UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
|
For
the quarterly period ended September 30, 2008
|
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 0–29486
MERGE
HEALTHCARE INCORPORATED
(Exact
name of Registrant as specified in its charter)
Wisconsin
|
|
39–1600938
|
(State
or other jurisdiction
of
incorporation or organization)
|
|
(I.
R. S. Employer
Identification
No.)
|
6737
West Washington Street, Suite 2250, Milwaukee, Wisconsin
53214–5650
(Address
of principal executive offices, including zip code)
(Registrant’s
telephone number, including area code)
(414)
977–4000
Indicate
by check mark whether the Registrant (1) 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 (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes
x
No
o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non–accelerated filer, or a smaller reporting company.
See the definitions of “accelerated filers”, “large accelerated filer” and
“smaller reporting company” in Rule 12b–2 of the Exchange Act.
Large
accelerated filer
o
Non–accelerated
filer
o
|
|
Accelerated
filer
x
Smaller
reporting company
o
|
Indicate
by check mark whether the Registrant is a shell company (as defined in
Rule 12b–2 of the Act).
Yes
o
No
x
The
number of shares outstanding of the Registrant’s common stock, par value $0.01
per share, as of November 3, 2008: 55,777,264
|
|
|
|
Page
|
|
|
PART I – FINANCIAL
INFORMATION
|
|
|
Item
1.
|
|
|
|
1
|
|
|
|
|
1
|
|
|
|
|
2
|
|
|
|
|
3
|
|
|
|
|
4
|
|
|
|
|
5
|
Item
2.
|
|
|
|
17
|
Item
3.
|
|
|
|
26
|
Item
4.
|
|
|
|
26
|
|
|
PART II – OTHER
INFORMATION
|
|
|
Item
1.
|
|
|
|
28
|
Item
1A.
|
|
|
|
29
|
Item
2.
|
|
|
|
30
|
Item
4.
|
|
|
|
31
|
Item
6.
|
|
|
|
32
|
|
|
Exhibit
31.1 Section 302 Certification of Principal Executive
Officer
|
|
|
|
|
Exhibit
31.2 Section 302 Certification of Principal Financial
Officer
|
|
|
|
|
Exhibit
32 Section 906 Certification of Principal Executive and Financial
Officers
|
|
|
PART I
– FINANCIAL INFORMATION
|
Condensed
Consolidated Financial Statements
|
MERGE
HEALTHCARE INCORPORATED AND SUBSIDIARIES
(In
thousands, except for share data)
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
ASSETS
|
|
(Unaudited)
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
14,424
|
|
|
$
|
14,000
|
|
Accounts
receivable, net of allowance for doubtful accounts and sales returns of
$1,351and $2,209 at September 30, 2008 and December 31, 2007,
respectively
|
|
|
10,588
|
|
|
|
11,810
|
|
Inventory
|
|
|
913
|
|
|
|
1,754
|
|
Prepaid
expenses
|
|
|
2,095
|
|
|
|
1,970
|
|
Deferred
income taxes
|
|
|
458
|
|
|
|
260
|
|
Other
current assets
|
|
|
547
|
|
|
|
771
|
|
Total
current assets
|
|
|
29,025
|
|
|
|
30,565
|
|
Property
and equipment:
|
|
|
|
|
|
|
|
|
Computer
equipment
|
|
|
6,399
|
|
|
|
6,776
|
|
Office
equipment
|
|
|
1,958
|
|
|
|
2,270
|
|
Leasehold
improvements
|
|
|
1,240
|
|
|
|
2,000
|
|
|
|
|
9,597
|
|
|
|
11,046
|
|
Less
accumulated depreciation
|
|
|
7,346
|
|
|
|
6,415
|
|
Net
property and equipment
|
|
|
2,251
|
|
|
|
4,631
|
|
Purchased
and developed software, net of accumulated amortization of $12,626 and
$10,452 at September 30, 2008 and December 31, 2007,
respectively
|
|
|
6,758
|
|
|
|
8,932
|
|
Customer
relationships, net of accumulated amortization of $1,022 and $259 at
September 30, 2008 and December 31, 2007, respectively
|
|
|
2,528
|
|
|
|
3,291
|
|
Trade
names
|
|
|
-
|
|
|
|
1,060
|
|
Deferred
income taxes
|
|
|
4,600
|
|
|
|
4,585
|
|
Investments
|
|
|
7,309
|
|
|
|
8,156
|
|
Other
assets
|
|
|
1,062
|
|
|
|
415
|
|
Total
assets
|
|
$
|
53,533
|
|
|
$
|
61,635
|
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
4,010
|
|
|
$
|
7,114
|
|
Accrued
wages
|
|
|
2,675
|
|
|
|
2,621
|
|
Restructuring
accrual
|
|
|
1,593
|
|
|
|
131
|
|
Other
accrued liabilities
|
|
|
2,454
|
|
|
|
2,920
|
|
Deferred
revenue
|
|
|
14,790
|
|
|
|
16,901
|
|
Total
current liabilities
|
|
|
25,522
|
|
|
|
29,687
|
|
Note
payable
|
|
|
14,104
|
|
|
|
-
|
|
Deferred
income taxes
|
|
|
85
|
|
|
|
257
|
|
Deferred
revenue
|
|
|
1,015
|
|
|
|
1,787
|
|
Income
taxes payable
|
|
|
5,577
|
|
|
|
5,338
|
|
Other
|
|
|
371
|
|
|
|
161
|
|
Total
liabilities
|
|
|
46,674
|
|
|
|
37,230
|
|
Shareholders'
equity:
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.01 par value: 2,999,997 shares authorized; zero shares issued
and Outstanding at September 30, 2008 and December 31,
2007
|
|
|
-
|
|
|
|
-
|
|
Series
A Preferred Stock, $0.01 par value: 1,000,000 shares authorized; zero
shares issued and outstanding at September 30, 2008 and December 31,
2007
|
|
|
-
|
|
|
|
-
|
|
Series
B Preferred Stock, $0.01 par value: 1,000,000 shares authorized; zero
shares issued and outstanding at September 30, 2008 and December 31,
2007
|
|
|
-
|
|
|
|
-
|
|
Series
3 Special Voting Preferred Stock, no par value: one share authorized; one
share issued and outstanding at September 30, 2008 and December 31,
2007
|
|
|
-
|
|
|
|
-
|
|
Common
stock, $0.01 par value: 100,000,000 shares authorized: 55,245,858 shares
and 32,237,700 shares issued and outstanding at September 30, 2008 and
December 31, 2007, respectively
|
|
|
552
|
|
|
|
322
|
|
Common
stock subscribed, 35,209 shares and zero shares at September 30, 2008 and
December 31, 2007, respectively
|
|
|
34
|
|
|
|
-
|
|
Additional
paid-in capital
|
|
|
464,727
|
|
|
|
456,371
|
|
Accumulated
deficit
|
|
|
(460,559
|
)
|
|
|
(434,958
|
)
|
Accumulated
other comprehensive income
|
|
|
2,105
|
|
|
|
2,670
|
|
Total
shareholders' equity
|
|
|
6,859
|
|
|
|
24,405
|
|
Total
liabilities and shareholders' equity
|
|
$
|
53,533
|
|
|
$
|
61,635
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
MERGE
HEALTHCARE INCORPORATED AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in
thousands, except for share and per share data)
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
7,398
|
|
|
$
|
6,927
|
|
|
$
|
19,733
|
|
|
$
|
21,790
|
|
Services
and maintenance
|
|
|
7,218
|
|
|
|
7,127
|
|
|
|
21,941
|
|
|
|
22,174
|
|
Total
net sales
|
|
|
14,616
|
|
|
|
14,054
|
|
|
|
41,674
|
|
|
|
43,964
|
|
Cost
of sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
|
1,314
|
|
|
|
1,576
|
|
|
|
3,842
|
|
|
|
5,018
|
|
Services
and maintenance
|
|
|
2,528
|
|
|
|
3,571
|
|
|
|
9,471
|
|
|
|
10,541
|
|
Amortization
and impairment
|
|
|
742
|
|
|
|
5,142
|
|
|
|
2,174
|
|
|
|
7,837
|
|
Total
cost of sales
|
|
|
4,584
|
|
|
|
10,289
|
|
|
|
15,487
|
|
|
|
23,396
|
|
Gross
margin
|
|
|
10,032
|
|
|
|
3,765
|
|
|
|
26,187
|
|
|
|
20,568
|
|
Operating
costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
1,824
|
|
|
|
4,463
|
|
|
|
7,497
|
|
|
|
13,850
|
|
Product
research and development
|
|
|
2,931
|
|
|
|
5,294
|
|
|
|
11,151
|
|
|
|
16,089
|
|
General
and administrative
|
|
|
3,483
|
|
|
|
7,454
|
|
|
|
18,093
|
|
|
|
21,893
|
|
Goodwill
and tradename impairment, restructuring and other expenses
|
|
|
(205
|
)
|
|
|
123,134
|
|
|
|
11,862
|
|
|
|
124,140
|
|
Depreciation,
amortization and impairment
|
|
|
654
|
|
|
|
5,338
|
|
|
|
2,954
|
|
|
|
7,374
|
|
Total
operating costs and expenses
|
|
|
8,687
|
|
|
|
145,683
|
|
|
|
51,557
|
|
|
|
183,346
|
|
Operating
income (loss)
|
|
|
1,345
|
|
|
|
(141,918
|
)
|
|
|
(25,370
|
)
|
|
|
(162,778
|
)
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
(751
|
)
|
|
|
4
|
|
|
|
(994
|
)
|
|
|
(59
|
)
|
Interest
income
|
|
|
68
|
|
|
|
286
|
|
|
|
218
|
|
|
|
1,088
|
|
Other,
net
|
|
|
35
|
|
|
|
(212
|
)
|
|
|
430
|
|
|
|
(527
|
)
|
Total
other income (expense)
|
|
|
(648
|
)
|
|
|
78
|
|
|
|
(346
|
)
|
|
|
502
|
|
Income
(loss) before income taxes
|
|
|
697
|
|
|
|
(141,840
|
)
|
|
|
(25,716
|
)
|
|
|
(162,276
|
)
|
Income
tax expense (benefit)
|
|
|
269
|
|
|
|
(286
|
)
|
|
|
(115
|
)
|
|
|
(261
|
)
|
Net
income (loss)
|
|
$
|
428
|
|
|
$
|
(141,554
|
)
|
|
$
|
(25,601
|
)
|
|
$
|
(162,015
|
)
|
Net
income (loss) per share - basic
|
|
$
|
0.01
|
|
|
$
|
(4.17
|
)
|
|
$
|
(0.59
|
)
|
|
$
|
(4.78
|
)
|
Weighted
average number of common shares outstanding - basic
|
|
|
56,171,905
|
|
|
|
33,926,092
|
|
|
|
43,496,189
|
|
|
|
33,909,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) per share - diluted
|
|
$
|
0.01
|
|
|
$
|
(4.17
|
)
|
|
$
|
(0.59
|
)
|
|
$
|
(4.78
|
)
|
Weighted
average number of common shares outstanding - diluted
|
|
|
56,859,379
|
|
|
|
33,926,092
|
|
|
|
43,496,189
|
|
|
|
33,909,065
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
MERGE
HEALTHCARE INCORPORATED AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in
thousands)
|
|
Nine
Months Ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(25,601
|
)
|
|
$
|
(162,015
|
)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation,
amortization and impairment
|
|
|
5,128
|
|
|
|
15,211
|
|
Share-based
compensation
|
|
|
3,836
|
|
|
|
3,889
|
|
Loss
on disposal of subsidiaries
|
|
|
1,665
|
|
|
|
-
|
|
Amortization
of note payable issuance costs & discount
|
|
|
336
|
|
|
|
-
|
|
Goodwill
and tradename impairment
|
|
|
1,060
|
|
|
|
123,171
|
|
Provision
for doubtful accounts receivable and sales returns, net of
recoveries
|
|
|
267
|
|
|
|
578
|
|
Deferred
income taxes
|
|
|
(384
|
)
|
|
|
(95
|
)
|
Changes
in operating assets and liabilities, net of effect of
dispositions:
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
868
|
|
|
|
2,259
|
|
Inventory
|
|
|
841
|
|
|
|
(169
|
)
|
Prepaid
expenses
|
|
|
(683
|
)
|
|
|
(432
|
)
|
Accounts
payable
|
|
|
(3,035
|
)
|
|
|
(1,527
|
)
|
Accrued
wages
|
|
|
52
|
|
|
|
(1,035
|
)
|
Restructuring
accrual
|
|
|
1,461
|
|
|
|
-
|
|
Deferred
revenue
|
|
|
(2,883
|
)
|
|
|
(588
|
)
|
Other
accrued liabilities
|
|
|
(196
|
)
|
|
|
(780
|
)
|
Other
|
|
|
231
|
|
|
|
6
|
|
Net
cash used in operating activities
|
|
|
(17,037
|
)
|
|
|
(21,527
|
)
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchases
of property, equipment, and leasehold improvements
|
|
|
(503
|
)
|
|
|
(2,109
|
)
|
Proceeds
from sale of subsidiary
|
|
|
413
|
|
|
|
-
|
|
Capitalized
software development
|
|
|
-
|
|
|
|
(828
|
)
|
Net
cash used in investing activities
|
|
|
(90
|
)
|
|
|
(2,937
|
)
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds
from issuance of term note, net of non-cash discount of
$510
|
|
|
14,490
|
|
|
|
-
|
|
Proceeds
from issuance of Common Stock
|
|
|
5,479
|
|
|
|
-
|
|
Note
and stock issuance costs paid
|
|
|
(2,386
|
)
|
|
|
-
|
|
Proceeds
from exercise of stock options and employee stock purchase
plan
|
|
|
63
|
|
|
|
215
|
|
Repurchase
of Common Stock
|
|
|
(47
|
)
|
|
|
-
|
|
Dividends
paid
|
|
|
(57
|
)
|
|
|
-
|
|
Net
cash provided by financing activities
|
|
|
17,542
|
|
|
|
215
|
|
Effect
of exchange rates on cash and cash equivalents
|
|
|
9
|
|
|
|
-
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
424
|
|
|
|
(24,249
|
)
|
Cash
and cash equivalents, beginning of period
|
|
|
14,000
|
|
|
|
45,945
|
|
Cash
and cash equivalents, end of period
|
|
$
|
14,424
|
|
|
$
|
21,696
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosures of Cash Flow Information:
|
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
975
|
|
|
$
|
-
|
|
Cash
paid for income taxes, net of refunds
|
|
$
|
17
|
|
|
$
|
257
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
MERGE
HEALTHCARE INCORPORATED AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENT OF SHAREHOLDERS’
EQUITY
(Unaudited)
(in
thousands, except for share and per share data)
|
|
Preferred
Stock
|
|
|
Common Stock
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
Other
|
|
|
Total
|
|
|
|
Shares
|
|
|
Issued
|
|
|
Shares
|
|
|
Subscribed
|
|
|
Shares
|
|
|
Issued
|
|
|
Paid–in
|
|
|
Accumulated
|
|
|
Comprehensive
|
|
|
Shareholders’
|
|
|
|
Issued
|
|
|
Amount
|
|
|
Subscribed
|
|
|
Amount
|
|
|
Issued
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Income
|
|
|
Equity
|
|
Balance
at December 31, 2007
|
|
|
1
|
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
|
32,237,700
|
|
|
$
|
322
|
|
|
$
|
456,371
|
|
|
$
|
(434,958
|
)
|
|
$
|
2,670
|
|
|
$
|
24,405
|
|
Exchange
of exchangeable share
rights into Common
Stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
657,545
|
|
|
|
7
|
|
|
|
(7
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Issuance
of Common Stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
21,085,715
|
|
|
|
211
|
|
|
|
4,614
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4,825
|
|
Stock
issued under ESPP
|
|
|
-
|
|
|
|
-
|
|
|
|
35,209
|
|
|
|
34
|
|
|
|
26,613
|
|
|
|
-
|
|
|
|
29
|
|
|
|
-
|
|
|
|
-
|
|
|
|
63
|
|
Vesting
of restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,238,285
|
|
|
|
12
|
|
|
|
(12
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Share–based
compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,836
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,836
|
|
Stock
dividend
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(57
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(57
|
)
|
Treasury
stock repurchase and retirement
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(47
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(47
|
)
|
Net
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(25,601
|
)
|
|
|
-
|
|
|
|
(25,601
|
)
|
Other
comprehensive loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(565
|
)
|
|
|
(565
|
)
|
Balance
at September 30, 2008
|
|
|
1
|
|
|
$
|
-
|
|
|
|
35,209
|
|
|
$
|
34
|
|
|
|
55,245,858
|
|
|
$
|
552
|
|
|
$
|
464,727
|
|
|
$
|
(460,559
|
)
|
|
$
|
2,105
|
|
|
$
|
6,859
|
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
MERGE
HEALTHCARE INCORPORATED AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(LOSS)
(Unaudited)
(in
thousands)
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net
income (loss)
|
|
$
|
428
|
|
|
$
|
(141,554
|
)
|
|
$
|
(25,601
|
)
|
|
$
|
(162,015
|
)
|
Translation
adjustment, net of income taxes
|
|
|
-
|
|
|
|
(99
|
)
|
|
|
283
|
|
|
|
(113
|
)
|
Unrealized
gain (loss) on marketable securities, net of income taxes
|
|
|
(368
|
)
|
|
|
(17
|
)
|
|
|
(848
|
)
|
|
|
450
|
|
Comprehensive
net income (loss)
|
|
$
|
60
|
|
|
$
|
(141,670
|
)
|
|
$
|
(26,166
|
)
|
|
$
|
(161,678
|
)
|
See
accompanying notes to unaudited condensed consolidated financial
statements.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements
(Unaudited
and in thousands, except for share and per share data)
(1)
|
Basis
of Presentation and Significant Accounting
Policies
|
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission (“SEC”) for reporting on Form 10-Q. Accordingly,
certain information and notes required by United States of America generally
accepted accounting principles (“GAAP”) for annual financial statements are not
included herein. These interim statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Annual
Report on Form 10-K for the year ended December 31, 2007 of Merge
Healthcare Incorporated, a Wisconsin corporation, and its subsidiaries and
affiliates (which we sometimes refer to collectively as “Merge Healthcare,”
“we,” “us” or “our”).
Liquidity
Prior to
the three months ended September 30, 2008, we suffered recurring losses from
operations and negative cash flows. We completed a financing transaction during
the second quarter of 2008 for net proceeds of $16,639 ($20,000 less issuance
costs of $2,386 and prepaid interest for two quarters totaling $975) as
discussed in Note 2. We have also paid significant lawsuit settlement
costs (see Note 7) and employee termination benefits (see Note 8). Although we
believe the remaining financing funds and operational initiatives that we have
undertaken as discussed in Notes 8, 9 and 11 are sufficient, these activities
alone may not be adequate to fund our future business and strategic
objectives. Based on these circumstances and the current economic
environment, management may or may not conclude in our Annual Report on Form
10-K that there exists substantial doubt about our ability to continue as a
going concern.
Principles
of Consolidation
We have
prepared our accompanying unaudited condensed consolidated financial statements
on the basis that we will continue as a going concern and, therefore, no
corresponding adjustments have been made to our assets or
liabilities.
Our
unaudited condensed consolidated financial statements reflect all adjustments,
which are, in the opinion of management, necessary for a fair presentation of
our financial position and results of operations. Such adjustments
are of a normal recurring nature, unless otherwise noted. The results
of operations for the three and nine months ended September 30, 2008 are not
necessarily indicative of the results to be expected for any future
period.
Our
unaudited condensed consolidated financial statements are prepared in accordance
with GAAP. These accounting principles require us to make certain estimates,
judgments and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. We believe that the estimates, judgments and
assumptions are reasonable, based on information available at the time they are
made. Actual results could differ materially from those estimates.
Reclassifications
Where
appropriate, certain reclassifications have been made to the prior year’s
financial statements to conform to the current year
presentation. Specifically, we are separately displaying our accrued
restructuring charges in the condensed consolidated balance sheet. In
addition, we are separately displaying the changes in other accrued liabilities,
accounts payable and accrued restructuring charges in the condensed consolidated
statement of cash flows for the nine months ended September 30, 2008 and
2007. In addition, we have reclassified the change in customer
deposits during the nine months ended September 30, 2007 in the condensed
consolidated statement of cash flows from deferred revenue to other accrued
liabilities.
(2)
|
Financing
Transaction with Related
Party
|
On June
4, 2008, we completed a private placement of our Common Stock pursuant to which
we raised net proceeds of $16,639 ($20,000 less issuance costs of $2,386 and
prepaid interest for two quarters totaling $975) through a securities purchase
agreement with Merrick RIS, LLC ("Merrick"), an affiliate of Merrick Ventures,
LLC ("Merrick Ventures"), which was executed on May 21, 2008. Based
on the terms of the private placement, we received $20,000 from Merrick in
exchange for a $15,000 senior secured term note (the “Note”) due June 4, 2010
and 21,085,715 shares of our Common Stock. The Note bears interest at
13.0% per annum, payable quarterly in arrears. On closing of the
private placement, we were required to prepay the first two interest payments
totaling $975. We also incurred $2,386 of issuance costs, including a
$750 closing fee paid to Merrick.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
The Note
contains various operating and financial covenants, including a requirement that
we have positive adjusted EBITDA for the last fiscal quarter of 2008 and
cumulatively thereafter through the term of the Note. The Note also contains
default provisions including, but not limited to, failure to pay, breach of
financial or operating covenants, and bankruptcy or insolvency. The Note is a
senior secured obligation and will be senior to any existing and future
indebtedness and is secured by all of our United States and Canadian
assets.
Merrick
may require us to redeem the Note in full if a change of control occurs. If the
change of control results in the payment of consideration to our shareholders
equal to or exceeding $1.75 per share, the redemption price of the Note shall be
at par. If such consideration is less than $1.75 per share, the
redemption price shall be 120% of par if the change of control occurs within one
year of the closing date, or 118% of par if the change of control occurs anytime
thereafter. In addition, upon an event of default, as defined in the
Note, the interest rate will increase to 18.5% and Merrick will have the right
to require us to redeem the Note at 120% of its principal amount. All
payments due to Merrick upon redemption shall be in addition to all accrued but
unpaid interest and accrued but unpaid late charges relating
thereto. The Note may also be voluntarily prepaid at 120% of par at
any time.
In
accordance with Financial Accounting Standards Board (“FASB”) Statement of
Financial Accounting Standard (“SFAS”) No. 133,
Accounting for Derivative
Instruments and Hedging Activities
, the change of control and default
provisions are considered put options which are derivative instruments and are
required to be bifurcated from the debt instrument and accounted for
separately. The fair value of these options is recorded as long-term
liabilities and changes in the fair value of these liabilities will be recorded
in the condensed consolidated statement of
operations.
The fair
values of the equity, Note and put options were determined utilizing the
assistance of independent valuation specialists. The fair value of
the two put options is $31 as of September 30, 2008. The proceeds of
$20,000 were reduced by the value of the put options and remaining amount was
allocated to the equity and Note based on the relative fair value of each
instrument. In addition, the transaction costs of $2,386 were
allocated to the equity and Note using the same relative fair value
allocation. The closing fees due Merrick were treated as a reduction
of proceeds, and as such, a portion of the closing fees was included as a
discount on the Note.
We
recorded a note payable of $13,945 and equity of $4,825 (net of related issuance
costs of $654) upon completion of the financing transaction. The note
discount of $1,055 (of which $545 relates to closing fees due Merrick) and
financing costs of $1,187 (which were recorded as a long-term asset) are being
amortized using the effective interest method at a rate of approximately 21.13%
over the term of the Note. During the three and nine month periods
ended September 30, 2008, we recorded interest expense of $750 and $986,
respectively, including amortization of financing costs of $139 and $178,
respectively, and amortization of note discount of $123 and $158,
respectively. As of September 30, 2008, there was no change in the
value of the put option liabilities.
The
private placement was made pursuant to an exemption from the registration
requirements under the Securities Act of 1933, as amended. We also
entered into a registration rights agreement in connection with the private
placement pursuant to which we have agreed to register the Common Stock with the
Securities and Exchange Commission for public resale under certain
circumstances.
In
connection with the private placement, Merrick was entitled to designate five
individuals to replace five of the eleven then current directors on our Board of
Directors, which occurred on the closing of the private placement. We also
agreed that Merrick will continue to have the right to designate five
individuals to be nominated for election to the Board of Directors in the
future, subject to reduction of such designated individuals upon a decrease in
Merrick’s ownership percentage. In June 2008, the Board of Directors
granted approval to Merrick and its affiliates, including Michael W. Ferro, Jr.,
Chairman and CEO of Merrick Ventures, who is also Chairman of our Board of
Directors, to purchase up to 49.9% of our Common Stock. As of
September 30, 2008, Merrick and its affiliates owned approximately 48.5% of our
Common Stock.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
(3)
|
Intangible
Assets Subject to
Amortization
|
Our
intangible assets, other than capitalized software development costs, subject to
amortization are summarized as of September 30, 2008 as follows:
|
|
Average
|
|
|
|
|
|
|
|
|
|
Remaining
Amortization
Period
(Years)
|
|
|
Gross
Carrying Amount
|
|
|
Accumulated
Amortization
|
|
Purchased
software
|
|
2.6
|
|
|
$
|
12,571
|
|
|
$
|
(7,107
|
)
|
Customer
relationships
|
|
2.6
|
|
|
|
3,550
|
|
|
|
(1,022
|
)
|
Total
|
|
|
|
|
$
|
16,121
|
|
|
$
|
(8,129
|
)
|
Purchased
software amortization expense, which is being recorded ratably over the life of
the related intangible asset in the amortization and impairment classification
of cost of sales, was $529 and $1,905 during the three months ended September
30, 2008 and 2007, respectively, and $1,589 and $3,411 during the nine months
ended September 30, 2008 and 2007, respectively. Included within the
expense for the three months and nine months ended September 30, 2007 is a
purchased software impairment charge of $1,091 as a result of our net realizable
value analysis associated with certain product lines and a complete impairment
of patents of $133. Customer relationships amortization expense,
which is being recorded ratably over the life of the related intangible asset in
the depreciation, amortization and impairment expense classification of
operating costs and expenses, was $245 and $4,821 during the three months ended
September 30, 2008 and 2007, respectively, and $763 and $5,961 during the nine
months ended September 30, 2008 and 2007, respectively. Included
within the customer intangible expense for the three and nine months ended
September 30, 2007 is an impairment charge of $4,252.
Estimated
aggregate amortization expense for purchased software and customer relationships
for the remaining periods is as follows:
For
the remaining 3 months of the year ended:
|
2008
|
|
$
|
766
|
|
For
the year ended December 31:
|
2009
|
|
|
3,066
|
|
|
2010
|
|
|
2,940
|
|
|
2011
|
|
|
1,220
|
|
|
2012
|
|
|
-
|
|
As of
September 30, 2008, we had gross capitalized software development costs of
$6,813 and accumulated amortization of $5,519. The weighted average
remaining amortization period of capitalized software development costs was 1.4
years as of September 30, 2008. We did not capitalize any software
development costs during the three and nine months ended September 30,
2008. During the three and nine months ended September 30, 2007, we
capitalized software development costs of $115 and $844,
respectively. Capitalized software development amortization expense
was $213 and $3,237 during the three months ended September 30, 2008 and 2007,
respectively, and $585 and $4,426 during the nine months ended September 30,
2008 and 2007, respectively, and was recorded in the amortization and impairment
classification of cost of sales. This expense included the impairment
of certain of our capitalized software projects of $2,914 and $3,470 during the
three and nine months ended September 30, 2007, due to significant risk of
technological obsolescence associated with certain projects, the majority of
which were still in development at the time of impairment.
Basic and
diluted net earnings or loss per share is computed by dividing earnings or loss
available to common shareholders by the weighted average number of shares of
Common Stock outstanding. Diluted earnings per share includes the
potential dilution that could occur based on the exercise of stock options and
restricted stock awards, except for stock options with an exercise price of more
than the average market price of our Common Stock as such exercise would be
anti-dilutive. The following table sets forth the computation of
basic and diluted earnings per share for the periods indicated:
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
428
|
|
|
$
|
(141,554
|
)
|
|
$
|
(25,601
|
)
|
|
$
|
(162,015
|
)
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares of Common Stock outstanding –
basic
|
|
|
56,171,905
|
|
|
|
33,926,092
|
|
|
|
43,496,189
|
|
|
|
33,909,065
|
|
Effect
of stock options
|
|
|
65,883
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Effect
of restricted stock
|
|
|
621,591
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Denominator
for net income (loss) per share - diluted
|
|
|
56,859,379
|
|
|
|
33,926,092
|
|
|
|
43,496,189
|
|
|
|
33,909,065
|
|
Net
income (loss) per share - basic
|
|
$
|
0.01
|
|
|
$
|
(4.17
|
)
|
|
$
|
(0.59
|
)
|
|
$
|
(4.78
|
)
|
Net
income (loss) per share - diluted
|
|
$
|
0.01
|
|
|
$
|
(4.17
|
)
|
|
$
|
(0.59
|
)
|
|
$
|
(4.78
|
)
|
The
weighted average number of shares of Common Stock outstanding used to calculate
basic net earnings or loss per share includes exchangeable share equivalent
securities traded on the Toronto Stock Exchange of 1,563,667 and 1,688,924 for
the three months ended September 30, 2008 and 2007, respectively, and 1,646,285
and 2,515,680 for the nine months ended September 30, 2008 and 2007,
respectively.
As a
result of the loss during the three months ended September 30, 2007, incremental
shares from the assumed conversion of employee stock options totaling 45,606
have been excluded from the calculation of diluted loss per share as their
inclusion would have been anti-dilutive. As a result of the loss
during the nine months ended September 30, 2008 and 2007, incremental shares
from the assumed conversion of employee stock options totaling zero and 53,702,
respectively, have been excluded from the calculation of diluted loss per share
as their inclusion would have been anti-dilutive. As a result of the
loss during the nine months ended September 30, 2008 incremental shares, based
on the assumption that unvested restricted stock awards totaling 1,290,434 will
fully vest, have been excluded from the calculation of diluted loss per share as
their inclusion would have been anti–dilutive. We did not grant any
restricted stock awards prior to the fourth quarter of 2007.
For the
three months ended September 30, 2008 and 2007, options to purchase 3,587,830
and 3,328,927 shares of our Common Stock, respectively, had exercise prices
greater than the average market price of our Common Stock, and, therefore, are
not included in the above calculations of net income (loss) per
share. For the nine months ended September 30, 2008 and 2007, options
to purchase 3,630,466 and 3,183,927 shares of our Common Stock, respectively,
had exercise prices greater than the average market price of our Common Stock,
and, therefore, are not included in the above calculations of net loss per
share.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
(5)
|
Share-Based
Compensation
|
The
following table summarizes share-based compensation expense related to
share-based awards subject to SFAS No. 123(R),
Share-Based Payment
,
recognized during the periods indicated:
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Share-based
compensation expense included in the statement of
operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
and maintenance (cost of sales)
|
|
$
|
4
|
|
|
$
|
112
|
|
|
$
|
70
|
|
|
$
|
340
|
|
Sales
and marketing
|
|
|
(19
|
)
|
|
|
328
|
|
|
|
363
|
|
|
|
923
|
|
Product
research and development
|
|
|
72
|
|
|
|
298
|
|
|
|
304
|
|
|
|
914
|
|
General
and administrative
|
|
|
245
|
|
|
|
607
|
|
|
|
1,129
|
|
|
|
1,712
|
|
Goodwill
and tradename impairment, restructuring and other expenses
|
|
|
-
|
|
|
|
-
|
|
|
|
1,970
|
|
|
|
-
|
|
Total
|
|
|
302
|
|
|
|
1,345
|
|
|
|
3,836
|
|
|
|
3,889
|
|
Tax
benefit
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Share-based
compensation expense, net of tax
|
|
$
|
302
|
|
|
$
|
1,345
|
|
|
$
|
3,836
|
|
|
$
|
3,889
|
|
Decrease
(increase) in basic income (loss) per share
|
|
$
|
0.01
|
|
|
$
|
(0.04
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.11
|
)
|
Decrease
(increase) in diluted income (loss) per share
|
|
$
|
0.01
|
|
|
$
|
(0.04
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.11
|
)
|
The
difference between the amounts recorded as share-based compensation expense in
the statements of operations and the amounts of share-based compensation
recorded as additional paid-in capital during the three months ended September
30, 2008 and 2007 of zero and $5, respectively, and zero and $14 during the nine
months ended September 30, 2008 and 2007, respectively, were attributed to
share-based compensation incurred by product research and development personnel
who worked on capitalizable software development projects during these
periods.
The
$1,970 of expense recorded during the nine months ended September 30, 2008
relates to the acceleration of certain stock options and restricted stock for
certain former officers as outlined in the respective individual’s employment
agreement or restricted stock purchase agreement. In addition, these
individuals, as of their respective separation dates, agreed to voluntarily
forfeit any unexercised vested stock options.
Stock
option activity for the nine months ended September 30, 2008 was as
follows:
|
|
Number
of
|
|
|
|
Options
|
|
Options
outstanding, December 31, 2007
|
|
|
4,081,060
|
|
Options
granted
|
|
|
2,550,000
|
|
Options
exercised
|
|
|
-
|
|
Options
forfeited and expired
|
|
|
(2,000,594
|
)
|
Options
outstanding, September 30, 2008
|
|
|
4,630,466
|
|
|
|
|
|
|
Options
exercisable, September 30, 2008
|
|
|
1,466,906
|
|
Restricted
stock award activity for the nine months ended September 30, 2008 was as
follows:
|
|
Number
of
|
|
|
|
Shares
|
|
Restricted
stock outstanding, December 31, 2007
|
|
|
1,699,995
|
|
Restricted
stock granted
|
|
|
92,500
|
|
Restricted
stock exercises
|
|
|
(1,282,498
|
)
|
Restricted
stock forfeited
|
|
|
(30,000
|
)
|
Restricted
stock outstanding, September 30, 2008
|
|
|
479,997
|
|
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
As of
September 30, 2008, there is approximately $3,555 of unrecognized compensation
cost that may be recognized in future periods related to share-based
compensation.
We record
income tax expense on an interim basis under Accounting Principles Board (“APB”)
Opinion No. 28,
Interim
Financial Reporting,
as amended by SFAS No. 109,
Accounting for Income
Taxes
. The estimated annual effective income tax rate is
adjusted quarterly and items discrete to a specific quarter are reflected in tax
expense for that interim period. The estimated annual effective
income tax rate includes the effect of a valuation allowance expected to be
necessary at the end of the year for deferred tax assets related to originating
deductible temporary differences and carry forwards during the
year. A valuation allowance is established when necessary to reduce
deferred tax assets to the amount more-likely-than-not to be
realized. Further limitations may apply to deferred tax assets if tax
ownership changes occur. We are evaluating ownership changes during
the current year to determine any further limitations. There was no
material change in unrecognized tax benefits during the nine month period ending
September 30, 2008, and we do not anticipate a material change in total
unrecognized tax benefits within the next 12 months.
(7)
|
Commitments
and Contingencies
|
Between
March 22, 2006 and April 26, 2006, seven putative securities class action
lawsuits were filed in the United States District Court for the Eastern District
of Wisconsin, on behalf of a class of persons who acquired shares of our Common
Stock between August 2, 2005 and March 16, 2006. On November 22, 2006, the Court
consolidated the seven cases, appointed the Southwest Carpenters Pension Trust
to be the lead plaintiff and approved the Trust’s choice of its lead counsel.
The lead plaintiff filed a consolidated amended complaint on March 21, 2007.
Defendants in the suit included us, Richard A. Linden, our former
President and Chief Executive Officer, Scott T. Veech, our former
Chief Financial Officer, David M. Noshay, our former Senior Vice
President of Strategic Business Development, and KPMG LLP, our independent
public accountants at the time. The consolidated amended complaint arose out of
our restatement of financial statements, as well as our investigation of
allegations made in anonymous letters received by us. The lawsuits allege that
we and the other defendants violated Section 10 (b) and that the individuals
violated Section 20(a) of the Securities Exchange Act of 1934, as amended. The
consolidated amended complaint seeks damages in unspecified amounts. The
defendants filed motions to dismiss. On March 31, 2008, the motions
to dismiss us, Mr. Linden and Mr. Veech were denied, and the motions
to dismiss Mr. Noshay and KPMG were granted without
prejudice. On April 30, 2008, we entered into an agreement in
principle with the plaintiff in the consolidated securities class action suits
filed against us. The agreement in principle provided for the settlement,
release and dismissal of all claims asserted against Merge Healthcare and the
individual defendants in the litigation. In exchange, we agreed to a one time
cash payment of $3,025 to the plaintiff and our primary and one of our excess
directors and officers insurance carriers agreed to a one time cash payment of
$12,975 to the plaintiff, for a total payment of $16,000. These costs
were accrued as of June 30, 2008, as payment was contingent upon completion of a
financing transaction, and were recorded as a general and administrative
expense. The settlement amounts were paid into escrow in July
2008. The proposed settlement was preliminarily approved on July 15,
2008 and is subject to final approval from the United States District Court for
the Eastern District of Wisconsin on November 10, 2008. The
defendants have steadfastly maintained that the claims raised in the litigation
are without merit. There was no admission of wrongdoing or liability
by the defendants in the settlement.
On August
28, 2006, a derivative action was filed in the
Circuit Court of Milwaukee County, Civil Division, against
Messrs. Linden and Veech, William C. Mortimore (our founder,
former Chairman and Chief Strategist, who served as our interim Chief Executive
Officer from May 15, 2006 to July 2, 2006) and all of the then-current members
of our Board of Directors. The plaintiff filed an amended complaint on June 26,
2007, adding Mr. Noshay as a defendant. The plaintiff alleged that (a) each
of the individual defendants breached fiduciary duties owed to us by violating
generally accepted accounting principles, willfully ignoring problems with
accounting and internal control practices and procedures and participating in
the dissemination of false financial statements; (b) we and the director
defendants failed to hold an annual meeting of shareholders for 2006 in
violation of Wisconsin law; (c) Directors Barish, Geras and Hajek violated
insider trading prohibitions and that they misappropriated material non-public
information; (d) a claim of corporate waste and gift against Directors Hajek,
Barish, Reck, Dunham and Lennox, members of the Compensation Committee at the
time of the restatement; and (e) claims of unjust enrichment and insider selling
against Messrs. Linden, Veech, Noshay and Mortimore. The plaintiff asked for
unspecified amounts in damages and costs, disgorgement of certain compensation
and profits against certain defendants as well as equitable relief. In response
to the filing of this action, our Board of Directors formed a Special Litigation
Committee, which Committee was granted full authority to investigate the
allegations of the derivative complaint and determine whether pursuit of the
claims against any or all of the individual defendants would be in our best
interest. On March 3, 2008, the parties to this derivative action
entered into a Memorandum of Understanding providing for the settlement of all
claims asserted in the case. Under the terms of the settlement, the
Board of Directors has agreed to pay fees and expenses of plaintiff’s counsel of
$250. These costs were accrued as of December 31, 2007 and were paid
in July 2008. The proposed settlement was preliminarily approved on
April 17, 2008 with final approval on June, 27, 2008. As a result of
this settlement, the Special Litigation Committee was dissolved by the Board of
Directors on August 19, 2008. The defendants have steadfastly
maintained that the claims raised in the litigation are without
merit. There was no admission of wrongdoing or liability by the
defendants in the settlement.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
In March
2008, we received $1,050 from our primary directors and officers liability
insurance carrier for reimbursement of legal expenses in connection with the
class action and derivative action against Merge Healthcare and some of its
current and former directors and officers. This reimbursement was
recorded as a credit to general and administrative expense. We do not
anticipate that additional funds will be collected from the insurance carriers
related to these defense costs.
On April
27, 2006, Merge Healthcare received an informal, non-public inquiry from the
Securities and Exchange Commission (“SEC”) requesting voluntary production of
documents and other information. The inquiry principally related to
our announcement, on March 17, 2006, that we would investigate allegations of
improprieties related to financial reporting and revise our results of
operations for the fiscal quarters ended June 30, 2005, and September 30,
2005. On July 10, 2007, SEC Staff advised us that the SEC had issued
a formal order of investigation in this matter. Merge Healthcare is
cooperating fully with the SEC. The SEC Staff has informed Merge
Healthcare that the Staff is considering recommending an injunctive or cease and
desist order against Merge Healthcare prohibiting violations of the reporting,
record-keeping, and internal control provisions under the Securities Exchange
Act of 1934. The Staff did not inform Merge Healthcare that it is
considering recommending any monetary sanctions against Merge
Healthcare. However, the matter has not yet been finally resolved,
and, until such final resolution, Merge Healthcare will continue to incur
expenses, including legal fees and other costs, in connection with the SEC’s
investigation.
In
addition to the matters discussed above, we are from time to time parties to
legal proceedings, lawsuits and other claims incident to our business
activities. Such matters may include, among other things, assertions of contract
breach or intellectual property infringement, claims for indemnity arising in
the course of our business and claims by persons whose employment has been
terminated. Such matters are subject to many uncertainties and outcomes are not
predictable with assurance. Consequently, we are unable to ascertain the
ultimate aggregate amount of monetary liability, amounts which may be covered by
insurance or recoverable from third parties, or the financial impact with
respect to these matters as of the date of this report.
During
2008 we completed two separate restructuring and reorganization
initiatives.
First
Quarter 2008 Initiative
On
February 14, 2008, we announced a reduction in our worldwide headcount,
including consultants, by approximately 160 individuals with the majority of
those reductions having been completed on or before the
announcement. This restructuring plan was designed to better align
our costs with our anticipated revenues going forward and included personnel
terminations from all parts of the organization. We recognized
restructuring related charges in our condensed consolidated financial statements
of $1,413, consisting of $1,130 in severance and related employee termination
costs and $283 in contract exit costs, primarily consisting of future lease
payments on our Burlington, Massachusetts leased office, which we completely
vacated during the first quarter of 2008.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
Second
Quarter 2008 Initiative
On June
4, 2008, we announced a change in executive management, reorganization of our
operating business units and reduction in headcount by approximately 60
individuals. This restructuring plan was designed primarily to align
our corporate costs and infrastructure with the size of the organization as well
as to align business unit costs with our anticipated revenues going
forward. We recognized restructuring related charges in our condensed
consolidated financial statements of $7,330, consisting of $4,544 in severance
and related employee termination costs, $1,970 of share-based compensation
expense associated with the accelerated vesting of stock options and restricted
stock for certain former officers and $816 in contract exit
costs. The severance costs are primarily related to payments to
former officers. The contract exit costs primarily consist of future
lease payments on the Alpharetta, Georgia office, which we completely vacated as
of September 30, 2008 and our Mississauga, Ontario office, of which we abandoned
a portion of the 60,000 square feet of leased space during the second quarter of
2008. See Note 5 for further discussion of share-based compensation
expense related to certain executive terminations.
The
following table illustrates our restructuring activity during the nine months
ended September 30, 2008:
|
|
Employee
Termination Costs
|
|
|
Contract
Exit Costs
|
|
|
Total
|
|
Fourth
Quarter 2006 Initiative
|
|
Balance
at December 31, 2007
|
|
$
|
131
|
|
|
$
|
-
|
|
|
$
|
131
|
|
Charges
to expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Payments
|
|
|
(131
|
)
|
|
|
-
|
|
|
|
(131
|
)
|
Balance
at September 30, 2008
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
First
Quarter 2008 Initiative
|
|
Balance
at December 31, 2007
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Charges
to expense
|
|
|
1,130
|
|
|
|
283
|
|
|
|
1,413
|
|
Payments
|
|
|
(1,085
|
)
|
|
|
-
|
|
|
|
(1,085
|
)
|
Balance
at September 30, 2008
|
|
|
45
|
|
|
|
283
|
|
|
|
328
|
|
Second
Quarter 2008 Initiative
|
|
Balance
at December 31, 2007
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Charges
to expense
|
|
|
4,544
|
|
|
|
816
|
|
|
|
5,360
|
|
Payments
|
|
|
(3,722
|
)
|
|
|
(227
|
)
|
|
|
(3,949
|
)
|
Foreign
currency exhange rate effects
|
|
|
(29
|
)
|
|
|
(26
|
)
|
|
|
(55
|
)
|
Balance
at September 30, 2008
|
|
$
|
793
|
|
|
$
|
563
|
|
|
$
|
1,356
|
|
Total
Balance at September 30, 2008
|
|
$
|
838
|
|
|
$
|
846
|
|
|
$
|
1,684
|
|
As of
September 30, 2008, $1,593 of the remaining balance for restructuring costs was
recorded in the restructuring accrual in current liabilities, and $91 related to
the long term portion of the remaining Alpharetta, Georgia lease obligation was
recorded in other long term liabilities on the condensed consolidated balance
sheet.
(9)
|
Tradenames
and Long-Lived Assets
|
In
accordance with SFAS No. 142,
Goodwill and Other Intangible
Assets
, we review indefinite-lived intangible assets for impairment
annually, as of December 31. In addition, we test an intangible
asset or group for impairment between annual tests whenever events or changes in
circumstances indicate that we may not be able to recover the asset’s carrying
amount.
During
the three months ended September 30, 2007, we concluded that all of our goodwill
was impaired, and recorded an impairment charge of $122,371. Also, we
concluded that certain trade names associated with our Cedara Software Corp.
business transaction had been impaired, and recorded an $800 charge within
goodwill and tradename impairment, restructuring and other
expenses.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
On April
11, 2008, we signed an agreement to divest our French subsidiary, Merge
Healthcare France SARL, to the local management team for no cash proceeds to
us. A loss on the disposition of the French subsidiary of $1,713 was
recognized in the condensed consolidated statement of operations in tradename
impairment, restructuring and other expense in second quarter of
2008. The majority of this estimated loss did not require additional
cash outlay subsequent to September 30, 2008. This transaction did
not meet the accounting requirements for classification as a discontinued
operation and, therefore, was accounted for as a disposal under SFAS
No. 144,
Accounting for
the Impairment or Disposal of Long–Lived Assets
(“SFAS No. 144”)
.
On June
4, 2008, we announced that we would rename our business units. Merge
Healthcare North America was renamed Merge Fusion and Cedara (our business unit
located in Mississauga, Ontario) was renamed Merge OEM. As a result of this
action the Cedara tradename had been impaired. We recorded a charge
of $1,060 during the second quarter of 2008 in tradename impairment,
restructuring and other expense within our condensed consolidated statement of
operations.
On August
29, 2008, we sold our Cedara Software Services (India) Private Limited
subsidiary (“CSSI”) located in India for $700. Included in the sale
were fixed assets with a gross value of $506, and accumulated depreciation of
$90 as of August 29, 2008. We received cash of $499 (net of fees) at
sale, with the remaining $200 placed in escrow for one year to cover any
remaining liabilities and expenses. As of September 30, 2008, we have
estimated our remaining liabilities related to the subsidiary to be
$71. In addition, we have estimated income taxes generated by the
subsidiary prior to the sale and capital gains taxes payable related to the sale
totaling $215 as of September 30, 2008. We have recorded net cash proceeds from
the sale of $413 in our condensed consolidated statement of cash flows under the
investing activities as proceeds from sale of
subsidiary. Additionally, we have recorded a gain on sale of $124 in
the goodwill and tradename impairment, restructuring and other expenses line on
the condensed consolidated income statement, and income tax expense of $215, for
the three months and nine months ended September 30, 2008. This
transaction did not meet the accounting requirements for classification as a
discontinued operation and, therefore, was accounted for as a disposal under
SFAS No. 144.
In the
three months ended September 30, 2008, we terminated all employees of our Merge
Healthcare Teleradiology Services Private Limited (India) subsidiary located in
India, and commenced closure of the facility. In conjunction with the
terminations, severance payments totaling $40 were paid to employees and
consultants, and are reflected in the goodwill and tradename impairment,
restructuring and other expenses line on the condensed consolidated income
statement for the three and nine months ended September 30, 2008.
In
addition, we recorded a $542 charge in depreciation, amortization and impairment
within our condensed consolidated statement of operations during the second
quarter of 2008 based on the fair value of certain fixed assets that were held
for sale. The assets related to the Alpharetta, Georgia office were
disposed of during the three months ended September 30, 2008. As of
September 30, 2008, the remaining fixed assets held for sale had a gross value
of $240 in computer equipment and related accumulated depreciation of
$240.
(10)
|
Shareholders’
Equity
|
On June
12, 2008, we announced the redemption of all preferred share purchase rights
outstanding as a result of our Shareholder Rights Plan, which was established in
2006. As provided for in the plan, we redeemed the rights for $0.001
per right. As a result, shareholders of record on June 23, 2008
received a dividend payment (in July 2008) totaling $57 and this plan is no
longer in effect.
At the
Annual Meeting of the Shareholders on August 19, 2008, the Shareholders approved
a reincorporation via merger of Merge Healthcare (Wisconsin) into Merge
Healthcare (Delaware). We expect this to be completed during the
fourth quarter of 2008.
As part
of our business combination with Cedara Software Corp. in June 2005, we issued
5,581,517 shares of our Common Stock to the shareholders of Cedara Software
Corp. and granted rights for the issuance of 13,210,168 shares of Common Stock
to holders of Cedara Software Corp. exchangeable shares on a one-for-one
basis. We have the right to redeem all of the exchangeable shares at
anytime after April 29, 2010 or if less than 10% of the number of exchangeable
shares issued on the effective date of the business combination remain
outstanding, provided that we give sixty days advance written
notice. As of September 30, 2008, there were 1,030,938 Cedara
Software Corp. exchangeable shares outstanding. We plan to provide
notice of redemption to holders of Cedara Software Corp. exchangeable shares
during the fourth quarter of 2008.
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
In July
2008 and August 2008, a total of 44,213 shares of Common Stock were withheld
from employees to satisfy tax obligations. The shares were recorded
as treasury stock at a value of $47 (market value of our Common Stock on the
dates the shares were withheld). The treasury shares were retired
during the three months ended September 30, 2008.
SFAS
No. 131,
Disclosures
about Segments of an Enterprise and Related Information
(“SFAS
No. 131”), establishes annual and interim reporting standards for operating
segments of a company. It also requires entity–wide disclosures about
the products and services an entity provides, the material countries in which it
holds assets and reports revenues, and its major customers. Our Chief
Executive Officer has been identified as the chief operating decision maker in
assessing the performance and the allocation of resources within Merge
Healthcare. Our Chief Executive Officer relies on the information
derived from our financial reporting process, which includes revenue by business
unit and consolidated operating results and consolidated assets. As
we do not have discrete financial information available for our business units,
we operate as a single segment for reporting purposes as prescribed by SFAS No.
131.
We have
reorganized our operating business units, effective July 1, 2008. The
relevant portions of the EMEA (formerly known as Merge Europe, Middle East and
Africa) operation have been allocated between the remaining business units of
Merge Fusion (formerly known as Merge Healthcare North America) and Merge OEM
(formerly known as Cedara). As a result, beginning with our third
quarter financial statements, we no longer separately report EMEA
revenues. In addition, we continue the process of developing systems
and processes to obtain discrete financial information for each of our business
units, which is intended to be used by our Chief Executive Officer.
The
following tables provide revenue from our business units for the periods
indicated:
|
|
Three
Months Ended September 30, 2008
|
|
|
|
Merge
Fusion
|
|
|
Merge
OEM
|
|
|
Total
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
3,175
|
|
|
$
|
4,223
|
|
|
$
|
7,398
|
|
Service
and maintenance
|
|
|
4,790
|
|
|
|
2,428
|
|
|
|
7,218
|
|
Total
net sales
|
|
$
|
7,965
|
|
|
$
|
6,651
|
|
|
$
|
14,616
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended September 30, 2007
|
|
|
|
Merge
Fusion
|
|
|
Merge
OEM
|
|
|
Total
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
4,195
|
|
|
$
|
2,732
|
|
|
$
|
6,927
|
|
Service
and maintenance
|
|
|
4,854
|
|
|
|
2,273
|
|
|
|
7,127
|
|
Total
net sales
|
|
$
|
9,049
|
|
|
$
|
5,005
|
|
|
$
|
14,054
|
|
Merge
Healthcare Incorporated and Subsidiaries
Notes
to Condensed Consolidated Financial Statements (continued)
(Unaudited
and in thousands, except for share and per share data)
|
|
Nine
Months Ended September 30, 2008
|
|
|
|
Merge
Fusion
|
|
|
Merge
OEM
|
|
|
Total
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
9,539
|
|
|
$
|
10,194
|
|
|
$
|
19,733
|
|
Service
and maintenance
|
|
|
13,894
|
|
|
|
8,047
|
|
|
|
21,941
|
|
Total
net sales
|
|
$
|
23,433
|
|
|
$
|
18,241
|
|
|
$
|
41,674
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
Months Ended September 30, 2007
|
|
|
|
Merge
Fusion
|
|
|
Merge
OEM
|
|
|
Total
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
12,883
|
|
|
$
|
8,907
|
|
|
$
|
21,790
|
|
Service
and maintenance
|
|
|
16,299
|
|
|
|
5,875
|
|
|
|
22,174
|
|
Total
net sales
|
|
$
|
29,182
|
|
|
$
|
14,782
|
|
|
$
|
43,964
|
|
(12)
|
Recent
Accounting Pronouncements
|
In
February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement
No. 115
(“SFAS No. 159”), which is effective for fiscal years
beginning after November 15, 2007. This statement permits entities to
choose to measure many financial instruments and certain other items at fair
value. This statement also establishes presentation and disclosure requirements
designed to facilitate comparisons between entities that choose different
measurement attributes for similar types of assets and liabilities. Unrealized
gains and losses on items for which the fair value option is elected would be
reported in earnings. We have adopted SFAS No. 159 and have elected
not to measure any additional financial instruments and other items at fair
value.
In
February 2008, FASB issued Staff Position FAS 157-2 which provides for a
one-year deferral of the effective date of SFAS No. 157,
Fair Value Measurements
(“SFAS No. 157”), for non-financial assets and liabilities that are recognized
or disclosed at fair value in the financial statements on a nonrecurring basis,
except those that are recognized or disclosed at fair value in the financial
statements on a recurring basis. We are evaluating the impact of SFAS
No. 157 as it relates to our financial position and results of
operations.
In March
2008, the FASB issued SFAS No. 161,
Disclosures about Derivative
Instruments and Hedging Activities
(“SFAS No. 161”)
.
SFAS No. 161 is intended to
improve financial reporting about derivative instruments and hedging activities
by requiring enhanced disclosures to enable investors to better understand the
effects on an entity’s financial position, financial performance, and cash
flows. It is effective for financial statements issued for fiscal
years and interim periods beginning after November 15, 2008. We
expect to adopt SFAS No. 161 and its required disclosures, in our consolidated
financial statements for the fiscal year beginning January 1,
2009.
In April
2008, the FASB issued FSP FAS 142-3,
Determination of the Useful Life of
Intangible Assets
(“FSP 142-3”)
.
FSP 142-3 amends
the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142,
Goodwill and Other Intangible Assets
(“SFAS No. 142”)
.
The intent of
FSB 142-3 is to improve the consistency between the useful life of a recognized
intangible asset under SFAS No. 142 and the period of expected cash flows used
to measure the fair value of the asset under SFAS No. 141R, and other U.S.
generally accepted accounting principles. FSP 142-3 is effective for
our interim and annual financial statements beginning after November 15,
2008. We do not expect the adoption of FSP 142-3 will have a material impact on
our financial position or results of operations.
In
October 2008, the FASB issued FASB Staff Position FAS 157-3,
Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active
(“FSP 157-3”). FSP 157-3 clarified the application of
SFAS No. 157. FSP 157-3 demonstrated how the fair value of
a financial asset is determined when the market for that financial asset is
inactive. FSP 157-3 was effective upon issuance, including prior
periods for which financial statements had not been issued. The
implementation of this standard did not have a material impact on our financial
position or results of operations.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
Cautionary
Note Regarding Forward-Looking Statements
The
discussion below contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995, Section 27A of the Securities
Act, and Section 21E of the Exchange Act. Forward-looking
statements usually describe our expected future business and financial outlook
or performance, and often contain words such as “will,” “believes,” “intends,”
“anticipates,” “expects,” "plans," "seeks," and similar
expressions. Forward-looking statements, by their nature, address
matters that are, to varying degrees, uncertain and subject to various known and
unknown risks. For us, particular uncertainties and risks that could
cause actual results to differ materially from our forward-looking statements
include: market acceptance and performance of our products and services; the
impact of competitive products and pricing; possible delays in the
implementation of our managed services offering; the risks and effects of our
recent changes in our executive and Board leadership, including the costs and
expenses related to severance payments made to departing officers; the risks and
effects of our recent securities issues, including the issuance of certain
senior secured notes; the past restatement of our financial statements and other
actions that may be taken or required as a result of such restatement; our
ability to generate sufficient cash from operations to meet future operating,
financing and capital requirements, including repayment obligations with respect
to our outstanding indebtedness; risks associated with our prior delays in
filings with the SEC or our ability to continue to meet the listing requirements
of The NASDAQ Stock Market; the costs, risks and effects of various pending
legal proceedings and investigations, including the formal investigation being
conducted by the Securities and Exchange Commission and the pending settlement
of certain class action lawsuits; and other risk factors detailed in our filings
with the Securities and Exchange Commission. These uncertainties and
risks may cause our actual future results to be materially different than those
expressed in our forward-looking statements. The following discussion
should be read in conjunction with our unaudited condensed consolidated
financial statements and notes thereto appearing elsewhere in this report and
the audited consolidated financial statements and notes thereto appearing on our
Annual Report on Form 10-K for the year ended December 31,
2007. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date the statement was
made. We undertake no obligation to update such forward-looking
statements or any of such risks, uncertainties and other factors.
In light
of our financial and liquidity positions, the fact that our 2007 financial
statements included a going concern qualification and the recent completion of
our financing transaction, Management’s Discussion and Analysis is presented in
the following order:
|
·
|
Liquidity
and Capital Resources
|
|
·
|
Critical
Accounting Policies
|
|
·
|
Material
Off Balance Sheet
Arrangements
|
We
develop medical imaging and information management software and deliver related
services. We have reorganized our operating business units, effective
July 1, 2008. The relevant portions of the EMEA (formerly known as
Merge Europe, Middle East and Africa) operation, which sells to the end-user
healthcare market in Europe, the Middle East and Africa, has been allocated
between the Merge Fusion (formerly known as Merge Healthcare North America) and
Merge OEM (formerly known as Cedara) business units. Merge OEM
primarily sells software products, developer toolkits and custom engineering
services to Original Equipment Manufacturers and Value Added Resellers
world-wide. These customers develop, manufacture or resell medical
imaging software or devices. Merge Fusion primarily sells directly to
the end-user healthcare market consisting of hospitals, imaging centers and
specialty clinics located in the U.S., Canada and Europe, the Middle East and
Africa and also distributes certain products through the Internet via our
website.
Healthcare
providers continue to be challenged by declining reimbursements, competition and
reduced operating profits brought about by the increasing costs of delivering
healthcare services. In the U.S., we are focusing our Merge Fusion
sales efforts on single and multi-site imaging centers that complete more than
10,000 studies per year, small-to-medium sized hospitals (fewer than 400 beds),
and certain specialty clinics, such as orthopaedic practices that offer imaging
services.
Recent
Events
The
following significant events either have an impact on our financial results for
the periods presented or are of note to our financial condition:
|
·
|
In
July 2008, we ceased operations in our Merge Healthcare Teleradiology
Services Private Limited (India) subsidiary, as disclosed in Note 9 of
notes to condensed consolidated financial
statements.
|
|
·
|
On
August 29, 2008, we completed the sale of our CSSI subsidiary, as
disclosed in Note 9 of notes to condensed consolidated financial
statements.
|
|
·
|
On
October 16, 2008, the NASDAQ Stock Market (“NASDAQ”) issued Alert
#2008-005 which immediately suspended enforcement of the NASDAQ rules
requiring a minimum $1.00 per share closing bid price as well as minimum
market value of publically held shares. The suspension will
remain in effect through Friday, January 16, 2009 and as a result, NASDAQ
will not take any action to delist any securities during the suspension
period.
|
Liquidity
and Capital Resources
Our cash
and cash equivalents were $14.4 million at September 30, 2008, an increase of
approximately $0.4 million, or 3.0%, from our balance of $14.0 million at
December 31, 2007 and a decrease of approximately $6.3 million, or 30.4%, from
our balance of $20.7 million at June 30, 2008. In addition, our
working capital was $3.5 million at September 30, 2008, an increase of $2.6
million from our working capital of $0.9 million at December 31, 2007 and an
increase of $2.0 million from our working capital of $1.5 million at June 30,
2008.
On June
4, 2008 we received cash of $16.6 million as proceeds, net of transaction costs
and prepaid interest, upon closing of a private placement transaction with
Merrick RIS, LLC (“Merrick”). Of the funds received, $3.3 million has
been used to pay our portion of the shareholder lawsuit settlement and
derivative lawsuit settlement (see Note 7 of notes to condensed consolidated
financial statements) in the third quarter of 2008, and $3.8 million has been
used to pay employee termination costs in the third quarter of
2008. The remainder will be used to fund our operations, including
future payments related to employee termination costs accrued as of September
30, 2008 (see Note 8 of notes to condensed consolidated financial
statements).
Cash used
in operating activities was $17.0 million during the nine months ended September
30, 2008, compared to $21.5 million during the nine months ended September 30,
2007. Our negative operating cash flow during the nine months ended
September 30, 2008 was primarily due to the loss from operations (excluding
non-cash depreciation, amortization and impairment expense of $5.1 million,
share-based compensation of $3.8 million, tradename impairment charges of $1.1
million and loss on disposal of our subsidiaries of $1.7 million), the timing of
payments for legal fees and insurance recoveries in connection with the class
action, derivative and other lawsuits and restructuring related
payments.
We
anticipate that we will pay approximately $1.7 million over the next several
quarters for termination benefits and contract exit costs in connection with our
restructuring initiatives. Termination benefits and contract exit
costs paid in the third quarter of 2008 were $4.0 million.
Total
outstanding commitments under our operating leases at September 30, 2008 (in
thousands), were as follows:
|
|
|
|
|
Payment due by period
|
|
|
|
|
|
|
Less than
|
|
|
|
|
|
|
|
|
More than
|
|
Contractual Obligations
|
|
Total
|
|
|
1 Year
|
|
|
1 – 3 Years
|
|
|
3 – 5 Years
|
|
|
5 Years
|
|
Operating
leases
|
|
$
|
2,283
|
|
|
$
|
1,176
|
|
|
$
|
1,043
|
|
|
$
|
64
|
|
|
$
|
-
|
|
Note
Payable
|
|
|
15,000
|
|
|
|
-
|
|
|
|
15,000
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
17,283
|
|
|
$
|
1,176
|
|
|
$
|
16,043
|
|
|
$
|
64
|
|
|
$
|
-
|
|
The above
obligations do not include lease payments related to facilities that we have
either ceased to use or abandoned as of September 30, 2008, as the related
obligations for such facilities have been recorded as restructuring related
accruals in our condensed consolidated balance sheet as of September 30,
2008. The note payable bears interest at 13.0% per annum, payable
quarterly in arrears. The note payable contains various operating and financial
covenants, including a requirement that we have positive adjusted EBITDA for the
last fiscal quarter of 2008 and cumulatively thereafter through the term of the
note payable.
We do not
have any other significant long-term obligations, contractual obligations, lines
of credit, standby letters of credit, guarantees, standby repurchase obligations
or other commercial commitments.
We
believe our current cash and cash equivalent balances will be sufficient to meet
our operating, financing and capital requirements through at least the next 12
months. However, any projections of future cash inflows and outflows
are subject to uncertainty. We have undertaken certain initiatives
that we believe will increase our revenues and decrease our costs, including the
reorganization during the second quarter of 2008 as previously discussed, the
disposal of certain non-core subsidiaries and related operations and personnel
reductions undertaken in the first and second quarters of
2008. Although we believe the remaining financing funds and
operational initiatives that we have undertaken as discussed in Notes 2, 8, 9
and 11 of the notes to condensed consolidated financial statements are
sufficient, these activities alone may not be adequate to fund our future
business and strategic objectives. Based on these circumstances and
the current economic environment, management may or may not conclude in our
Annual Report on Form 10-K that there exists substantial doubt about our ability
to continue as a going concern.
In the
event that it is necessary to raise additional capital to meet our short term or
long term liquidity needs, such capital may be raised through additional debt,
equity offerings or sale of certain assets. If we raise additional
funds through the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to those of our
Common Stock. Furthermore, because of the low trading price of our
Common Stock, the number of shares of any new equity or equity-related
securities that may be issued may result in significant dilution to existing
shareholders. In addition, the issuance of debt securities could
increase the liquidity risk or perceived liquidity risk that we
face. We cannot, however, be certain that additional financing, or
funds from asset sales, will be available on acceptable terms. If
adequate funds are not available or are not available on acceptable terms, we
will likely not be able to take advantage of opportunities, develop or enhance
services or products or respond to competitive pressures. Any
projections of future cash inflows and outflows are subject to
uncertainty. In particular, our uses of cash in 2008 and beyond will
depend on a variety of factors such as the costs to implement our business
strategy, the amount of cash that we are required to devote to defend and
address our outstanding legal and regulatory proceedings, and potential merger
and acquisition activities. For a more detailed description of risks
and uncertainties that may affect our liquidity, see Item 1A, “Risk Factors” in
our Annual Report on Form 10-K for the year ended December 31, 2007 and in this
Quarterly Report on Form 10-Q.
Critical
Accounting Policies
Our
discussion and analysis of our financial condition and results of operations are
based upon our unaudited condensed consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these condensed consolidated
financial statements requires our management to make estimates and judgments
that affect the reported amounts of assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. On an
ongoing basis, our management evaluates these estimates. We base our
estimates and judgments on our experience, our current knowledge (including
terms of existing contracts), our beliefs of what could occur in the future, our
observation of trends in the industry, information provided by our customers and
information available from other sources. Actual results may differ
materially from these estimates.
We have
identified the following accounting policies and estimates as those that we
believe are most critical to our financial condition and results of operations
and that require management’s most subjective and complex judgments in
estimating the effect of inherent uncertainties: revenue recognition,
allowance for doubtful accounts, software capitalization, other long-lived
assets, intangible asset valuation, share-based compensation expense, income
taxes, guarantees and loss contingencies. There have been no
significant changes during the three months ended September 30, 2008 in our
method of application of these critical accounting policies. For a
complete description of our critical accounting policies, please refer to
Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Critical Accounting Policies” in our
Annual Report on Form 10-K for the year ended December 31,
2007.
Results
of Operations
Three
Months Ended September 30, 2008 Compared to the Three Months Ended September 30,
2007
The
following table sets forth selected, summarized, unaudited, consolidated
financial data for the periods indicated, as well as comparative data showing
increases and decreases between the periods. All amounts, except
percentages, are in thousands.
|
|
Three
Months Ended September 30,
|
|
|
Change
|
|
|
|
2008
|
|
|
|
%
|
(1)
|
|
2007
|
|
|
|
%
|
(1)
|
|
$
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
7,398
|
|
|
|
50.6
|
%
|
|
$
|
6,927
|
|
|
|
49.3
|
%
|
|
$
|
471
|
|
|
|
6.8
|
%
|
Services
and maintenance
|
|
|
7,218
|
|
|
|
49.4
|
%
|
|
|
7,127
|
|
|
|
50.7
|
%
|
|
|
91
|
|
|
|
1.3
|
%
|
Total
net sales
|
|
|
14,616
|
|
|
|
100.0
|
%
|
|
|
14,054
|
|
|
|
100.0
|
%
|
|
|
562
|
|
|
|
4.0
|
%
|
Cost
of sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
|
1,314
|
|
|
|
17.8
|
%
|
|
|
1,576
|
|
|
|
22.8
|
%
|
|
|
(262
|
)
|
|
|
-16.6
|
%
|
Services
and maintenance
|
|
|
2,528
|
|
|
|
35.0
|
%
|
|
|
3,571
|
|
|
|
50.1
|
%
|
|
|
(1,043
|
)
|
|
|
-29.2
|
%
|
Amortization
and impairment
|
|
|
742
|
|
|
NM
|
(2)
|
|
|
5,142
|
|
|
NM
|
(2)
|
|
|
(4,400
|
)
|
|
|
-85.6
|
%
|
Total
cost of sales
|
|
|
4,584
|
|
|
|
31.4
|
%
|
|
|
10,289
|
|
|
|
73.2
|
%
|
|
|
(5,705
|
)
|
|
|
-55.4
|
%
|
Gross
margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
|
5,342
|
|
|
|
72.2
|
%
(3)
|
|
|
209
|
|
|
|
3.0
|
%
(3)
|
|
|
5,133
|
|
|
NM
|
(2)
|
Services
and maintenance
|
|
|
4,690
|
|
|
|
65.0
|
%
|
|
|
3,556
|
|
|
|
49.9
|
%
|
|
|
1,134
|
|
|
|
31.9
|
%
|
Total
gross margin
|
|
|
10,032
|
|
|
|
68.6
|
%
|
|
|
3,765
|
|
|
|
26.8
|
%
|
|
|
6,267
|
|
|
|
166.5
|
%
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
1,824
|
|
|
|
12.5
|
%
|
|
|
4,463
|
|
|
|
31.8
|
%
|
|
|
(2,639
|
)
|
|
|
-59.1
|
%
|
Product
research and development
|
|
|
2,931
|
|
|
|
20.1
|
%
|
|
|
5,294
|
|
|
|
37.7
|
%
|
|
|
(2,363
|
)
|
|
|
-44.6
|
%
|
General
and administrative
|
|
|
3,483
|
|
|
|
23.8
|
%
|
|
|
7,454
|
|
|
|
53.0
|
%
|
|
|
(3,971
|
)
|
|
|
-53.3
|
%
|
Goodwill
and tradename impairment,
restructuring and other
expenses
|
|
|
(205
|
)
|
|
|
-1.4
|
%
|
|
|
123,134
|
|
|
NM
|
(2)
|
|
|
(123,339
|
)
|
|
|
-100.2
|
%
|
Depreciation,
amortization and impairment
|
|
|
654
|
|
|
|
4.5
|
%
|
|
|
5,338
|
|
|
|
38.0
|
%
|
|
|
(4,684
|
)
|
|
|
-87.7
|
%
|
Total
operating costs and expenses
|
|
|
8,687
|
|
|
|
59.4
|
%
|
|
|
145,683
|
|
|
NM
|
(2)
|
|
|
(136,996
|
)
|
|
|
-94.0
|
%
|
Operating
income (loss)
|
|
|
1,345
|
|
|
|
9.2
|
%
|
|
|
(141,918
|
)
|
|
NM
|
(2)
|
|
|
143,263
|
|
|
|
-100.9
|
%
|
Other
income (expense), net
|
|
|
(648
|
)
|
|
|
-4.4
|
%
|
|
|
78
|
|
|
|
0.6
|
%
|
|
|
(726
|
)
|
|
NM
|
(2)
|
Income
(loss) before income taxes
|
|
|
697
|
|
|
|
4.8
|
%
|
|
|
(141,840
|
)
|
|
NM
|
(2)
|
|
|
142,537
|
|
|
|
-100.5
|
%
|
Income
tax expense (benefit)
|
|
|
269
|
|
|
|
1.8
|
%
|
|
|
(286
|
)
|
|
|
-2.0
|
%
|
|
|
555
|
|
|
|
-194.1
|
%
|
Net
income (loss)
|
|
$
|
428
|
|
|
|
2.9
|
%
|
|
$
|
(141,554
|
)
|
|
NM
|
(2)
|
|
$
|
141,982
|
|
|
|
-100.3
|
%
|
|
(1)
|
Percentages
are of total net sales, except for cost of sales and gross margin, which
are based upon related net
sales.
|
|
(2)
|
NM
denotes percentage is not
meaningful.
|
|
(3)
|
Gross
margin for software and other sales includes amortization expense recorded
in cost of sales.
|
Net
Sales
Net
sales, by business unit, are indicated as follows:
|
|
Three
Months Ended September 30,
|
|
|
Change
|
|
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
|
$
|
|
|
|
%
|
|
Merge
OEM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
4,223
|
|
|
|
28.9
|
%
|
|
$
|
2,732
|
|
|
|
19.4
|
%
|
|
$
|
1,491
|
|
|
|
54.6
|
%
|
Services
and maintenance
|
|
|
2,428
|
|
|
|
16.6
|
%
|
|
|
2,273
|
|
|
|
16.2
|
%
|
|
|
155
|
|
|
|
6.8
|
%
|
Total
net sales
|
|
|
6,651
|
|
|
|
45.5
|
%
|
|
|
5,005
|
|
|
|
35.6
|
%
|
|
|
1,646
|
|
|
|
32.9
|
%
|
Merge
Fusion
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
|
3,175
|
|
|
|
21.7
|
%
|
|
|
4,195
|
|
|
|
29.8
|
%
|
|
|
(1,020
|
)
|
|
|
-24.3
|
%
|
Services
and maintenance
|
|
|
4,790
|
|
|
|
32.8
|
%
|
|
|
4,854
|
|
|
|
34.5
|
%
|
|
|
(64
|
)
|
|
|
-1.3
|
%
|
Total
net sales
|
|
|
7,965
|
|
|
|
54.5
|
%
|
|
|
9,049
|
|
|
|
64.4
|
%
|
|
|
(1,084
|
)
|
|
|
-12.0
|
%
|
Total
net sales
|
|
$
|
14,616
|
|
|
|
|
|
|
$
|
14,054
|
|
|
|
|
|
|
$
|
562
|
|
|
|
|
|
We have
reorganized our operating business units, effective July 1, 2008. The
relevant portions of the EMEA (formerly known as Merge Europe, Middle East and
Africa) operation have been allocated between the remaining business units of
Merge Fusion (formerly known as Merge Healthcare North America) and Merge OEM
(formerly known as Cedara). As a result, we no longer separately
report EMEA revenues.
Software and Other Sales.
Total software and other sales for the three months ended September 30, 2008
were $7.4 million, an increase of $0.5 million, or 6.8%, from $6.9 million for
the three months ended September 30, 2007. The increase in software
and other sales results from an increase in OEM sales of $1.5 million, primarily
due to recognition of software revenue upon delivery of, or relief from delivery
of, certain products or services associated with contracts signed in prior
periods. This is offset by a decrease in Fusion sales of $1.0
million, as a result of revenue recognition on two large projects in the three
months ended September 30, 2007, compared to one large project in the three
months ended September 30, 2008.
Service and Maintenance
Sales.
Total service and maintenance sales for the three months ended
September 30, 2008 were $7.2 million, an increase of $0.1 million, or 1.3%, from
$7.1 million for the three months ended September 30, 2007. Service
and maintenance sales recognized through our Merge OEM business unit increased
$0.2 million, while service and maintenance sales recognized through our Merge
Fusion business unit decreased $0.1 million.
Gross
Margin
Gross Margin – Software and Other
Sales
.
Gross margin on
software and other sales was $5.3 million for the three months ended September
30, 2008, an increase of approximately $5.1 million, from $0.2 million for the
three months ended September 30, 2007. Gross margin as a percentage
of software and other sales, increased to 72.2% for the three months ended
September 30, 2008 from 3.0% for the three months ended September 30,
2007. The increase in gross margin is primarily due to a $4.1 million
impairment related to our purchased and capitalized software development costs
recorded in the three months ended September 30, 2007, which also resulted in a
corresponding reduction in the software amortization run rate during 2008
because of the impairment, as well as cost controls that were implemented in the
second quarter of 2008. Excluding the impairment charge, the gross
margin as a percentage of sales was 62.8% for the three months ended September
30, 2007. The remainder of the increase is attributable to greater
software and other sales from our OEM business unit, which generally consists of
software-only contracts at higher margins.
Gross Margin – Services and
Maintenance Sales
.
Gross margin on
services and maintenance sales was $4.7 million for the three months ended
September 30, 2008, an increase of $1.1 million, or 31.9%, from $3.6 million for
the three months ended September 30, 2007. Gross margin as a
percentage of services and maintenance sales, increased to 65.0% for the three
months ended September 30, 2008 from 49.9% for the three months ended September
30, 2007. The increases are primarily due to a $0.7 million decrease
in headcount-related expenses as a result of our restructuring activities, and a
$0.2 million decrease in third party support
costs.
Sales and
marketing expense decreased $2.7 million, or 59.1%, to approximately $1.8
million for the three months ended September 30, 2008 from $4.5 million for the
three months ended September 30, 2007. As a result of our
restructuring initiatives in 2008, salaries, commissions and other related
expenses (including travel and entertainment) decreased by $1.8 million and
share-based compensation expense decreased by $0.3 million. In
addition, we incurred $0.2 million less in direct marketing costs for the three
months ended September 30, 2008 compared to the three months ended September 30,
2007 as a result of cost containment efforts. Also, the three months
ended September 30, 2007 includes $0.3 million of sales and marketing incurred
by the French subsidiary, which we disposed of on April 11, 2008.
Product
Research and Development
Product
research and development expense decreased approximately $2.4 million, or 44.6%,
to $2.9 million for the three months ended September 30, 2008 from $5.3 million
for the three months ended September 30, 2007. Decreased expenses for
the three months ended September 30, 2008 were primarily attributable to a $2.1
million reduction in salaries, related expenses (including travel and
entertainment) and third party service costs, as well as a decrease of $0.2
million of share-based compensation expense, all of which were a result of our
restructuring initiatives in 2008. In addition, the three months
ended September 30, 2007 included $0.2 million of product research and
development expenses incurred by the French subsidiary, which we disposed of on
April 11, 2008.
General
and Administrative
General
and administrative expense decreased approximately $4.0 million, or 53.3%, to
$3.5 million for the three months ended September 30, 2008 from $7.5 million for
the three months ended September 30, 2007. Decreased expenses were
primarily attributable to a $1.8 million decrease in legal, accounting and other
professional fees associated with the settlement of the class action lawsuit and
prior restatement of financial statements, a $1.3 million decrease in salaries
and related expenses (including travel and entertainment) and a share-based
compensation expense decrease of $0.4 million, all of which were a result of our
restructuring initiatives in 2008. In addition, the three months
ended September 30, 2007 included $0.2 million of general and administrative
expenses were incurred by the French subsidiary, which we disposed of on April
11, 2008.
Goodwill
and Tradename Impairment, Restructuring and Other Expenses
We
recorded a $0.2 million gain in goodwill and tradename impairment,
restructuring, and other expenses for the three months ended September 30, 2008,
primarily due to the $0.1 million gain on the sale of CSSI, and a $0.1 decrease
in restructuring expenses due to changes in original estimates related to the
initiative announced in June 2008. As discussed in Note 9 to
the condensed consolidated financial statements, during the three months ended
September 30, 2007, we concluded that all of our goodwill was impaired, and
recorded an impairment charge of $122.4 million, and also concluded that trade
names associated with our Cedara Software Corp. business transaction were
impaired, and recorded an impairment charge of $0.8 million.
Depreciation,
Amortization and Impairment
Depreciation,
amortization and impairment expense decreased approximately $4.6 million, or
87.7 %, to $0.7 million for the three months ended September 30, 2008 from $5.3
million for the three months ended September 30, 2007. The decrease
is primarily attributable to a $4.3 million impairment of customer relationships
in the three months ended September 30, 2007, and $0.3 million reduction in the
amortization run rate during 2008 due to the impairment.
Other
Income (Expense), Net
Other
income (expense), net decreased by approximately $0.7 million to $0.6 million of
net expense for the three months ended September 30, 2008 compared to $0.1
million of income for the three months ended September 30, 2007. The
net expense for the three months ended September 30, 2008 is primarily due to
$0.8 million of interest expense and amortization of issuance costs and note
discount associated with the $15.0 million note payable issued on June 4, 2008
pursuant to the Merrick financing transaction as discussed in Note 2 to the
condensed consolidated financial statements.
Income
Tax Expense (Benefit)
During the three months ended September
30, 2008 we recorded income tax expense resulting in an effective tax rate of
38.6%. The net income tax expense recorded during the three months
ended September 30, 2008 is primarily attributable to income taxes payable in
India and capital gains taxes payable in India resulting from the sale of CSSI
which we were not able to offset with either U.S. or Canadian
losses. During the three months ended September 30, 2007 we recorded
an income tax benefit resulting in an effective tax rate of
(0.2)%. Our effective tax rates for the three months ended September
30, 2008 and the three months ended September 30, 2007 differ significantly from
the statutory rate primarily due to recording a valuation allowance for deferred
tax assets that are not more-likely-than-not to be realized. Our expected
effective income tax rate is volatile and may move up or down with changes in,
among other items, operating income and the results of changes in tax law and
regulations of the United States and foreign jurisdictions in which we
operate.
Nine
Months Ended September 30, 2008 Compared to the Nine Months Ended September 30,
2007
The
following table sets forth selected, summarized, unaudited, consolidated
financial data for the periods indicated, as well as comparative data showing
increases and decreases between the periods. All amounts, except
percentages, are in thousands.
|
|
Nine
Months Ended September 30,
|
|
|
|
Change
|
|
|
|
2008
|
|
|
%
|
|
(1)
|
|
2007
|
|
|
%
|
|
(1)
|
|
|
|
|
$
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
19,733
|
|
|
|
47.4
|
%
|
|
|
$
|
21,790
|
|
|
|
49.6
|
%
|
|
|
$
|
(2,057
|
)
|
|
|
-9.4
|
%
|
Services
and maintenance
|
|
|
21,941
|
|
|
|
52.6
|
%
|
|
|
|
22,174
|
|
|
|
50.4
|
%
|
|
|
|
(233
|
)
|
|
|
-1.1
|
%
|
Total
net sales
|
|
|
41,674
|
|
|
|
100.0
|
%
|
|
|
|
43,964
|
|
|
|
100.0
|
%
|
|
|
|
(2,290
|
)
|
|
|
-5.2
|
%
|
Cost
of sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
|
3,842
|
|
|
|
19.5
|
%
|
|
|
|
5,018
|
|
|
|
23.0
|
%
|
|
|
|
(1,176
|
)
|
|
|
-23.4
|
%
|
Services
and maintenance
|
|
|
9,471
|
|
|
|
43.2
|
%
|
|
|
|
10,541
|
|
|
|
47.5
|
%
|
|
|
|
(1,070
|
)
|
|
|
-10.2
|
%
|
Amortization
and impairment
|
|
|
2,174
|
|
|
NM
|
|
(2)
|
|
|
7,837
|
|
|
NM
|
|
(2)
|
|
|
(5,663
|
)
|
|
|
-72.3
|
%
|
Total
cost of sales
|
|
|
15,487
|
|
|
|
37.2
|
%
|
|
|
|
23,396
|
|
|
|
53.2
|
%
|
|
|
|
(7,909
|
)
|
|
|
-33.8
|
%
|
Gross
margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
|
13,717
|
|
|
|
69.5
|
%
|
(3)
|
|
|
8,935
|
|
|
|
41.0
|
%
|
(3)
|
|
|
4,782
|
|
|
|
53.5
|
%
|
Services
and maintenance
|
|
|
12,470
|
|
|
|
56.8
|
%
|
|
|
|
11,633
|
|
|
|
52.5
|
%
|
|
|
|
837
|
|
|
|
7.2
|
%
|
Total
gross margin
|
|
|
26,187
|
|
|
|
62.8
|
%
|
|
|
|
20,568
|
|
|
|
46.8
|
%
|
|
|
|
5,619
|
|
|
|
27.3
|
%
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
7,497
|
|
|
|
18.0
|
%
|
|
|
|
13,850
|
|
|
|
31.5
|
%
|
|
|
|
(6,353
|
)
|
|
|
-45.9
|
%
|
Product
research and development
|
|
|
11,151
|
|
|
|
26.8
|
%
|
|
|
|
16,089
|
|
|
|
36.6
|
%
|
|
|
|
(4,938
|
)
|
|
|
-30.7
|
%
|
General
and administrative
|
|
|
18,093
|
|
|
|
43.4
|
%
|
|
|
|
21,893
|
|
|
|
49.8
|
%
|
|
|
|
(3,800
|
)
|
|
|
-17.4
|
%
|
Goodwill
and tradename impairment, restructuring and other expenses
|
|
|
11,862
|
|
|
|
28.5
|
%
|
|
|
|
124,140
|
|
|
|
282.4
|
%
|
|
|
|
(112,278
|
)
|
|
|
-90.4
|
%
|
Depreciation,
amortization and impairment
|
|
|
2,954
|
|
|
|
7.1
|
%
|
|
|
|
7,374
|
|
|
|
16.8
|
%
|
|
|
|
(4,420
|
)
|
|
|
-59.9
|
%
|
Total
operating costs and expenses
|
|
|
51,557
|
|
|
|
123.7
|
%
|
|
|
|
183,346
|
|
|
|
417.0
|
%
|
|
|
|
(131,789
|
)
|
|
|
-71.9
|
%
|
Operating
loss
|
|
|
(25,370
|
)
|
|
|
-60.9
|
%
|
|
|
|
(162,778
|
)
|
|
|
-370.3
|
%
|
|
|
|
137,408
|
|
|
|
-84.4
|
%
|
Other
income (expense), net
|
|
|
(346
|
)
|
|
|
-0.8
|
%
|
|
|
|
502
|
|
|
|
1.1
|
%
|
|
|
|
(848
|
)
|
|
|
-168.9
|
%
|
Loss
before income taxes
|
|
|
(25,716
|
)
|
|
|
-61.7
|
%
|
|
|
|
(162,276
|
)
|
|
|
-369.1
|
%
|
|
|
|
136,560
|
|
|
|
-84.2
|
%
|
Income
tax expense (benefit)
|
|
|
(115
|
)
|
|
|
-0.3
|
%
|
|
|
|
(261
|
)
|
|
|
-0.6
|
%
|
|
|
|
146
|
|
|
|
-55.9
|
%
|
Net
loss
|
|
$
|
(25,601
|
)
|
|
|
-61.4
|
%
|
|
|
$
|
(162,015
|
)
|
|
|
-368.5
|
%
|
|
|
$
|
136,414
|
|
|
|
-84.2
|
%
|
|
(1)
|
Percentages
are of total net sales, except for cost of sales and gross margin, which
are based upon related net sales.
|
|
(2)
|
NM
denotes percentage is not
meaningful.
|
|
(3)
|
Gross
margin for software and other sales includes amortization expense recorded
in cost of sales.
|
Net
Sales
Net
sales, by business unit, are indicated as follows:
|
|
Nine
Months Ended September 30,
|
|
|
Change
|
|
|
|
2008
|
|
|
%
|
|
|
2007
|
|
|
%
|
|
|
$
|
|
|
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Merge
OEM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
$
|
10,194
|
|
|
|
24.5
|
%
|
|
$
|
8,907
|
|
|
|
20.3
|
%
|
|
$
|
1,287
|
|
|
|
14.4
|
%
|
Services
and maintenance
|
|
|
8,047
|
|
|
|
19.3
|
%
|
|
|
5,875
|
|
|
|
13.4
|
%
|
|
|
2,172
|
|
|
|
37.0
|
%
|
Total
net sales
|
|
|
18,241
|
|
|
|
43.8
|
%
|
|
|
14,782
|
|
|
|
33.6
|
%
|
|
|
3,459
|
|
|
|
23.4
|
%
|
Merge
Fusion
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software
and other
|
|
|
9,539
|
|
|
|
22.9
|
%
|
|
|
12,883
|
|
|
|
29.3
|
%
|
|
|
(3,344
|
)
|
|
|
-26.0
|
%
|
Services
and maintenance
|
|
|
13,894
|
|
|
|
33.3
|
%
|
|
|
16,299
|
|
|
|
37.1
|
%
|
|
|
(2,405
|
)
|
|
|
-14.8
|
%
|
Total
net sales
|
|
|
23,433
|
|
|
|
56.2
|
%
|
|
|
29,182
|
|
|
|
66.4
|
%
|
|
|
(5,749
|
)
|
|
|
-19.7
|
%
|
Total
net sales
|
|
$
|
41,674
|
|
|
|
|
|
|
$
|
43,964
|
|
|
|
|
|
|
$
|
(2,290
|
)
|
|
|
|
|
We
have reorganized our operating business units, effective July 1,
2008. The relevant portions of the EMEA (formerly known as Merge
Europe, Middle East and Africa) operation have been allocated between the
remaining business units of Merge Fusion (formerly known as Merge Healthcare
North America) and Merge OEM (formerly known as Cedara). As a result,
beginning with our third quarter financial statements, we will no longer
separately report EMEA revenues.
Software and Other Sales.
Total software and other sales for the nine months ended September 30, 2008 were
$19.7 million, a decrease of approximately $2.1 million, or 9.4%, from $21.8
million for the nine months ended September 30, 2007. The decrease in
software and other sales primarily resulted from a $3.3 million decrease in
revenue recognized on software and other sales through our Merge Fusion business
unit, offset by a $1.2 million increase in our Merge OEM software and other
sales. The increase in OEM software and other sales was primarily due
to recognition of software revenue upon delivery of, or relief from delivery of,
certain contract elements associated with contracts signed in prior
periods. Our Merge Fusion business net sales have decreased as a
result of the delay of certain product deliverables during the first two
quarters of 2008, the disposal of our French subsidiary at the beginning of the
second quarter of 2008 and the previous uncertainty regarding the status of the
remaining operations located in Europe, the Middle East, and
Africa. Although we believe that the financing transaction completed
in June 2008 and settled class action derivative lawsuits are positive events,
it may take time for our customers to fully react, especially in the current
economic environment. In addition, we anticipate that the revenue
recognized from software and other sales may vary significantly on a quarterly
basis.
Service and Maintenance
Sales.
Total service and maintenance sales for the nine months ended
September 30, 2008 were $21.9 million, a decrease of $0.3 million, or 1.1%, from
$22.2 million for the nine months ended September 30, 2007. Service
and maintenance sales recognized through our Merge Fusion business unit
decreased
$2.4
million, while service and maintenance sales recognized through our Merge OEM
business unit increased $2.1 million. The Merge Fusion sales decrease
is a result of a decrease in services to install software products as well as a
decrease in
renewals
of maintenance contracts for certain customers, primarily due to prior viability
concerns with respect to us
. Our Merge OEM business unit
experienced increased revenue during the nine months ended September 30, 2008
resulting from an increase in customer contracts involving custom engineering
services.
Gross
Margin
Gross Margin – Software and Other
Sales
.
Gross margin on
software and other sales was $13.7 million for the nine months ended September
30, 2008, an increase of approximately $4.8 million, or 53.5%, from $8.9 million
for the nine months ended September 30, 2007. Gross margin as a
percentage of software and other sales, increased to 69.5% for the nine months
ended September 30, 2008 from 41.0% for the nine months ended September 30,
2007. The increase in gross margin as a percentage of sales is
primarily due to the mix in sales from our business units and a decrease in
amortization expense in the nine months ended September 30,
2008. Sales from our Merge OEM business unit, which typically consist
of software only contracts at higher margins, were 51.7% of software and other
sales during the nine months ended September 30, 2008 compared to 40.9% during
the nine months ended September 30, 2007. The decrease in
amortization is primarily due to the fact that amortization for the nine months
ended September 30, 2007 included impairment of certain of our acquired and
capitalized software projects of $4.7 million due to significant risk of
technological obsolescence associated with certain projects, the majority of
which were still in development at the time of impairment, as well as a decrease
in recurring amortization associated with gross acquired and capitalized
software costs in 2008 as a result of the 2007 impairment charges. We
expect our gross margin on software and other sales going forward to fluctuate
depending on the mix between the business units.
Gross Margin – Services and
Maintenance Sales
.
Gross margin on
services and maintenance sales was $12.5 million for the nine months ended
September 30, 2008, an increase of $0.9 million, or 7.2%, from $11.6 million for
the nine months ended September 30, 2007. Gross margin as a
percentage of services and maintenance sales increased to 56.8% for the nine
months ended September 30, 2008 from 52.5% for the nine months ended September
30, 2007.The increase was primarily due to a $1.6 million decrease in
headcount-related expenses in the Fusion business as a result of our
restructuring activities, offset by a $0.6 million increase in OEM
headcount-related expenses due to an increase in custom engineering
projects.
Sales and
marketing expense decreased $6.4 million, or 45.9%, to $7.5 million for the nine
months ended September 30, 2008 from $13.9 million for the nine months ended
September 30, 2007. As a result of ongoing cost reductions previously
discussed, including the restructuring initiatives announced in 2008, salaries,
commissions and other related expenses (including travel and entertainment)
decreased by $4.1 million and share-based compensation expense decreased by $0.6
million. In addition, we incurred $0.5 million less in direct
marketing costs for the nine months ended September 30, 2008 compared to the
nine months ended September 30, 2007 as a result of cash saving
efforts. Also, the nine months ended September 30, 2007 includes $0.5
million of sales and marketing expenses incurred by the French subsidiary, which
we disposed of on April 11, 2008. We anticipate that the quarterly
sales and marketing expenses will increase in the fourth quarter of 2008, as
compared to the third quarter of 2008, due to increased costs associated with
the RSNA trade show in the fourth quarter.
Product
Research and Development
Product
research and development expense decreased $4.9 million, or 30.7%, to $11.2
million for the nine months ended September 30, 2008 from $16.1 million for the
nine months ended September 30, 2007. Decreased expenses for the nine
months ended September 30, 2008 were primarily attributable to a $4.6 million
reduction in our off-shore and on-shore salaries and related expenses (including
travel and entertainment). As of the filing date, we do not contract
with any off-shore engineering service providers. Research and
development costs also decreased due to a decrease in share-based compensation
expense of $0.6 million as a result of our restructuring initiatives in 2008 and
$0.5 million of product research and development expenses for the nine months
ended September 30, 2007 incurred by the French subsidiary, which we disposed of
on April 11, 2008. Partially offsetting this decrease was
the fact that we did not capitalize any software development costs during the
nine months ended September 30, 2008 compared to $0.8 million of capitalized
costs, which reduce expense in the applicable period, for the nine months ended
September 30, 2007.
General
and Administrative
General
and administrative expense decreased $3.8 million, or 17.4%, to $18.1 million
for the nine months ended September 30, 2008 from $21.9 million for the nine
months ended September 30, 2007. Decreased expenses were primarily
attributable to a $2.4 million reduction in our salaries and related expenses
(including travel and entertainment), a share-based compensation expense
decrease of $0.6 million as a result of our restructuring initiatives in 2008
and a $1.1 million reimbursement from our primary directors and officers
liability insurance carrier for legal expenses incurred in connection with the
class action lawsuit against us. Also, legal, accounting and
other professional fees decreased $2.4 million, due to costs associated with the
settlement of the class action lawsuit and prior restatement of financial
statements that were incurred in the nine months ended September 30,
2007. Additionally, the nine months ended September 30, 2007 include
$0.3 million in general and administrative expenses incurred by the French
subsidiary, which we disposed of on April 11, 2008. These decreases
are offset by the $3.0 million settlement cost related to the putative class
action lawsuit accrued in the second quarter of 2008.
Goodwill
and Tradename Impairment, Restructuring and Other Expenses
As
discussed in Note 8 to the condensed consolidated financial statements, we
recorded $8.7 million of restructuring charges for the nine months ended
September 30, 2008 related to the initiatives announced in February 2008 and
June 2008. In addition, as discussed in Note 9 to the condensed
consolidated financial statements, we recorded a $1.1 million tradename
impairment charge associated with renaming our Cedara Software business unit and
a $1.7 million charge associated with the disposal of our French subsidiary
during the nine months ended September 30, 2008. We also recorded a
$0.4 million charge during the nine months ended September 30, 2008 related to a
change in estimate associated with our ability to sublease a facility for which
we had a prior tenant. As discussed in Note 9 to the condensed
consolidated financial statements, during the nine months ended September 30,
2007, we recorded a goodwill impairment charge of $122.4 million and a trade
name impairment charge of $0.8 million.
Depreciation,
Amortization and Impairment
Depreciation,
amortization and impairment expense decreased $4.4 million, or 59.9 %, to $3.0
million for the nine months ended September 30, 2008 from $7.4 million for the
nine months ended September 30, 2007. Decreased depreciation,
amortization and impairment expenses were primarily attributable to a $4.3
million impairment of customer relationships during the third quarter of
2007.
Other
Income (Expense), Net
Other
income (expense), net decreased by approximately $0.8 million, to $0.3 million
of net expense for the nine months ended September 30, 2008 from $0.5 million of
net income for the nine months ended September 30, 2007. The decrease
is primarily due to $1.0 million of interest expense and amortization of
issuance costs and note discount associated with the $15.0 million note payable
issued on June 4, 2008 as discussed in Note 2 to the condensed consolidated
financial statements and a $0.9 million decrease in interest income as a result
of a decrease in the average balance of our cash and cash equivalents in 2008
compared to 2007 as well as a decrease in the yield on cash and cash
equivalents. Partially offsetting the decrease was a $0.9 million
increase in the effect of foreign currency in the nine months ended September
30, 2008 compared to the nine months ended September 30, 2007. The
nine months ended September 30, 2007 included a foreign currency exchange loss
of $0.5 million whereas the nine months ended September 30, 2008 included a
foreign currency exchange gain of $0.4 million.
Income
Tax Expense (Benefit)
During
the nine months ended September 30, 2008 we recorded an income tax benefit
resulting in an effective tax rate of (0.4)%. The net income tax
benefit recorded during the nine months ended September 30, 2008 is primarily
attributable to changes in deferred taxes resulting from the impairment of
indefinite lived tradenames offset by income taxes payable in India and capital
gains taxes payable in India resulting from the sale of CSSI which we were not
able to offset with either U.S. or Canadian losses. Our effective tax
rate for the period differed significantly from the statutory rate primarily as
a result of the fact we have a valuation allowance for deferred tax assets which
we have concluded are not more-likely-than-not to be realized. During
the nine months ended September 30, 2007, we recorded an income tax benefit
resulting in an effective tax rate of (0.2)%. Our effective tax
rate for the period differed significantly from the statutory rate primarily due
to recording a valuation allowance for deferred tax assets that are not
more-likely-than-not to be realized. Our expected effective income tax rate is
volatile and may move up or down with changes in, among other items, operating
income and changes in tax law and regulations of the United States and foreign
jurisdictions in which we operate.
Material
Off Balance Sheet Arrangements
We have
no material off balance sheet arrangements.
|
Quantitative
and Qualitative Disclosures About Market
Risk
|
Our cash
and cash equivalents are exposed to financial market risk due to fluctuations in
interest rates, which may affect our interest income. As of September
30, 2008, our cash and cash equivalents included money market funds and short
term deposits totaling $14.4 million, and earned interest at a weighted average
rate of approximately 2.6%. The value of the principal amounts is
equal to the fair value for these instruments. Due to the relative
short-term nature of our investment portfolio, our interest income is vulnerable
to changes in short-term interest rates. At current investment
levels, our results of operations would vary by approximately $0.1 million on an
annual basis for every 100 basis point change in our weighted average short-term
interest rate. We do not use our portfolio for trading or other
speculative purposes.
Foreign
Currency Exchange Risk
We have
sales and expenses in Canada, Europe and India that are denominated in
currencies other than the U. S. Dollar and, as a result, have exposure to
foreign currency exchange risk. In the event our exposure to foreign
currency exchange risk increases to levels that we do not deem acceptable, we
may choose to hedge those exposures. We did not enter into any
derivative financial instruments to hedge such exposures during 2007 or
2008.
Disclosure
Controls and Procedures
We
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures as of September 30, 2008, as required by
Rule 13a–15 of the Exchange Act. This evaluation was carried out under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer. As described in
Part II, Item 9A under “Management’s Report on Internal Control Over Financial
Reporting” of our Annual Report on Form 10-K for the year ended
December 31, 2007, a material weakness was identified in our internal
control over financial reporting relating to our accounting for income
taxes. We anticipate that we will remediate the material weakness
relating to our accounting for income taxes prior to December 31, 2008, and we
do not expect to incur significant costs associated with our remediation
efforts.
Based on
the evaluation described above, our principal executive officer and principal
financial officer have concluded that, as of September 30, 2008, this material
weakness continues to exist and, as a result, our disclosure controls and
procedures were not effective to ensure (1) that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the SEC’s rules and forms, and (2) information required to be
disclosed by us in our reports that we file or submit under the Exchange Act is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, or persons performing similar
functions, as appropriate to allow timely decisions regarding required
disclosure.
Changes
in Internal Control Over Financial Reporting
As a
result of our June 2008 reorganization and effective July 1, 2008, we have made
certain changes to our control environment to allow our principal executive
officer and our principal financial officer to have greater visibility into and
accountability for certain operational activities. In addition, the
following significant changes in our internal control over financial reporting
occurred during the three months ended September 30, 2008 and have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting:
|
·
|
A
regular review by operations personnel, in concert with finance and
accounting, of expenses recorded;
|
|
·
|
A
review of revenue recognition determination by the principal financial
officer for all contracts greater than $100,000 (previously this amount
was $350,000); and
|
|
·
|
A
review by the principal financial officer of quarterly customer revenue
greater than $100,000 (previously this was performed by a corporate
controller).
|
PART II
– OTHER INFORMATION
Between
March 22, 2006 and April 26, 2006, seven putative securities class action
lawsuits were filed in the United States District Court for the Eastern District
of Wisconsin, on behalf of a class of persons who acquired shares of our Common
Stock between August 2, 2005 and March 16, 2006. On November 22, 2006, the Court
consolidated the seven cases, appointed the Southwest Carpenters Pension Trust
to be the lead plaintiff and approved the Trust’s choice of its lead counsel.
The lead plaintiff filed a consolidated amended complaint on March 21, 2007.
Defendants in the suit included us, Richard A. Linden, our former President and
Chief Executive Officer, Scott T. Veech, our former Chief Financial Officer,
David M. Noshay, our former Senior Vice President of Strategic Business
Development, and KPMG LLP, our independent public accountants at the time. The
consolidated amended complaint arose out of our restatement of financial
statements, as well as our investigation of allegations made in anonymous
letters received by us. The lawsuits allege that we and the other defendants
violated Section 10 (b) and that the individuals violated Section 20(a) of the
Securities Exchange Act of 1934, as amended. The consolidated amended complaint
seeks damages in unspecified amounts. The defendants filed motions to
dismiss. On March 31, 2008, the motions to dismiss us, Mr. Linden and
Mr. Veech were denied, and the motions to dismiss Mr. Noshay and KPMG were
granted without prejudice. On April 30, 2008, we entered into an
agreement in principle with the plaintiff in the consolidated securities class
action suits filed against us. The agreement in principle provided for the
settlement, release and dismissal of all claims asserted against Merge
Healthcare and the individual defendants in the litigation. In exchange, we
agreed to a one time cash payment of $3,025 to the plaintiff and our primary and
one of our excess directors and officers insurance carriers agreed to a one time
cash payment of $12,975 to the plaintiff, for a total payment of
$16,000. These costs were accrued as of June 30, 2008, as payment was
contingent upon completion of a financing transaction, and were recorded as a
general and administrative expense. The settlement amounts were paid
into escrow in July 2008. The proposed settlement was preliminarily
approved on July 15, 2008 and is subject to final approval from the United
States District Court for the Eastern District of Wisconsin on November 10,
2008. The defendants have steadfastly maintained that the claims
raised in the litigation are without merit. There was no admission of
wrongdoing or liability by the defendants in the settlement.
On August
28, 2006, a derivative action was filed in the Circuit Court of Milwaukee
County, Civil Division, against Messrs. Linden and Veech, William C. Mortimore
(our founder, former Chairman and Chief Strategist, who served as our interim
Chief Executive Officer from May 15, 2006 to July 2, 2006) and all of the
then-current members of our Board of Directors. The plaintiff filed an amended
complaint on June 26, 2007, adding Mr. Noshay as a defendant. The plaintiff
alleged that (a) each of the individual defendants breached fiduciary duties
owed to us by violating generally accepted accounting principles, willfully
ignoring problems with accounting and internal control practices and procedures
and participating in the dissemination of false financial statements; (b) we and
the director defendants failed to hold an annual meeting of shareholders for
2006 in violation of Wisconsin law; (c) Directors Barish, Geras and Hajek
violated insider trading prohibitions and that they misappropriated material
non-public information; (d) a claim of corporate waste and gift against
Directors Hajek, Barish, Reck, Dunham and Lennox, members of the Compensation
Committee at the time of the restatement; and (e) claims of unjust enrichment
and insider selling against Messrs. Linden, Veech, Noshay and Mortimore. The
plaintiff asked for unspecified amounts in damages and costs, disgorgement of
certain compensation and profits against certain defendants as well as equitable
relief. In response to the filing of this action, our Board of Directors formed
a Special Litigation Committee, which Committee was granted full authority to
investigate the allegations of the derivative complaint and determine whether
pursuit of the claims against any or all of the individual defendants would be
in our best interest. On March 3, 2008, the parties to this
derivative action entered into a Memorandum of Understanding providing for the
settlement of all claims asserted in the case. Under the terms of the
settlement, the Board of Directors has agreed to pay fees and expenses of
plaintiff’s counsel of $250. These costs were accrued as of December
31, 2007 and were paid in July 2008. The proposed settlement was
preliminarily approved on April 17, 2008 with final approval on June, 27,
2008. As a result of this settlement, the Special Litigation
Committee was dissolved by the Board of Directors on August 19,
2008. The defendants have steadfastly maintained that the claims
raised in the litigation are without merit. There was no admission of
wrongdoing or liability by the defendants in the settlement.
In March
2008, we received $1,050 from our primary directors and officers liability
insurance carrier for reimbursement of legal expenses in connection with the
class action and derivative action against Merge Healthcare and some of its
current and former directors and officers. This reimbursement was
recorded as a credit to general and administrative expense. We do not
anticipate that additional funds will be collected from the insurance carriers
related to these defense costs.
On April
27, 2006, Merge Healthcare received an informal, non-public inquiry from the
Securities and Exchange Commission (“SEC”) requesting voluntary production of
documents and other information. The inquiry principally related to
our announcement, on March 17, 2006, that we would investigate allegations of
improprieties related to financial reporting and revise our results of
operations for the fiscal quarters ended June 30, 2005, and September 30,
2005. On July 10, 2007, SEC Staff advised us that the SEC had issued
a formal order of investigation in this matter. Merge Healthcare is
cooperating fully with the SEC. The SEC Staff has informed Merge
Healthcare that the Staff is considering recommending an injunctive or cease and
desist order against Merge Healthcare prohibiting violations of the reporting,
record-keeping, and internal control provisions under the Securities Exchange
Act of 1934. The Staff did not inform Merge Healthcare that it is
considering recommending any monetary sanctions against Merge
Healthcare. However, the matter has not yet been finally resolved,
and, until such final resolution, Merge Healthcare will continue to incur
expenses, including legal fees and other costs, in connection with the SEC’s
investigation.
In
addition to the matters discussed above, we are from time to time parties to
legal proceedings, lawsuits and other claims incident to our business
activities. Such matters may include, among other things, assertions of contract
breach or intellectual property infringement, claims for indemnity arising in
the course of our business and claims by persons whose employment has been
terminated. Such matters are subject to many uncertainties and outcomes are not
predictable with assurance. Consequently, we are unable to ascertain the
ultimate aggregate amount of monetary liability, amounts which may be covered by
insurance or recoverable from third parties, or the financial impact with
respect to these matters as of the date of this report.
Our
operations and financial results are subject to various risks and uncertainties
that could adversely affect our business, financial condition, results of
operations, and the market price for our Common Stock. Part I,
Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year
ended December 31, 2007, includes a detailed discussion of these factors
and these factors have not changed materially from those included in the Form
10-K, other than as set forth below.
See also
the discussions in Part I, Item 2, “Liquidity and Capital Resources” and Part I,
Item 4, “Controls and Procedures” in this Quarterly Report on Form
10-Q.
There are risks
associated with our outstanding indebtedness
– As of September 30,
2008, we had an aggregate of $15.0 million of outstanding indebtedness that will
mature in 2010, and we may incur additional indebtedness in the future. Our
ability to repay the principal of our indebtedness is dependent upon our ability
to manage our business operations and generate sufficient cash flows to service
such debt. There can be no assurance that we will be able to manage any of these
risks successfully.
If the investors
in our private placements sell their shares, which we have agreed to register
under the Securities Act, the market price of our common stock may decline
significantly
– The shares of Common Stock issued to the investors in our
June 2008 private placement have not yet been registered under the Securities
Act of 1933, known as the Securities Act, but we have agreed to register the
shares for public resale under certain circumstances. At the time of
registration, such shares will become freely transferable without restriction
under the Securities Act (but may be subject to the short-swing profit rules and
other restrictions on affiliates under the Securities Exchange Act of 1934, as
amended). If a large number of shares are sold into the public market, the
market price of our Common Stock may decline significantly.
Our ownership is
concentrated among a small number of stockholders –
Our ownership is
concentrated among a small number of stockholders, including Merrick RIS, LLC
("Merrick"), an affiliate of Merrick Ventures, LLC ("Merrick Ventures") and
Michael W. Ferro, Jr., Chairman and CEO of Merrick Ventures, who is also
Chairman of our Board of Directors. As of September 30, 2008, Mr.
Ferro and his affiliates held approximately 48.5% of our outstanding Common
Stock, and are thus able to exert substantial control over various corporate
matters including approvals of mergers, sales of assets, issuance of capital
stock and similar transactions.
We may fail to
achieve our internal financial forecasts due to inaccurate sales projections or
other factors
– Our net sales, and particularly our software and other
sales, are difficult to forecast, and, as a result, our quarterly operating
results can fluctuate substantially. We use a “pipeline” system, a common
industry practice, to forecast sales and trends in our business. Our sales
personnel monitor the status of all proposals and estimate when a customer will
make a purchase decision and the dollar amount of the sale. These estimates are
aggregated periodically to generate a sales pipeline. Our pipeline estimates can
prove to be unreliable both in a particular quarter and over a longer period of
time, in part because the “conversion rate” of the pipeline into contracts can
be very difficult to estimate. A contraction in the conversion rate, or in the
pipeline itself, could cause us to plan or budget incorrectly and adversely
affect our business or results of operations. In particular, a slowdown in IT
spending or economic conditions generally can reduce the conversion rate in
particular periods as purchasing decisions are delayed, reduced in amount or
cancelled. The conversion rate can also be affected by the tendency of some of
our customers to wait until the end of a fiscal period in the hope of obtaining
more favorable terms, which can also impede our ability to negotiate and execute
these contracts in a timely manner.
An economic
slowdown or recession could hurt our business --
Recent economic reports
suggest that the United States and global economies are slowing, and may enter
into a recession, as a result of the deterioration in the credit markets, the
related financial crisis and other factors. A downturn in the United
States or global economies could hurt our business in a number of ways,
including longer sales and renewal cycles, delays in signing or failing to sign
customer agreements or signing customer agreements at reduced purchase levels.
Furthermore, a prolonged tightening of the credit markets could affect our
access to capital. These effects could have a material adverse effect on
our revenues, financial condition and results of operations.
Fluctuations in
foreign exchange rates could affect our business and financial results –
Our revenues are largely denominated in United States dollars. We
have significant operations in Canada, and to a lesser extent in Europe, and
those operations’ expenses are generally paid in their local currencies.
Because our consolidated financial statements are presented in United
States dollars, we must translate our foreign revenues, income and expenses, as
well as our foreign assets and liabilities, into United States dollars at
exchange rates in effect during or at the end of each reporting period. As
a result, increases or decreases in the value of the United States dollar
against other major currencies, particularly the Canadian dollar, may affect our
net operating revenues, operating income and balance sheet items. While we
may, from time to time, use derivative financial instruments to reduce our net
exposure to currency exchange rate fluctuations, we cannot assure you that
fluctuations in foreign currency exchange rates will not materially affect our
financial results.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds
|
On June
4, 2008, we completed a private placement of our Common Stock pursuant to which
we raised net proceeds of $16,639 ($20,000 less issuance costs of $2,386 and
prepaid interest for two quarters totaling $975) through a securities purchase
agreement with Merrick RIS, LLC ("Merrick"), an affiliate of Merrick Ventures,
LLC ("Merrick Ventures"), which was entered into on May 21,
2008. Based on the terms of the private placement, we received
$20,000 from Merrick in exchange for a $15,000 senior secured term note (the
“Note”) due June 4, 2010 and 21,085,715 shares of our Common
Stock. The Note will bear interest at 13.0% per annum, payable
quarterly in arrears. On closing of the private placement, we were
required to prepay the first two interest payments totaling $1.0
million. We also incurred $2.4 million of issuance costs, including
$0.8 million closing fee paid to Merrick. As a result, total proceeds
from this transaction were $16.6 million.
Of the
funds received, $3.3 million has been used to pay our portion of the shareholder
lawsuit settlement agreement and derivative lawsuit settlement agreement (see
Note 7 of notes to condensed consolidated financial statements) and $4.0 million
has been used to pay employee termination costs and contract exit costs in the
third quarter of 2008. The remainder will be used to fund our
operations, including future payments related to employee termination costs
accrued as of September 30, 2008 (see Note 8 of notes to condensed consolidated
financial statements).
The
private placement was made pursuant to an exemption from the registration
requirements under the Securities Act of 1933, as amended. We also
entered into a registration rights agreement in connection with the private
placement pursuant to which we have agreed to register with the Securities and
Exchange Commission for public resale the Common Stock under certain
circumstances.
During
the three months ended September 30, 2008, 44,213 shares of Common Stock were
withheld from employees to satisfy tax obligations. The shares were
recorded as treasury stock at a value of $47 (market value of our Common Stock
on the dates the shares were withheld) and were retired during the three months
ended September 30, 2008.
|
Submission
of Matters to a Vote of Security
Holders
|
Our
Annual Meeting of Shareholders was held on August 19, 2008 (“Annual
Meeting”). At the time of our Annual Meeting, we had received
executed forms of proxy in the same form as addressed on our behalf to the
shareholders of record as of July 11, 2008, the record date for our Annual
Meeting, representing 47,434,527 shares in person or by
proxy. Matters voted on and the results of such votes are as
follows:
The
holders of 29,088,100 shares voted FOR approval of the amendment to our 2005
Equity Incentive Plan to increase the shares of Common Stock authorized for
issuance thereunder by 3,000,000 shares; the holders of 7,440,194 shares voted
AGAINST such approval, and the holders of 16,562 shares ABSTAINED.
The
holders of 46,528,209 shares voted FOR approval of the amendment to our Amended
and Restated Articles of Incorporation (or the Certificate of Incorporation of
the surviving corporation of the merger described below) allowing our Board of
Directors, in its discretion at any time prior to August 19, 2009, to effect a
reverse stock split of our outstanding Common Stock with an exchange ratio of
either two–for–three or one–for–two; the holders of 853,217 shares voted AGAINST
such approval, and the holders of 53,099 shares ABSTAINED.
The
holders of 36,325,344 shares voted FOR approval of the change in our state of
incorporation from Wisconsin to Delaware by approving and adopting an Agreement
and Plan of Merger providing for our merger into our wholly–owned subsidiary
incorporated in Delaware; the holders of 204,329 shares voted AGAINST such
approval, and the holders of 53,158 shares ABSTAINED.
The
holders of 47,238,953 shares voted FOR ratification of our appointment of the
accounting firm BDO Seidman, LLP as our independent registered public accounting
firm for 2008; the holders of 156,480 shares voted AGAINST such ratification,
and the holders of 39,092 shares ABSTAINED.
Of the
proxies represented at our Annual Meeting and referred to above, the following
number of shares were voted FOR and WITHHELD authority for the following seven
(7) individuals to serve as our Directors until the next annual meeting of the
shareholders, or otherwise as provided in our bylaws:
|
|
Votes
For
|
|
|
Votes
Against or Withheld
|
|
Result
|
Elect
Dennis Brown to serve as Director until the next annual meeting of
Shareholders
|
|
46,371,343
|
|
|
1,063,184
|
|
Elected
|
|
|
|
|
|
|
|
|
Elect
Justin C. Dearborn to serve as Director until the next annual meeting of
Shareholders
|
|
47,067,251
|
|
|
367,276
|
|
Elected
|
|
|
|
|
|
|
|
|
Elect
Michael W. Ferro, Jr. to serve as Director until the next annual meeting
of Shareholders
|
|
47,054,473
|
|
|
380,054
|
|
Elected
|
|
|
|
|
|
|
|
|
Elect
Robert T. Geras to serve as Director until the next annual meeting of
Shareholders
|
|
46,738,638
|
|
|
695,889
|
|
Elected
|
|
|
|
|
|
|
|
|
Elect
Gregg G. Hartemayer to serve as Director until the next annual meeting of
Shareholders
|
|
46,719,489
|
|
|
715,038
|
|
Elected
|
|
|
|
|
|
|
|
|
Elect
Richard A. Reck to serve as Director until the next annual meeting of
Shareholders
|
|
47,030,159
|
|
|
404,368
|
|
Elected
|
|
|
|
|
|
|
|
|
Elect
Neele E. Stearns, Jr. to serve as Director until the next annual meeting
of Shareholders
|
|
47,066,601
|
|
|
367,926
|
|
Elected
|
No other
business was brought before the Annual Meeting.
See
Exhibit Index.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
Registrant:
|
|
|
|
MERGE
HEALTHCARE INCORPORATED
|
|
|
|
November
10, 2008
|
By:
|
/s/
Justin C. Dearborn
|
|
|
Justin
C. Dearborn
|
|
|
Chief
Executive Officer
|
|
|
(principal
executive officer)
|
|
|
|
November
10, 2008
|
By:
|
/s/
Steven M. Oreskovich
|
|
|
Steven
M. Oreskovich
|
|
|
Chief
Financial Officer
|
|
|
(principal
financial officer and principal accounting
officer)
|
EXHIBIT
INDEX
4.1
|
|
Form
of Term Note between Merge Healthcare Incorporated and Merrick RIS, LLC.
(1)
|
4.2
|
|
Amendment
to that certain Rights Agreement (the “Rights Agreement”) between Merge
Healthcare Incorporated and American Stock Transfer & Trust Co., as
the Rights Agent, dated September 6, 2006. (1)
|
4.3
|
|
Term
Note, dated June 4, 2008, between Merge Healthcare Incorporated and
Merrick RIS, LLC. (2)
|
10.1
|
|
Separation
Agreement, dated April 16, 2008, by and between the Registrant and
Jacques Cornet. (3)
|
10.2
|
|
Securities
Purchase Agreement, dated May 21, 2008, by and between Merge
Healthcare Incorporated, the subsidiaries listed on the Schedule of
Subsidiaries attached thereto, and Merrick RIS, LLC.
(1)
|
10.3
|
|
Escrow
Agreement, dated May 21, 2008, by and among Merge Healthcare
Incorporated, Merrick RIS, LLC and SunTrust Bank, as escrow agent.
(1)
|
10.4
|
|
Form
of Registration Rights Agreement by and between Merge Healthcare
Incorporated and Merrick RIS, LLC. (1)
|
10.5
|
|
Registration
Rights Agreement, dated June 4, 2008, by and between Merge Healthcare
Incorporated and Merrick RIS, LLC.(2)
|
10.6
|
|
Amendment
dated July 1, 2008 to that certain Securities Purchase Agreement, dated
May 21, 2008, by and between Merge Healthcare Incorporated, certain
of its subsidiaries and Merrick RIS, LLC(4)
|
10.7
|
|
Employment
Letter Agreement between the Registrant and Justin C. Dearborn entered
into as of June 4, 2008. (5)
|
10.8
|
|
Employment
Letter Agreement between the Registrant and Steven M. Oreskovich entered
into as of June 4, 2008. (5)
|
10.9
|
|
Employment
Letter Agreement between the Registrant and Nancy J. Koenig entered into
as of June 4, 2008. (5)
|
10.10
|
|
Employment
Letter Agreement between the Registrant and Antonia Wells entered into as
of June 4, 2008. (5)
|
10.11
|
|
Separation
Agreement between the Registrant and Kenneth D. Rardin entered into as of
July 17, 2008. (6)
|
10.12
|
|
Separation
Agreement between the Registrant and Steven R. Norton entered into as of
July 17, 2008. (6)
|
10.13
|
|
Separation
Agreement between the Registrant and Gary D. Bowers entered into as of
July 20, 2008. (6)
|
|
|
Certification
of principal executive officer pursuant to Rule 13a-14 (a) under
the Securities Exchange Act of 1934.
|
|
|
Certification
of principal accounting officer pursuant to Rule 13a-14
(a) under the Securities Exchange Act of 1934.
|
|
|
Certification
of principal executive officer and principal accounting officer pursuant
to Section 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
|
|
(1)
|
Incorporated
by reference from the Current Report on Form 8-K filed on May 22,
2008.
|
|
|
(2)
|
Incorporated
by reference from the Current Report on Form 8-K filed on June 6,
2008.
|
|
|
(3)
|
Incorporated
by reference from the Current Report on Form 8-K filed on April 22,
2008.
|
|
|
(4)
|
Incorporated
by reference from the Current Report on Form 8-K filed on July 7,
2008.
|
|
|
(5)
|
Incorporated
by reference from the Current Report on Form 8-K filed on July 15,
2008.
|
|
|
(6)
|
Incorporated
by reference from the Current Report on Form 8-K filed on July 23,
2008.
|
|
|
*Filed
herewith
|
34
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