This Annual Report on Form 10‑K and other written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and future financial performance.  Certain statements in this Annual Report on Form 10-K are “forward-looking statements.”  You can identify these forward-looking statements by our use of the words “believes,” “anticipates,” “forecasts,” “projects,” “could,” “plans,” “expects,” “may,” “will,” “would,” “intends,” “estimates” and similar expressions, whether in the negative or affirmative.  We wish to caution you that any forward-looking statements made by us or on our behalf are subject to uncertainties and other factors that could cause such statements to be wrong.  We cannot guarantee that we actually will achieve these plans, intentions or expectations.  Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make and we cannot guarantee future results, levels of activity, and/or performance.  We do not assume any obligation to update or revise any forward-looking statements that we make, whether as a result of new information, future events or otherwise.

Factors that may impact forward-looking statements include, among others, the risks and other matters set forth in the section entitled “Item 1A Risk Factors” in this Annual Report on Form 10-K.  Although we have attempted to list comprehensively these important factors, we also wish to caution investors that other factors may prove to be important in the future in affecting our business and operating results.  New factors emerge from time to time, and it is not possible for us to predict all of these factors, nor can we assess the impact each factor or combination of factors may have on our business.

 

Unless otherwise indicated by the context, references to “we” include Merge Healthcare Incorporated and its consolidated subsidiaries.

Item 1.

BUSINESS

Overview

We develop software solutions that facilitate the sharing of images to create a more effective and efficient electronic healthcare experience for patients and physicians.  Our solutions are designed to help solve some of the most difficult challenges in health information exchange today, such as the incorporation of medical images and diagnostic information into broader healthcare IT applications, the interoperability of proprietary software solutions, the profitability of outpatient imaging practices and the ability to improve the efficiency and cost effectiveness of our customers’ businesses. 

We are a Delaware corporation that was founded in 1987.  Our principal executive offices are located at 350 North Orleans Street, 1st Floor, Chicago, Illinois, 60654, and our telephone number there is (312) 565-6868. 

Our website address, which we use to communicate important business information, can be accessed at: www.merge.com. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports available free of charge on or through our website as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (SEC).  References to our website addressed in this Annual Report on Form 10-K are provided as a convenience and do not constitute, and should not be viewed as, an incorporation by reference of the information contained on, or available through, the website. Therefore, such information should not be considered part of this Annual Report on Form 10-K.  Materials we file with or furnish to the SEC may also be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.  Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.  Also, the SEC Internet website (www.sec.gov) contains reports, proxy and information statements, and other information that we file electronically with the SEC.

Our solutions optimize processes for healthcare providers ranging in size from single provider practices to large health systems, to the sponsors of clinical trials and medical device manufacturers.  We operate under two reportable segments: Merge Healthcare and Merge DNA.  Our Merge Healthcare segment represents approximately 85% of our total revenues and markets, sells and implements interoperability, imaging and clinical solutions to healthcare providers.  Our Merge DNA (Data and Analytics) segment represents approximately 15% of our total revenues and focuses on the marketing and sale of data capture software for clinical trials and related solutions.  We evaluate the performance of each operating segment based on its respective revenues and operating income.

Our Merge Healthcare segment primarily generates revenue from the licensing of software (including upgrades), the sale of hardware, professional services, maintenance and electronic data interchange (EDI) services.  Our Merge DNA segment generates revenue from software, through both on-premise licensing and hosting arrangements, and professional services. Going forward, we expect the vast majority of revenues of Merge DNA will come from hosted clinical trial arrangements.

 

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3

 

o

Clinical information systems: These systems provide a complete electronic record of a medical procedure across a variety of specialties – including Merge OrthoEMR for orthopedics and Merge RIS for radiology.

o

Revenue Cycle Management: We offer software and services for the revenue cycle management of physician practices. These solutions can be used across many physician specialties, but our solutions are most commonly used by radiology practices, imaging centers and billing services.

o

Merge One: A cloud-based radiology solution for ambulatory imaging businesses to power a practice’s entire workflow.

·

Software Development Toolkits, Technologies and Platforms.

o

Merge toolkits, technologies and platforms provide software developers with the necessary resources to assist in the timely development of new products and enhance existing products. They can be used by original equipment manufacturers (OEMs), medical device manufacturer, RIS/PACS or general healthcare IT vendors. We offer development toolkits in the basic standards of medical imaging and information interoperability, as well as advanced toolkits and unfinished applications for specialized medical image review and distribution.

·

Hosted Software Solutions for Clinical Trial Data Management.

o

We provide hosted software solutions for the collection, aggregation, analysis, reporting and overall management of clinical trials information. These solutions can be sold to sponsors of clinical trials, including pharmaceutical companies, contract research organizations (CRO) or imaging core labs.  Our solutions include electronic data capture (EDC), interactive voice/web response (IVR/IWR) and electronic patient reported outcomes (ePRO) software and devices.

 

Backlog

At the end of 2014, we had software and professional services backlog, both licensed and hosted, of $76.0 million as compared to $80.1 million at the end of 2013. This backlog represents revenue from signed contracts that has not yet been recognized.  Due to the variability in timing and length of maintenance renewals, we do not track maintenance backlog.

Competition

The healthcare IT and imaging markets in which we participate are highly competitive, rapidly evolving and subject to rapid technological change.

Our principal competitors in the healthcare solutions and services market include: General Electric, McKesson Corporation, Fuji, Philips, Carestream, and Agfa, each of which offers software solutions that compete with a portion of our product portfolio. Almost all of these competitors are substantially larger or have more experience and market share than Merge in their respective markets.  We also partner with certain of these companies.

Other competitors focus on specific portions of the market that we address or compete against specific products we sell. For example, there are 30 other companies in the North American PACS market, according to Frost & Sullivan.  These companies include original equipment manufacturers, former film companies and healthcare IT companies.  Our eClinical solutions and services are in a highly competitive market led by Oracle and Medidata.  Our OEM technologies most often compete with internal development departments, but also compete with software development companies for our Digital Imaging and Communications in Medicine (DICOM) and HL7 toolkits. 

In addition, major software information systems companies, large information technology consulting service providers and system integrators, start-up companies, managed care companies and others that specialize in the healthcare industry offer competitive software solutions or services. The pace of change in the healthcare IT market is rapid and there are frequent new software solutions or service introductions, enhancements and evolving industry standards and requirements. We believe that the principal competitive factors in this market include the breadth and quality of solution and service offerings, the stability of the solution provider, the quality, features and performance of the products, the ongoing support for the systems and the potential for enhancements and future compatible software solutions.

 

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Employees

 

At December 31, 2014, we had approximately 800 employees worldwide.  Competition for personnel in the industry in which we compete is intense.  We believe that our future success depends in part on our continued ability to hire, assimilate, train and retain qualified personnel.

 

Software Development

 

We commit significant resources to developing new health information system solutions. At December 31, 2014, approximately 200 of our employees were engaged in research and development activities. Total expenditures for the development and enhancement of our solutions, including capitalized software costs, were approximately $32.7 million, $32.4 million and $32.4 million during 2014, 2013 and 2012, respectively.

 

Our products, ranging from standards-based development toolkits to fully integrated clinical applications, have been used by healthcare providers worldwide for over 20 years.  Our software solutions follow industry standards such as DICOM, which ensures that images from any DICOM-compliant imaging modality can be displayed, moved and stored within a standard set of guidelines.  In addition, Merge follows the guidelines of the Integrating the Healthcare Enterprise (IHE) standards body, an organization dedicated to developing standard profiles for health information exchange.  Our long-time involvement with the standards committees and continuous development of products like our DICOM and HL7 toolkits have enabled Merge to stay closely tied to industry innovation.  As discussed above, continued investment in research and development remains a core element of our strategy. This will include ongoing enhancement of our core solutions and development of new solutions and services such as iConnect Cloud Archive, our cloud-based platform and iConnect Network, our new image and data exchange network.

 

Patents, Trademarks, Copyrights and Trade Secrets

 

 

We hold inbound licenses for certain intellectual property that is used internally, and in some cases, utilized in our products or services. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products and services, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our operations and products and services are not materially dependent on any single license or other agreement with any third party.

 

Sales, Marketing and Distribution

 

Sales to large health systems typically require a minimum of nine months of development time, while the sales cycle can be shorter when selling to smaller hospitals and imaging centers.  At December 31, 2014, approximately 135 of our employees were engaged in sales and marketing activities. Our executive sales and marketing management is located in Chicago, Illinois, while our sales team is deployed across the U.S. and globally.

 

We employ quota based sales teams that specialize in particular solutions and services.  In addition, we have sales teams dedicated to establishing and maintaining distributor relationships on a global basis.  We have concentrated inside and telesales staff in one location in order to bring economies of scale in management and process.  Our sales teams are complemented by a staff of lead generation and marketing employees.  These teams use online tools and resources that streamline and track the sales process. 

 

Our marketing efforts are mainly electronic, utilizing our website and our extensive email database of customers for our communication campaigns, as well as our website for online communities and certain social media.  Beyond electronic media, we employ consistent media relations efforts for market communications.  In addition, we participate in the major industry trade shows for our respective product lines.  We also have an active user group for our U.S. customers and an industry advisory board. 

 

Financial Information about Segments

 

For financial information regarding our  two operating groups as well as our geographic areas of operation, refer to Item 8, “Note 1 – Basis of Presentation and Significant Accounting Policies” and “Note 14 – Segment Information and Concentrations of Risk” of this Annual Report on Form 10-K.

 

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Item 1A.

RISK FACTORS

 

Discussion of our business and operating results included in this annual report on Form 10-K should be read together with the risk factors set forth below.  They describe various risks and uncertainties to which we are or may become subject.  These risks and uncertainties, together with other factors described elsewhere in this report, have the potential to affect our business, financial condition, results of operations, cash flows, strategies, prospects, or the market price of our common stock in a material and adverse manner.  New risks may emerge at any time, and we cannot predict those risks or estimate the extent to which they may affect financial performance.  We undertake no obligation to update or revise the statements. 

 

Reductions in Medicare and Medicaid Reimbursement Rates for Imaging Procedures and Professional Services or Delays in the Payment of Reimbursements could Negatively Affect Revenues of our Hospital and Imaging Clinic Customers, which could cause our Customers to Reduce or Delay Purchases of our Software and Services.

 

The ability of customers to obtain appropriate reimbursement for their services from these programs and payors is critical to our success.  Reductions in the amount of reimbursements or uncertainty or delays in those reimbursements have in the past, and could in the future, cause our customers to cancel or delay making new expenditures on healthcare IT.  Federal budget reductions can affect the timing of the sales of our software and services.

 

In addition, the U.S. Congress has enacted far-reaching health system reform legislation that could have a negative impact on our business.  While the impact of the legislation is difficult to predict, the legislation will increase pressure to control spending in government programs (e.g., Medicare and Medicaid) and by third party payors.  For example, changes in the equipment utilization rate, once fully implemented, have the potential to decrease technical reimbursements for radiology procedures, and could have a particularly negative impact on hospitals and imaging clinics in rural regions of the country where utilization rates are naturally lower.  A second significant potential reimbursement change relates to the Sustainable Growth Rate (SGR) component of the Medicare Physician Fee Schedule.  The SGR is part of the update factor process used to set the annual rate of growth in allowed reimbursable medical expenditures, and is determined by a formula specified by Congress.  Because the annual calculation of the SGR would have led to reimbursement reductions that Congress found unacceptable, Congress has interceded on an annual basis to delay the implementation of this statutory SGR update factor.  While these changes have provided temporary reimbursement relief to healthcare providers and us, because of the significant budgetary impacts, Congress has retained the SGR formula, thereby allowing annual unimplemented payment reductions to accumulate in the Medicare statute.  The current SGR fix delay expires in March, and there are again various proposals to implement a permanent fix.  The changes being considered have the potential to negatively impact the professional component of any reimbursement system.  In addition, the SGR delay legislation contained many additional reimbursement provisions, such as the mandate to delay the implementation of ICD-10 for one year.

 

Annual changes related to CMS reimbursement inputs and the SGR calculation could result in a reduction in software and service procurement of our customers, and have a material adverse effect on our revenues and operating results.

 

We are Subject to Government Regulation, Changes to which could Negatively Impact our Business.

 

We are subject to regulation in the U.S. by the Food and Drug Administration (FDA), including periodic FDA inspections, in Canada under Health Canada’s Medical Devices Regulations, and in other countries by corresponding regulatory authorities.  We may be required to undertake additional actions in the U.S. to comply with the Federal Food, Drug and Cosmetic Act (FDCA), regulations promulgated under the FDCA, and any other applicable regulatory requirements.  For example, the FDA has increased its focus on regulating computer software intended for use in a healthcare setting.  If our software solutions are deemed to be actively regulated medical devices by the FDA, we could be subject to more extensive requirements governing pre- and post-marketing activities.  Complying with these regulations could be time consuming and expensive, and may include:

 

·

Requiring us to receive FDA clearance of a pre-market notification submission demonstrating substantial equivalence to a device already legally marketed, or to obtain FDA approval of a pre-market approval application establishing the safety and effectiveness of the software;

 

·

Requiring us to comply with rigorous regulations governing the pre-clinical and clinical testing, manufacture, distribution, labeling and promotion of medical devices; and

 

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Requiring us to comply with the FDCA regarding general controls, including establishment registration, device listing, compliance with good manufacturing practices, reporting of specified malfunctions and adverse device events.

 

Similar obligations may exist in other countries in which we do business, including Canada. Any failure by us to comply with other applicable regulatory requirements, both domestic and foreign, could subject us to a number of enforcement actions, including warning letters, fines, product seizures, recalls, injunctions, total or partial suspensions of production, operating restrictions or limitations on marketing, refusals of the government to grant new clearances or approvals, withdrawals of marketing clearances or approvals and civil and criminal penalties.

 

We are subject to periodic FDA inspections and there can be no assurances that we will not be required to undertake additional actions to comply with the FDCA and any other applicable regulatory requirements.  Any failure by us to comply with the FDCA and any other applicable regulatory requirements could have a material adverse effect on our ability to continue to manufacture and distribute our software solutions.  The FDA has many enforcement tools including recalls, seizures, injunctions, civil fines and/or criminal prosecutions.  Any of the foregoing could have a material adverse effect on our business, results of operations or financial condition.

 

Changes in Federal and State Regulations Relating to Handling of Data and Data Privacy could Depress the Demand for our Software and Impose Significant Software Redesign Costs.

 

 Federal regulations under the Health Insurance Portability and Accountability Act (HIPAA) impose national health data standards on healthcare providers that conduct electronic health transactions, healthcare clearinghouses that convert health data between HIPAA compliant and non-compliant formats and health plans.  Collectively, these groups are known as covered entities.  HIPAA regulations prescribe transaction formats and code sets for electronic health transactions, protect individual privacy by limiting the uses and disclosures of individually identifiable health information and require covered entities to implement administrative, physical and technological safeguards to ensure the confidentiality, integrity, availability and security of individually identifiable health information in electronic form.  Although we are not a covered entity, most of our customers are, and they require that our software and services adhere to HIPAA regulations.  Any failure or perceived failure of our software or services to meet HIPAA regulations, or any breach of the HIPAA regulations or any other federal, state or foreign data privacy laws or regulations, could result in remediation costs and fines, and could adversely affect demand for our software and services and potentially require us to expend significant capital, research and development and other resources to modify our software or services to address the privacy and security requirements of our clients.

 

 States and foreign jurisdictions have adopted, or may adopt, privacy standards that are similar to or more stringent than the federal HIPAA privacy regulations.  This may lead to different restrictions for handling individually identifiable health information.  As a result, our customers may demand IT solutions and services that are adaptable to reflect different and changing regulatory requirements, which could increase our development costs. In the future, federal, state or foreign governmental authorities may impose new data security regulations or additional restrictions on the collection, use, transmission and other disclosures of health information.  We cannot predict the potential impact that these future rules may have on our business; however, the demand for our software and services may decrease if we are not able to develop and offer software and services that can address the regulatory challenges and compliance obligations facing our clients.

 

Our Business could be Harmed by Adverse General Economic and Market Conditions.

 

Our markets have been and will continue to be affected by general economic and market conditions.  If general economic conditions deteriorate or economic uncertainty continues in the markets in which we do business, our clients might experience deterioration of their businesses, cash flow shortages and difficulty obtaining financing which may impact the decisions of customers to purchase products that improve their processes and delay or reduce their purchases, and in our having higher customer receivables with increased default rates.  General concerns about the fundamental soundness of domestic and foreign economies may also cause customers to reduce their purchases, even if they have cash or if credit is available to them.  This could result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies and increased price competition.  In addition, weakness in the end-user market could negatively affect our OEM and VAR customers who could, in turn, delay paying their obligations, which would increase our credit risk exposure and cause a decrease in operating cash flows.  Also, if OEM and VAR customers experience excessive financial difficulties and/or insolvency, and we are unable to successfully transition end-users to purchase products from other vendors or directly from us, sales could decline.  Any of these events would likely harm our business, results of operations and financial condition. 

 

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The Financial Covenants in our Credit Agreement Dated April 29, 2014 (Credit Agreement), may Force Us to Take Certain Actions that Could Adversely Affect our Future Results of Operations.

The Credit Agreement contains a leverage ratio covenant and an interest coverage ratio covenant in future periods.  Our ability to satisfy these financial covenants going forward will depend on our future operating performance, which is in part subject to prevailing economic and competitive conditions and various financial, business, legislative, regulatory and other factors, some of which are beyond our control.  If we cannot, or expect that we may not, meet the Credit Agreement’s financial  covenants in the future, we may need to dispose of material assets or operations, reduce or delay investments and capital expenditures, seek additional equity capital investments or negotiate to restructure or refinance our indebtedness with our lenders.  We may not be able to affect any such alternative measures on commercially reasonable terms or at all.  Even if successful, such alternative measures may not allow us to meet the financial covenants in future periods, and/or they could limit our ability to realize the value of our assets and opportunities, restrict our ability to execute our long-term strategy or otherwise adversely affect our future results of operations.

 

We have a Substantial Amount of Indebtedness, which could Impact our Ability to Obtain Future Financing or Pursue our Growth Strategy.

 

 We have substantial indebtedness.  As of December 31, 2014, our indebtedness principally consisted of a Term Loan of $229.1 million.  In addition, we may incur additional amounts of debt under our existing credit facilities.

 

 Our high level of indebtedness could have important consequences and significant adverse effects on our business, including the following:

 

·

We must use a substantial portion of our cash flow from operations to pay interest and principal on our indebtedness, which will reduce the funds available to us for operations and other purposes;

 

·

We must use a substantial portion of the proceeds of any asset sales to repay our indebtedness;

 

·

Our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes may be limited;

 

·

We are exposed to fluctuations in the interest rate environment because the interest rates under the Credit Facilities are variable;

 

·

Our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate may be limited, which may place us at a competitive disadvantage compared to our competitors that have less debt;

 

·

Our ability to pursue additional business opportunities may be limited; and

 

·

Our high level of indebtedness may make us more vulnerable to economic downturns and adverse developments in our business.

 

The Credit Agreement contains, and the instruments governing any indebtedness we may incur in the future may contain, restrictive covenants that impose significant operating and financial restrictions, including restrictions on our ability to take actions that we believe may be in our best interest.  The Credit Agreement, among other things, limits our ability to:

 

·

Incur additional indebtedness and issue preferred stock;

 

·

Create or incur liens;

 

·

Enter into certain sale-leaseback transactions;

 

·

Make certain investments or certain other restricted payments or make certain capital expenditures or acquisitions;

 

·

Merge or consolidate without meeting certain conditions;

 

·

Sell assets;

 

·

Pay dividends on our capital stock or redeem, repurchase or retire our capital stock or indebtedness;

 

·

Enter into transactions with our affiliates;

 

·

Guarantee indebtedness;

 

·

Issue or sell stock of certain subsidiaries.

 

Our failure to comply with these restrictive covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all or a portion of our outstanding indebtedness, which would have a material adverse effect on our business, financial condition and results of operations.

 

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Payments on our Indebtedness will Require a Significant Amount of Cash and our Ability to Service our Indebtedness is Impacted by Many Factors that are Outside of our Control.

We expect to obtain the funds to pay our expenses and to pay the amounts due under the Credit Agreement primarily from our operations.  Our ability to meet our expenses and make these payments thus depends on our future performance, which will be affected by financial, business, economic and other factors, many of which we cannot control.  Our business may not generate sufficient cash flow from operations in the future and our currently anticipated growth in revenue and cash flow may not be realized, either or both of which could result in our being unable to service our indebtedness, including the Credit Agreement, meet the financial covenants in the Credit Agreement or to fund other liquidity needs.  If we do not have sufficient cash resources in the future, we may be required to refinance all or part of our then existing indebtedness, sell assets or borrow more money.  We cannot be assured that we will be able to accomplish any of these alternatives on terms acceptable to us or at all.  See the section captioned “Liquidity and Capital Resources” in the Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.

 

We may Incur Substantial Additional Indebtedness that could Further Exacerbate the Risks Associated with our Indebtedness.

 

We may incur substantial additional indebtedness in the future. Although the Credit Agreement contains restrictions on our incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions, and we could incur substantial additional indebtedness in the future, including additional secured indebtedness.  In addition, we may refinance our existing indebtedness, which would permit us to incur additional indebtedness.  If we incur additional indebtedness, certain of the risks described above would intensify. Our ability to meet our cash requirements and service our indebtedness is impacted by many factors that are outside of our control.

The Credit Agreement provides that borrowings under the Credit Agreement bear interest at a variable rate.  While we are able to mitigate the effects of interest rate changes pursuant to the Credit Agreement through the use of hedging transactions, we will not completely eliminate the effect of interest rate changes. As a result, interest rate changes will not affect our obligation for any debt incurred under the Credit Agreement, but could affect the amount of our interest payments, and accordingly, our future earnings and cash flows, assuming other factors are held constant. An increase in interest rates, whether because of an increase in market interest rates or an increase in our own cost of borrowing, would increase the cost of servicing our debt and could materially reduce our profitability.

 

We rely on sales of software (including upgrades) and maintenance agreements for a significant portion of our revenue.  Many of the customers in our industry expect to utilize software and services over a period of years and require access to upgrades and maintenance services during that time period.  To the extent our customers have doubts about our financial stability and our ability to continue to operate as a going concern, those customers may seek alternative solutions from competitors who those customers believe to be more financially stable.  If our customers shift their business to our competitors who appear to be more financially stable, our revenues and results of operations could be adversely affected.

 

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Inadequate Liquidity Could Limit our Ability to Meet our Obligations and could Materially Adversely Affect our Business Operations in the Future.

 

We require substantial liquidity to make interest and principal payments on our indebtedness and run our normal business operations.  Our business is subject to numerous risks and uncertainties that could negatively affect our cash flow and liquidity position in the future, including the other risks discussed under the heading "Risk Factors" in this Annual Report on Form 10-K. Our ability to incur additional indebtedness in the future is dependent upon our ability to manage business operations and generate sufficient cash flows to service such indebtedness and may be limited or available only on disadvantageous terms.  Unless we can achieve cash flow levels sufficient to support our operations, we may require additional borrowings or the sale of debt or equity securities, sale of non-strategic assets, or some combination thereof, to provide funding for our operations.    If we are unable to generate sufficient working capital or obtain alternative financing, we may not be able to borrow or otherwise obtain additional funds to finance our operations when needed, our financial condition and operating results would be materially adversely affected. In addition to generating sufficient liquidity to meet our obligations, we must generate sufficient liquidity to fund our business plan.  If we cannot raise funds on acceptable terms when necessary, we may not be able to develop or enhance products and services, execute our business plan, take advantage of future opportunities or respond to competitive pressures or unanticipated customer requirements and funding our plan. Any such failure to raise funds on acceptable terms could weaken our competitive position and materially adversely affect our business.

 

 

 

 Many hospitals and imaging centers have consolidated to create larger healthcare enterprises with greater market and purchasing power.  If this consolidation trend continues, it could reduce the size of our potential customer base and give the resulting enterprises greater bargaining or purchasing power, which may lead to erosion of the prices for our software or decreased margins for our products.  In addition, when hospitals and imaging centers combine, they often consolidate infrastructure, and consolidation of our customers could result in fewer overall customers and erode our revenue base.

 

We may Fail to Achieve our Financial Forecasts due to Inaccurate Sales Forecasts, Delays in Sales and Installation of our Products and Other Reasons.

We may not be able to accurately forecast our revenue which may decrease or fluctuate significantly. Our revenue and operating profit growth depends on the continued demand for our products and services offered through us or our OEM and VAR customers, and our business is affected by general economic and business conditions worldwide. We base expense levels and investment plans on sales estimates, which are reviewed on a quarterly basis, and signed customer contracts, which may be cancelable or subject to modification.  As a result, our revenues are difficult to forecast, and our operating results can fluctuate substantially from quarter to quarter.  Because a significant portion of our cost structure, including expenses and investments, are fixed in the short-term, if revenues are lower than expected we may not be able to adjust spending quickly enough and as such we may experience a disproportionately negative impact on our profitability. 

Delays in the expected sales or installation of our software may have a significant impact on our anticipated quarterly revenues and, because a significant percentage of our expenses are relatively fixed, our expenses may not align with our revenue. Additionally, we sometimes depend, in part, upon large contracts with a limited number of significant customers to meet projected sales goals in any particular quarter.  Delays in the expected sales or installation of solutions under these large contracts may have a significant impact on our quarterly net sales and consequently our earnings.

 

The Length of our Sales and Implementation Cycles may Adversely Affect our Operating Results.

 

We have experienced long sales and implementation cycles.  How and when to implement, replace, expand or substantially modify medical imaging management software, or to modify or add business processes, are major decisions for our end-user target market.  The sales cycle for our software ranges from six to 18 months or more from initial contact to contract execution.  Our end-user implementation cycle has generally ranged from three to nine months from contract execution to completion of implementation.  During the sales and implementation cycles, we will expend substantial time, effort and resources preparing contract proposals, negotiating the contract and implementing the software, and may not realize any revenues to offset these expenditures.  Additionally, any decision by our customers to delay or cancel purchases or the implementation of our software may adversely affect net sales.

 

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We Operate in Competitive Markets, which may Adversely Affect our Market Share and Financial Results.

 

The markets for Healthcare IT solutions are highly competitive and subject to rapid technological change. We may be unable to maintain our competitive position against current and potential competitors.  Some of our competitors are focused on sub-markets within targeted industries, while others have significant financial and information-gathering resources with recognized brands, technological expertise and market experience.  We believe that competitors are continuously enhancing their products and services, developing new products and services and investing in technology to better serve the needs of their existing customers and to attract new customers.  In addition, new competitors may emerge and our system and software solution offerings may be threatened by new technologies or market trends that reduce the value of our solutions.

 

We face competition in specific industries and with respect to specific offerings.  We may also face competition from organizations and businesses that have not traditionally competed with us, but that could adapt their products and services to meet the demands of our customers.  In addition, we often compete with our OEM customers’ own internal software engineering groups. The size and competency of these groups may create additional competition.  Increased competition may require us to reduce the prices of our offerings or make additional capital investments that would adversely affect margins.  If we are unable or unwilling to do so, we may lose market share in target markets and our financial results may be adversely affected.

 

 

If We Are Unable to Successfully Identify or Effectively Integrate Acquisitions, our Financial Results may be Adversely Affected.

 

We have in the past and may in the future acquire and make investments in companies, products or technologies that we believe complement or expand our existing business and assist in quickly bringing new products to market.  There can be no assurance that we will be able to identify suitable candidates for successful acquisitions at acceptable valuations.  In addition, our ability to achieve the expected returns and synergies from past and future acquisitions depends in part upon our ability to integrate the offerings, technology, administrative functions, and personnel of these businesses into our business in an efficient and effective manner.  We cannot predict whether we will be successful in integrating acquired businesses or that our acquired businesses will perform at anticipated levels.  In addition, our past and future acquisitions may subject us to unanticipated risks or liabilities, or disrupt operations and divert management’s attention from day-to-day operations.  In addition, we may use our capital stock to acquire acquisition targets, which could be dilutive to the existing stockholders and cause a decline in the price of our common stock.

 

In making or attempting to make acquisitions or investments, we face a number of risks, including risks related to:

 

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Identifying suitable candidates, performing appropriate due diligence, identifying potential liabilities and negotiating acceptable terms;

 

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The potential distraction of our management, diversion of our resources and disruption to our business;

 

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Retaining and motivating key employees of the acquired companies;

 

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Managing operations that are distant from our current headquarters and operational locations;

 

·

Entering into industries or geographic markets in which we have little or no prior experience;

 

·

Competing for acquisition opportunities with competitors that are larger or have greater financial and other resources than us;

 

·

Accurately forecasting the financial impact of a transaction;

 

·

Assuming liabilities of acquired companies, including existing or potential litigation related to the operation of the business prior to the acquisition;

 

·

Reducing our working capital and hindering our ability to expand or maintain our business, if acquisitions are made using cash;

 

·

Maintaining good relations with the customers and suppliers of the acquired company; and

 

·

Effectively integrating acquired companies and achieving expected synergies.

 

 In addition, any acquired business, products or technologies may not generate sufficient revenue and net income to offset the associated costs of such acquisitions, and such acquisitions could result in other adverse effects.  In the years ended December 31, 2014, 2013 and 2012, we incurred $0.2 million, $0.9 million, and $3.4 million of acquisition related costs, respectively.  All such direct acquisition costs are expensed as incurred by us.  In addition, we often are required to incur charges to operations in the quarters following an acquisition to reflect costs associated with integrating acquired companies.   We anticipate that our acquisition activities will require cash outflows directly related to completing acquisitions as well as costs related to integration efforts.  If the benefits of an acquisition do not exceed the costs of integrating the businesses, our financial results may be adversely affected.

 

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Moreover, from time to time, we may enter into negotiations for the acquisition of businesses, products or technologies but be unable or unwilling to consummate the acquisitions under consideration.  This can be expensive and could cause significant diversion of managerial attention and resources.

 

A Portion of our Business Relies Upon a Network of Independent Contractors and Distributors Whose Actions could have an Adverse Effect on our Business.

 

We obtain some critical services from independent contractors.  In addition, we rely on a network of VARs and distributors to sell our offerings in locations where we do not maintain a sales office or direct sales team.  These independent contractors, VARs and distributors are not our employees.  As a result, we have limited ability to monitor and direct their activities.  The loss of a significant number of these independent contractors, VARs or distributors could disrupt our sales, marketing and distribution efforts and we may not be able to obtain or utilize on favorable terms, or at all, replacement licenses or other rights with respect to intellectual property we do not own in providing services under commercial agreements.  Furthermore, if any actions or business practices of these individuals or entities violate our policies or procedures, or laws or regulations to which we are subject, we could be subject to litigation, regulatory sanctions or reputation damage, any of which could adversely affect our business and require us to terminate relationships with them.

 

Our Investments in Technology may not be Sufficient and may not Result in an Increase in our Revenues or Decrease in our Operating Costs.

 

 

As the technological landscape continues to evolve, it may become increasingly difficult for us to make timely, cost-effective changes to our product offerings to allow us to effectively compete against our competitors’ product offerings.  In order to effectively market our products, we require constant innovation, which requires investments in research and development, among other things.  We cannot provide any assurance that our investments will result in successful applications that will be sufficient to maintain or improve our competitive position.

·

Our existing products and services;

·

Our new products and services; and

·

Enhancements to existing products support and services.

We may not be Able to Adequately Protect our Intellectual Property Rights or may be Accused of Infringing Intellectual Property Rights of Third Parties.

 

We regard our intellectual property as important to our success. We have a portfolio of U.S. and international patents, trademarks, service marks, copyrights and trade secrets covering our products and services.   Our proprietary technology is not dependent on any single patent or copyright or groups of related patents or copyrights. Our business is not dependent on any single patent, copyright or other form of intellectual property. We believe the term of each of our patents is adequate relative to the expected lives of our products. We rely on trademark, copyright, patent and trade secret law, and utilize confidentiality, license and other agreements with employees, customers and others to protect our proprietary rights.

 

We hold inbound licenses for certain intellectual property that is used internally, and in some cases, utilized in our products or services. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products and services, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our operations and products and services are not materially dependent on any single license or other agreement with any third party.

 

We may not be able to discover or determine the extent of any unauthorized use of our intellectual property and proprietary rights.  Third parties that license our proprietary rights also may take actions that diminish the value of these rights.  Any claims of alleged infringement of the intellectual property rights of third parties, whether or not meritorious, may result in the expenditure of significant financial and managerial resources.  If we are found liable of infringement, we may be required to pay damages or cease making or selling certain products.  We may need to obtain licenses from third parties who allege that we have infringed on their rights, but such licenses may not be available on terms acceptable to us or at all.  

 

We also rely on proprietary know how and confidential information and employ various methods, such as entering into confidentiality and non-compete agreements with our current employees and with certain third parties to whom we have divulged proprietary information to protect the processes, concepts, ideas and documentation associated with our solutions.  Such methods may not afford sufficient protection, and we may not be able to protect trade secrets adequately or ensure that other companies would not acquire information that we consider proprietary, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the U.S.  Our inability to protect our proprietary technology could result in competitive harm that could adversely affect our business.

 

Changes in Foreign Exchange Rates may Impact our Results of Operations and Financial Condition.

 

Our international operating results are exposed to foreign exchange rate fluctuations. While the functional currency of most of our international operations is the U.S. Dollar, we conduct transactions in currencies other than the U.S. Dollar, and certain account balances in foreign countries are maintained in the local currency. As such, changes in the value of certain foreign currencies relative to the U.S. Dollar can affect our revenues, operating results and the value of our foreign currency account balances.  Generally, our revenues, operating results and foreign currency account balances are adversely affected when the dollar strengthens relative to other currencies and are positively affected when the dollar weakens.  As we expand international operations, our exposure to exchange rate fluctuations may increase.

 

We may not be Successful in our Efforts to Expand into International Markets.

 

Our international activities are material to our revenues and profits, and we plan to further expand internationally.  In 2014, our international revenues were $14 million, or about 7% of total revenues.  We have limited experience operating in international markets and may not benefit from any first-to-market advantages or otherwise succeed in developing products to meet demand in new markets.  It is costly to establish, develop and maintain international operations and websites and promote our brand internationally.  Our international operations may not be profitable on a sustained basis.

 

In addition to risks described elsewhere in this section, our international sales and operations are subject to a number of risks, including:

 

·

Local economic and political conditions;

 

·

Foreign government regulation of healthcare and government reimbursement of health services;

 

·

Local restrictions on sales or distribution of certain products or services and uncertainty regarding liability for products and services;

 

·

Local import, export or other business licensing requirements;

 

·

Local limitations on the repatriation and investment of funds and foreign currency exchange restrictions;

 

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·

Shorter payable and longer receivable cycles and the resultant negative impact on cash flow;

 

·

Local  laws and regulations regarding data protection, privacy, network security and restrictions on pricing;

 

·

Difficulty in staffing, developing and managing foreign operations as a result of distance, language and cultural differences;

 

·

Different employee/employer relationships and the existence of workers’ councils and labor unions;

 

·

Laws and policies of the U.S. and other jurisdictions affecting trade, foreign investment, loans and taxes; and

 

·

Geopolitical events, including war and terrorism.

 

Litigation or Regulatory Actions could Adversely Affect our Financial Condition.

 

As a result of lawsuits and regulatory matters, including the matters discussed in Item 3, Legal Proceedings in this Annual Report on Form 10-K, we have incurred and may continue to incur substantial expenses.  In addition, we are, from time to time, parties to legal and regulatory 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.  The defense of these actions may be both time consuming and expensive.  We are unable to estimate 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 Annual Report on Form 10-K.  If any of these legal proceedings were to result in an unfavorable outcome, it could have a material adverse effect on our business, financial position and results of operations.

 

We may be Subject to Product Liability Claims if People or Property are Harmed by the Products and Services that we Sell. 

 

Some of the products we sell or manufacture may expose us to product liability claims relating to personal injury, death or environmental or property damage and may require product recalls or other actions.  Moreover, because our products are intended to be used in connection with providing medical care to patients, users of our products may have a greater sensitivity to errors than in the general market for software products.  If our products lead to faulty medical decisions or injury to patients, we could be exposed to claims or litigation that could have an adverse effect on our business.  Certain third parties, primarily our customers, also sell products or services using our products.  This may increase our exposure to product liability claims.  Although we maintain liability insurance, we cannot be certain that coverage will be adequate for liabilities actually incurred or that insurance will continue to be available on economically reasonable terms or at all.  In addition, some of our agreements with vendors do not indemnify us from product liability.  Even unsuccessful claims could result in substantial costs and diversion of management resources.  A claim brought against us that is uninsured or under-insured could harm our business, financial condition and results of operations.

 

We Provide Customers with Certain Warranties that could Result in Higher Costs than Anticipated.

 

Software products such as ours that are used in a wide range of clinical and health information system settings may contain a number of errors or “bugs,” especially early in their product life cycle.  Our products include clinical information systems used in patient care settings where a low tolerance for errors or bugs exists.  Testing of products is difficult due to the wide range of environments in which systems are installed.  The discovery of defects or errors in our software products or in our implementation of integrated solutions may cause delays in product delivery, poor client references, payment disputes, contract cancellations, harm to our reputation, product liability claims or additional expenses and payments to rectify problems.  Furthermore, our customers might use our software together with products from other companies or those that they have developed internally.  As a result, when problems occur, it might be difficult to identify the source of the problem.  Even when our software does not cause these problems, the existence of these errors might cause us to incur significant costs, divert the attention of our technical personnel from our research and development efforts; impact our reputation and cause significant customer relations problems.  Any of those factors may result in delayed acceptance of, or the return of, our software products.

 

We Depend on Licenses from Third Parties for Rights to Some Technology we use, and if we are Unable to Continue these Relationships and Maintain our Rights to this Technology, our Business could Suffer.

 

Some of the technology used in our software depends upon licenses from third party vendors.  These licenses typically expire within one to five years, can be renewed only by mutual consent and may be terminated if we breach the license and fail to cure the breach within a specified period of time.  We may not be able to continue using the technology made available to us under these licenses on commercially reasonable terms or at all.  As a result, we may have to discontinue, delay or reduce software shipments until we obtain equivalent technology, if available, which could hurt our business.  Most of our third party licenses are nonexclusive.  Our competitors may obtain the same right to use any of the technology covered by these licenses and use the technology to compete directly with us.  In addition, if our vendors choose to discontinue support of the licensed technology in the future or are unsuccessful in their continued research and development efforts, particularly with regard to the Microsoft Windows/Intel platform on which most of our products operate, we may not be able to modify or adapt our own software.  This could have an adverse effect on our business.

 

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Our Large Stockholders may have Interests that Differ from other Stockholders.

 

Merrick Ventures, LLC (Merrick Ventures) and its affiliates, including Merrick Venture Management Holdings, LLC (Merrick Holdings), beneficially own, as of December 31, 2014, 26.9% of our outstanding common stock.  Michael W. Ferro, Jr., our Chairman of the Board, and trusts for the benefit of Mr. Ferro’s family members beneficially own a majority of the equity interests in Merrick Ventures and Merrick Holdings.  Mr. Ferro also serves as the chairman and chief executive officer of Merrick Ventures and Merrick Holdings.  Accordingly, Mr. Ferro indirectly owns or controls all of the shares of our common stock owned by Merrick Ventures and Merrick Holdings.  Due to their stock ownership, Merrick Ventures and Merrick Holdings have significant influence over our business, including the election of our directors.

 

The interests of Merrick Ventures, Merrick Holdings and their affiliates may differ from those of our other stockholders.  Merrick Ventures, Merrick Holdings and their affiliates are in the business of making investments in companies and maximizing the return on those investments. They currently have, and may from time to time in the future acquire, interests in businesses that directly or indirectly compete with certain aspects of our business or that supply us with goods and services.  Merrick Ventures, Merrick Holdings and their affiliates may also pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us.  Merrick Ventures’ and Merrick Holdings’ significant ownership of our voting stock will enable it to influence or effectively control us and the influence of our large stockholders could impact our business strategy and also have the effect of discouraging others from purchasing or attempting to take a control position in our common stock, thereby increasing the likelihood that the market price of our common stock will not reflect a premium for control.

 

Shares of our Common Stock Eligible for Public Sale may have a Negative Impact on the Market Price of our Common Stock.

 

Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales may occur, could cause the market price of our common stock to decline.  In addition, the sale of these shares could impair our ability to raise capital, should we wish to do so, through the sale of additional common or preferred stock.  As of December 31, 2014, we had approximately 98.4 million shares of common stock outstanding.  In addition, as of December 31, 2014, we had outstanding options to purchase approximately 6.0 million shares of our common stock.  Future sales of shares of our common stock by existing holders of our common stock or by holders of outstanding options, upon the exercise thereof, could have a negative impact on the market price of our common stock.  As additional shares of common stock become available for sale in the public market, due to the exercise of options or the issuance of shares as a result of acquisitions, the market supply of shares of common stock will increase, which could also decrease the market price.

 

We are unable to estimate the number of shares that may be sold because this will depend on the market price for our common stock, the personal circumstances of the sellers and other factors.  Any sale of substantial amounts of our common stock or other securities in the open market may adversely affect the market price of such securities and may adversely affect our ability to obtain future financing in the capital markets as well as create a potential market overhang.

 

Because we do not Intend to Pay Cash Dividends, Stockholders will Benefit from an Investment in our Stock Only if it Appreciates in Value.

 

We currently intend to retain future earnings, if any, to fund future growth, and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in our common stock will depend upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain the price at which stockholders have purchased and will purchase shares.

 

The Trading Price of our Common Stock has been Volatile and may Fluctuate Substantially in the Future.

 

The price of our common stock has been, and may continue to be, volatile.  The trading price of our common stock may continue to fluctuate widely as a result of a number of factors, some of which are not in our control, including:

 

·

Our ability to meet or exceed the expectations of analysts or investors;

 

·

Changes in our forecasts or earnings estimates by analysts;

 

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·

Quarter-to-quarter variations in our operating results;

 

·

Announcements regarding clinical activities or new products by us or our competitors;

 

·

General conditions in the healthcare IT industry;

 

·

Governmental regulatory action and healthcare reform measures, including changes in reimbursement rates for imaging procedures;

 

·

Rumors about our performance or software solutions;

 

·

Announcements regarding acquisitions;

 

·

Uncertainty regarding our ability to service existing debt;

 

·

Price and volume fluctuations in the overall stock market, which have particularly affected the market prices of many software, healthcare and technology companies; and

 

·

General economic conditions.

 

In addition, the market for our common stock may experience price and volume fluctuations unrelated or disproportionate to our operating performance.  These fluctuations could have a significant impact on our business due to diminished incentives for management and diminished currency for acquisitions.

 

If our Operating and Financial Performance Does not Meet the Guidance that we Have Provided to the Public, our Stock Price may Decline.

 

Periodically, we provide public guidance on our expected operating and financial results for future periods. Although we believe that this guidance provides investors and analysts with a better understanding of management's expectations for the future and is useful to our stockholders and potential stockholders, such guidance is comprised of forward-looking statements subject to the risks and uncertainties described in this report and in our other public filings and public statements. Our actual results may not always be in line with or exceed the guidance we have provided, especially in times of economic uncertainty. If our financial results for a particular period do not meet our guidance or the expectations of investment analysts, or if we reduce our guidance for future periods, the market price of our common stock may decline.

 

Certain Provisions of our Certificate of Incorporation, Bylaws and Delaware law could make a Takeover Difficult and May Prevent or Frustrate Attempts by our Stockholders to Replace or Remove our Management Team.

 

Various provisions contained in our certificate of incorporation and bylaws could delay or discourage some transactions involving an actual or potential change in control and may limit the ability of our stockholders to remove current management or approve transactions that our stockholders may deem to be in their best interests.  For instance, we have an authorized class of 1,000,000 shares of preferred stock all of which shares are undesignated except for 50,000 shares of Series A Preferred Stock (none of which were issued and outstanding as of December 31, 2014 and 2013). Shares of our authorized but unissued preferred stock may be issued by our board of directors without stockholder approval, on such terms and with such rights, preferences and designation as the board of directors may determine. Issuance of such preferred stock, depending upon the rights, preferences and designations thereof, may have the effect of delaying, deterring or preventing a change in control.

 

In addition, provisions of our certificate of incorporation and bylaws:

 

·

Require that any action required or permitted to be taken by our stockholders be effected at a duly called annual or special meeting of stockholders and may not be effected by any consent in writing;

 

·

Provide an advance written notice procedure with respect to stockholder proposals and the nomination of candidates for election as directors, other than nominations made by or at the direction of our board of directors or a committee of our board of directors;

 

·

State that special meetings of our stockholders may be called only by the chairman of our board of directors, our chief executive officer or by a majority of our board of directors then in office; and

 

·

Allow our directors to fill vacancies on our board of directors, including vacancies resulting from removal or enlargement of the board of directors.

 

We are also subject to provisions of Delaware corporate law which, subject to certain exceptions, will prohibit us from engaging in any “business combination” with a person who, together with affiliates and associates, owns 15% or more of our common stock for a period of three years following the date that the person came to own 15% or more of our common stock, unless the business combination is approved in a prescribed manner.

 

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These provisions of our certificate of incorporation, bylaws and of Delaware law, may have the effect of delaying, deterring or preventing a change in control, may discourage bids for our common stock at a premium over market price and may adversely affect the market price, and the voting and other rights of the holders, of our common stock. In addition, these provisions make it more difficult to replace or remove our current management team in the event our stockholders believe this would be in our best interest and the best interests of our stockholders.

 

Some of our Activities may Subject us to Risks under Laws and Regulations relating to Healthcare Fraud.

We are subject to extensive and frequently changing local, state and federal laws and regulations relating to healthcare fraud, waste and abuse, and the government, both state and federal, continues to strengthen its position and scrutiny over practices involving fraud, waste and abuse affecting Medicare, Medicaid and other government healthcare programs. Our relationships with hospitals and imaging centers, as well as our provision of products and services to government entities, subject our business to laws and regulations on fraud and abuse, which among other things: (1) prohibit persons from soliciting, offering, receiving or paying any remuneration in order to induce the referral of a patient for treatment or for inducing the ordering or purchasing of items or services that are in any way paid for by Medicare, Medicaid or other government-sponsored healthcare programs; (2) impose a number of restrictions upon referring physicians and providers of designated health services under Medicare and Medicaid programs; and (3) prohibit the knowing submission of a false or fraudulent claim for payment to, and knowing retention of an overpayment by, a federal health care program such as Medicare and Medicaid. Many of the regulations applicable to us, including those relating to marketing incentives, are vague or indefinite and have not been interpreted by the courts. They may be interpreted or applied by a prosecutorial, regulatory, or judicial authority in a manner that could require us to make changes in our operations.  If we fail to comply with applicable laws and regulations, we could become liable for damages, suffer civil and criminal penalties, including the loss of licenses or our ability to participate in Medicare, Medicaid and other federal and state healthcare programs.

Our Failure to Comply with Evolving Interoperability Standards could Depress the Demand for our Software and Impose Significant Software Redesign Costs.

There is increasing demand among customers, industry groups and government authorities that healthcare software and systems provided by various vendors be compatible with each other. This need for interoperability is leading to the development of standards by various groups, and certain federal and state agencies are also developing standards that could become mandatory for systems purchased by these agencies. For example, the HITECH Act requires meaningful use of “certified” healthcare information technology products by healthcare providers in order to receive stimulus funds from the federal government. Effective September 27, 2010, Centers for Medicare and Medicaid Services (“CMS”) issued a rule that utilizes a staged approach for defining meaningful use criteria. Under the staged approach, CMS has issued rules that identify the initial criteria for meaningful use and is updating these initial criteria with additional rules.  On September 4, 2012, CMS published a final rule that specifies the Stage 2 criteria that eligible professionals, eligible hospitals, and critical access hospitals must meet in order to continue to participate in the Medicare and Medicaid Electronic Health Record Incentive Programs. All providers must achieve meaningful use under the Stage 1 criteria before moving to Stage 2.  In addition, these standards are subject to interpretation by the entities designed to certify such technology. A combination of our solutions has been certified as meeting the initial criteria. However, we may incur increased development costs and delays in upgrading our customer software and systems to be in compliance with these varying and evolving standards. In addition, these new standards may lengthen our sales and implementation cycle and we may incur costs in periods prior to the corresponding recognition of revenue. To the extent these standards are narrowly construed or delayed in publication, or that we are delayed in achieving certification under these evolving standards for applicable products, our customers may postpone or cancel their decisions to purchase or implement our software and systems.  For example, the 2014 Meaningful Use program included changes, proposed in July and finalized in October, which allowed providers to report using older technology. This significantly impacted upgrades, as our customers could use older versions of our product and still stay compliant with the program.  Currently, CMS has issued a proposal to change the reporting period in 2015 from a full year to 90 days.  We anticipate that this could further delay upgrades. 

 

In addition to national programs like Meaningful Use, state laws and subsequent change can impact development costs on our products.  Some examples include varying state laws on radiation dosage tracking and the reporting of breast density in mammography tracking.  Both state and national regulations are becoming increasingly focused on health IT, and it has caused roadmap changes for our products.

 

With regard to interoperability, the Office of the National Coordinator (ONC) has published an interoperability roadmap titled Connecting Health and Care for the Nation: A 10-year vision to Achieve Interoperable Health IT Infrastructure first published in June 2014 and updated in October 2014, which will impact virtually all of our products if implemented.  It contains both standards for clinical data definitions and standards for the mechanisms of moving such data among providers and patients.

 

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None.

 

Item 2.

PROPERTIES

 

Our five largest facilities, all of which are leased, are set forth in the following table:

 

We actively monitor our real estate needs in light of our current utilization and projected growth.  We believe that we can acquire any necessary additional facility capacity on reasonably acceptable terms within a relatively short timeframe.  We devote capital resources to facility improvements and expansions as we deem necessary to promote growth and most effectively serve our customers.

Item 3.

LEGAL PROCEEDINGS

 

In August 2010, Merge Healthcare was sued in the Northern District of Texas by the Court-appointed receiver for Stanford International Bank, Ltd.  The receiver alleges that Merge Healthcare was a recipient of a fraudulent conveyance as a result of a Ponzi scheme orchestrated by Robert Stanford and Stanford International Bank, Ltd. (SIBL).  Merge Healthcare is not alleged to have participated in the Ponzi scheme.  The receiver’s claims arise from the failed acquisition of Emageon, Inc. (Emageon) by Health Systems Solutions, Inc. (HSS), an affiliate of SIBL, in February 2009, which resulted in the payment of a $9.0 million break-up fee by HSS, which payment is alleged to have been financed by SIBL.  Merge Healthcare subsequently acquired Emageon as part of our AMICAS acquisition.  The complaint seeks to recover the $9.0 million payment to Emageon, plus interest, costs, and attorneys’ fees.  We have retained litigation counsel and intend to vigorously defend this action.  We filed a motion to dismiss the complaint, which motion was denied.  Trial has been scheduled for May 2015.  Discovery in this matter is ongoing.  We believe it is reasonably possible that we may incur a loss with respect to this matter.  The potential loss may lie in a range from zero to the full amount claimed, plus interest.

 

On January 16, 2014, a purported shareholder class action complaint was filed in the United States District Court for the Northern District of Illinois by Fernando Rossy, who claims to be a Merge Healthcare stockholder, against Merge Healthcare and certain current and former directors and officers claiming violations of federal securities laws and asserting that a class of our stockholders suffered damages due to the alleged dissemination or approval of false and misleading statements by Merge Healthcare from August 1, 2012 through January 7, 2014 related to falsified subscription backlog figures and a reluctance amongst large health systems to make enterprise purchases, as well as a lack of effective controls.  Several other putative shareholder class action complaints alleging materially the same causes of action were subsequently filed.  A hearing was held on March 26, 2014 before the Court of the Northern District Illinois, at which time the Court granted the motion of the Arkansas Teacher Retirement System (“ATRS”) to consolidate the class action cases and to appoint ATRS as lead plaintiff.  ATRS filed an amended complaint on May 28, 2014.  We have filed a motion to dismiss the purported class action lawsuit, and we expect a decision on the motion to be rendered in the first quarter of 2015.  On February 14, 2014, William B. Federman, who claims to be a Merge Healthcare stockholder, filed a derivative complaint in the Circuit Court of Cook County, Illinois against certain of our current and former directors and officers, asserting breaches of fiduciary duty arising out of materially the same conduct alleged in the securities fraud class action complaints.  Subsequently, two other derivative complaints were filed in the United States District Court of the Northern District of Illinois.  On June 6, 2014, the judge assigned to the class action case granted our motion to reassign the two Federal derivative actions to her on the basis of relatedness and stayed the Federal derivative cases until she rules on our motion to dismiss the class action case.  The plaintiffs in the class action and derivative cases have not claimed a specific amount of damages.  Merge Healthcare and the other named defendants are actively considering all possible responses to these complaints.  While we intend to defend the claims vigorously and carry directors and officers insurance, it is reasonably possible that we may incur a loss in this matter.  At this stage of the proceedings, however, it is not possible for management to reasonably estimate either the likelihood of such a loss or its magnitude. 

 

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20

21

		Years Ended December 31,
		2014				2013				2012				2011				2010 (1)
		(in thousands, except for share and per share data)
Statement of Operations Data:
Net sales		$	212,304			$	231,667			$	248,904			$	232,428			$	140,332
Operating income (loss)			23,628				9,807				6,620				29,155				(8,524	)
Income (loss) before income taxes			1,889				(36,094	)			(24,729	)			(1,866	)			(25,162	)
Income tax expense (benefit)			2,297				2,889				4,091				3,665				(13,646	)
Net loss			(408	)			(38,983	)			(28,820	)			(5,531	)			(11,516	)
Net loss attributable to Merge			(447	)			(38,980	)			(28,802	)			(5,521	)			(11,516	)
Net loss available to common shareholders			(447	)			(38,980	)			(28,802	)			(8,674	)			(30,592	)
Net loss per share attributable to common shareholders of Merge
Basic		$	(0.00	)		$	(0.42	)		$	(0.31	)		$	(0.10	)		$	(0.38	)
Diluted			(0.00	)			(0.42	)			(0.31	)			(0.10	)			(0.38	)
Weighted average number of common shares outstanding
Basic			95,439,676				93,727,394				92,128,717				86,647,097				80,231,427
Diluted			95,439,676				93,727,394				92,128,717				86,647,097				80,231,427
		December 31,
			2014				2013				2012				2011				2010
		(in thousands)
Balance Sheet Data:
Working capital		$	13,277			$	11,889			$	43,201			$	46,020			$	28,357
Total assets			374,337				382,081				436,853				450,387				396,645
Long-term debt obligations			213,676				233,942				250,046				249,438				195,077
Shareholders’ equity			50,601				45,260				77,461				92,471				104,806

 

(1)	Includes the results of AMICAS from April 28, 2010, the date of the business combination.

22

·

Overview

 

·

Business Segments

 

·

Revenue and Expenses

 

·

Results of Operations

 

·

Liquidity and Capital Resources

 

·

Material Off Balance Sheet Arrangements

 

·

Critical Accounting Policies

23

24

25

26

27

28

29

30

31

32

Contractual Obligations

 

Total outstanding commitments as of December 31, 2014 (in thousands), were as follows:

 

The above obligations include lease payments for facilities that we use.

 

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 except for the contractual obligations shown above as of December 31, 2014.

 

As of December 31, 2014, approximately $1.1 million of our cash balance was held by our foreign subsidiaries.  We may need to accrue and pay taxes if we choose to repatriate these funds.

 

General

 

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, including minimum principal and interest payments due under the Term Loan.  However, any projections of future cash inflows and outflows are subject to uncertainty.  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, however our ability to undertake such transactions may be limited by the Credit Agreement.  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, 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.  In particular, our uses of cash in 2015 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 any legal or regulatory proceedings, and potential merger and acquisition activities.  Liquidity on a go forward basis is dependent on our ability to meet covenants in our Credit Agreement, including certain financial covenants.  For a description of the other covenants included in our Credit Agreement, see Note 6 of the notes to consolidated financial statements included in this Annual Report on Form 10-K.

 

Material Off Balance Sheet Arrangements

 

We have no material off balance sheet arrangements.

 

Critical Accounting Policies

 

Our consolidated financial statements are impacted by the accounting policies used and the estimates, judgments, and assumptions made by management during their preparation.  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 from these estimates under different assumptions or conditions.

 

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 and sales returns, intangible assets and goodwill, share-based compensation expense, income taxes, guarantees and loss contingencies.

 

Revenue Recognition

 

Revenues are derived primarily from the licensing of software, sales of hardware and related ancillary products, SaaS offerings, installation and engineering services, training, consulting, and software maintenance and EDI.  Inherent to software revenue recognition are significant management estimates and judgments in the interpretation and practical application of the complex rules to individual contracts.  These interpretations generally would not influence the amount of revenue recognized, but could influence the timing of such revenues.  In addition, revenue results are difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from period to period.  Significant areas of judgment include:

 

---

·

The determination of deliverables specified in a multiple-element arrangement and treatment as separate units of accounting;

 

·

Whether separate arrangements with the same customer executed within a short time frame of each other are a single arrangement;

 

·

The assessment of the probability of collection and the current credit worthiness of each customer since we generally do not request collateral from customers;

 

·

The determination of whether the fees are fixed and determinable;

 

·

Whether or not installation, engineering or consulting services are significant to the software licensed; and

 

·

The amount of total estimated labor hours, based on management’s best estimate, to complete a project we account for under the input method of percentage of completion accounting.  We review our contract estimates periodically to assess revisions in contract values and estimated labor hours, and reflect changes in estimates in the period that such estimates are revised under the cumulative catch-up method.

 

Typically, our contracts contain multiple elements, and while the majority of our contracts contain standard terms and conditions, there are instances where our contracts contain non-standard terms and conditions.  As a result, contract interpretation is sometimes required to determine the appropriate accounting.  We analyze our multiple element arrangements to determine the estimated selling price of each element, the amount of revenue to be recognized upon shipment, if any, and the period and conditions under which deferred revenue should be recognized. As a result, if facts and circumstances change that affect our current judgments, our revenue could be materially different in the future.

 

Allowance for Doubtful Accounts and Sales Returns

 

Based upon past experience and judgment, we establish allowances for doubtful accounts related to our accounts receivable and customer credits with respect to our sales returns.  We determine collection risk and record allowances for bad debts based on the aging of accounts and past transaction history with customers.  In addition, our policy is to allow sales returns when we have preauthorized the return.  We have determined an allowance for estimated returns and credits based on our historical experience of returns and customer credits.  We monitor our collections, write-offs, returns and credit experience to assess whether adjustments to our allowance estimates are necessary.  Changes in trends in any of the factors that we believe impact the realizability of our receivables or modifications to our credit standards, collection, return and credit, authorization practices or other related policies may impact our estimates. 

 

Intangible Assets and Goodwill

 

Intangible assets include purchased software, capitalized software, customer relationships, backlog, trade names, and non-compete agreements.  Finite-lived intangible assets are amortized to reflect the pattern in which the economic benefits are consumed, which is primarily the straight-line method.

 

Purchased software and capitalized software are tested for impairment quarterly by comparing the net realizable value (estimated using undiscounted future cash flows) to the carrying value of the software.  If the carrying value of the software exceeds its net realizable value, we record an impairment charge in the period in which the impairment is incurred equal to the amount of the difference between the carrying value and estimated undiscounted future cash flows. 

 

Customer relationships, backlog, trade names and non-compete agreements are evaluated for potential impairment whenever events or circumstances indicate that the carrying amount may not be recoverable, based primarily upon whether expected future undiscounted cash flows are sufficient to support the asset’s recovery.  If the actual useful life of the asset is shorter than the useful life estimated by us, the asset may be deemed to be impaired, and, accordingly, a write-down of the value of the asset determined by a discounted cash flow analysis, or a shorter amortization period, may be required.  We have reviewed these long-lived assets with estimable useful lives and determined that their carrying values as of December 31, 2014 are recoverable in future periods.

 

We review goodwill for impairment annually or more frequently if impairment indicators arise.   Our policy provides that goodwill will be reviewed for impairment as of October 1st of each year.  In calculating potential impairment losses, we evaluate the fair value of our reporting units using either quoted market prices or, if not available, by estimating the expected present value of their future cash flows.   We use a two-step impairment test.  The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, thus the second step of the impairment test is unnecessary.  If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any.  The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

 

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Identification of, and assignment of assets and liabilities to, a reporting unit require our judgment and estimates.  In addition, future cash flows are based upon our assumptions about future sales activity and market acceptance of our products.  If these assumptions change, we may be required to write down the gross value of our remaining goodwill to a revised amount.  We performed our goodwill testing and determined that there is no impairment as of December 31, 2014, since the fair value of our reporting units substantially exceeded the carrying value.

 

Software Development Costs

 

Costs incurred internally in creating computer software solutions and enhancements to those solutions are expensed until completion of a detailed program design, when technological feasibility has been established.  Thereafter, all software development costs are capitalized until the software solutions and enhancements are available for general release, and subsequent capitalized costs are reported at the lower of amortized cost or net realizable value.

 

Net realizable value is computed as the estimated gross future revenues from each software solution less the amount of estimated future costs of completing and distributing of that product.  Because the development of projected net future revenues related to our software solutions used in our net realizable value computation is based on estimates, a significant reduction in our future revenues could impact the recovery of our capitalized software development costs. 

 

Capitalized costs are amortized straight-line over the estimated economic life of the software solution with minimum annual amortization based on current and expected net future revenue for each software solution. We are generally amortizing capitalized costs over five years. The five-year period over which capitalized software development costs are amortized is an estimate based upon our forecast of a reasonable useful life for the capitalized costs. Historically, use of our software programs by our clients has exceeded five years and is capable of being used a decade or more.

 

Share-based Compensation Expense

 

We calculate share-based compensation expense for option awards based on the estimated grant-date fair value using the Black-Scholes option pricing model, and recognize the expense on a straight-line basis over the vesting period, net of estimated forfeitures.  The fair value of stock-based awards is based on certain assumptions, including:

 

·

Expected volatility, which we base on the historical volatility of our stock and other factors; and

 

·

Estimated option life, which represents the period of time the options granted are expected to be outstanding and is based, in part, on historical data.

 

We also estimate employee terminations (option forfeiture rate), which is based, in part, on historical data, employee class and the type of award.  We evaluate the assumptions used to value stock options and restricted stock awards on a quarterly basis.  The estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised.  Although we believe our assumptions used to calculate share-based compensation expense are reasonable, these assumptions can involve complex judgments about future events, which are open to interpretation and inherent uncertainty.  In addition, significant changes to our assumptions could significantly impact the amount of expense recorded in a given period.

 

Income Taxes

 

As part of the process of preparing our consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate.  Our provision for income taxes is determined using the asset and liability approach to account for income taxes.  A current liability is recorded for the estimated taxes payable for the current year.  Deferred tax assets and liabilities are recorded for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using the enacted tax rates in effect for the year in which the timing differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of changes in tax rates or tax laws are recognized in the provision for income taxes in the period that includes the enactment date.

 

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Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount more-likely-than-not to be realized.  Changes in valuation allowances will flow through the statement of operations unless related to deferred tax assets that expire unutilized or are modified through translation, in which case both the deferred tax asset and related valuation allowance are similarly adjusted.  Where a valuation allowance was established through purchase accounting for acquired deferred tax assets, any future change will be credited or charged to income tax expense.

 

The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws.  We are subject to income taxes in the U.S. and numerous foreign jurisdictions.  Significant judgment is required in determining our worldwide provision for income taxes and recording the related tax assets and liabilities.  In the ordinary course of our business, there are transactions and calculations for which the ultimate tax determination is uncertain.  In spite of our belief that we have appropriate support for all the positions taken on our tax returns, we acknowledge that certain positions may be successfully challenged by the taxing authorities.  We determine the tax benefits more likely than not to be recognized with respect to uncertain tax positions.  Unrecognized tax benefits are evaluated quarterly and adjusted based upon new information, resolution with taxing authorities and expiration of the statute of limitations.  The provision for income taxes includes the impact of changes in the liability for our uncertain tax positions.  Although we believe our recorded tax assets and liabilities are reasonable, tax laws and regulations are subject to interpretation and inherent uncertainty; therefore, our assessments can involve both a series of complex judgments about future events and rely on estimates and assumptions.  Although we believe these estimates and assumptions are reasonable, the final determination could be materially different than that which is reflected in our provision for income taxes and recorded tax assets and liabilities.

 

Guarantees

 

We recognize the importance of identifying the fair value of guarantee and indemnification arrangements issued or modified by us, as applicable.  In addition, we must continue to monitor the conditions that are subject to the guarantees and indemnifications in order to identify if a loss has occurred.  If we determine it is probable that a loss has occurred, then any such estimable loss would be recognized under those guarantees and indemnifications.

 

Under our standard software license agreements, we agree to indemnify, defend and hold harmless our licensees from and against certain losses, damages and costs arising from claims alleging the licensees’ use of our software infringes the intellectual property rights of a third party.  Historically, we have not been required to pay material amounts in connection with claims asserted under these provisions, and, accordingly, we have not recorded a liability relating to such provisions.  We also represent and warrant to licensees that our software products will operate substantially in accordance with published specifications, and that the services we perform will be undertaken by qualified personnel in a professional manner conforming to generally accepted industry standards and practices.  Historically, only minimal costs have been incurred relating to the satisfaction of product warranty claims.

 

Other guarantees include promises to indemnify, defend and hold harmless each of our executive officers, non-employee directors and certain key employees from and against losses, damages and costs incurred by each such individual in administrative, legal or investigative proceedings arising from alleged wrongdoing by the individual while acting in good faith within the scope of his or her job duties on our behalf. 

 

Loss Contingencies

 

We have accrued for costs as of December 31, 2014 and may, in the future, accrue for costs associated with certain contingencies when such costs are probable and reasonably estimable.  Liabilities established to provide for contingencies are adjusted as further information develops, circumstances change, or contingencies are resolved.

 

Recent Accounting Pronouncements

 

We describe below recent pronouncements that have had or may have a significant effect on our financial statements or have an effect on our disclosures. We do not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to our financial condition, statement of operations, or related disclosures.

 

In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exist, which is included in ASC Topic 740 (Income Taxes).  ASU 2013-11 requires an entity to net its liability for unrecognized tax positions against a net operating loss carryforward, a similar tax loss or a tax credit carryforward when settlement in this manner is available under the tax law.  The provisions of this new guidance are effective for reporting periods beginning after December 15, 2013.  We applied this guidance in the first quarter of 2014 and it did not have a material impact on our statement of operations, financial position, or cash flows.

 

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the criteria for determining which disposals can be presented as discontinued operations and modifies the related disclosure requirements. To qualify as a discontinued operation the standard requires a disposal to represent a strategic shift that has, or will have, a major effect on an entity's operations and financial results. The standard also expands the disclosures for discontinued operations and requires new disclosures related to individually material dispositions that do not qualify as discontinued operations. The standard is effective prospectively for fiscal years beginning after December 15, 2014, with early adoption permitted. We applied this guidance in the third quarter of 2014 and it did not have a material impact on our statement of operations, financial position, or cash flows.

 

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In May 2014, the FASB issued ASU No. 2014- 09, Revenue from Contracts with Customers (Topic 606).  ASU 2014-09 also adds Subtopic 340-40 Other Assets and deferred Costs‒Contracts with Customers.  The FASB issued ASU 2014-09 to clarify the principles for recognizing revenue and to develop a common revenue standard for generally accepted accounting principles and International Financial Reporting Standards. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes the most current revenue recognition guidance.  ASU 2014-09 requires retrospective application either, a) to each prior period presented, or, b) retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application as an adjustment to opening retained earnings.  The provisions of this new guidance are effective for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.  Earlier application is not permitted.  We are currently evaluating the impact of the new guidance on our financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern which requires management to evaluate, in connection with preparing financial statements for each annual and interim reporting period, whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable) and provide related disclosures.  ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. We are currently evaluating the impact of the new guidance on our financial statements.

 

In November 2014, the FASB issued ASU No. 2014-17, Business Combinations (Topic 805): Pushdown Accounting (a consensus of the FASB Emerging Issues Task Force) to make pushdown accounting optional for an acquiree.  In addition, the staff of the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) No. 115, which rescinds SAB Topic 5J (the SEC staff’s pre-existing guidance on pushdown accounting).  The standard provides an acquired entity with an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity.  If the acquiree elects not to apply pushdown accounting at the time an acquirer obtains control of it, the acquiree can later elect to apply pushdown accounting retrospectively to the most recent event in which an acquirer obtained control of the acquiree.  Such an election will be treated as a change in accounting principle in accordance with Accounting Standards Codification (ASC) 250.  Once an entity elects to apply pushdown accounting, its decision is irrevocable.  The provisions of this new guidance are effective on November 18, 2014. The new guidance did not have an impact upon our consolidated financial statements. 

 

Item 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate 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 December 31, 2014, our cash and cash equivalents included money market funds and short term deposits, including certain cash which is restricted, totaling approximately $42.5 million, and earned interest at a weighted average rate of approximately 0.1%.  The value of the principal amounts is equal to the fair value of these instruments.  Due to the relative short-term nature of our investment portfolio, our interest income is subject to changes in short-term interest rates.  At current investment levels, our net income (loss) would vary by approximately $0.4 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.

 

We utilize a combination of short-term and long-term debt to finance our operations and are exposed to interest rate risk on these debt obligations.

 

Indebtedness under our senior secured credit facility bears interest at rates that fluctuate with changes in certain short-term prevailing interest rates. As of December 31, 2014, our outstanding borrowings under the Term Loan were $225.4 million (net of $3.7 million unamortized original issue discount). As of December 31, 2014, current borrowings under our credit agreement had an effective interest rate of 7.5% and weighted average interest rate of 7.00%, determined as the LIBOR rate (subject to a 1.00% floor) plus 6.00%.

 

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To partially offset variable interest rate risks, we maintain an interest rate cap at 3.00% (versus the 1.00% LIBOR floor) with a notional amount equal to $122,588 as of December 31, 2014.  The notional amount of the interest rate cap decreases over time to $121,950 as of September 29, 2015, and thereafter is equal to $62,316 through termination on October 23, 2015. See Part II Item 8, Note 6 for more information on the refinancing of our debt. We will continue to assess the appropriateness of hedging interest rate risk with our outstanding variable debt under our current senior secured credit facilities.

 

Our net income would likely be affected by changes in market interest rates on our variable-rate obligations. As discussed above, our term loan facility is subject to a 1.00% LIBOR floor. Therefore, a 100 basis point increase in the December 31, 2014 market interest rate would increase interest expense under the term loan by approximately $1.3 million on an annual basis.

 

Foreign Currency Exchange Risk

 

We have sales and expenses 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 in 2014 or 2013.

 

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Item 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Merge Healthcare Incorporated

Chicago, Illinois

 

We have audited the accompanying consolidated balance sheets of Merge Healthcare Incorporated (“the Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive loss, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statement.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Merge Healthcare Incorporated at December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Merge Healthcare Incorporated’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 27, 2015, expressed an unqualified opinion thereon.

/s/BDO USA, LLP

 

Milwaukee, Wisconsin

February 27, 2015

 

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ASSETS		December 31, 2014				December 31, 2013
Current assets:
Cash and cash equivalents, including restricted cash of $209 and $392 at December 31, 2014 and December 31, 2013		$	42,531			$	19,729
Accounts receivable, net of reserves of $4,990 and $11,938 at December 31, 2014 and December 31, 2013			51,300				61,895
Inventory			5,686				5,851
Prepaid expenses			3,690				4,803
Deferred income taxes			1,131				1,915
Other current assets			11,110				12,506
Total current assets			115,448				106,699
Property and equipment:
Computer equipment			9,159				8,930
Office equipment			2,927				2,857
Leasehold improvements			1,589				1,870
			13,675				13,657
Less accumulated depreciation			9,596				8,918
Net property and equipment			4,079				4,739
Purchased and developed software, net of accumulated amortization of $23,764 and $18,591 at December 31, 2014 and December 31, 2013			14,585				15,906
Other intangible assets, net of accumulated amortization of $38,370 and $34,466 at December 31, 2014 and December 31, 2013			17,956				26,200
Goodwill			214,374				214,374
Deferred income taxes			5,396				6,979
Other assets			2,499				7,184
Total assets		$	374,337			$	382,081
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	21,072			$	22,072
Current maturities of long-term debt			11,750				2,490
Accrued wages			11,169				5,559
Restructuring accrual			-				1,301
Other current liabilities			4,996				8,205
Deferred revenue			53,184				55,183
Total current liabilities			102,171				94,810
Long-term debt, less current maturities, net of unamortized discount			213,676				233,942
Deferred income taxes			4,025				4,065
Deferred revenue			1,091				378
Income taxes payable			1,109				1,399
Other liabilities			1,664				2,227
Total liabilities			323,736				336,821
Shareholders' equity:
Preferred Stock, $0.01 par value: 1,000,000 shares authorized; none issued			-				-
Series A Non-voting Preferred Stock, $0.01 par value: 50,000 shares authorized; none issued			-				-
Common stock, $0.01 par value: 150,000,000 shares authorized: 98,442,336 and 96,688,889 shares issued and outstanding at December 31, 2014 and December 31, 2013			984				967
Common stock subscribed, 14,429 and 26,259 shares at December 31, 2014 and December 31, 2013			49				57
Additional paid-in capital			590,938				585,102
Accumulated deficit			(543,622	)			(543,175	)
Accumulated other comprehensive income			1,766				1,862
Total Merge shareholders' equity			50,115				44,813
Noncontrolling interest			486				447
Total shareholders' equity			50,601				45,260
Total liabilities and shareholders' equity		$	374,337			$	382,081

		Years Ended December 31,
		2014				2013				2012
Net sales:
Software and other		$	71,084			$	78,575			$	94,466
Professional services			38,033				43,830				40,978
Maintenance and EDI			103,187				109,262				113,460
Total net sales			212,304				231,667				248,904
Cost of sales:
Software and other			30,433				41,813				43,281
Professional services			25,092				25,114				24,693
Maintenance and EDI			27,744				28,989				31,090
Depreciation, amortization and impairment			7,475				6,980				8,987
Total cost of sales			90,744				102,896				108,051
Gross margin			121,560				128,771				140,853
Operating costs and expenses:
Sales and marketing			31,991				36,585				43,908
Product research and development			28,434				32,388				32,419
General and administrative			27,144				34,689				42,366
Acquisition-related expenses			232				906				3,402
Restructuring and other expenses			-				3,856				830
Depreciation, amortization and impairment			10,131				10,540				11,308
Total operating costs and expenses			97,932				118,964				134,233
Operating income			23,628				9,807				6,620
Other income (expense):
Interest expense			(17,199	)			(21,762	)			(32,926	)
Interest income			18				514				766
Loss on debt extinguishment			(4,821	)			(23,822	)			-
Other, net			263				(831	)			811
Total other income (expense)			(21,739	)			(45,901	)			(31,349	)
Income (loss) before income taxes			1,889				(36,094	)			(24,729	)
Income tax expense			2,297				2,889				4,091
Net loss			(408	)			(38,983	)			(28,820	)
Less:  noncontrolling interest's share			39				(3	)			(18	)
Net loss available to common shareholders of Merge		$	(447	)		$	(38,980	)		$	(28,802	)
Net loss per share attributable to common shareholders of Merge - basic		$	(0.00	)		$	(0.42	)		$	(0.31	)
Weighted average number of common shares outstanding - basic			95,439,676				93,727,394				92,128,717
Net loss per share attributable to common shareholders of Merge - diluted		$	(0.00	)		$	(0.42	)		$	(0.31	)
Weighted average number of common shares outstanding - diluted			95,439,676				93,727,394				92,128,717

		Years Ended December 31,
		2014				2013				2012
Net loss		$	(408	)		$	(38,983	)		$	(28,820	)
Translation adjustment			(96	)			(103	)			4
Change in fair value of marketable security, net of income taxes			-				398				(50	)
Comprehensive loss			(504	)			(38,688	)			(28,866	)
Less:  noncontrolling interest's share			39				(3	)			(18	)
Comprehensive loss attributable to Merge		$	(543	)		$	(38,685	)		$	(28,848	)

		Preferred Stock								Common Stock
		Shares Issued				Issued Amount				Shares Subscribed				Subscribed Amount				Shares Issued				Issued Amount				Additional Paid-in Capital				Accumulated Deficit				Accumulated Other Comprehensive Income				Total Merge Shareholders’ Equity				Non- controlling Interest				Total Shareholders’ Equity
Balance at December 31, 2011			-			$	-				195,116			$	1,311				90,939,053			$	909			$	563,563			$	(475,393	)		$	1,613			$	92,003			$	468			$	92,471
Stock activity for acquisitions			-				-				(53,574	)			(373	)			1,410,491				14				5,561				-				-				5,202				-				5,202
Stock issued under ESPP			-				-				16,853				(4	)			92,886				1				356				-				-				353				-				353
Exercise of stock options			-				-				-				-				190,269				2				686				-				-				688				-				688
Issuance of restricted shares			-				-				-				-				505,038				5				1,822				-				-				1,827				-				1,827
Share-based compensation expense			-				-				-				-				-				-				5,786				-				-				5,786				-				5,786
Net loss			-				-				-				-				-				-				-				(28,802	)			-				(28,802	)			(18	)			(28,820	)
Other comprehensive loss			-				-				-				-				-				-				-				-				(46	)			(46	)			-				(46	)
Balance at December 31, 2012			-			$	-				158,395			$	934				93,137,737			$	931			$	577,774			$	(504,195	)		$	1,567			$	77,011			$	450			$	77,461
Stock activity for acquisitions			-				-				(122,292	)			(850	)			40,225				1				123				-				-				(726	)			-				(726	)
Stock issued for settlement			-				-				-				-				400,000				4				881				-				-				885				-				885
Stock issued under ESPP			-				-				(9,844	)			(27	)			108,427				1				279				-				-				253				-				253
Exercise of stock options			-				-				-				-				902,500				9				1,227				-				-				1,236				-				1,236
Issuance of restricted shares			-				-				-				-				2,100,000				21				(21	)			-				-				-				-				-
Share-based compensation expense			-				-				-				-				-				-				4,839				-				-				4,839				-				4,839
Net loss			-				-				-				-				-				-				-				(38,980	)			-				(38,980	)			(3	)			(38,983	)
Other comprehensive income			-				-				-				-				-				-				-				-				295				295				-				295
Balance at December 31, 2013			-			$	-				26,259			$	57				96,688,889			$	967			$	585,102			$	(543,175	)		$	1,862			$	44,813			$	447			$	45,260
Stock issued under ESPP			-				-				(11,830	)			(8	)			90,238				-				207								-				199				-				199
Exercise of stock options			-				-				-				-				1,191,250				12				1,006				-				-				1,018				-				1,018
Issuance of restricted shares			-				-				-				-				652,195				7				(7	)			-				-				-				-				-
Share-based compensation expense			-				-				-				-				-				-				5,169				-				-				5,169				-				5,169
Return of shares to satisfy recipients' income tax obligations related to restricted stock vesting											-				-				(180,236	)			(2	)			(539	)			-				-				(541	)			-				(541	)
Net loss			-				-				-				-				-				-				-				(447	)			-				(447	)			39				(408	)
Other comprehensive loss			-				-				-				-				-				-				-				-				(96	)			(96	)			-				(96	)
Balance at December 31, 2014			-			$	-				14,429			$	49				98,442,336			$	984			$	590,938			$	(543,622	)		$	1,766			$	50,115			$	486			$	50,601

		Year Ended December 31,
		2014				2013				2012
Cash flows from operating activities:
Net loss		$	(408	)		$	(38,983	)		$	(28,820	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation, amortization and impairment			17,606				17,520				20,295
Share-based compensation			5,169				4,839				5,786
Amortization of term loan and note payable issuance costs & discounts			1,129				1,649				2,724
Unrealized gain on equity security			-				-				(486	)
Realized loss on equity security			-				745				-
Change in contingent consideration for acquisitions			-				-				1,380
Loss on extinguishment of debt			4,821				23,822				-
Provision for doubtful accounts receivable and allowances, net of recoveries			200				693				10,523
Deferred income taxes			2,113				2,301				3,581
Loss on acquisition settlement			-				1,345				-
Stock issued for lawsuit settlement			-				885				-
Gain on lawsuit settlement			-				(2,500	)			-
Changes in operating assets and liabilities, net of effects of acquisitions and dispositions:
Accounts receivable			10,395				9,476				(9,659	)
Inventory			164				128				(1,261	)
Prepaid expenses			1,110				(708	)			(148	)
Accounts payable			(1,000	)			(2,243	)			2,258
Accrued wages			5,611				(322	)			(979	)
Restructuring accrual			(1,301	)			1,079				(1,297	)
Other accrued liabilities			(3,244	)			(6,585	)			(556	)
Deferred revenue			(1,286	)			2,312				(422	)
Other			1,508				5,828				(3,559	)
Net cash provided by (used in) operating activities			42,587				21,281				(640	)
Cash flows from investing activities:
Cash paid for acquisitions, net of cash acquired			-				-				(876	)
Investment in securities			-				-				(240	)
Purchases of property, equipment and leasehold improvements			(1,844	)			(2,239	)			(2,174	)
Purchased technology			(300	)			(450	)			-
Capitalized software development			(3,942	)			(85	)			-
Change in restricted cash			183				422				(106	)
Proceeds from sale of equity investment			-				1,785				-
Net cash used in investing activities			(5,903	)			(567	)			(3,396	)
Cash flows from financing activities:
Proceeds from debt issuance			231,251				252,450				-
Retirement of debt			(230,133	)			(252,000	)			-
Penalty for early extinguishment of debt			-				(16,863	)			-
Note issuance costs paid			(250	)			(4,588	)			-
Proceeds from exercise of stock options and employee stock purchase plan			1,217				1,489				1,039
Principal payments on term loan and notes payable			(14,467	)			(16,286	)			(37	)
Principal payments on capital leases			(680	)			(535	)			(396	)
Repurchase and retirement of common stock			(541	)			-				-
Net cash (used in) provided by financing activities			(13,603	)			(36,333	)			606
Effect of exchange rates on cash and cash equivalents			(96	)			(106	)			(73	)
Net increase (decrease) in cash and cash equivalents			22,985				(15,725	)			(3,503	)
Cash and cash equivalents (net of restricted cash), beginning of period (1)			19,337				35,062				38,565
Cash and cash equivalents (net of restricted cash), end of period (2)		$	42,322			$	19,337			$	35,062
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest		$	15,949			$	24,847			$	29,792
Cash paid for income taxes, net of refunds		$	402			$	411			$	261
Non-Cash Investing and Financing Activities
Equity securities received in settlement of receivable		$	-			$	-			$	1,530
Value of common stock issued for acquisitions and returns for settlements		$	-			$	(726	)		$	7,029
Assets purchased under capital lease obligations		$	60			$	187			$	1,412
Assets purchased under lease line facility		$	-			$	-			$	897

		Balance at December 31,
		2014				2013
Revenue recognized in excess of billings, net of reserves of $1,389 and $2,249, respectively		$	9,924			$	12,069
Other current assets			1,186				437
		$	11,110			$	12,506

		Balance at Beginning of Period				Net Additions Charged to Expenses				Deductions				Balance at End of Period
For year ended December 31:
2014		$	2,249			$	745			$	(1,605	)		$	1,389
2013			1,763				1,279				(793	)			2,249
2012			235				1,528				-				1,763