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Merge Healthcare Incorporated (NASDAQ:MRGE)

Q4 2012 Earnings Conference Call

February 19, 2013; 08:30 a.m. ET

Executives

Jeff Surges - Chief Executive Officer

Justin Dearborn - President

Steve Oreskovich - Chief Financial Officer

Analysts

Deepak Chaulagai - Dougherty

Chad Bennett - Craig-Hallum Capital

Ryan Daniels - William Blair & Company

Anthony Esposito - Imperial Capital LLC

Operator

Good morning and welcome to Merge’s, fourth quarter 2012 earnings call. Today's call is being hosted by Jeff Surges, Chief Executive Officer; Justin Dearborn, President; and Steve Oreskovich, Merge’s Chief Financial Officer.

Before we get started, please consider that the comments today may contain forward-looking statements under the Private Securities Litigation Reform Act of 1995 and not historical facts. Actual results may differ. Various critical factors that could affect future results are set forth in the company’s recent SEC filings and press releases. The company undertakes no obligation to update or revise any forward-looking statements.

In addition, there may be references to non-GAAP financial measures. These measures are supplemental to the GAAP financial measures and should not be viewed as an alternative to them. For greater information regarding these metrics, please see the related discussion in the company’s earnings release.

With that, I will turn the call over to Jeff Surges.

Jeff Surges

Well, thank you operator and thanks to all of you for joining us this morning. I'm pleased to have the opportunity to share our 2012, Q4 record results, as well as an update on the company's market outlook and our strategies for 2013.

Before I begin this discussion, I want to first address the announcement we made in September of 2012. As you'll recall, at that time we stated that our Board of Directors, in response to certain inquiries made to Merge last year, had retained Allen & Company LLC, a New York based investment banking firm, to assist Merge in exploring and evaluating a broad range of strategic alternatives.

Following discussions with other companies in our sector, as well as with various private equity firms, we received several non-binding indications of interest. Our board has unanimously determined that the valuation ranges set forth in these indications of interest, did not appropriately value the company.

During this lengthy process, management remains very focused on the execution of our operational plan as evidenced by our strong Q4. Going forward we will continue this momentum and build Merge organically.

In Q4 we saw one of the strongest selling quarters in Merge’s history. As we've done in the past, I will provide an update on the Merge Healthcare side of the business and Justin Dearborn will provide an update on the Merge DNA operating group.

But before we turn to Q4, I think it's very important to look back even further. Two years ago Merge was $190 million company. Last year we ended our fiscal year $235 million in revenue, up from that $190 million, and this year we are finishing the year $251 million.

Our healthcare bookings are up 40% year-over-year, while eClinical bookings are up 79%. Additionally we grew our subscription backlog by 82%, while still maintaining our non-recurring backlog. To me, it's very clear that we've made substantial progress.

For the fourth quarter specifically, revenue increased to a healthy $65.1 million on a pro forma basis. Adjusted EBITDA was $13.9 million, representing 21% of pro forma revenue. Subscription based pricing arrangements generated 13.5% of total revenue in the quarter, as subscription backlog grew 12.8%.

For the Merge Healthcare portion of the business, revenue was $57.4 million, with subscription revenue comprising 3.1% of total revenue for this operating group. Adjusted EBITDA for the group was $15.1 million or 26.3% of pro forma revenue.

Our strong quarter was driven by sales of iConnect, adoption of our subscription based solutions and growth in several specialty areas. Let me briefly speak to each of these. This quarter, 12 more clients embraced the enterprise imaging strategy with our iConnect enterprise clinical platform, ranging from large IDM’s to community hospitals.

I'm pleased to report we saw a positive trend this quarter, with customers including Northeast Georgia Health System, who do not use Merge tax platforms selecting our vendor neutral archive. Competitors in this space have tried to claim that a company like Merge cannot be vendor neutral, because we offer our PACS; however, the selection of Merge by clients like Northeast Georgia, proves that our iConnect enterprise archive is a compelling choice, regardless of the clients legacy PACS.

As we have mentioned in the past, our VNA, which you may recall as the global market leader of VNA, is integrated to over 45 non-Merge clinical systems. Northeast Georgia joint clients including Health Ventures of Central Iowa, St. John's Providence Health System, Edward Hospital and Altru Health System, who also selected Merge’s iConnect solutions to enable their enterprise imaging strategies.

Remember, it was only two years ago that we started broadly selling and promoting the iConnect platform. At that time we predicted health systems were not going to be reimbursed for duplicate images. Payment models are changing and it's clear like no time in the past, that interoperability and particularly imaging interoperability is imperative to our health system’s success.

The second part of our strong quarter was fueled by growth in our subscription backlog. It was up $20 million or 82% in 2012. As of today clients have contracted with us to move more than $4 million annual studies in the Merge Honeycomb archive, our cloud-based archiving solution now live and yearning.

When customers sign up for our Honeycomb archive, they contract to pay a per study fee, almost like a tollbooth, for every image ingested into the cloud, plus a small monthly archiving fee. These arrangements are generally three-year agreements and each client agrees to a minimum annual study volume for the contract based on their size. The market opportunity here is significant.

On an annual basis 800 million imaging exams are done in the United States. Honeycomb allows hospitals and imaging centers to satisfy federal requirements to have disaster recovery plans in place, and it also solves referring physician and consumer engagement needs at the same time.

As I said in Q1, 2012, the subscription-based model is here to stay and I'm glad that we've seen such rapid adoption of this approach amongst our client base. Just last week in fact we sold our first Honeycomb archive through our inside telesales team. We are very excited by the idea of expanding this and selling Honeycomb to our installed client base via the inside team. That installed base by the way consists of over 2,200 imaging centers nationwide.

Third and finally, in Q4 we saw strong growth in specialty areas of cardiology and orthopedics. In cardiology for the second year in a row, our Merge Hemo solution was named Category Leader in the 2012 Best In Class Award software and services report for cardiology hemodynamics, and between our Merge Cardio and Merge Hemo solutions, we added 17 more clients to the Merge family, including Borgess Medical Center, DuPage Medical Center, Boca Raton Regional Hospital, St. Thomas in Nashville and Palos Hospital among others.

Recall, cardiology imaging practices are now completely owned by hospitals and they are the second largest imaging silo within these hospitals. Combined with radiology images, cardiology provides the anchored storage and archive for our (inaudible).

Another specialty area which we saw growth was orthopedics. We launched a new version of Merge OrthoPACS at that point in 2012 and the market really responded in Q4, with 34 clients selecting and contracting for this solution from Merge.

In addition to these primary sales drivers, Q4 posted several other highlights. By the end of 2012, radiology clients using Merge solutions received an estimated $14 million in meaningful use incentive payments. For industry that a few years ago did not think meaningful use applied to radiology, this is quite an accomplishment. We are proud that we've been taking a leadership position in advocating for radiologists and enabling them to be eligible for this program.

As meaningful use moves forward and requirements for imaging and sharing become increasingly stringent in both stage II and stage III, we have announced a strategic partnership in Q4 that will ensure our continued leadership in this area. Specifically, we announced that we will connect our extensive imaging network with the Surescripts Network for clinical interoperability. We are very excited about this partnership, as Merge is the first specialty content provider to the Surescripts Network.

This new offering which we’re calling the iConnect network, will allow hospitals and imaging centers to provide electronic delivery of imaging reports to care provider organizations through any EHR. This new offering builds on the clear patient referral concept we previewed at RSNA back in November.

Because of meaningful use stage II, reports and images will have to be delivered electronically to referring physician. That simply means that electronic access will need to be provided to over 37 million images per year, a substantial marketplace opportunity. However, the cost for large health system to connect to every EHR that is being used in their community can be hundreds of thousands of dollars, not only to build, but maintain point to point interfaces; this solution fixes that.

The iConnect network will completely eliminate this and allow our health system to deliver reports and eventually access patient images to any EHR in the community, just by “plugging in” to the Merge iConnect network. We believe that the iConnect network in combination with Merge Honeycomb represents over a $550 million marketplace opportunity that we can penetrate.

This announcement has been met with interest and great enthusiasm amongst our client base, and by the end of 2013, just like Honeycomb, we expect to have several million iConnect transactions under contract, live and contributing to our subscription revenue model. This will be reflected in margin acceleration and recurring revenue, as we become the network by which all images are shared.

Thing about it this way; if two years ago we were waiting for the EHR game to expire and we survived and in a many ways thrived in 2012, and as the government extended EHR timelines yet one more year, what we have now are millions of EHR nodes across the country. The problem is they are not connected and more importantly, they are not connected in sharing images, Merge’s core competency.

Those are the highlights from Q4. While 2012 did have its challenges, I believe that across the business we are stronger than ever. At this time last year, we had line of sight for one or two deals that were $5 million or greater. We were able to win one of those opportunities with Advocate Health Care.

Today I'm pleased to report we have line of sight to three deals that are each $10 million plus within the very near future. This and our 2012 progress gives me great confidence in the 2013 guidance that we provided. We expect to see continued traction from our subscription-based offerings, resulting in an increase in backlog in at least $25 million or 50% plus growth by the end of 2013, with pro forma revenue between $265 million and $275 million, and adjusted EBITDA growing to 22% to 24%.

In 2013 we know that millions of images will be moving to the cloud and millions more that are currently stored in the PACS or a non-Merge DNA will need to be accessible to an EHR to meet the meaningful use of stage II and then stage III requirements. Every one of the studies that moved to the Merge Honeycomb cloud or are part of our iConnect network is a transaction for which we’ll charge our clients. Layered on top of that, our client base of 1,500 hospitals, 6,000 clinics, and you can see the substantial opportunity this represents for our company.

This year we also believe that 50 plus VNA buying decisions will be made by leading healthcare organizations across the country. Remember, a recent independent report ranked the Merge VNA number one in the world. Based on that we expect to win many of these deals.

Again, if I look back two years ago when we first announced the iConnect platform, which is composed of iConnect Share, iConnect Access and iConnect Enterprise Archive, clients initially began to embrace the enterprise imaging approach by starting with Share and Access. An Access or Share deal would typically be in the hundreds of thousands of dollars. Now they are moving forward with their strategies and looking at our VNA. A VNA deal can be a multi-million dollar project and our 2013 pipeline is a good indication of this trend.

Additionally, while competition in the VNA space is fierce, we believe that with several main competitors may not be as focused as they’ve been in the past. One such competitor which has been gaining ground in the marketplace was recently acquired by a much larger company that is not known to be a core HIT provider. As we all know, an acquisition by a larger company means a lot of change; change to culture, change to pace and changes to level of investment. We believe we can capitalize on this opportunity.

My last comment today as we look forward into 2013 is about our debt. Several years ago the most frequent question we would receive from shareholders and investors was simple: Will you be able to service your debt? Today we are one payment away from having more flexibility to consider refinancing these notes if we so choose.

So again, the strategic process is behind us. We remain laser focused on growth across our business and delivering upon the guidance we provided for 2013. I believe that we have the right partnerships and the team in place. We have strong momentum and a substantial marketplace lies in front of us.

With that, I’d like to turn it over to Justin Dearborn.

Justin Dearborn

Thanks Jeff. I’m happy to share an update on Merge DNA business. From a financial perspective this quarter, Merge DNA generated $7.7 million in pro forma revenue, with a 24.7% adjusted EBITDA margin. Further, subscription revenue comprised over 90% of total revenue for this operating group, while backlog at December 30 grew $5.5 million to $34.9 million and is 100% subscription revenue base.

We continue to see tremendous growth from our eClinical group since the launch of our new platform Merge eClinical OS at the end of Q2. Sales continue to grow aggressively, both from new and existing customers and new system capabilities continue to increase total contract value. We gained 32 clients across the globe, including (inaudible), global genomics group, Roche (inaudible), Tampa General Hospital and the world's largest end point coordination center.

Q4 saw 55% growth in the number of sites using our solutions, on top of 25% growth in Q3; 57% growth in the number of studies under contract, on top of 40% in Q3. On a full year-over-year basis bookings increased 79%. We continue to see strong demand across all customer segments, with especially strong demand from our clinical research organization channel. Our partners continue to expand the use of our tools for all trial phases.

We signed 192 contracts in Q4, far exceeding our best quarter. One good example of a healthy six-figure client win that shows the strength of our ability to cross-sell into existing healthcare clients is Tampa General Hospital. As an existing Merge Cardio and Merge Hemo client, Tampa General Hospital was excited to expand their partnership in selecting Merge’s clinical trials management solution for all their clinical trials.

Now, Steve will provide additional comments on the quarter's financial information.

Steve Oreskovich

Thanks Justin. During the fourth quarter and for the full year 2012, revenue generated through subscription and other highly predictable revenue sources approximated 60% of the total revenue. Subscription revenue continued to account for approximately 15% of revenue, while maintenance and EDI was 45%.

Revenue generated through perpetual license agreements with our customers, under which the software, hardware and professional services are considered to be sources of non-recurring revenue contributed the remaining 40%.

Pro forma sales were $65.1 million in Q4, which was within $0.5 million of GAAP revenue. Further pro forma revenue for 2012 was $251 million. Both Q4 and full-year revenue were above analyst consensus.

As Jeff previously stated, we continue to expect pro forma revenue of $265 million to $275 million for 2013. We again experienced strong growth in subscription backlog of $5.2 million in Q4 to $45.6 million at year-end. During 2012 subscription backlog grew by over $20 million or 82%, and for 2013 we expect subscription backlog to grow by another $25 million or 55%, led by our eClinical, Interoperability and Honeycomb solutions.

Non-recurring backlog was $31.3 million at year-end, which remain constant to both Q3 2012 and December 31, 2011. While we continue to contract in a manner that best fits the needs of our customers, the goal is to focus on subscription, as growth of this and other predictable revenue resources will help us attain our long-term, three plus year goal of over 70% of the total revenue being generated by these sources. We expect that attainment of this goal, along with other operational activities, will stimulate operating margin improvement and allow us to eventually achieve an adjusted EBITDA percentage in the high 20’s to the low 30’s.

During the quarter Merge had $14.3 million of one-time charges, of which $13 million impacted adjusted EBITDA. We have included a table at the back of our earnings release illustrating pro forma results for Q4 with and without these items.

The majority of the charge of $9.2 million, primarily relates to un-collectable billings from customer contracts obtained through certain acquisitions in the past few years. Excluding these charges adjusted EBITDA would have been $13.9 million or 21.4% during Q4 and $52.5 million or 21% for 2012, both of which are above analyst consensus. We continue to expect adjusted EBITDA of 22% to 24% for 2013, up 2% to 4% from 2012.

Excluding one-time items, gross margin on a pro forma basis was 59% in Q4, which is consistent with the quarterly average for 2012 and compares to 63% in Q4 2011. Please recall that the mix of software and hardware sales, both individually and as a percentage of overall sales will continue to fluctuate and may impact our gross margin on a quarterly basis.

Also operating expenses excluding the one-time items, as well as depreciation and amortization, restructuring and acquisition related expenses were $28.9 million in Q4 2012, compared to $26.9 million in 2011. The $2 million increase is primarily driven by bad debt expense of approximately $1 million, recorded as a result of the inability to pay from a few customers contracted within the normal course of business.

Turning to the balance sheet, cash generated from operations was $9.3 million in Q4, which is very consistent with the $9.6 million in Q3. Offsetting this was the $14.8 million semi-annual interest payment. As a result, cash decreased in the quarter to $36 million at year-end.

Net Accounts Receivable or AR increased slightly in the quarter by $1.8 million to $72.1 million at year-end. Of this balance, over 60% is less than 30 days aged, which speaks to the overall health of the AR at year-end.

Along with AR the activity on the current asset called the revenue in excess of billings and deferred revenue will fluctuate on a quarterly basis due to contracted billing terms and the achievement of such milestones.

Revenue in excess of billings decreased by $2.5 million in the quarter to $18.8 million at year-end, while deferred revenue increased in Q4 by $4 million to $53.3 million. Finally, accounts payable increased by $5 million to $24.4 million in the quarter, primarily due to payment timing resulting from continued negotiation of more preferable payment terms with our significant vendors.

With that, I’ll now turn it back to Jeff.

Jeff Surges

Thanks Steve. I’d like to provide some color on the right-off Steve just mentioned. Over the years Merge has engaged in quite a few acquisitions. Amicus, Confirma and Stryker among others. Over time we synergized those acquisitions, operationalizing for business lines to achieve a one Merge.

At this juncture we feel that its prudent and appropriate to write-off some one-time charges that mainly relate to billings from customer contracts obtained through those acquisitions, before Merge owned them. This dose not affect our operations or our operating plans for 2013. This move was done with the full support of our Board and with the approval of our audit committee, and we believe it is the right thing to do as we start 2013.

With that operator, you may now open the call up for questions.

Question-and-Answer Session

Operator

Line is un-muted.

Deepak Chaulagai - Dougherty

Good morning guys. This is Deepak Chaulagai from Dougherty. Can you hear me?

Jeff Surges

Hi Deepak, it’s Jeff. Sorry, we were supposed to introduce you, but good morning.

Deepak Chaulagai - Dougherty

Good morning. Yes, I thought so too. Could you provide just a little bit more color on the large deals that you alluded to in your prepared remarks and so to compound and contrast where you were at this time last year and what you see going forward in terms of the pipeline build?

Jeff Surges

Yes, thanks a lot Deepak. So again, part of a little bit of the lengthier call this morning was to demonstrate kind of the evolution of the strategy, right. So iConnect Share and Access were the initial modules of the iConnect platform and those really were providing simple access and simple sharing across a health system.

We knew that the bigger opportunity was always going to be in the content management or the vendor neutral archive. That would be where we would provide the solution that would allow all of the images from across their health system, whether there are Merge PACS or another system, to all get into our archive, right.

That is a much heavier, much longer sales cycle, much more significant in dollars. And so the fact that the EMR is over and people are now looking for requirements for Stage II and Stage III, we saw beginning in Q3 and at the tail end of Q2, the activity there both from an RFP, as well as from large academic, large integrated delivery networks and some of the larger chains start to really invest.

And as you know and have been in this business long enough, when the tipping point of the large academics and the large health systems start the movement, they pull everybody else through. The community hospital, the large standalone, as well is the small group.

So by virtue of the size of the shopper right now, it’s the number of studies, the number of storage and the dollars just get bigger. So when we talk about these opportunities in the near term, we really see a complete enterprise solution, not just imaging, access and share, but the core, which is the DNA in making that mobile.

In addition you add on to that the second copy of the cloud for Honeycomb and we are now in the position where we are quoting, facilitating and in some ways negotiating several large deals that we just haven’t seen before, but that two years ago we knew were coming.

So we are excited about the size of those. I’ll be more excited when we win them and announce them. But clearly, travel is up here and activity is up.

Deepak Chaulagai - Dougherty

That was like going into my follow-up question. So it’s very, really encouraging that you have these deals in your pipeline now. What do you think about the sales cycle in terms of when you could close them and put it in your backlog?

Jeff Surges

Yes. So again, our data suggests that there is going to be about 50 decisions in the space at least over this year, and hence will be a great point in time to see that type of activity. So if there is 50 throughout the year and we are a global leader, my expectation is we are winning and we are holding serge and we are gaining market share, and so I don’t think this is a back end loaded sales cycle.

I think what we saw in Q2 at the end, and the start of Q3 in 2012, you add the typical healthcare nine to 12 month cycle and we’ll start to see those penetrate, the initial few in the next 60 to 90 days and then I think there’ll just be a consistent flow of these opportunities, that now that we are completely focused on this we have references and we’ve got our cloud up and running, we are in a much more formidable place to compete, than where we were a couple years ago when we were introducing the concept and at top of mind, the CIO was just introducing the EMR to get those initial, meaningful use dollars.

Deepak Chaulagai - Dougherty

Sure, that’s really helpful color. One last one and I’ll hop back in the queue. In terms of these one-off charges, primarily related to the acquisitions that you have made in the last several years, are we to expect anything else going forward or do you think this is the last one that you are taking the charge and we should see going forward what I might say as a cleaner quarter without these one-off charges.

Jeff Surges

Yes, I think in more of a general discussion with the clean bill of health, the way you say that, maybe the best way to think about it. I’ll let Steve comment more in detail, but again I think what we wanted to do was close the process and enter 2013 stronger than ever and I think this was the right thing to do. So Steve, why don’t you just elaborate.

Steve Oreskovich

Yes, and I would add Deepak that we wouldn’t expect any significant negative charges going forward in the future. One of the items I pointed in the prepared remarks is AR as of year-end, 60% plus was in the less than 30 days aged category. So that gives us a lot of confidence in the health of the AR going forward.

Deepak Chaulagai - Dougherty

Thank you.

Jeff Surges

Thanks Deepak. Operator, next question.

Operator

I would like to introduce Chad Bennett.

Chad Bennett – Craig-Hallum Capital

Hey guys, good morning.

Jeff Surges

Good morning Chad.

Chad Bennett – Craig-Hallum Capital

Just a couple of questions for me. Can you give an update Jeff on how the EMC partnership is going and if expectations are still in line with what you were thinking when I think you guys talked about this at RSNA.

And then secondly, the $25 million backlog growth you expect this year, I think its subscription backlog growth to be specific. Steve, you alluded to it and maybe Jeff can elaborate; I assume that’s going to be primarily driven by Merge Healthcare versus the clinical business?

Jeff Surges

Yes, so two great questions. The EMC partnership again, just to recap, more of a distribution arrangement. EMC one of the largest storage platforms, they wanted a competitive VNA offering to go with their said portfolio of storage. Their big storage sits on EPC, sits on (inaudible) and sits on places like that, and so we were awarded their select program.

A great example is the one I referenced in the call; Northeast Georgia. Over 80% of their storage is on the EMC box. We already knew Northeast Georgia, but having EMC already be there, where we could say our platform and our software is certified on their Isilon (ph) and their Atmos offerings makes the process more comfortable and confident for everybody. So that was one tangible one.

But we continue to in Q1, as most of Q1 for healthcare IT and companies are kicking off for the year, we got a number of go to markets and amongst all of our storage platform partners as well, I don’t want to isolate EMC, we continue to see kind of a push-pull trend where more of these VNA’s, which is more of the heavier, more robust storage application become more relevant to them than just accessing and sharing, which is more viewer driven as you know.

So that’s really what we are seeing. We’ll get more highlights at our HIMSS tradeshow, but I think we are pleased with where we are at with EMC in the progress.

Steve Oreskovich

And then Chad, this is Steve. With respect to your backlog growth question, 2012 obviously a lot of the backlog growth came from the VNA and specifically eClinical as we moved that entire business to subscription, early in the year as we saw we had an opportunity to do that.

As it relates to 2013, I would expect it to be more in the half and half range. Obviously it will depend a little bit on how quickly a lot of these sales, the Honeycomb sales comes during the year, but looking overall for the entire year, we would expect to be much more in the half to half range.

Jeff Surges

Chad, just to top that off, not only in the VNA, but the amount of proposals and quotes we are sending out to clients for the Honeycomb archive, the reality is when we introduced it, it takes a while to stand it up, and it takes a while to get through security and to make sure your partners are aligned.

Just yesterday we sold yet another one through our inside sales team. So again when in the future we talk about millions of studies under contract, then they go through the tollbooth, that adds because it’s a contractual commitment over a three-year term, that gives us help in that.

The other thing which I’ll talk about more in the coming months is our iConnect network. Being able to set up a network with our partner Surescripts will provide every health system that has multiple EMR's or EHR's, the ability to not have to go to market and contract for singular point-to-point interfaces at hundreds of thousands of dollars, but to use the existing hub that routes millions of prescriptions today in more of a subscription based environment will also be a statistic we’ll be profiling or we’re excited about.

That one was as much client driven as partner driven and we are very excited to bring that to market in the next few weeks as well.

Chad Bennett – Craig-Hallum Capital

Okay. And then, just a couple more for me. On the quarter we are in now, the March quarter, how should we think about kind of seasonality there in the March quarter relative to the health IT space and you guys?

And then secondly, do you have a target in the March quarter. I think the March quarter is typically a decent cash generation quarter. Do have a target for cash by the end of the March quarter?

Jeff Surges

Yes, so we’ll start with the last one first. So, a number of our clients that we contract with in Q4, they make their first payment in Q1. Another, a number of our OEM partner agreement, they make their payments in Q1, so its sets up nice for their fiscal and budget years. Deals that we would have closed in Q3 or Q4, where you do payment milestones, may represent in Q1 and we don’t have an interest payment. So we look forward to gaining traction on the AR front and we’ll continue to report on that.

In terms of seasonality, you are correct. What I think is our opportunity is to get off to a stronger start than we have in the past. Because of some of these larger opportunities, I can’t commit or guarantee we can close them and bring them in, in the next few weeks, but clearly the momentum is there that we can pull one or two of these over, provides a great on-ramp to the guidance for the year, although we look at it annually and we are very confident with what we see across them.

Chad Bennett – Craig-Hallum Capital

Okay, thanks guys.

Jeff Surges

Thanks Chad. Next question operator.

Operator

I would line to introduce Ryan Daniels.

Ryan Daniels - William Blair & Company

Yes, good morning guys. Thanks for taking my question. Jeff, I wanted to start with one for you on the end market. You highlighted, I think two times the 50 VNA buying decisions and I’m curious if you could just give us a proxy of how that metric is tracked over the last few years. It seems like this is going to be bigger cycle, but can you give us a little bit of color on how big it is.

Jeff Surges

Yes. So we track it a few ways. It’s not something we’ll report on, but I want to just give an indication. So through our CRM tracking tool, Salesforce.com, remember our sales force now has been with us over a year, in many cases a year and a half, right, 2010, 2011 we overhauled. So we’ve had the same guys and the same dirt now for over a year and our Intel and our relationship development, not only at current clients, but new is really taking hold.

So we are able to see based on the number of proposals. We are generating the number of categories that we put the deal in. If it’s in a kind of a pipeline or is it forecasted or starts to get to a commit phase and then we look at share RFP volume. It’s fair to say that if you went to some of these large healthcare consulting firms, they are doing more imaging and interoperability and I think that’s where this is starting to really show Ryan.

If I went to Orion, if went to dbMotion, if I went to Exalade, you’d hear more about imaging as part of their HIE strategy and if you went to large health systems where you got 300-plus docs, getting that stage II box checked for image and interoperability really starts the question of how am I going to access the images and the only way to access that efficiently for a CIO is through the archives.

So, it’s tracked three ways; one, the number of net new deals we’ve started, number of existing client proposals, the number of RFPs across that we are just competing in, in more of a peripheral process, and then the consultant HIE activity is all coming together and showing us where we are putting more of an investment in our sales and presentation teams, in our product in segment marketing and ultimately in our R&D and our investment and our portfolio.

Ryan Daniels - William Blair & Company

And do you have a feel for kind of maybe year-over-year growth in that. I assume with meaning for your Stage II and ACO’s in front of you and maybe the EHR implementations behind you, that’s probably seeing a nice up-tick. Is that fair to say?

Jeff Surges

Yes, I think it’s fair to say that I guess by definition there were probably 15 or so VNA's done last year. I think those were all defined as VNA, but I think that would have had an asterisk, because it could have been what I would probably call internally maybe like an Uber PACS, because they just wanted a hospital or a health system who wanted to consolidate two or three PACS into one, but it really wasn’t a vendor neutral play, right.

So I think it’s a more robust offering today, because they are looking at what I would say and this is technical, but DICOM, which is the way we talk about radiology images, but they are looking at non-DICOM and document management looking at JPEG’s and wound care and things that just traditionally wouldn’t have been in a pure PACS play.

When we see that type of scope and that type of enterprise discussion from a CIO, that means he’s really going wing to wing to image enable an ecosystem, where I think in the years past some of these kind of smaller private equity funded guys were core to what they could deliver and that was maybe just let’s look at one or two PACS, dealt them down and called that the archive.

So the wider this goes the bigger it is, the dollars get bigger and I think the ROI for that health system gets much bigger and that’s where we are seeing a lot of our demonstration, a lot of our reference activity, and a lot of the kind of intimate responses we are giving the clients to get them comfortable for their outside of PACS environment.

Ryan Daniels - William Blair & Company

Okay, that’s helpful, that’s exactly what I was looking for; maybe two more quick ones. Just you mentioned off the internal teller sales team. It sounds like you’re seeing some nice traction there. Obviously you have a huge installed base to sell into. So could you give us a little bit more color? I don’t know that you’ve actually called out that internal teams, so it must be seeing a little bit more success. So maybe the size of that, the investments and kind of the traction you are seeing there?

Jeff Surges

Yes, so like every more mature sales organization you have to have kind of a career path, and so for us it starts with our teller sales, inside sales, which are going to be more of our early entry level sales teams, we are educating them and in the past that group would have been eight to 10. We beat that up to 15 people. They are live a productive and they typically go after existing clients, lower dollar amount, so that our more seasoned field sales organization teams can go after larger deals and they work collaboratively.

That group can focus now. Again their key is smaller sales, shorter sales cycle and really the up-tick here Ryan is the fact that Honeycomb is live and in production, because most people when they want to start archiving, they want to sign today and begin next week. They don’t have a 12 month sales cycle or they don’t have a 12 month implementation.

So this is more about a present solution that can go into a present market and again, we look for that group to provide consistency in our sales and more intimate relationships with our clients and we are enjoying some of that early success, which is encouraging.

Ryan Daniels - William Blair & Company

Okay great. That’s great for me. I’ll hop back in the queue. Thanks.

Jeff Surges

Thanks Ryan. Operator, are there any more questions?

Operator

Yes. I would now like to introduce Anthony Esposito.

Anthony Esposito - Imperial Capital LLC

Good morning.

Jeff Surges

Good morning Anthony.

Anthony Esposito - Imperial Capital LLC

First, I just wanted to ask about some of the new contract times, specifically the cardiology and ortho and to the extent which those are real with new customers or are they within the existing customer base?

Jeff Surges

Great question Anthony. So, we’ll split it in two. So orthopedic strategy initially began when we made an acquisition several years ago of the Stryker OrthoPad business, right. Stryker was in the business of not only selling the implants and the like, but also had a small kind of throw away PACS system for orthopedics. Overtime that was a large base but not really monetized.

Our strategy was to use our core Merge PACS that we use in radiology, so we have one system, but make it available to ortho, which is going to be smaller size files and maybe non-DICOM in terms of the way you think about those.

Many of our sales there are going to be to the existing clients of Stryker that are now Merge, where we are able to upgrade them and monetize a base that hasn’t been monetized in the past. That base is 500-plus across the country and we walk in more to a friendlier environment there. So we are going to focus on holding serve there.

In the cardiology space, it’s more net new, right. Cardiologist have gone through the two year earn out window when they are required by hospitals are class rated number one system by a factor of 10 points gets us in the door, not only from existing client who expand by acquiring new hospitals or by our competitors that are endoliting (ph) several mission critical systems like Hemodynamics.

So in the case of Hemo I would say 80% plus are net new. In the case of ortho at least for 2013, we are going to up-sell the existing pace and just monetize it better.

Anthony Esposito - Imperial Capital LLC

Great, thank you. And then I just want to clarify on your comments regarding the status of the senior notes, and if that means that you are still kind of looking to all those in May after the next coupon space.

Steve Oreskovich

Thanks Anthony, this is Steve. I think what Jeff was saying in his prepared comments is that we now have an opportunity. There is a penalty out there. The penalty drops significantly after May. The penalty goes away for what it’s worth in May of 2014. So we continue to evaluate the economics of when is the right time to call those notes and will update everybody when it’s appropriate.

Jeff Surges

And Anthony, this is Jeff, and again this is starting my third year as CEO of the company. I recall in my first year, most questions I had from our investors or the community was, holy cow, you have this big $250 million, a big coupon, how are you going to do it? And my point is, well, we’ve done it. We are one payment away from at least the flexibility to consider alternatives, which I think is tremendous progress.

We may not be in the mood to take on additional, higher debt load, even though we could get a lower rate. We may want to wait it out, but at least we have the flexibility and the strength on our AR and our cash to endure that decision and discussion in a period where we’ve never been able to have that discussion. So I think bodes to the strength and the focus of our team and our clients and the retention and the organic progress we’ve made here. So that’s really more of a point to go on Steve’s more deliberate answers.

Anthony Esposito - Imperial Capital LLC

Okay. Thank you.

Operator

I would now like to turn the call back over to Jeff Surges.

Jeff Surges

Well, thanks operator. I’d like to wrap things up and thank you all for joining us with a few summary comments. First, we exceeded industry and analyst expectations for Q4. I am very proud of the hard work by all of our teams.

Second, we are reiterating our 2013 guidance and believe it reflects our pipeline, our marketplace that our operational readiness. Third, we’ve halted the process of exploring strategic alternatives and management’s efforts are solely focused on the execution of our 2013 operational plan.

You will all have a chance to see this in full affect as we showcase our solutions at the HIMSS tradeshow, the largest healthcare IT conference, which is taking place in New Orleans, March 3 through March 7. You can expect to see several additional announcements leading up to HIMSS, as we prepare for this critical tradeshow which will help us achieve our goals for 2013. We are hosting an investor event at HIMSS on Monday, March 4 at noon at our booth. Please let us know if you’ll attend, so we can coordinate accordingly.

Thanks again for joining us and we hope to see many of you in New Orleans. Have a great day.

Operator

Thank you for joining our call. You may now disconnect.

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