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Executives

Paul Merrild - SVP, Marketing & Corporate Strategy

Michael Ferro - Chairman

Jeff Surges - CEO

Justin Dearborn - President

Steve Oreskovich - CFO

Analysts

Eric Martinuzzi - Craig-Hallum

Corey Tobin - William Blair

Chad Bennett - Northland Capital

Doug Dieter - Imperial Capital

Eric Coldwell - Robert W. Baird

Merge Healthcare Incorporated (MRGE) Q3 2010 Earnings Call November 9, 2010 8:30 AM ET

Operator

Good morning my name is Bettina and I will your conference operator today. At this time I would like to welcome everyone to the Merge Healthcare quarter three 2010 earnings announcement. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer-session. (Operator Instructions). Thank you, I'll now turn the call over to Paul Merrild, Senior Vice President of Marketing. Sir, please go ahead.

Paul Merrild

Good morning and welcome to Merge Healthcare's third quarter 2010 earnings call. I am Paul Merrild Merge Healthcare's Senior Vice President of Marketing. Joining me on the phone today are Michael Ferro, our Chairman, Jeff Surges our newly appointed CEO, Justin Dearborn, our President; Steve Oreskovich, our Chief Financial Officer.

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 Michael Ferro for opening comments.

Michael Ferro

Thank you Paul. Good morning everyone, we've great news today on a number of fronts. I would like to begin by introducing Jeff Surges as the new CEO of Merge Healthcare. Many of you may know Jeff from his most recent role as President of sales at Allscripts Healthcare Solutions. Jeff brings 20 years of experience managing high growth technology companies in the healthcare and information services industries and in depth knowledge of the key trends in healthcare IT. Before we dive into the details of why Jeff is joining Merge Healthcare, I think it's important to remind everyone of what Merge Healthcare has become over the last few years.

Merge Healthcare is a company that has amassed nearly 70 patents in healthcare IT. Critical product such as vendor-neutral archiving and a customer base of over 22,000 imaging centers, 1500 hospitals, 800 orthopedic clinics, 1200 labs and 250 OEM partners. These assets uniquely position Merge Healthcare to transform the challenges facing today's healthcare providers to improve quality and reduce costs.

Providers, physicians, payers and patients all need access to healthcare information and the ability to share clinical data for our healthcare system to improve quality and reduced costs. At Merge, we have created an interoperability and connectivity platform, designed to make that vision a reality. Our new I-Connect platform offers IDNs, hospitals, imaging centers and health information exchanges the ability to create information exchanges with their environment and with other entities.

Having an electronic health record industry veteran such as Jeff join us is a testament to both the work we have done to date as well as the opportunity that lies in front of us. As electronic health record adoption is well underway, we believe the market for interoperability and connectivity is the next wave of growth in healthcare IT.

Concurrent with Jeff Surges' new role of CEO, Justin Dearborn has accepted the position of President of Merge Healthcare. Justin's leadership has been instrumental as we've grown from a $60 million annual revenue company to a $200 million annual revenue run rate company. Justin will continue to be a critical part of our strategy in operations as we scale our international business.

I believe we have the team to take Merge Healthcare to the next level. Please join me in welcoming Jeff to the Merge Healthcare team.

Jeff Surges

Thank you, Michael. I am honored to join Merge Healthcare. I left a growth company to join Merge Healthcare and the team because I believe the next phase of growth in healthcare IT lies in connectivity and interoperability. As providers adopt electronic health records, the need for solutions that connect the spare providers with other constituents in healthcare will become a multi-billion dollar opportunity.

I joined Merge Healthcare because I believe we are well positioned to become a billion dollar company addressing this unique market opportunity. As a Director of the Merge Healthcare Board since June of 2010, I've been fortunate to see the foundation Merge Healthcare has put in place to capitalize on the trends in healthcare IT. With a very strong customer base, an excellent portfolio a world class team, we are positioned to capitalize on the next phase of growth in healthcare IT.

This is all coming together at a time when investments in healthcare IT solutions are accelerating thanks to the American Reinvestment and Recovery Act. With the strength of the Merge assets in place and the availability of the federal stimulus funding, we will be investing in sales and marketing to transform Merge Healthcare into a growth company that can dominate our space over the next 36 months. The upcoming RSNA Trade Show in Chicago presents a unique opportunity for us to get in front of our clients, our customers, the market and our investors to share additional details about our business and our strategy.

We will be hosting an investor session at RSNA and we will welcome the opportunity to meet with all of you. Please email us at ir@merge.com or check on our website for logistical details early next week. Personally I am very excited to be part of Merge Healthcare's team. I believe that the market is right. The timing is right for us to build a billion dollar company.

With that I will turn it over Justin Dearborn to review the highlights from Q3.

Justin Dearborn

Thank you Jeff and Michael, as you may recall from our last call we spent the second quarter focused on a single overarching mission to take the steps required to create the leading independent provider of healthcare IT and imaging solutions. We had two clear areas of focus in the second quarter to capture the synergies and the transaction and to solidify our go-forward strategy to create the foundation for the future of our business.

Our results in the third quarter in particular are in topline growth EBITDA and our non-recurring backlog balance demonstrates that we established an operational baseline in Q2 to deliver solid results in Q3. When I look at our revenue growth in Q3, it is interesting to examine the sources of growth. Broadly speaking, we saw strength in our cross-selling efforts, our solutions focused on growth segments of the market and broad healthcare IT industry strength.

We are starting to see some encouraging market trends. Clearly the largest trend is the increasing focus on IT adoption in healthcare. As intended, the American Recovery and Reinvestment Act and the accompanying High Tech Act have sparked a tremendous amount of interest in health IT. Whereas the legislation initially caused a market freeze, the increased clarity around health providers qualifying for the high tech funds is now leading to actual purchase activity.

As you know, the general purpose of the High Tech Act is to reward providers who use certified electronic health record in a meaningful way. It was difficult for providers to assess its potential reimbursement into both solution certification and meaningful use where better to find. Both of these elements are now clear with the final meaningful used guidelines for Phase I published in July. The largest and most complicated element of the legislation is meaningful use. So I want to take some time to explain how our products help a provider meet these guidelines. As Michael Ferro discussed on last quarter's call imaging represents over 90% of the data generated by healthcare providers today.

We along with other vendors, doctors and academic thought leaders in the space do not believe in electronic medical record can be considered meaningful if 90% of your healthcare data is missing. Merge healthcare solutions manage the images and the diagnostic results and also distribute this information to care decision makers. All this information is stored in a format that allows for a diagnostic comparison with future exams which ensures that the electronic record can be used for better patient care decisions while minimizing duplicative testing. Reducing costs while improving quality are the essence of meaningful use.

Merge Healthcare spend a lot effort in the third quarter investigating how radiology and orthopedic practices would fare into the final definition of meaningful use. We work through our customers and some outside experts to understand how this market segment and many of our customers might be able to qualify for stimulus funding. We are pleased to find that our radiology EMR and our orthopedic EMR can help these practices qualify with some minor enhancements to our products. We view this as extremely positive development for Merge Healthcare.

Last quarter we discussed a few products that we have developed to address the interoperability and connectivity challenges of provider space. Specifically, the new Merge healthcare I-Connect interoperability suite offers hospitals, imaging centers and health information exchanges the ability to create healthcare exchanges within their environment and with other entities. This platform provides access to imaging and diagnostic data across disparate systems, geographies, specialties and providers. This solution enables providers to expedite care, reduce duplicate exams, consolidate infrastructure and limit the expenses associated with moving, managing and the storage of diagnostic content and results. The Merge Healthcare I-Connect Interoperability Solutions suite went through some extensive testing this past quarter as we held both virtual and in person focus groups with hospital CIOs to refine the capabilities of this solution. I-Connect will be available in a variety of packages ranging from I-Connect Share for the sharing of images to eliminate CDs to I-Connect Kiosk for our front office automation to I-Connect Exchange for a full interoperability solution. We feel very confident that this solution suite is going to meet the market's interoperability and connectivity needs and will be a significant area of focus for us too 2011.

In summary we believe that our Q3 performance in terms of top line growth, EBITDA and non-recurring backlog balance all demonstrate that the operational baseline we established in Q2 helped us deliver solid results in Q3. Merge Healthcare is bringing innovative new solutions to market. Our customers have reacted favorably to our progress in the last two quarters and macro level factors and Healthcare IT remain very positive from Merge Healthcare.

With that, I will turn it over to Steve to review our financials.

Steve Oreskovich

Thank you, Justin. I will review our results for the third quarter of 2010 and compare these to the third quarter of 2009. Similar to last quarter, I will focus my comments primarily on the financial results of the third quarter of 2010. I will also provide additional information related to the third quarter of 2010 some of which is non-GAAP which we use internally to manage our business. A detailed reconciliation of GAAP net income available to common shareholders to adjusted EBITDA is located in the tables at the back of our earnings release. In addition, I will also provide certain pro forma data for the third quarter of 2010 compared to the second quarter. And finally I will provide some additional data regarding 2011 guidance.

Merge Healthcare's GAAP net sales for the third quarter of 2010 totaled 45.2 million compared to 16.9 million in the third quarter of 2009. On a pro forma basis, net sales for the third quarter of 2010 were 48.5 million compared to 41.5 million for the second quarter. The primary reason for the 7 million pro forma increase was attributed to revenue recognized from nonrecurring sources with software and other accounting for the majority of that amount.

That said, over 65% of net sales both GAAP and pro forma in the third quarter were from recurring revenue sources. In addition, nonrecurring backlog increased in the third quarter by approximately 2.5 million to 48.6 million as of September 30th. As it relates to the purchase accounting adjustment for sales which is not in our GAAP results but is reflected in pro forma sales, we have a remaining balance of 16.3 million as of September 30th that will continue to require a reconciliation between our GAAP net sales and pro forma sales over the next several quarters, about half of which will occur between now and the end of 2011. As mentioned on prior calls the mix of software and other sales as a percentage of overall sales impacts our GAAP gross margin on a quarterly basis.

Gross margin for the third quarter of 2010 was approximately 54% compared to 76% in the third quarter of 2009. The difference is primarily related to greater hardware and third party software and maintenance cost included in products and the related maintenance from acquired businesses. On a pro forma basis and excluding non-cash depreciation amortization and impairment cost, gross margin for the third quarter of 2010 stayed constant with the second quarter at approximately 62%. Merge Healthcare had GAAP operating income of 3.1 million in the third quarter of 2010 compared to a loss of 200,000 in the third quarter of 2009. Included in these results are total acquisition related and restructuring cost of 2.1 million and 2.6 million in the respective periods. Merge Healthcare has completed the restructuring activities as planned and expects minimal impact to operations going forward.

We also incurred 6.5 million of interest expense including the amortization of debt issuance and debt discount cost in the third quarter of 2010 which was the primary factor leading to the GAAP net loss of 3.4 million. This compares to a net loss of 900,000 for third quarter of 2009. Net income available to common shareholders which considers the non-cash preferred stock dividend was a loss of 6 tones per share in the third quarter of 2010 compared to a loss of $0.02 per share in the third quarter of 2009.

Merge Healthcare had an adjusted EBITDA of 13 million or $0.15 per share in the third quarter of 2010 which was up significantly from 7.8 million or $0.09 per share in the second quarter. We also had adjusted net income of 3.2 million or $0.04 per share in the third quarter of 2010. As it relates to 2011 we anticipate pro forma sales of between 235 and 240 million and an adjusted EBITDA of approximately 23%. We plan to increase investments in sales and marketing to allow us to capture the increasing market demand for our solutions and position us for continued growth for years to come.

Further, as it relates to 2011, we expect the following. Amortization and depreciation and cost of goods sold of approximately 10.5 million of which 7.5 million relates to the amortization of intangibles from significant acquisitions, approximately 8 million of depreciation and amortization with an operating expense of which 5 million relates to the amortization of intangibles from significant acquisitions, approximately 26 million of interest expense including the amortization of debt issuance and debt discount costs, approximately 2.5 million of non-cash stock based compensation expense, a non-cash preferred stock dividend of approximately 7 million and minimal impact to expense for income taxes as we continue to utilize substantial NOLs.

Although we view guidance on an annual basis for 2011, I recognized that there are those that may desire to model a quarterly outlook. For those persons the expectation should be greater sequential quarterly sales growth in the latter half of 2011 as the investments referred to previously take effect. Regarding the balance sheet Merge Healthcare end of the quarter where the cash balance of 40 million, an increase 2.1 million compared to the balances of June 30th. There is a table and liquidity section of MD&A included in our Form 10-Q that sets forth the sources and uses of cash in the third quarter and year-to-date in 2010 in a manner that differentiates cash flows from business operations which was an increase of 8 million in the quarter from other activities.

With respect to a couple of other key balance sheet items net accounts receivable was 47.7 million as of September 30th, an increase of 7.9 million from June 30th and DSO for the quarter was 97 days. Now that we have completed our integration efforts and have a single process regarding collection efforts, we expect improvement in this metric going forward.

Finally deferred revenue as of September 30th was 44 million an increase of 6.6 million compared to June 30th. With that I would like to open up the call for questions.

Question-and-Answer Session

Operator

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

Eric Martinuzzi - Craig-Hallum

Thank you. Congratulations to you, Jeff, on your new position. That's quite a move coming over. And you obviously see some good things going on at Merge. I would like to speak specifically to your guidance for 2011. We're talking about a pretty big step up here given the 200 million annualized revenue color for Q4 2010. On average you are going to need to be putting up close to 60 million a quarter in 2011. I know that sequentially ramps throughout the year, but on average that's a 20% step up, where do you see that growth coming from and I would like to hear some specifics on the sales and marketing investment.

Steve Oreskovich

To answer your first question, as I just previously indicated we are looking for greater sequential growth in the back half of 2011, that said as we had indicated the efforts that we are partaking on right now as far as from a product innovation standpoint such as the products Justin discussed as well as ramping up in sales and marketing we believe will allow us to meet those goals.

Michael Ferro

When we have started the sales and marketing ramp with a higher yesterday, with Jeff Surges coming in as CEO, so Jeff brings with him at Allscripts, Jeff had about, how large was your organization, Jeff?

Jeff Surges

600 plus.

Michael Ferro

That's in sales. So, Jeff at Allscripts ran all of sales and what we want to do is have Jeff go and basically build an organization over the next few years that mimics what he was doing at his last company and so our goal is to bring enterprise sales people in, have generalists covering the country, to start covering these hospitals who have been asking us for our front office automation solutions and ways for them to do interoperability and vendor neutral archive solutions. For right now we don't even have the balance, we are building up more board rooms and conference rooms at our Chicago corporate office to handle visits and right now we are dealing with how do we recruit and train and build an army of sales people over the next couple of years to accomplish this.

Eric Martinuzzi - Craig-Hallum

Just your background, Jeff, I would like to really ring the register, you guys have to be all over large hospitals and integrated delivery networks. Can you talk a little bit about your experience, your exposure there?

Jeff Surges

Yes for the better part of 15 years have basically led organizations in the integrated delivery network, top academic medical centers, community based for profit, non-profit hospitals. The assets of Merge Healthcare, the innovation of Merge healthcare and in my time on the board seeing month over month all of our metrics increasing in terms of demos, in terms of awareness, in terms of hits on the website told me that this no longer needs to be the best kept secret and we need to take the message out.

The advent of interoperability and connected communities as well as electronic health records will change the landscape, accountable care organizations will also change the landscape and the desire for what Michael talked about as the need to get images and scans and data is the most meaningful piece of the electronic health record once the industry is automated and we will continue to see that and the desire to participate in the connected communities.

So my experience there, great to my confidence that Merge Healthcare is uniquely positioned to capitalize on their footprint, on the product innovation and getting the message out and RSNA in Chicago in a few weeks will be the best example to show the footprint of Merge Healthcare and truly what the company is capable of in the years to come.

Eric Martinuzzi - Craig-Hallum

Stepping back into the 2011, that outlook for 23% EBITDA margins for a company that just reported 27% EBITDA margins, you guys obviously are investing a significant amount. Is there anything else besides the sales and marketing investment, anything? Development, facilities, any other areas of investment?

Steve Oreskovich

It's sales and marketing, sales and marketing and sales and marketing first and foremost.

Eric Martinuzzi

Okay. That keeps it simple. And then just what is the interest, the actual cash interest that you will be expected to pay in 2011?

Steve Oreskovich

It's about $23.5 million.

Operator

Your next question comes from the line Corey Tobin with William Blair.

Corey Tobin - William Blair

A couple of quick questions, if I could. One, just following up on the sales force ramp. Can you just give us metrics as to where the sales force stands today and what we can expect to see in terms of what your target is where it should be about a year from now, I guess at the end of 2011?

Justin Dearborn

So right now we are about 40 people in the direct quarter, caring external enterprise reps and around 20 we brought in sort of ramping up inside sales and lead gen, so that number will easily double next year. Jeff now is obviously responsible for ramping that up.

Corey Tobin - William Blair & Company

You have 40 direct and you had 20 internal?

Justin Dearborn

Inside.

Corey Tobin - William Blair

So the 60 should go to 120 by next year.

Justin Dearborn

Yes, correct.

Jeff Surges

Corey, this is Jeff, I would just add that there is a great opportunity in multiple fronts on the sales area, both through our inside sales, telesales, account executive, regional managers, national accounts as we enter this new opportunity and landscape, it really takes this portfolio out to the market place. We'll see different layers and skills sets across to address all of the different opportunities within the settings I talked about earlier.

Corey Tobin - William Blair

Do you plan on building some sort of channel strategy, maybe a reseller-type strategy as well?

Jeff Surges

We continue to evaluate the opportunity for a reseller network in many of the standalone centers and many of the area where it makes economical sense to take advantage of our portfolio in a cost effective way. I do see and we continue to see as a management team that opportunity making itself more and more available, so we will certainly be exploring it.

Corey Tobin - William Blair

Let's talk about I-Connect. Obviously an exciting new product launch. Can you give us a feeling for the pricing model? I think during the prepared remarks Michael you mentioned three different parts to the product. Can you give us a sense on how you will price each of those three different parts?

Paul Merrild

I-Connect is an overall interoperability solution suite and we have got packages that range all the way from $499 a month up to multi-7 figure deals that are going to be available depending on the needs of the customer and the segment of the market that we are going after. So it's really a suite designed to hit a bunch of different pain points and needs in the market place, that's going to scale from relatively small to very, very large.

Operator

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

Chad Bennett - Northland Capital

Just a question, I guess. I think Justin was hinting a little bit that related to the meaningful use in what you are seeing early on in terms of EMR electronic health record adoption with funds starting to flow. I know imaging and respects and what not was really not the focus of the first phase of meaningful use and it was kind of geared towards I think the second potentially. Are you implying you guys are kind of getting pulled in and people are saying, hey, we know we got to kind of deal with this at some point. So let's just do it on the front end instead of kind of waiting here. Is that what you are trying to convey?

Jeff Surges

And what I would tell you is in my most recent view of the electronic health record space as you know the adoption from all aspects of the healthcare equation is happening whether it's in standalone practices, mid-size, large ambulatory, integrated delivery networks and that is happening at record paces and we all see those statistics. What will be most meaningful to the electronic health record will be the quality of the data and the significance of the data that moves along.

So we believe not only will you see more and more standalone opportunities to participate whether it's late Phase I or Phase II of stimulus, but the need to get that information real time to avoid duplication, to avoid what I believe the accountable care organization will address which is not allowing or funding a second scan or a second picture because of a convenience issue, connectivity needs to take care of that and help us all reduce the cost. So that's really the opportunity that I've started to see, most recently. And once I put on the Merge Healthcare view it happens everyday now and it's a requirement.

Chad Bennett - Northland Capital

Obviously Merge has a partnership with Allscripts for their EMR. I guess considering you were a pretty prominent major player at Allscripts, I'm assuming there is no friction there that now you are over at Merge and that relationship is still good?

Jeff Surges

Yes, positive career growth has been promoted by all parties and it is a great honor to participate and to be part of a high growth company. Most recently as well as the opportunity to lead another high growth company and so the partnership remains strong, great communication and relationships and I look forward to further expanding all of our partnerships as we connect and move data across all continuums of care.

Chad Bennett - Northland Capital

So in terms of when hospitals and clinics purchase I-Connect, will that qualify, or will they be able to use money from the high tech app to purchase that? Or will it be incremental to kind of their funding through that?

Paul Merrild

We do believe that the providers will absolutely be able to use the I-Connect portfolio to help them qualify for meaningful use. And the meaningful use takes a bunch of different forms as you know. We absolutely believe that whether it is through an accountable care organizations reducing duplicate exams or even more specifically individual components for radiology practice that will clearly qualify, they will absolutely be able to use the products we have to qualify for stimulus funding.

Operator

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

Doug Dieter - Imperial Capital

I wanted to talk a little bit about the EBITDA margin that you have guided for next year. What I'm trying to understand is, I understand it's all about sales, sales, sales. But I know there is also quite a bit of synergies that are going to be made over the next several quarters. Wanted to know where we stand in terms of realization in the synergies. How much more we have to go, and if that is baked into your number for next year, because that would imply that you are doubling, almost tripling the sales costs over a four quarter period?

Steve Oreskovich

I think Justin and I indicated in last quarter's call that we were ahead of where we plan to be with respect to the synergies. As I indicated early in this quarter's call, all of our efforts are complete and behind this, so I think what you see in this quarter's numbers is the positive impact of a lot of those synergy savings.

Doug Dieter - Imperial Capital

In terms of your guidance of 235 to 240 of sales, that's a pretty tight guidance range. Just trying to get a sense for why that is so tight, why it isn't a wider range? You are expecting numbers to be greater in the second half of next year?

Steve Oreskovich

That is the number that I'm going through the analysis that we perform, that we were comfortable with providing. So others and that I am not sure we could have provided a larger number, but we have confidence in a larger range, but we have confidence in the range that we have selected.

Doug Dieter - Imperial Capital

Okay, in terms of your day sales outstanding, obviously they ticked up with what's going on. How do you see that trending over the next few quarters?

Steve Oreskovich

I would probably expect that to start trending downward, one of the items that we had that was later lagged in our integration efforts was the shift from some of the accounting personnel that we had in Boston to a full accounting team in Hartland, Wisconsin. That was to ensure that we could report to you in a timely manners and so now that those items are complete and we have a single process regarding our collection efforts, I would definitely expect that to start trending downward and quickly.

Doug Dieter - Imperial Capital

Last quarter I asked a question about your international focus and the comment was that you were very focused on performing this quarter and the next quarter and seeing the synergies which you have begun to do. Now with Justin's new role in leading international efforts, I was hoping you could talk about where you stand today from an international perspective and where you hope to go.

Justin Dearborn

We actually put out a pres release, a few days ago we were talking about a nice win in South America, so the focus had been off international. The teams is still there performing, but frankly given the integration effort that wasn't the area of focus for the company. Bringing Jeff on allows me to focus on an area more, I was in Japan in October, I was in China in the beginning of October. So we will be reemphasizing growth in Asia as well as with the I-Connect solution, we do think that's a great opportunity in the EMEA region particularly Western Europe which also has pretty high digital adoption, but we think the I-Connect solution is going to be a great solution for that market, so really the obvious areas, Asia, EMEA and South America.

Doug Dieter - Imperial Capital

In terms of your guidance for next year, can you give us any sense for what growth you expect international from this year to next year?

Michael Ferro

We are not going to break that down right now, traditionally it had been a pretty significant number for Merge obviously with the transaction we did in April the international revenue become a smaller piece of the overall revenue so the growth rates will be pretty significant but coming off a lower number for the company.

Doug Dieter - Imperial Capital

And Jeff, last question here, could you please talk a little bit about the strategy for selling I-Connect? Is it just to integrate that product amongst your whole platform, your current sales force and just cross sell it? Or sell it as a package or could you give us any guidance there?

Michael Ferro

We are happy to share this with you at Analyst Day, too. This is Michael speaking. We have a multi-tier strategy for I-Connect. The first strategy very simple is that we do have a large install base that we're going to sell to you which that alone would increase our gross numbers dramatically over the next 24 months of this company but we are also are doing a channel strategy which we have started to begin where we do have partners out there who have their EMR solutions and the HR solutions that we are going to be both private labeling and co-branding what so they can sell the I-Connect solution and lastly but not least is that we do have 250 OEM partners today who take some of our products and you never know it and they are selling them under their own label and we plan of bringing I-Connect to those partners so its three different channels to go through, to bring I-Connect to the market over the next two years.

Doug Dieter - Imperial Capital

And last question. Could you please just comment on, because many people may not be familiar with interoperability. What competitors you currently have in the interoperability space, products similar to I-Connect in the market?

Jeff Surges

There are remarkably not very many products out there that are directly competitive with I-Connect because it's a fairly broad portfolio, it ranges everything from an imaging exchange to front office automation to image enabling and EMR with zero plane viewing and if you look at those things in the aggregate, they are really almost zero competitors that offer a solution comparable to that. Clearly if you dig in to individual features and functions, we could get down and to talk about a competitive discussion there. But we think that one of the biggest assets around I-Connect is the fact that we get to bring together, things that nobody else can bring together and do so in a really compelling way for the marketplace.

Justin Dearborn

And I-Connect would have been a great product as recently as 24 months ago, without electronic health record adoption, no one really cared about putting their attachment to their e-mail as Jeff said when we were in discussions that I am coming to Merge, Jeff Surges has always used the example of that. Well I went through the HR people to start having electronic health records or e-mail back and forth to each other but you need the attachment. In our case, imaging and labs represent over 90% of the data in healthcare. So once doctor's offices and hospitals and imaging centers all start becoming EHR enabled, EMR enabled they need to move this data back and forth which comes to a timing you need to have what I-Connect is vendor-neutral archive, web access and EMPI type of functionality which you need all those pieces to move this large amount of data back and forth through all these (inaudible) parties.

So I mean that's where I-Connect's right now. If the time is now for an I-Connect solution, the time was not 24 months ago. So we're just, it's the right time to do it and we do need, it is based on the curve of EHR and EMR adoption, that's how we follow that way.

Doug Dieter - Imperial Capital

Are you seeing lower, faster sales cycles for I-Connect than obviously compared to RIS or PACs?

Justin Dearborn

Well we see more interest, a lot more interest where people want to sit down at the table and are setting meetings. There will still be sales cycle to do this because the numbers for large institutions are quite large because the benefits are quite large for them also. So this is a normal software cycle but there are parts of I-Connect that we can sell over the phone into our install base that are helping them use their EHR system to automate their front office.

Jeff Surges

This is Jeff. One of the things I have witnessed most recently and over the last few years is that the definition of a health information exchange varies depending on the community, depending on the profile and depending on the pain point. And anywhere from sending standard information which is just connecting the initial face sheet ADT data to wanting to get to more meaningful information about a scan or about particular images begins to get to the next level the more quantitative level of it where there is bigger value.

So one of the things about I-Connect that is most appealing to me and the interest level we are seeing is that it participates both on a standalone basis for business need and can plug into a larger scale operability play when people specifically want to get after the imaging, the data and the scans as we talked about before. So it's got great flexibility to partner with and play as well as standalone on its own for community initiative.

Operator

Your next question comes from the line of Eric Coldwell with Robert W. Baird.

Eric Coldwell - Robert W. Baird

How many I-Connect customers do you have today that are taking the full package?

Paul Merrild

We have literally hundreds of sites out there running components of the I-Connect package today. As I mentioned earlier, it comes in a variety of different packages. So when you say using the full I-Connect package, it's a little bit of a misleading way to present the information. But we got some of the largest IDNs running components of I-Connect as well as relatively small imaging centers. So it appeals to broad segments of marketplace and is well proven in a variety of circumstances.

Eric Coldwell - Robert W. Baird

When I look at the 3Q 2010 revenue growth on a pro forma basis up about 6% year-on-year, does that 6% growth include 2009 being reclassified for all acquisitions or just the significant ones?

Paul Merrild

For the significant ones Eric.

Eric Coldwell - Robert W. Baird

So constant dollar organic growth would have been, I assume lower than the 6%? Fair statement?

Paul Merrild

I think that's probably a fair statement to quantify that though there wasn't much from in 2009 from other entities that we the smaller acquisitions that we made.

Eric Coldwell - Robert W. Baird

Right, that would include Docusys, Olivia Greets, Stryker Imaging, Fletcher-Flora etc. I guess you wouldn't have had Fletcher-Flora in the 3Q '09 numbers.

Paul Merrild

Correct.

Eric Coldwell - Robert W. Baird

Can you give us the revenue of those acquisition either individually or perhaps an aggregate?

Steve Oreskovich

No that is something that we are not going to discuss. We stated prior calls as well we will discuss significant acquisitions and provide information required but we are not discussing any insignificant ones.

Eric Coldwell - Robert W. Baird

I guess I'm just qualitatively trying to get to where we are exiting 4Q, what the annualized growth rate will be going into 2011, and how much of that is projected to be organic versus either a contribution from FX or in M&A.

Steve Oreskovich

Yes I think we'll continue down the similar strategy that we have for the past several quarters with respect to growing the business overall.

Eric Coldwell - Robert W. Baird

It's kind of interesting that you gave 2011 top line in EBITDA targets but didn't specifically address 4Q or 2010 in the press release. Is there any directionality you can give us here for the fourth quarter? Should we stick with the guidance that was provided at the time of the closing of Amicus? How should we think about that?

Steve Oreskovich

Yes, we remain very confident with those numbers Eric.

Eric Coldwell - Robert W. Baird

And I know there was some discussion on the international revenue. I didn't see it today, I might have missed it, but can we get a quantification of what percent of 3Q '10s revenue was international?

Steve Oreskovich

We don't break that out. It is as Justin had mentioned in the prior question, it has become a smaller overall component of revenue, yet that said it does have significant growth opportunities for us. In 2009 the percentage is 23 guessing right now for where 2010 might come out, it's probably somewhere round 10% to 12%.

Eric Coldwell - Robert W. Baird

Last question for Jeff, I think. We can do some back of the envelope math on where we were targeting adjusted EBITDA versus the lower guidance today and maybe if this is all sales and marketing in terms of the incremental cost, we can come up with a pretty good estimate of what you are looking to spend there incrementally this year. But I'm just curious if we can get any greater detail on if you have a sense on the cost of the average rep you are trying to bring in, in terms of recruiting, training, compensation structure, is it going to be based up front and then shifting to commission over time? And then just I guess technically I would suppose that Jeff is probably prohibited in a non-compete from stealing folks from AllScripts, but I would love to get a sense on where you are planning to target these reps, because it's a pretty competitive environment obviously.

Jeff Surges

What I would tell you is, as Steve laid out sales and marketing and the growth ramp also leads to positive growth in the terms of implementation and services because if you sell more you have to install more and that's a positive line of growth. So when you think about sales and marketing you have to open up that circle to think about the other attributes of an increased backlog implementation and the like. So the business starts to scale.

From a packaging standpoint, again on the question you had, we talk about individual components that have been assembled what I have liked about Merge Healthcare is now the ability to solution sell, consultative sell in a bundling environment and that's really led by the I-Connect conversation. So in historic months or years as Michael talked about, there is individual pieces that have come together. As you go into healthcare, IDNs, hospitals, large and small academic complex centers, all of the buyers want consultative partnership solution, they want to see bundles, they want to see products that move data back and forth. That professional that you need to get comes from many places, both from competitors, both from the marketplace and for successful people that have been in this industry for a long time that have reputations. They want to have a product of the company in a portfolio that sticks to their integrity and those are the people we will be looking for. We will be scaling towards the high end of those solution sellers and then we'll also be selling to accommodate the client base that we are going to be working with everyday from an account management standpoint, an inside sales and telesales standpoint and as we compliment our OEM partners and our reseller network. So quite available today in this market when you are growing and you have a good message and great products and strong clients, your ability to recruit comes from many different places and Merge Healthcare will be a recipient of such talent.

Operator

Your final question is a follow-up question from Corey Tobin with William Blair.

Corey Tobin - William Blair

One last quick one if I could. Given all this focus on I-Connect which clearly sounds like its going to be the story here for the next few years, what would you say revenue target specifically on the I-Connect components would be for 2011? What I'm trying to get to here is, how can we gauge the ramp in I-Connect versus what's going on with the non I-Connect business as we look over the next couple of years?

Steve Oreskovich

I think the nice part of I-Connect is that it will also lead to additional sales of other products that we have and vise-versa as Michael had mentioned going into our customer install base and pitching them the components of I-Connect that they may be missing or it may provide them the greatest benefit, will also lead to additional sales for us in other areas. So we have not broke out a specific number in the 2011 guidance that says this is I-Connect, this is rest of the business. That said we do believe there will be a lot of cross opportunities that sales of existing products that we have sold previously as well as the I-Connect package will offer to all of our clients.

Jeff Surges

I would only add that a great example is Merge Healthcare's vendor neutral archiving pack system is an industry leader and the pull through that I have seen over the last six to eight months participating with the company is that, that technology as it resides is a solution also pulls through additional modules that get more valuable because of the vendor-neutral archive approach. The I-Connect approach follows a similar model because so to speak the cloud or the interoperability, availability to move data, the constituents have an ability to bundle up into that, and that's why I talked about from a consultative solution selling approach versus more of a traditional product feature function approach. So we expect to see both standalone as well as a growing number of bundled solutions as we scale up the business.

Corey Tobin - William Blair

Just to try it one more way. Does that imply that that I-Connect components, specifically I-Connect components, not the related add on or pull through sales should be a material percentage of revenue next year?

Steve Oreskovich

I would think you will see it grow continuing Corey throughout the three year period that we have previously discussed. We have not put a specific percentage on expectations because again there is a lot of cross between the various pieces.

Jeff Surges

Well this is Jeff Surges and I want to thank everybody for attending the call today. As we wrap up the call, I would lead you with kind of the statement we started with. It's a great time to be at Merge Healthcare with a great customer base, a great portfolio and great employees throughout the company. In this time of electronic health records, interoperability and automation, we not only look at that as a leading indicator but participating with great quality information. 90% of the data people want is going to be a Merge Healthcare software solution and service and we look forward to participating in that. I personally look forward to working with our employees, getting to know people, getting to know people on this call and sharing a great opportunity and a great story with you which is what I firmly believe exists here at Merge Healthcare and look forward to the days and years ahead in growing a great business and becoming a billion dollar company. Thank you.

Operator

This does conclude today's conference call. You may now all disconnect.

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