Merge Healthcare Incorporated. (MRGE)

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Merge Healthcare Incorporated (MRGE)

Q4 2013 Earnings Call

February 20, 2014 8:30 am ET


Justin C. Dearborn - Chief Executive Officer, Director, Chief Executive Officer of Merge Dna and President of Merge Healthcare

Steven M. Oreskovich - Chief Financial Officer, Chief Accounting Officer and Treasurer

Steven Tolle - Senior Vice President of Solutions Management


Joseph Fadgen

Ryan Daniels - William Blair & Company L.L.C., Research Division

Eugene M. Mannheimer - B. Riley Caris, Research Division

Evan A. Stover - Robert W. Baird & Co. Incorporated, Research Division

Brooks G. O'Neil - Dougherty & Company LLC, Research Division



Good morning, and welcome to Merge's Fourth Quarter 2013 Earnings Call. Today's teleconference is being hosted by Justin Dearborn, Merge's Chief Executive Officer; and Steve Oreskovich, its Chief Financial Officer. My name is Colin, and I will be moderating today's session. [Operator Instructions]

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

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

With that, I would now like to turn the call over to Merge's CEO, Justin Dearborn. Mr. Dearborn, please go ahead.

Justin C. Dearborn

Thank you, operator, and thank you, everyone, for joining us this morning. Q4 was a challenging but successful quarter for Merge. Sales were up marginally in our Healthcare segment when compared to Q3. We increased gross margin by 3%, adjusted EBITDA by 4% to 17% in sales, and we voluntarily repaid another $9 million of debt. We continued this strategy into 2014, with an additional $3 million payment in January. However, the industry trend that drove our results during the second and third quarters continue to be present during Q4. Market uncertainty remained, and with many health care information technology imaging-centric vendors merged out the impact of provider indecision.

In both the ambulatory and the acute hospital settings, several external pressures had caused customers to defer spending. In the hospital market, the federal government sequester, which started in April, cut $11.8 billion in Medicare reimbursements to providers during 2013. Additional federal budget reductions and reimbursement uncertainties, such as the planned 2-Midnight Rule, led several large health system clients to defer making decisions on new health IT projects.

By year end, hospitals and health systems have begun to focus on 2014 mandates of ICD-10 and Meaningful Use. IT budgets and other resources were consumed by the planning and implementation of technology upgrades to billing and EMR applications to meet these mandates.

In the non-hospital or ambulatory market, the trend towards partnerships, mergers and acquisitions between physician practices and health systems continued. Unfortunately, when ambulatory providers explored deals like this, they often put technology purchases on hold.

Along with their hospital counterparts, ambulatory providers also face spending and budgetary concerns with respect to meeting the 2014 mandates, as well as general uncertainty regarding the impact of the Affordable Care Act requirements in 2014.

In addition to the observed market spending disruption in 2013, Merge faced a number of expensive legal issues. While I'll refrain from commenting on the merits of the specific intellectual property claims or the current state of IP litigation, I will note that we've put 2 very costly IP suits behind us in 2013. The first was related to our health station business and it was settled in late fall. The second was a patent infringement suit initiated by Heart Imaging Technologies in September of 2012 relating to our web-based image viewer. This past quarter, we settled the litigation and obtained a nonexclusive patent license to Heart IT's portfolio of health care information patents, including Zero Footprint technologies. This settlement should resolve any customer infringement concerns about our iConnect Access image interoperability solution.

These 2 patent infringement actions have cost the company significantly in both hard dollars and as distraction to our core business and were not covered by insurance.

In addition, as previously announced, we discovered in Q4 that a former Merge eClinical sales employee had falsified certain customer contracts. We immediately performed an internal investigation and then engaged both outside legal counsel and a forensic accounting firm to conduct an independent investigation. Both investigations concluded that the illicit activity was isolated to this one individual, and we referred the matter to the U.S. Attorney's Office for criminal prosecution.

I want to emphasize again there was no impact to any previously reported revenue results or customer billings. While we did revise our previously announced subscription backlog number, none of these changes affected our reported financial results.

We incurred around $200,000 of legal and accounting costs in Q4 to investigate the matter with outside counsel and the aforementioned forensic accounting firm.

Our eClinical offering remains strong and I fully expect it to continue its positive growth. I, along with our board and the rest of the senior management team, take matters of corporate governance and ethics very seriously. We continue to focus on ensuring that this remains a single, isolated incident. I mentioned this today to keep our stakeholders informed, but also to provide the proper context. This was a single employee who's no longer with the company, acting alone, and committing a fraud for illicit gain. It was the company that identified the problem, investigated the situation and reported it to the proper authorities.

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