service revenues for the nine-month period ended September 30, 2004increased 17.7% to $11.3 million from $9.6 million in the comparable period in2003.  The increases in the three-monthperiod and nine-month period ended September 30, 2004 in relation to the comparableperiods in 2003 are primarily due to higher number of MammoTestâ and SenoScanâ units on service contracts in both the USand Europe.

 

**Cost ofSales—Products**

 

Cost of sales for productsin the third quarter of 2004 was $8.9 million or 64.8% of product revenuescompared to $4.4 million or 52.2% of product revenues in the third quarterof 2003. The overall increase in cost of product sales, as a percentageof product revenues is primarily due to a $1.6 million increase inmanufacturing and repair costs.

 

Cost of salesfor products in the nine-month period ended September 30, 2004 was $26.6million or 69.5% of product revenues compared to $15.4 million or 65.3% ofproduct revenues, in the nine-month period ended September 28, 2003.  The overall increase in cost of productsales, as a percentage of product revenue is primarily due to a $0.7 millionincrease in manufacturing and repair costs and a $0.9 million higher warrantyprovision for a non-domestic sale because the product warranty provided to thecustomer is longer than the 12-month standard warranty period.

 

**Cost ofSales—Service**

 

Cost of sales for servicesfor the quarter ended September 30, 2004 increased 14.3% to $4.8 millionfrom $4.2 million in the quarter ended September 28, 2003.  As a percent of service revenues, cost ofservice sales decreased to 117.4% in the third quarter of 2004 from 133.5% inthe third quarter of 2003.  Of thisincrease, $0.3 million relates to parts costs and $0.3 million relates to staffingadditions to support and service our increased installed base.  The US MammoTest® and SenoScan® units underwarranty and service contract support increased 26% and 134%, respectively, inthe third quarter of 2004 compared to the third quarter of 2003.

 

Cost of sales for servicesfor the nine-month period ended September 30, 2004 increased 28.7% to$13.0 million from $10.1 million for the nine-month period ended September28, 2003.  As a percent of servicerevenues, cost of service sales increased to 115.4% in the nine-month periodended September 30, 2004 compared to 105.2% for the nine-month period endedSeptember 28, 2003. Of this increase $2.0 million relates to parts costs and$0.8 million relates to staffing additions to support and service our increasedinstalled base.  The US MammoTest® andSenoScan® units under warranty and service contract support increased 34% and 152%,respectively, in the nine-month period ended September 30, 2004 compared to thenine-month period ended September 28, 2003.

 

**Researchand Development Expenses**

 

Research and developmentexpenses increased 88.8% to $1.7 million in the quarter ended September30, 2004 from $0.9 million in the quarter ended September 28, 2003. Wespent 9.6% of revenue on research and development in the third quarter of 2004compared to 8.1% in the third quarter of 2003. Our employee compensation costs increased $0.2 million or 32.3% as weincreased our staffing levels in software development and engineering to focuson redesigning older products for improved reliability and serviceability andenhancing the features, functionality and reliability of our SenoScanâ product. To support these redesign and product development efforts currentlyunderway, contract engineering services increased $0.4

 

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million and expenditures forresearch and development materials increased $0.1 million.

 

Research and developmentexpenses increased 26.5% to $4.3 million for the nine-month period endedSeptember 30, 2004 from $3.4 million in the nine-month period endedSeptember 28, 2003. We spent 8.7% of revenue on research and development forthe nine-month period ended September 30, 2004 compared to 10.2% of revenue forthe nine-month period ended September 28, 2003. Our employee compensation costs increased $0.4 million or 19.7% as weincreased our staffing levels in software development and engineering to focuson redesigning older products for improved reliability and serviceability andenhancing the features, functionality and reliability of our SenoScanâ product.  To support these redesign and product development efforts currentlyunderway, contract engineering services increased $0.6 million and expendituresfor research and development materials increased $0.1 million.  These increases in our operating costs duringthe nine-month period ended September 30, 2004 were partially offset by $0.2million reimbursement of funding from research grants.

 

**Selling andMarketing Expenses**

 

Selling and marketingexpenses increased 15.0% to $2.3 million in the quarter ended September30, 2004 from $2.0 million in the quarter ended September 28, 2003. Wespent 12.7% of revenue on selling and marketing expenses in the third quarterof 2004 compared to 17.6% in the third quarter of 2003.  Our expenditures for trade shows andconventions increased $0.2 million in preparation of the annual RadiologicalSociety of North America trade show in November 2004 and commissions increased$0.4 million due to higher sales volume. These increases in operating expenses were partially offset by $0.2million decrease in salaries and wages and $0.1 million decrease in travelrelated costs due to lower sales personnel headcount in 2004 as compared to2003.

 

Selling and marketingexpenses increased 23.8% to $7.8 million in the nine-month period endedSeptember 30, 2004 from $6.3 million in the nine-month period endedSeptember 28, 2003.  Our selling andmarketing expenses, as a percent of sales decreased to 15.8% of revenues in thenine-months ended September 30, 2004 from 18.9% of revenues in the nine-monthsended September 28, 2003.  Of the totalspending increase, $1.3 million relates to commission on non-domestic sales in2004, $0.5 million relates to commission on higher domestic sales and $0.1million relates to increased marketing and promotional efforts.  These spending increases were partiallyoffset by $0.4 million decrease in salaries and wages due to lower salespersonnel headcount in 2004 as compared to 2003.

 

**General andAdministrative Expenses**

 

General andadministrative expenses decreased 9.5% to $1.9 million in the quarterended September 30, 2004 from $2.1 million in the quarter ended September28, 2003.  Our spending for audit feeswas $0.5 million lower in the third quarter of 2004, as compared to the thirdquarter of 2003, because the restatement effort that started in the firstquarter of 2003 was completed in April of 2004. We continued to incur legal costs associated with the class actionlawsuit and the SEC investigation and such spending was $0.1 million higherthan the same period of 2003.  Inaddition, we experienced $0.1 million higher insurance costs in the quarter dueto renewal of our policies in May 2004.

 

General andadministrative expenses increased 1.7% to $6.0 million in the nine-monthperiod ended September 30, 2004 from $5.9 million in the nine-month periodended September 28, 2003.  In the ninemonths ended September 30, 2004, as compared to the nine months ended September28, 2003, we incurred $0.5 million higher legal costs associated with therestatement, the class action lawsuit and the SEC investigation, $0.3 millionhigher insurance costs associated with the renewal of our policies and $0.1million higher spending for printing the restated financial statements andholding the annual shareholders’ meeting. These increases were partially offset by a $0.6 million decrease inaudit fees due to completion of restatement in April of 2004 and $0.2 milliondecrease in travel expenses as result of cost containment efforts.

 

**InterestExpense/Interest Income**

 

Interest expense for thequarter ended September 30, 2004 increased to $13,000 from $5,000 for thequarter ended September 28, 2003 and interest expense for the nine-month periodended September 30, 2004 increased to $33,000 from $18,000 for the nine monthperiod ended September 28, 2003.  These increasesare due to the financing of our insurance premiums. Interest income during thequarter ended September 30, 2004 decreased to $1,000 from $3,000 in thecomparable quarter of 2003 and interest income during the nine-month periodended September 30, 2004 decreased to $3,000 from $33,000 during the comparableperiod in 2003.  These decreases ininterest income are due to the lower cash balances in 2004.

 

**OtherIncome**

 

During the second quarter of2002, we settled a patent infringement lawsuit and $7.2 million of thesettlement was scheduled to be received in equal annual installments of $0.9million over the remaining eight-year life of the associated

 

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patents.  We recognized an other income item in theamount of $0.9 million during both the second quarter of 2003 and 2004.  On June 2, 2004 we amended the settlementagreement, received a one-time accelerated payment totaling $4.3 million inlieu of the six remaining $0.9 million payments that were due annually through2010 and recognized the one-time payment as an other income item.

 

**IncomeTaxes**

 

We estimated that we wouldnot owe taxes for the nine-month period ended September 30, 2004 and the yearended December 31, 2003. Accordingly, no income tax benefit or provisionwas recorded. This was determined based upon the anticipated 2004 results ofoperations and an available net operating loss carry-forward of$30.1 million at December 31, 2003. As of December 31, 2003 wehad a 100% valuation allowance against our deferred tax asset of$16.2 million that resulted in a net deferred tax asset of $0.

 

**Liquidityand Capital Resources**

 

As of September 30, 2004, wehad $1.7 million in cash and $6.5 million in working capital comparedto $1.4 million in cash and $9.4 million in working capital atDecember 31, 2003.  The $2.9 milliondecrease in our working capital reflects funding for a portion of our $8.2million loss from operations for the nine-month period ended September 30,2004.  The remainder of the $8.2 millionloss from operations was funded by the $4.3 million accelerated settlementpayment received in the second quarter of 2004 and $0.8 million non-cashcharges for depreciation and amortization.

 

Our operating activitiesgenerated $1.4 million of cash for the nine-month period ended September 30,2004. Our net loss of $3.1 million, reflecting the favorable impact ofthe $4.3 million accelerated patent infringement payment received in June 2004and recognized as other income, was funded by $0.8 million non-cash charges fordepreciation and amortization and $3.7 million change in operating assets andliabilities.  Our $3.7 million net changein current assets and current liabilities consists primarily of $0.2 million decreasein inventories, $1.7 million increase in warranty obligation due to longerwarranty period provided on units sold in Mexico, $2.3 million increase in ourpayables policy to pay our obligations no earlier than they are due, $0.4million increase in deferred revenue due to prepayment of service contracts and$0.4 million increase in other current liabilities.  These sources of funds were partially offsetby a $1.1 million increase in accounts receivable due to stronger sales and$0.3 million decrease in customer deposits to $3.7 million at September 30,2004 from $4.1 million at December 31, 2003 due to a lower backlog.  We typically receive deposits in connectionwith sales of large systems to direct customers and the downturn in bookings andbacklog has adversely affected our liquidity.

 

We used $1.0 million ofcash in our investing activities during the nine months ended September 30,2004 for capital expenditures to support efforts in manufacturing and researchand development, as well as the purchase of office equipment for staff additions.

 

In June 2003, weentered into an $8.0 million credit facility, subject to restrictionsbased on eligible receivables. The amount available under the credit facilityat September 30, 2004 was approximately $6.1 million. As amended, this credit agreementexpires on December 9, 2004, and is secured by all of our assets.Borrowings under the agreement bear interest at the bank’s prime rate, plus2.75%, with a minimum total interest rate of 7%.  The credit facility requires the Company tocomply with a tangible net worth covenant. As amended on July 27, 2004, the tangible net worth covenant wasmodified to $4.0 million from $10.0 million, effective April 1, 2004, and thebank waived the Company’s non-compliance with this covenant through March 31,2004.  If we do not maintain compliancewith the tangible net worth covenant any outstanding borrowings may beimmediately due, the amount available under the credit facility may be furtherreduced or we may not be permitted to make borrowings against the facility. As of September 30, 2004 andDecember 31, 2003, there were no outstanding borrowings under thefacility.  In November 2004, we borrowed$1.6 million against this credit facility. We are currently negotiating a line of credit arrangement to replace theexisting credit facility upon its expiration.

 

We expect to continueincurring operating losses into 2005 as it will take time for our strategic andoperating initiatives to have a positive effect on our businessoperations.  We have developed anoperating plan intended to return the company to positive cash flow fromoperations.  Please see “Overview” abovefor discussion of that plan.

 

We believe that our balancesof cash, cash flows expected to be generated by future operating activities,and amounts available under our credit facility may not be sufficient to meetour cash requirements over the next twelve months and we may require additionalfinancing.  To meet our working capitalrequirements we may need to raise additional funds through the sale of equitysecurities, the incurrence of indebtedness, through funds derived throughentering into collaborative agreements with third parties or throughdivestiture of product lines.   Inaddition, we may be required to reduce our sales and marketing activities,reduce the scope of or eliminate our research and development programs, orrelinquish rights to technologies or

 

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products that we mightotherwise seek to develop or commercialize.

 

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

 

**Backlog**

 

As of September 30, 2004, wehad backlog of $10.0 million, including $1.1 million related to a large orderfrom a non-domestic customer that shipped in December 2003.  The revenue associated with this non-domesticorder was not recorded at September 30, 2004 because our criteria for revenuerecognition had not been met.    As ofDecember 31, 2003 we had backlog of $19.8 million, which included $8.4 millionrelated to the non-domestic order discussed above.  The decrease in backlog is partiallyattributable to recognition of revenue totaling $7.3 million on the large orderfrom a non-domestic customer and a $2.5 million decrease in domestic andEuropean sales orders.  The $2.5million decrease in U.S. domestic and European sales backlog at September 30,2004 to $8.9 million from $11.4 million at December 31, 2003 has beeninfluenced by unanticipated program delays in the introduction of performanceenhancements for the SenoScanâ product.   Of the $10.0 million backlog as of September30, 2004, it is expected that $9.4 million will be filled in the fourth quarterof 2004 and $0.6 million will be filled in the first quarter of 2005.

 

**Item 3.   Quantitative and QualitativeDisclosures About Market Risk**

 

**ForeignCurrency Risk**

 

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

 

We are exposed to foreigncurrency risks through our subsidiary operations in Switzerland and Germany. AtSeptember 30, 2004 and December 31, 2003 we had cash, receivables andcurrent liabilities that represent a net asset balance denominated in Euros of$1.3 million and $1.9 million, respectively. We do not employ any riskmitigation or hedging techniques with respect to amounts exposed tofluctuations in foreign currency exchange rates.

 

**Interest Rate Risk**

 

We have no variable ratedebt outstanding as of September 30, 2004 or December 31, 2003 so we are notexposed to interest expense risk.  We dohave short-term investments in low risk and no risk financial instruments,which are readily convertible into cash, which earn interest at variablerates.   At times, cash balances with ourfinancial institution exceed FDIC insurance limits.

 

**Item 4.    Controls and Procedures**

 

In early 2003, we identifiedseveral accounting inaccuracies and errors that significantly affected ourpreviously reported financial results. Under the direction of our Board ofDirectors, and primarily our Audit Committee, we completed a comprehensiveanalysis of our accounting policies and practices and a restatement of ourpreviously reported financial results for 2000, 2001 and nine months endedSeptember 29, 2002. Our former auditors, Ernst & Young LLP,completed a re-audit of our consolidated financial statements for 2000 and 2001and have also performed an audit of our 2002 and 2003 annual financialstatements. See our annual report for 2002 filed on Form 10-K for adetailed description of our internal review and restatement of our financialstatement.

 

As a result of our internalreview, our Chief Executive Officer concluded that our disclosure controls andprocedures (as defined in Rules 13a-14 and 15d-14 under the SecuritiesExchange Act of 1934) were not effective during 2003, and, as a result, we werenot able to timely file all reports required to be filed by us pursuant toSection 15(d) of the Securities Exchange Act of 1934. Our inability totimely file the required reports was due to, among other things, the fact thatmanagement’s time and attention had been consumed by the auditing andre-auditing of our financial statements for the years ended December 31,2003, 2002, 2001 and 2000 and the resulting restatements in 2001 and 2000.

 

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However, we implementedactions and modifications to our disclosure controls and procedures in aneffort to correct the deficiencies and weaknesses. As a result, we carried outan evaluation, under the supervision and with the participation of our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined inRules 13a-14 and 15d-14 under the Securities Exchange Act of 1934) as ofSeptember 30, 2004. Our disclosure controls and procedures are designed withthe objective of ensuring that information required to be disclosed in ourreports filed under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms. Based on this evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures areeffective in alerting them to material information required to be included inour periodic SEC reports.

 

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**PART II.OTHER INFORMATION**

 

**Item 1.Legal Proceedings:**

 

InApril 2003, we reported to the Securities and Exchange Commission that wewould restate our financial results for the reporting periods beginningJanuary 1, 2000 and ending September 30, 2002. On June 10, 2003,we received notice of a formal order of investigation and subpoena from theSecurities and Exchange Commission. This request followed the voluntary disclosuresthat we made to the SEC beginning in April 2003 and the creation of anindependent board committee to review the facts and circumstances underlyingour decision to restate financial results. On November 15, 2004, the Companyentered into a settlement agreement with the U.S. Securities and ExchangeCommission arising out of the Commission's investigation of the Company'sreported financial results for the periods beginning January 1, 2000 andending September 30, 2002, which have since been restated by the Company.In the settlement, the Company has agreed, without admitting or denying theallegations in the Commission's complaint, to the entry of a cease and desistorder against future violations of the antifraud, reporting, recordkeeping andinternal controls provisions of the federal securities laws. The Commission'scomplaint alleges that the Company violated Section 17(a) of the SecuritiesAct of 1933, Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) ofthe Securities Exchange Act of 1934, and Rules 10b-5, 12b-20, 13a-1,13a-13, and 13b2-1 thereunder. The Company is not required to pay any civilpenalties or fines as part of the settlement. The Commission's investigationagainst other persons or entities who may have been involved is ongoing. Theadministrative order containing the Commission's allegations and the terms of thesettlement with the Company is available at www.sec.gov/litigation/admin.shtml.

 

On April 10, 2003 andon June 3, 2003, The Sorkin, LLC and James K. Harbert filed putative classaction lawsuits against us and three of our former officers and directors,Morgan Nields, Gerald Knudson and Louis Rivelli, in the United States DistrictCourt for the District of Colorado. The complaints are purportedly brought onbehalf of purchasers of shares of our common stock during the periodFebruary 14, 2001 to April 1, 2003 and allege that, among otherthings, during the putative class period, we and the individual defendants madematerially false statements in violation of Section 10(b) of the ExchangeAct, Rule 10b-5 promulgated under the Exchange Act, and Section 20(a)of the Exchange Act. The complaints seek unspecified compensatory damages andother relief.  On August 7, 2003,we, and Messrs. Nields and Knudson moved to dismiss all claims asserted byThe Sorkin, LLC and Harbert.  OnAugust 18, 2003, Mr. Rivelli moved to dismiss all claims asserted inthose lawsuits. On October 20, 2003, Mr. Harbert moved to dismiss hislawsuit, which the court subsequently granted. On October 21, 2003, TheSorkin, LLC and Mr. Harbert filed an amended class action complaint. Theamended complaint contains the same claims for relief against us andMessrs. Nields and Rivelli, but does not assert any claims againstMr. Knudson. In addition, the amended complaint seeks to recoverunspecified compensatory damages and other relief on behalf of purchasers ofshares of our common stock during the period February 14, 2001 toJuly 17, 2003. The Company, Mr. Nields and Mr. Rivelli have filedmotions to dismiss all claims asserted in the amended complaint.  The parties recently reached agreement inprinciple to settle this case, which is subject to final documentation andapproval by the parties, court approval and receipt of the necessary classconsents.  The Company believes any costsincurred under this agreement to settle will be covered by insurance.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds:**   Not applicable.

 

**Item 3.Defaults Upon Senior Securities:**   Not applicable.

 

**Item 4.Submission of Matters to a Vote of Security Holders:**   Not applicable.

 

**Item 5.Other Information:**   Notapplicable.

 

**Item 6.Exhibits:**

 

**(a)   Exhibits:**

 

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

 
| **Exhibit  Number** |   | **Description of Exhibit**                                                                                                                     |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.21               |   | Master Purchasing  Agreement between the Company and Philips Medical Systems DMC GmbH dated October  14, 2004.                                 |
| 31.1                |   | Certification of Harris  Ravine, 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 SECRelease 33-8212 these exhibits are furnished with the Quarterly Report on Form10-Q and are not deemed filed with the Securities and Exchange Commission andare not incorporated by reference in any filing of Fischer Imaging Corporationunder the Securities Exchange Act of 1933 or the Exchange Act of 1934, whethermade

 

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before or after the datehereof and irrespective of any general incorporation language in such filings.

 

 

**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
| Date: November 15, 2004 | FISCHER IMAGING  CORPORATION |
|-------------------------|------------------------------|
|                    |                         |   | /s/   HARRIS  RAVINE | * * |
|                    |                         |   | Harris Ravine |   |
|                    |                         |   | *Chief  Executive Officer and President* |   |
| Date: November 15, 2004 |                         |   |   |   |
|                    |                         |   | /s/   DAVID  KIRWAN | * * |
|                    |                         |   | David Kirwan |
|                    |                         |   | *Chief  Financial Officer* |

 

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