Merge Healthcare Incorporated Q2 2010 Earnings Call Transcript

| About: Merge Healthcare (MRGE)

Merge Healthcare Incorporated (NASDAQ:MRGE)

Q2 2010 Earnings Call

August 10, 2010 08:30 am ET

Executives

Julie Pekarek - Head of IR

Michael Ferro - Chairman

Justin Dearborn - CEO

Steve Oreskovich - CFO

Paul Merrild - SVP of Marketing and Business Development

Analysts

Eric Martinuzzi - Craig-Hallum

Corey Tobin - William Blair & Company

Chad Bennett - Northland Capital

Doug Dieter - Imperial Capital

Bill Dezellem - Titan Capital Management

Jake Kemeny - Morgan Stanley

Operator

Good morning and welcome to Merge Healthcare's second quarter 2010 earnings call. I am Julie Pekarek, Merge's Head of Investor Relations. We have a lot to review today, given that Merge had milestones during the second quarter of 2010. Joining me on the phone today are Michael Ferro, our Chairman; Justin Dearborn, our Chief Executive Officer; Steve Oreskovich, our Chief Financial Officer; and Paul Merrild, our Senior Vice President of Marketing and Business Development.

This call will begin with Justin's review of the business and what we have achieved since the closing of the AMICAS transaction. Given that the AMICAS transaction has transformed our company, we have asked Michael to share the vision and go-forward strategy for Merge Healthcare. Before wrapping up with Q&A, Steve will review the quantitative aspects of the quarter.

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

In addition, we may refer today to non-GAAP financial measures. These measures are supplemental to our 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 our earnings release.

With that, I will turn the call over to Justin.

Justin Dearborn

Thanks, Julie. We ended the second quarter with a single overarching mission to take the steps required to create the leading independent provider of healthcare IT and imaging solutions with the acquisition of AMICAS.

We had two clear areas of focus in the second quarter: to capture the synergies from the transaction, and to fortify our go-forward strategy to create the foundation for the future of our business. I would like to share with you what we've accomplished since the closing of this transformative transaction.

Since raising a required $242 million of capital to close the transaction, we shut down four major offices, eliminated over 100 physicians and reduced our spend in the areas of IT, marketing and public company expenses. We also moved from a decentralized organizational structure into a centralized organizational structure to create a more streamlined set of processes.

For example, we moved from having business units with separate R&D organizations to a single R&D organization for the entire business, centralized functions with a long-term positive effect on our ability to efficiently develop products.

In addition, our focused efforts and work performed in the 75 days since closing the transaction will ensure we meet the $15 million of aggregate annual expense synergies we previously committed to. We exceeded our targets in Q2 and we are significantly ahead of schedule to capture our overall targeted synergies goal by the end of 2010.

I look forward to comment on the top-line. Prior to the closing of the transaction, there existed a period of uncertainty for customers regarding our go-forward corporate and product strategy. Immediately following the closing of the acquisition, we began a proactive communication effort with customers in order to share and validate our corporate strategy and product roadmap.

We did experience some expected weakness in the top-line, but they were the changes we needed to create the right platform for the future of the company, including office closures, personnel changes and product roadmap decisions.

The activity we saw over the last two weeks of the quarter and during the month of July support our belief that our customers are behind our go-forward strategy, and we saw a healthy pickup of selling activity in this timeframe. We are confident we will achieve a top-line run rate of $200 million for the year.

With that, I'll turn it over to Michael for some additional market and company updates.

Michael Ferro

Thanks, Justin. Good morning, everyone. I'm excited and honored to join the call today to talk about the future of Merge Healthcare.

As you all know, healthcare delivery is a complicated and costly endeavor. Today, we spend over $2 trillion per year in the United States on healthcare; yet, we spend the smallest percent of any other sector of the economy on IT. This is all changing, thanks to the intervention of the United States government with the American Reinvestment and Recovery Act. The government is spending $30 billion to stimulate hospitals and physicians to invest in healthcare IT solutions and transform the entire healthcare industry.

Diagnostic images, known to many of you as X-rays, are the cornerstone of an effective healthcare delivery system. Imaging is used in virtually every medical specialty as a critical component of any patient visit. The ability to review current and historical diagnostic images provides the doctor with data that is not available in any other form, and a quantitative data at that.

At the same time, the volume of data and the size of data make imaging one of the most complicated elements of the electronic health sector. Imaging represents over 90% of the data generated by healthcare providers today. This creates unprecedented challenges in moving, storing and managing data. An electronic medical record cannot be considered meaningful if 90% of your healthcare data is missing.

Today, we have created a company that will tackle these challenges. We have amassed nearly 70 patents in healthcare IT; critical products such as zero client viewing, a vendor neutral archiving solution, a customer base of 2,200 imaging centers which represents one out of every three imaging centers in the U.S. 1,500 hospitals, 800 orthopedic clinics which represents one out of every two orthopedic clinics. And 250 OEM partners, these assets uniquely position Merge to transcend the challenges in healthcare to improve quality and reduce cost.

Over the last several weeks, we have been invited to visit Washington D.C. on multiple occasions and have had the privilege of working with both the White House and the Department of Health and Human Services to review the importance of imaging in healthcare and the importance of providing universal access to healthcare for all Americans.

Our solutions make the electronic medical record meaningful by including images. And our solutions offer the ability for all Americans to have an entry and the ability to manage in their new healthcare system being designed. Providers, patients, physicians and payers all need access to healthcare information and the ability to share all clinical data for our healthcare system to thrive.

At Merge, we have created an imaging interoperability platform and a healthcare automation platform designed to make that vision a reality. The need for interoperability in imaging and for access to healthcare is immense. As the electronic medical record market matures over the next 24 months, our opportunity in the market for interoperability and healthcare access is the next frontier.

The market for interoperating accessed has the opportunity to be a $5 billion market. We are in the beginning of an arms race in healthcare as a consolidation amongst providers accelerates.

The next battle in healthcare is the collapse of closed systems with providers getting acquired or acquiring their competition and referral network. Providers understand that a single referring position means over $1.5 million of value, and are moving aggressively to catch our market share. Our new Merge I-Connect platform offers large hospitals, independent hospitals, imaging centers, orthopedic and other specialty clinic and health information exchanges the ability to create imaging exchanges within their environment and with other entities.

Our platform provides access to imaging data across disparate sites, geographies, specialties and providers. Our solution enables providers to expedite care, reduce duplicate exams, consolidate infrastructure, and limit expenses associated with moving, managing and storing of imaging data.

The reaction to this solution has been phenomenal, and many providers and other constituents view imaging interoperability as the next phase of healthcare IT adaption. The excitement around our healthcare automation platform has also been fantastic.

Our kiosk technology and solutions for mobile computing offer our end users, electronic medical record partners and others the opportunity to extend their partnership with Merge while addressing key issues such as market differentiation, staff efficiencies and optimization of their collection cycles.

Our intelligent kiosk is now moving past the earlier adopter stage as being recognized as a must-have patient interaction solution. We are uniquely situated to provide the solution to our nearly 3,000 orthopedic and imaging center customer sites that are running our radiology electronic medical record systems and our orthopedic electronic medical record systems. We also have the opportunity to work with our partner network to bring this exciting platform to our 1,500 hospital sites.

Well, the pieces from our acquisition strategy are fitting together as planned, and the total solution is coming together at the right time for the right market. Bringing solutions such as I-Connect to market is incredibly important for our business, for our investors, for the broader healthcare industry and for patients. The addressable market for these solutions is a multi-billion dollar opportunity which dwarfs the market for our legacy imaging businesses.

I'd like to invite all shareholders, customers and partners to join us and come visit us at our Chicago Innovation Center to learn more about our healthcare automation solutions and imaging interoperability solutions.

With that, I'll turn over to Steve to review the numbers.

Steve Oreskovich

Thank you, Michael. I will review our financial results for the second quarter of 2010, and compare these to the second quarter of 2009. I will also provide additional information related to the second quarter of 2010, some of which is non-GAAP, which we use internally to manage our business, including recurring revenue as a percentage of total revenue, non-recurring revenue backlog and adjusted EBITDA.

A detailed reconciliation of GAAP net income available to common shareholders to adjusted EBITDA is located at the tables at the back of the earnings release we issued last night, a copy of which can be obtained from the investor section of our website at www.merge.com. We also filed our 10-Q yesterday evening for the quarter.

As these two documents contain a lot of detailed information, I will focus my comments primarily on the financial results of the second quarter of 2010. In addition, I will also provide certain pro forma data for the second quarter. This data represents the results of Merge as if the acquisition had been completed at the beginning of the quarter.

Before I review the numbers, I would like to personally thank all of our employees for their efforts in the second quarter, as the company not only focused a solid month-end closing the acquisition on April 28, but also on centralizing our operations and aligning our cost structure. Concurrent with our focus on these activities, we were also able to significantly increase our cash balance.

With regards to our operating results, net sales for the second quarter of 2010 totaled $29 million compared to $15.4 million in the second quarter of 2009. Net sales for 2010 include two months of acquisitions activity post completion of the acquisition, which provided $13.9 million of net sales.

On a pro forma basis, net sales for the second quarter of 2010 were $41.5 million. Over 70% of net sales, both GAAP and on a pro forma basis in the second quarter are from recurring revenue sources. In addition, non-recurring backlog increased approximately $2 million to $46 million as of June 30.

Gross margin for the second quarter of 2010 was 45% compared to 75% in the second quarter of 2009. Depreciation, amortization and impairment costs in the second quarter of 2010 impacted gross margin by 15.5% compared to only 4% in 2009.

These costs, including impairment of approximately $2.4 million in the second quarter of 2010, we don't expect in future quarters. We do expect future amortization and depreciation in cost of goods sold to run at approximately $2.3 million to $2.4 million per quarter for the remainder of 2010.

In addition, the second quarter of 2009 included a large software only sale for $2.2 million of revenue, with minimal cost of sales, which had a significant positive impact to the gross margin in 2009. Also as mentioned on prior calls, the mix of software and other sales as a percentage of overall sales will have an impact on our gross margin on a quarterly basis.

We had a GAAP operating loss of $10.6 million in the second quarter of 2010 compared to operating income of $4.1 million in 2009. In addition, we had a GAAP net loss of $15 million in the second quarter of 2010 compared to income of $400,000 in 2009. Both operating and net income in the second quarter of 2010 were significantly impacted by $2.4 million of acquisition related expenses, and $3.5 million of restructuring expenses incurred as part of the acquisition.

Going forward we expect to incur an additional $1.3 million of restructuring cost mostly in the third quarter as we complete remaining transition activities and close our Boston office. The primary difference between total restructuring cost of $4.8 million and our prior estimated range is solely attributed to the accounting for former AMICAS office severance payment of approximately $2.2 million, which we were able to record as an opening balance sheet payable as opposed to a second quarter restructuring expense.

We also incurred two months of interest expense including amortization of debt issuance cost and note discount, totaling $4.3 million in the second quarter of 2010, associated with the issuance of the $200 million worth of notes. In addition to the notes we also issued $41.8 million of preferred and common stock.

These two sources provided us the majority of funds to close the acquisition. The preferred stock here is a cumulative annual compounding dividend at 15%, which is payable solely at our discretion. In accounting for this equity transition in the second quarter, we recorded the preferred and common stock at their relative fair values, and then recorded an additional entry of $14.9 million to bring the preferred stock up to its face value of $41.8 million.

Given this equity issuance, we are required to report earnings per share on a basis that includes the impact of the preferred stock dividend, thus the caption, net income available to common shareholders on the face of our income statement. This is computed as net income, less the amount to bring preferred stock to its face value, a onetime consideration, less the preferred dividend.

It is important to note that these items do not impact our GAAP net income, but do impact EPS. In the second quarter of 2010, net income available to common shareholders with the loss of $30.9 million or $0.39 per diluted share compared to income of $0.01 per diluted share in 2009. In future quarters, in which the preferred stock remains outstanding, net income is expected to be decreased by $1.6 million to account for the 15% dividend.

Our adjusted EBITDA on the second quarter of 2010 was $6.7 million compared to $6.3 million in 2009. On a pro-forma basis, adjusted EBITDA for the second quarter of 2010 was $7.8 million or 18.7% of pro-forma net sales.

We ended the quarter with a cash balance of $38 million, an increase of $6.4 million when compared to the pro-forma balance as of March 31 that we estimated in the 8-K filed in late June. Considering that we paid $800,000 of restructuring cost associated with the second quarter of 2010 restructuring initiative in the quarter, and that the three primary accounts impacting working capital had activity that had minimal impact on cash.

We are very pleased with cash flows from operations during the quarter. We continue to believe that adjusted EBITDA is a good proxy of the cash generated from operating activities. With that said, there maybe differences between these two amounts primarily related to the timing of payments for the restructuring cost and the interest on our debt, which is due November and May of each year.

Also we have approximately $6.5 million remaining to pay related to the restructuring and reorganization of our business including cost associated with the facilities that we have or will exist, and payments to the former officers. While there is still cash payments to be made we are very pleased that much of the heavy lifting associated with our cost saving synergy efforts is behind us.

As Justin stated earlier, we can now turn a 100% of our focus towards revenue generating activities with confidence that at least the $15 million of annualized savings will be fully reflected in our fourth quarter results.

With respect to a couple of other key balance sheet items, net accounts receivable was $39.8 million as of June 30, a decrease of $1.1 million from the pro-forma amount as of March 31, as indicated in aforementioned 8-K. Given the timing of the acquisition during the quarter, day sales outstanding is not a meaningful metric, but something that we will provide in future quarters.

Deferred revenue as of June 30 was $37.4 million. The opening balance sheet deferred revenue amount for AMICAS was decreased by $12.5 million as a result of acquisition accounting. In addition, an asset of $7.3 million was reported to reflect contracts under which we have completed substantially or all of our performance obligations, but customer payment still exists.

As a result, our GAAP net sales for the second quarter and in future quarters will not reflect this $19.8 million adjustment. In the second quarter of 2010, $4.9 million of such amount would have otherwise been recognizable. And when considered with prior significant acquisitions, this led to $5.1 million of net sales that were not recorded in our GAAP results, but are reflected in our pro-forma and adjusted EBITDA numbers.

We expect the majority of the remaining purchase accounting adjustment of $14.9 million to impact our GAAP net sales over the next eight quarters.

With that I would like to open up the call to questions.

Question-and-Answer Session

Operator

(Operations Instructions) Your first question comes from the line of Eric Martinuzzi of Craig-Hallum.

Eric Martinuzzi - Craig-Hallum

Question regarding Michael's comments regarding the strategic direction of the company. You're talking about basically having a seat at the table on the national stimulus dollars when it comes to EMR, EHR. Just curious to know, the product set that you've got, do you feel like what you've assembled, that you've got what you need or are there any other pieces that need to be added? And then I'm going to follow up.

Michael Ferro

Right now we do have a great solution. I think some of the acquisitions we did over the last 12 months to complete portfolio of the main pieces we needed were vendor-neutral archive. Web viewing tool for doctors to exchange images, the vendor-neutral archive allows you, for those who needs the stats if someone has it didn't matter what PAC system you have or multiple PAC systems, this allowed everyone to exchange images within the hospital or from hospital to hospital.

And lastly, but most importantly we needed to have our own EMPI solution which is an Electronic Master Patient Index. Because as the electronic road finally grabs hold in healthcare, everything from dentist offices to imaging centers to orthopedic clinics to hospitals, they're already exchanging data. And everybody needs to be able to figure out if is it the right patient between each of those offices. And we're right now at the infancy, only a few health information exchanges and a few hospitals, even beginning to implement EMPI.

So there's 5000 hospitals in the U.S. and by the way this is not is a U.S. only issue, this is going to be a global topic as our healthcare becomes electronic, which it is if you believe that it is, we do. Because the U.S. in not the only government stimulating. The U.K., China other countries are doing the same. So you put together the three pieces and the reason is this is going to be so important is that imaging, which comprises as I said earlier 90% of the data in stores globally, were healthcare facts are one of the biggest data repositories in the world, including if you take MySpace and YouTubes and Facebooks and a whole lot of rest of them. You need to first have the doctors become electronic.

So first add that we should be electronic themselves before they can take on this really 90% of the data and how they're going to move it around. And the costs have come down too, which we're not responsible for. But for infrastructure, compression and encryption costs have come down to the point where we'll probably be rolling about 18 or 24 months behind adoption of EHRs where imaging becomes very important.

Eric Martinuzzi - Craig-Hallum

Okay. you've got the assembled pieces that you need to participate, connected that you say 18 to 24 months, I'm just curious the discussions that are happening at the White House and the Health and Human Services. Where are those? Are those still very preliminary or do those have specific milestones metrics where you guys see yourselves benefiting in the financials?

Michael Ferro

They're preliminary but more importantly it's that, those dialog is open, that they agree to imaging's going to have to become part of meaningful use. And it was not there at the beginning, because first I needed to get these doctors electronic, but they all know and I talked to the highest levels.

But HHS and at the White House regarding healthcare, and they're all in agreement that we have to make sure that we have to make sure that when a health record is not complete and you go see a doctor. If he can go look at, he/she will look at your prior X-rays or images, be it a dentist or a surgeon. And that this today is not part of our electronic health record which means we really don't have a meaningful health work. They all agree, we do have solutions that we can bring to the government to help them with this.

Eric Martinuzzi - Craig-Hallum

Okay. And then just on the commentary, the sort of quasi guidance here, this $200 million run rate revenue that you are talking about, Justin, or, Steve, are we still talking about a $57 million adjusted EBITDA run rate in Q4? In other words, you previously talked about profitability, now you're talking about a revenue number. Did those two still two tie out to each other?

Steve Oreskovich

Yes, Eric, they do.

Operator

Your next question comes from the line of Corey Tobin of William Blair & Company.

Corey Tobin - William Blair & Company

A couple of quick questions if I could, just on the comments, Justin, on integrating the sales environment. It sounds like around the time of the acquisition there might have been some turbulence in the market. But can you give us a feeling for your comments, a little bit more color rather on your comments with respect to what's happened after the acquisitions closed and into July and I guess up to today.

Justin Dearborn

Sure, just give a little more background. Some of this was probably disclosed or discussed. Going into the acquisition we really didn't do any collaboration for two reasons. One some legal constraints around what we could do prior to the close of the acquisition because technically we were competitors so we were prohibited from not collaborating on product direction. And some other things typically you do in any acquisition and we have always done in the past, advance and closing.

So that, as well as just as everyone knows the contentious nature of the acquisition. So there is little collaboration before the transaction. So we had to go out quickly to customers which just takes time when you have balance, I'm saying we'd be in course trying to focus on the large ones.

So we went out and had to reaffirm some product strategies that were laid out a year ago. If you recall the AMICAS merger and transaction, AMICAS did the same thing; basically had to go out and assure the large imaging installed base, the IDNs and hospitals, that nothing is changing on the product roadmap, the direction which products are supported. So all normal stuff you'd expect.

When there was some overlap, really there was more perceived overlap in the product than there actually was. However, in dealing with very, very large organizations, some of the largest organizations in the world, in and out of healthcare. So take us time to get to message. Made it a lot simpler, frankly getting people of Chicago, they saw what we were doing here in Chicago CV center here, innovation center and walk you some of the products.

I would say unanimously to the left conflict in the direction of the company. And where we are headed strategically as well as more tactically on just the price that they were interested in at the moment, but showed them a lot of new stuff for the future as well. So that took time and that caused some pauses.

Corey Tobin - William Blair & Company

You're looking at sort of the internal booking numbers, can you just give any commentary on where you think the book-to-bill ratio would have come out for the June quarter and then how do you expect that change in third quarter here?

Steve Oreskovich

Both from a bookings perspective, a lot of the bookings that we had in the quarter came in the last probably ten days which is not unusual, but a bit a more back-ended than we've seen in the past. Depending upon the terms of the contract from a billing perspective, we may or may not have been able to invoice on those, nothing significantly changed in our billing process.

So I think a part of what you saw from a bookings perspective was the growth in the non-recurring backlog. Spoke to the fact of how back-ended it was. As well as Justin had mentioned earlier in the call that we saw some crossover that led to you bookings in early July, which is a good sign for us. In fact, from a first of the month quarter perspective, one of the largest and the best first month of the quarter that we've seen from the bookings perspective in a long time.

Corey Tobin - William Blair & Company

Shifting for a second to the cost side, AMICAS says synergies are coming through a little bit faster than maybe initially thought. I guess two questions related to that. One would be what are the area that you are finding the synergies, probably get a positive surprise areas if you will, where the synergies are coming as fast as expected. And second, you mentioned that $15 million number with respect to those synergy target, so you could assume at this point that perhaps we could end up seeing it come in higher than that $15 million number, if may be not in 2010 but in 2011?

Justin Dearborn

So I'll take the last half of that. Potentially, but I wouldn't focus on that as much. And we were tracking synergy number, because that's something we have publicly disclosed and talked about considerably. So we are confident, we are hitting that, we are a little ahead of schedule. But you will see us continue to invest in the business. So in years past, this I'm just really speaking from June '08 on. We always were cautious about investing in sales and marketing, frankly. We wanted to see the market opportunity there, didn't see it in '09, frankly. So we didn't invest in sales and marketing. So now it's a full court press, the sales and marketing side.

We will continue to drive EBITDA numbers we just discussed, but we're not to push the synergy number to record highs, because we do need investment business.

Michael Ferro

We are going to trying to be as transparent as possible. But right now, we feel, if you go back to (inaudible) our biggest issue right now is distribution. We need more feet on the street. We need more bodies. So determining how well accepted our healthcare automation is and our interoperability, we do not have enough inside sales, outside sales, sales specialists and business consultants today at the company to handle the leads we've received in the last week.

So we have issues of having to match that rate on which we make the decision that we need to add more. But you'll be able to see it in the sales and marketing line to manage what we think is a good three or four-year growth in the interoperability and healthcare automation that we have a limited time to get the market share.

Justin Dearborn

And then, Corey, just quickly on the first half of your question, when we outlined this in the filing, we talked about headcount rationalization, real estate and public company cost, marketing and the operating costs. We're pretty closed on all those buckets. We gave a range on all three of those categories. But we're basically in those ranges. And there hasn't been one year that surprised us.

That's frankly it's the easier piece to do upfront. So we were able to do that in advance at the close of the transaction. Being a public company in the same space, we kind of know where the costs are and whether there was going to be some overlap from a G&A perspective. So we did take that up as planned. Again, that was easier to see in advance without having discussions with AMICAS.

Corey Tobin - William Blair & Company

Michael, can you give us a little bit more color on the registration or the kiosk product that you mentioned in your prepared remarks?

Michael Ferro

We acquired some technology in this quarter that allows us to have a healthcare automation system that's actually big. It has a live avatar, which allows it to put it in a waiting room, so that patients can check-in, they can fill out their forms, they can find out what their co-pay is, pay it and have someone at system through the kiosk so they don't have to bother the receptionist or the office manager for the whole process. So they can pay, fill out their forms, get their receipt. Everything happens at the kiosk. They have a live avatar who is talking to them that will even fill out their forms for them.

Our issue right now is how to build it and service it and get it out there. We have early adopters using it all over the country and in some other parts of the world. And we're going to pass this early adopter stage, trying to figure out how we work with partners to install it and for us to sell direct to our installed base. So that's what that feature is. And obviously, the reasons for the some of the slowdowns, we have to connect to everybody's backend system, each kiosk.

So right now, it's very easy for us to focus on our 3,000 installed sites where we have the backend system running, which is in the orthopedic and imaging site, but then we're going to have to partner with companies out there. The names you'd be familiar with, to connect to their backend systems. So there's not a signing of partners, it's only direct, and then making sure our software interfaces.

Our healthcare automation is just one piece of our I-Connect interoperability solution they are offering. But it's very popular.

Justin Dearborn

Limited rollout to our installed base and really trying to find the early adopters do some beta testing with it. We'll accelerate that now that we have acquired the technology, can control their R&D roadmap and keep their cost of goods lower. So that was really the rationale behind the acquisition. They had done some cool stuff around the R&D and the interfaces that we wanted to be able to control go-forward. We actually debuted really outside of our installed base.

We had the Allscripts customer that last week. I was out there and we had a good presence there. Allscripts did a great job running about 3,000 of their clients, and we had a line at the kiosk all day, every day. So it was well received even outside of our installed base.

Operator

Your next question comes from the line of Chad Bennett of Northland Capital.

Chad Bennett - Northland Capital

Just a couple of questions on the numbers. So from a revenue standpoint, maybe I'm looking at this wrong, but is there a way of giving us a pro forma revenue number since you've owned AMICUS for the quarter, or would that just be the $29 million GAAP plus the $5.1 million in kind of write-down stuff?

Steve Oreskovich

That is correct, Chad. It would be the GAAP number plus the $5.1 million.

Chad Bennett - Northland Capital

And then the $200 million run rate that you gave, or kind of reiterated I guess, would that be a GAAP number, revenue run rate number?

Steve Oreskovich

No, that'd be a pro forma number which it's always been that we have discussed and put in, in the K or other presentations in the past. So it will include the add back for the remaining $14 million or $15 million of purchase accounting adjustments as they flow through naturally in the remaining quarters of the year.

Chad Bennett - Northland Capital

And maybe this is one for Michael. Michael, you hit on EMR on meaningful use and the importance of imaging going forward. Just relative to the final rules or determination that came out recently on meaningful use, how would you categorize it with respect to imaging, and your timelines of ramping imaging in EMR? So is it kind of roughly what you thought it would be? Is it ahead of schedule, maybe were delayed a year, anything like that?

Michael Ferro

No, I actually am curious to sit down with Dr. David Blumenthal and Todd Park and discuss this with them. The imaging piece, they all understood that this would be Phase 2, which everybody understood which they're not going with meaningful use. This is Phase 1 of meaningful use. They have a lot more to do, even getting access.

This theme of getting people set up goes into 2014. It's when everything really get activated. The first phase is let's get these stocks doing something. And then the other phase is to get public access to healthcare, which is the ultimate goal as they're all Americans, no matter what your economic situation is. You should be able to have the same access to public healthcare. And that is the tone and the tune that's being implied out of Washington. And the images have value to everyone.

So there is natural value composition of them just getting electronic and have a lot of doctors (audio gap) So the reason that they did not stimulate imaging was because imaging needs stimulating when they stop us, because we were going electronic. In fact, the radiologists of the country or the most advanced and best EMR group of practitioners in all healthcare are radiologists, and followed by orthopedics, because they need images and do everything electronically, as it has a value on it.

Now that value can be moved around and archived, people could start using it, everything from clinical trials, which is very big opening space for us that we're very excited about, and that's what (inaudible) talked to us about too, to allow pharmaceutical companies and other researchers to get access to what people opt in with their images in the future.

So there's a lot of cool stuff going on. That's the word they use by the way. And they are very open and active and I have to tell you, as a Republican that's very impressive, these democrats in Washington.

Chad Bennett - Northland Capital

Steve, do you have a dollar impact of the uncertainty in the quarter on the AMICAS customer side or maybe even a little bit on the merged customer side of how that negatively impacted revenue?

Steve Oreskovich

We do not have a specific dollar impact or a number that we tried to apply to that. What we did look at is what occurred from a booking to activity perspective late in the quarter and into the first months of the third quarter here. And given our results we saw there, we were very pleased with the fact that it appears that all of our customers do have that clarification that they were looking for from us and understand our vision going forward.

Chad Bennett - Northland Capital

From a gross margin perspective, going forward, how should we look at a normalized kind of pro forma gross margin, Steve?

Steve Oreskovich

That's not something that we are providing at this point. We do have some other cost saving efforts or synergy efforts ongoing today that we think we can improve our gross margins. But from putting into a bucket a tight range, that's not something that we've provided at this point. What we did provide, though, is what our expected range of amortization will be in both the gross margin or cost line as well as the operating expense line.

So we could provide some guidance or provide individuals some information on the variable aspects of the non-cash or call it variable aspects of the business going forward to work into the models. But for a specific gross margin number, that's not something that we've tied down at this point.

Operator

Your next question comes from the line of Doug Dieter of Imperial Capital.

Doug Dieter - Imperial Capital

My first question is around the $15 million in synergies. How much in this quarter did you realize in synergies? Am I correct to assume that there is one right number, $15 million, by yearend or is that all-in $15 million?

Steve Oreskovich

Doug, you are correct. The $15 million is an annualized savings number. And then with respect to what flows in, in the quarter, that's very difficult to provide an exact number, because what we have is as people are transitioning through, there is real cost associated with them until they go ahead and have transition built in that cost, then it does not hit our P&L going forward.

So as opposed to trying to craft some quasi-P&L, it says what would have the P&L look like for the full quarter for those individuals or facilities or vendors who weren't into that at the beginning of the quarter, we've guided people to look to the fourth quarter, because the fourth quarter will be coming into quarter with all those costs in it.

And quite frankly, without the efforts of those people or those vendors who are working with them through the quarter, we wouldn't have been able to continue with the business going forward in the manner that we planned. So that's not something that we're separately tracking.

Doug Dieter - Imperial Capital

Am I correct to assume that you've actually executed on all initiatives to achieve that $15 million or you'll see that realization as that flows through?

Steve Oreskovich

Yes, that is correct.

Justin Dearborn

So what additional capital that we'd see just articulating would be like (inaudible) that gets in Q4. So that's not something you see right now, but we're not spending what we spent last year. So both companies we're attending, that would be twice the cost. So that's one end that just flows through Q4, and you see that in other trade shows and other marketing expend (inaudible) it's the biggest single event we (inaudible).

Doug Dieter - Imperial Capital

And then in working capital, I know there has been a lot of movement there. Do you still expect that to be use of cash over the next quarter or two or can you kind of walk through your thoughts there?

Michael Ferro

It may fluctuate slightly from quarter-to-quarter. But on an annual basis, we would expect it to be net neutral to a slight increase to cash as you look to the cash flow statement.

Doug Dieter - Imperial Capital

On your cross-selling initiatives, can you comment so far on where you've seen the most success and most pushback, and how much of your backlog in this past quarter is a result of the cross-selling?

Steve Oreskovich

On the backlog number, I would say not a huge percent of it right now is showing up there. So these are conversations that we've started in the last 75 days. We do that with some of the largest entities in the world, the big OEMs, multi-billion dollar entities which don't make decisions on a monthly basis.

We were very quick to expose them to the new products and the broader portfolio. So for ongoing sales cycles where we fully expected to show up in future quarters, but really it was about stabilizing, explaining who Merge was. We're just in the business 20-plus years, and we have done business with most of these companies over the years, but at different levels, different products. So we had to basically educate some of the larger IDNs and hospitals on who Merge was and where Merge is set. So we do fully expect it to keep showing up, but generally it was not in the first 60 days.

Doug Dieter - Imperial Capital

And then how much of your business currently is government related? Are you working with the VA or any other government programs? And is it correct to assume that dialogue you're having with the government might result in government contracts?

Justin Dearborn

Right now, we have a small amount of government. I would not assume anything. Why can't you work with the government is just that the way earnings work is that since the private sector is getting money from the government, we are really more focused on making sure the government puts in the right direction, so that when people are getting the money to installing tough information exchanges, hospitals and clinics, that our solution needs to be an important part of that.

So the way the money goes is when that's flowing out to all the thousands of entities, you want to make sure you're part of that. We've got our opportunities for us too with the federal government and different groups that we are talking to. But right now, we have a small percentage of our business from government.

Doug Dieter - Imperial Capital

$5 million of potential liabilities associated with the lawsuit. And in the Q, you mentioned that you checked your insurer. Are you guys insured for that amount?

Justin Dearborn

Could you just go back up please? I think you broke up on the first part of the question.

Doug Dieter - Imperial Capital

In the Q, it comments on a $5 million lawsuit I think with the former employees, and you mentioned in the Q that you had insurance against that. Are you covered completely for that $5 million should you owe that $5 million?

Justin Dearborn

Correct.

Doug Dieter - Imperial Capital

Okay. I didn't see in the Q any commentary on international sales. Clearly, that's a focus of yours in expanding international effort. Can you comment on how your international sales has evolved over the last quarter or two and kind of your expectations in the coming quarters with this acquisition?

Michael Ferro

We have not been as focused as we would have liked due to this acquisition for the last 90 days, just getting things cleaned up. As Justin said, contentious was a nice word for hostile. But as you know, we were a hostile bidder to win this transaction.

So we put our focus, and we have not focused as much internationally, that will be corrected over the next couple of quarters if there are opportunities there. Right now, a lot of our revenue comes from the North American market. So we felt like, first let's get that cleaned up, and then we'll start investing in the international. But right now, it is time to invest in the U.S. market. We would not have said that. With our products out a year ago, we would never have said those words. But now it is time to invest in the U.S.

Justin Dearborn

So I'll make one additional comment there. So really in addition to a few products that we think we can take international, I'm actually heading to China in a month, and we're going to test some of those products with our installed base. What it gives is, is scale and being the largest independent imaging provider software company in the world.

So what it does is it gives us better exposure to vendors. And you know what? We go indirect outside the U.S. right now. So we're getting inbound calls. Being just a bigger player, people know us, have more confidence. There is no stability issues, no viability issues. So what it's added internationally without doing any new product introductions is just having the scale and being a bigger company, people knowing Merge Healthcare outside the U.S.

Doug Dieter - Imperial Capital

As a result of the transaction, have you lost any contracts this past quarter that were significant?

Justin Dearborn

No, we have not.

Operator

The next question comes from the line of Bill Dezellem of Titan Capital Management.

Bill Dezellem - Titan Capital Management

I had a couple of questions to tie in with the prior questioners or your responses. The first one relative to the last questioner in the international market that I believe it was in the 10-K. You referenced that you had 34 new VARs and/or distributor contracts that were added in the last calendar year.

And we're curious off of what base that 34 was. I'm trying to get the magnitude. And which countries were most important there? And now if we roll the clock forward, how does that interplay with having the AMICAS product line and the AMICAS relationships that you've acquired?

Steve Oreskovich

I don't have the exact number, but it's a huge percent. So I would say we had less than 60 active VARs, so a huge uptick in the number of VARs. The areas most important to me, to state the obvious, we're pretty excited about the South American markets. So we did add a VAR in Brazil that has very broad coverage in Brazil in the hospital market.

Middle East continues to be an area where we expect a lot of growth. We had some growth quarter-to-quarter. So it slows one quarter, picks back up. But that's still an interesting area. And then Asia, China specifically, and there we continue to invest. We did grow the revenue in Q2, but that's an area where, as Michael indicated, we did not focus as much on outside the U.S. in the last quarter as we go forward. But there is a large market in the U.S.

The international market will continue to drive and be the next growth driver for us. But the U.S. market, because of the EMR stimulus and what it's doing to digital conversion overall is a good market right now to invest in.

Bill Dezellem - Titan Capital Management

And the interplay of the acquisition and the impact that has for our relationships and whether directly or just indirectly in terms of their behavior?

Michael Ferro

Indirectly hard to measure of course, but I just again feel that having a scale and being the size we are and the investment we can make in product and distribution, will benefit us. People do want to do business with us. Internationally just getting your name out there further, it is a good thing. On the product side, we have introduced cardiology to (inaudible) in Europe. We will take that as well as our CAD application to China and test the waters there. And then PACs, we'll make some decisions on, but overall we're serving that market anyway with our own PAC solutions.

Bill Dezellem - Titan Capital Management

Next question, Allscripts, would you please provide an update in terms of that relationship, and what the AMICAS transaction does or does not do for that relationship please?

Michael Ferro

Sure overall, relationship is very positive. As I mentioned, we had a number of people, Andy Booth, at Allscripts customer events held till last week. That was the biggest event that you might except given their growth. So we are right now introducing some new products into their market, the good thing we have it gets really, really interesting for us and to be very candid even when they closed the Eclipsys's deal which we announced will expect given a publicly givable information.

So after that transaction Allscripts will be the second largest healthcare software provider in the world. And this expands their install base and they really are hospital based quite a bit. So very positive right now and we expect it to just continue to grow.

Bill Dezellem - Titan Capital Management

I have to beg ignorance here. Would you please discuss why the Eclipses transaction is potentially so exciting to merge?

Michael Ferro

Sure, and this is just my speculation based on publicly available information and what other analysts and bloggers are talking about. Eclipses has a big hospital install base as a large company, period. So just under $500 million of run rate, so you put two together, they are $1 billion plus revenue company. And we have had some good relationships, have had some good success with so. Company almost doubling in size and expanding their install base deep in the hospital market is exciting for us.

Steve Oreskovich

And Eclipsys is know for selling other products, some of which we have right now, that I hope to displace those once Allscripts and Eclipsys merge. That we have an opportunity on there with a whole package solution for Allscripts to resell to the Eclipsys install base, but Eclypsys is out there signing everything from PACS systems, et cetera which Allscripts does not do today.

Bill Dezellem - Titan Capital Management

My final question is relative to when Merrick came in and initially engaged with Merge or acquired Merge, however one wants to think about it. What was the original cost savings number that you folks laid out to the investment community, and what ultimately was the actual cost savings number that you were able to achieve?

Michael Ferro

Pardon me, can you repeat that?

Bill Dezellem - Titan Capital Management

When Merrick originally came in to rescue Merge, you all had stated a cost savings number to the investment community that you hoped to achieve. And ultimately, the actual number was in excess of that and I just don't remember what the original number stated was and what the actual number achieved was? And was hoping that you answer both of those, a) what the original estimate was? And b) what the final actual was?

Michael Ferro

Back in the second quarter of 2008, well, there was a restructuring initiative that occurred at the time. There was no cost savings initiative that was provided to the market other than the fact that we did announce the restructuring and the rightsizing of the business, so that the cost matched the revenue run rate at that time.

So there was not an expected amount of synergy savings similar to what we have here when you're putting two public companies together that we had discussed and announced to the Street at that point of time. I don't recall it specifically what that restructuring amount was. But it wasn't an apples to apples sort of comparison to what we've done with the best transaction as well as the prior two significant transactions in 2009.

Bill Dezellem - Titan Capital Management

That makes the question a little more difficult to think about. So I'm going to try one more time from a slightly different direction. If you internally, presumably, had some targets on what you were hoping to accomplish, because the clearly the cost structure was too high relative to the sales level. How much is say, on a percentage basis, did you exceed your internal thoughts?

Michael Ferro

We didn't have a specific in mind. It was very easy to go in and look and say, "Here specifically is what we can take out of the business." So sorry, we didn't have a number that you said, here is your low and high. We had a specific number, because we were able to look at the business in detail and understand the cost structure at that time. So if you're trying to say where are we at, 95% versus 105% it was probably very close to 100% because we were dealing with no information at that time as opposed to this transaction where we had some information but not complete information because of speech of companies where we can achieve upside.

Justin Dearborn

Just one additional comment there, Bill. Just two completely different scenarios. And when Michael, myself and Nancy came into the business in June of '08, there was a much different landscape than today. We were obviously trying to stem the bleeding in company turnaround and were new to products we were doing and needed to remove the viability concern that was plaguing much of the market. Then of course the economy tanked and we had to manage through that. So much different scenario than following this large acquisition.

Operator

Your next question comes from the line of Jake Kemeny of Morgan Stanley.

Jake Kemeny - Morgan Stanley

Wondering if you guys could help us bridge the 2Q results to the run rate numbers that you're talking about given that 2Q is down pretty hard sequentially. What gives you the confidence that you'll actually be able to achieve those run rate numbers that you're talking about?

Steve Oreskovich

Sure, first thing is you're looking at a sequential basis. You're looking at apples and oranges trying to compare Q2 to the first quarter given that you add two public companies running separate businesses versus this quarter where we have taken a lot of our efforts and focuses as Michael, Justin and I have said in insuring that we won't need the cost saving synergy numbers that we believed we could achieve out of this transaction.

And then secondly, changing gears here in third quarter and going forward to grow our costs in the sales and marketing line appropriately so that we can meet the revenue numbers and growth numbers that we're looking for in future quarters.

I think the second item that's probably important to point out when I say it's apples and oranges is if you looked at the first quarter combining numbers, you add an adjusted EBITDA of approximately $12.5 million plus while the two businesses exclusive of restructuring and other related cost payments only generated cash of $5 million.

This quarter, you have cash flow being generated from operations that closely aligns to the adjusted EBITDA numbers. So it's proof-positive in our minds that we did the right thing in focusing our efforts a 100% in the direction of the cost saving synergies first to enable us to turn around and grow the company accordingly going forward.

The other piece from our revenue perspective is, we've talked about previously is the bookings that we had incurred, we have hardly incurred in the last half of June and in July have also provided us confidence that the $200 million run rate going forward is an achievable number.

Jake Kemeny - Morgan Stanley

On the EBITDA this quarter, it came in around $7 million. So to get to like the 56 or 57 run rate, you have to be doing about $14 million by the fourth quarter. Can you kind of walk us through how you think you're going to get it on a pro-forma basis from seven today, kind of ramping sequentially up to that $14 million by the fourth quarter?

Steve Oreskovich

On a high level, one, if you're running at the $200 million run rate of $50 million a quarter, obviously at a gross margin if you exclude the non-cash fees that adds a significant amount to the bottom line. And then secondly, you're seeing an adjusted EBITDA number this quarter that does not fully reflect all of our cost saving synergies being impacted through the quarter.

So by the fourth quarter you will see the $15 million of annualized cost saving synergies totally impacted in the quarter. So you take those two items in concert and you get back to that adjusted EBITDA that we've been indicating in the 8-K and other filings all along.

Jake Kemeny - Morgan Stanley

So do you guys see kind of a sequential, and I'm talking pro-forma run rate, from this quarter do you see some sequential improvement going into the third quarter into the fourth quarter such that will get by the fourth quarter that roughly $50 million of quarterly revenue and $14 million of quarterly EBITDA?

Justin Dearborn

Yes, and I think as Steve has alluded to, our margin's going to fall pretty quickly and new sales would fall at probably a little bit higher margin than our overall company margin, just because we have the cost, we have the infrastructure in place. So another million dollars of software and license revenue is going to have munch on our EBITDA there, the overall company.

Jake Kemeny - Morgan Stanley

On cash flow, can you just walk us through the major cash items for the remainder of the year? In particular, can you touch on your cash uses for restructuring CapEx, your coupon payment and any working capital or taxes, and do you expect to generate free cash flow for the balance of the year?

Steve Oreskovich

So the answer in reverse order, yes we definitely expect to generate free cash flow from the rest of the year. There is the first semi-annual interest payment in November. From a cash tax perspective, we expect it to be fairly minimal. We do have significant NOLs. That said, we will be in an EMT and maybe some state cash tax paying position.

From a CapEx expenditure rate, I was expected to probably mirror what has occurred in the first half of the year. And then from the working capital needs perspective I was expected to be generally neutral but no significant swing one way or the other that working capital should have on cash flow from operations.

The last piece that you had asked about was from a restructuring-related cost. I believe the number was about $6.5 million left to pay. I would think that the majority of that will be paid over the third and fourth quarters of this year. There will be some tail into 2011, depending on how quickly we finalize things on the real estate side.

Jake Kemeny - Morgan Stanley

And then just one last one from me. You kind of mentioned you might need some more sales people people to chase all the leads you have. How should we think of the run rate operating expenses exclusive of G&A on a go-forward basis? Like per quarter, what do you make SG&A and R&D would be like?

Steve Oreskovich

I think you should continue to see the decrease as cost saving synergies continue to flow through those, exclusive of the sales and marketing line, which, depending on how quickly we ramp up may start to increase comparative to the second quarter and the third quarter.

Operator

At this time, there are no further questions. Do you have any closing remarks?

Michael Ferro

Thanks everyone for being on the call today, and look forward to providing another update in less than 90 days.

Operator

Thank you for participating in today's conference. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!