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FORM 10-KSB
[As last amended in Release No. 33-7505, effective January 1, 1999, 63 F.R.9632]
U.S. Securities and Exchange Commission
Washington, DC 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31,1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from .............. to ..............
Commission file number .................................
Merge Technologies Incorporated
Name of small business issuer in its charter
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Wisconsin Identification No.) 39-1600938
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1126 South 70th Street, Milwaukee, Wisconsin 53214-3151
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: 414-475-4300
Securities registered under Section 12(b) of the Exchange Act:
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Title of each class: Common Name of each exchange on which registered: NASDAQ Small Cap
Securities registered under Section 12(g) of the Exchange Act: ............................................. (Title of class)
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Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year. $9,669,172
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, or the average bid and asked price of such common
equity, as of a specified date within the past 60 days. (See definition of
affiliate in Rule 12b-2 of the Exchange Act.)
- The aggregate market value for the Registrant's stock held by
non-affiliates of the Registrant based upon the closing sale price of the Common
Stock on March 29, 1999 as reported on the NASDAQ Small Cap Market System, was
approximately $7,330,681. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 5,778,216.
DOCUMENTS INCORPORATED BY REFERENCE
If the following documents are incorporated by reference, briefly
describe them and identify the part of the Form 10-KSB (e.g., Part I, Part II,
etc.) into which the document is incorporated: (1) any annual report to security
holders, (2) any proxy or information statement; and (3) any prospectus filed
pursuant to Rule 424(b) or (c) of the Securities Act of 1933 ("Securities Act").
The list documents should be clearly described for identification purposes
(e.g., annual report to security holders for fiscal year ended December 24,
1990). The information required by Part III is incorporated by reference to the
Company's Proxy Statement for the 1999 Annual Meeting of Stockholders.
Transitional Small Business Disclosure Format (check one):
Yes _____ No__X___
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INDEX
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Page
PART I
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Item 1. Description of Business............................................................ 1
Item 2. Description of Properties..........................................................11
Item 3. Legal Proceedings..................................................................11
Item 4. Submission of Matters to a Vote of Security Holders................................11
PART II
Item 5. Market for Common Equity and Related Stockholder Matters...........................12
Item 6. Management's Discussion and Analysis...............................................14
Item 7. Financial Statements...............................................................20
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...........................................................36
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons.......................36
Item 10. Executive Compensation; Compliance with Section 16(a) of the Exchange Act..........36
Item 11. Security Ownership of Certain Beneficial Owners and Management.....................36
Item 12. Certain Relationships and Related Transactions.....................................36
Item 13. Exhibits and Reports on Form 8-K...................................................37
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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
Certain statements in this report that are not historical facts
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of
1933, as amended (the "Securities Act") and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Discussions containing
such forward-looking statements may be included herein in the material set forth
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations" as well as within this report generally. In addition, when used
in this report, the words "believes," intends," "anticipates," "expects" and
similar expressions are intended to identify forward-looking statements. These
statements are subject to a number of risks and uncertainties, including, among
others, the Company's lack of consistent profitability, history of operating
losses, fluctuations in operating results, credit and payment risks associated
with end-user sales, involvement with rapidly developing technology in highly
competitive markets, dependence on major customers, expansion of its
international sales effort, broad discretion of management and dependence on key
personnel, risks associated with product liability and product defects, costs of
complying with government regulation, changes in external competitive market
factors which might impact trends in the Company's results of operation,
unanticipated working capital and other cash requirements, general changes in
the industries in which the Company competes, and various other competitive
factors that may prevent the Company from competing successfully in the
marketplace. Actual results could differ materially from those projected in the
forward-looking statements. The Company undertakes no obligation to publicly
release the result of any revisions to these forward-looking statements that may
be made to reflect any future events or circumstances.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Merge Technologies Incorporated is an international provider of
clinical information systems integration solutions for healthcare organizations.
Current offerings include software, hardware, and integration component products
that facilitate networking and information management of image-producing and
image-using devices in diagnostic radiology. A hospital or an imaging center can
use Merge Technologies' components to create a communications bridge between
incompatible devices, permit radiologists to use video images on electronic
workstations or film as a diagnostic medium and create a diagnostic-quality
electronic archive of imaging results. In addition, the Company's products can
convert the data generated by medical imaging devices into concise electronic
reports with relevant images that may be distributed in a health care
organization's information network or included in an electronic patient record
("EPR").
The incompatibility of the various "legacy" imaging devices in a
typical radiology department or diagnostic imaging center has made the sharing
of diagnostic information difficult. The Company's MergeBOX(TM) products convert
the output of medical image-producing devices such as Computed Tomography ("CT")
scanners and Magnetic Resonance ("MR") scanners into an industry-standard
network communications protocol known as DICOM (Digital Imaging Communications
for Medicine or the "DICOM standard"). The Company's component products also
connect various legacy diagnostic image printers and workstations and other
image-using devices to a DICOM network. The Company's MergeCOM(TM)
communications software is used worldwide by most medical imaging device
manufacturers to build DICOM into new scanners and image-using devices.
Other Merge products store DICOM images into a permanent electronic
archive, facilitate the creation of electronic reports containing relevant
diagnostic images, and manage the secure distribution of reports via fax or an
intra/extranet. In addition, the Company also provides consulting services to
assist customers in the planning and implementation of electronic imaging
information systems.
Radiology departments and diagnostic imaging centers and their
customers benefit from the Company's solutions in a variety of ways including:
(i) networking of multiple image-producing and image-using devices eliminates
redundancy, resulting in reduced capital equipment expenditures; (ii) permanent
electronic archives of diagnostic-quality imaging results can be created,
enabling the retrieval of these images and reports at any time in the future;
(iii) the modular architecture of the Company's products allows radiology
departments and other diagnostic imaging centers to build their electronic image
management systems in an incremental, flexible and cost-effective manner;
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and (iv) with the continued development of health care information technology,
diagnostic images and reports collected and managed with the Company's
technology can readily be incorporated into a patient's EPR.
INDUSTRY BACKGROUND
In recent years, managed care has been applied to health care in an
effort to introduce increased efficiency to the health care delivery system. Any
attempt to increase efficiency requires a dramatic improvement in the exchange
of information between the various participants in the health care delivery
system. The EPR is the concept of a patient-specific repository of medical and
financial information that can be accessed by various participants in the health
care delivery system, including, but not limited to, attending and consulting
physicians, insurance providers, medical laboratories, pharmacies, and the
various departments of a hospital, clinic, nursing home or other care providing
organization
The health care industry is working to automate the collection and
storage of clinical and financial data within the various departments of health
care institutions, and, ultimately, to create an EPR by connecting such
departments into an electronically networked system. In a national survey of
health care information professionals conducted in February of 1997 by the
Health Information Management Systems Society ("HIMSS") and the Hewlett-Packard
Company ("Hewlett-Packard"), the 1997 HIMSS/Hewlett-Packard Leadership Survey,
twenty percent of those professionals indicated that their information
technology budgets would grow by more than fifty percent in the following two
years and sixty-nine percent indicated that their budgets would grow by more
than ten percent in the following two years. Fifty percent of respondents
indicated that upgrading their information technology infrastructure and
integrating existing systems from multiple vendors were their current top
priorities.
Recently developed health care information technology has greatly
improved the electronic management of textual and numeric data but, with the
exception of picture archiving and communication systems ("PACS"), such systems
still lack the ability to acquire, store and manage electronically the large
number of diagnostic images produced by radiological examinations. While a
large-scale PACS would permit electronic image transmission, storage, retrieval
and display, such systems have not been widely accepted by the diagnostic
imaging community for several reasons, including: (i) a PACS is usually very
expensive, with a complete PACS for a hospital radiology department or
diagnostic imaging center performing 150,000 procedures per year frequently
costing over $6 million; (ii) the existing inventory of legacy image-producing
and image-using devices cannot typically be cost-effectively integrated into a
PACS thereby negating the department's previous capital expenditures; (iii) the
unedited data output of a PACS may overload an institution's communications
network due to the large number of images generated by a typical imaging study;
and (iv) the preference of most radiologists to use "hard copy" film for
diagnostic purposes rather than a "soft copy" diagnosis on video display
terminals of a typical PACS. Accordingly, the distribution of medical images has
continued to be a manual, labor-intensive and inefficient process based on the
sharing of a single patient film jacket filled with individual film sets.
Electronic image management is made especially difficult due to the
incompatibility of the communications protocols and data formats between medical
imaging devices produced by different OEMs. The OEMs that dominate the US and
international markets for medical image-producing equipment are the GE Medical
Systems Division of the General Electric Company ("GE"), Philips Medical Systems
Nederland B.V. ("Philips"), Picker International, Inc. ("Picker"), Siemens A.G.
("Siemens") and Toshiba Corp. ("Toshiba"). The OEMs that dominate the U.S. and
international markets for medical image-using equipment are Sterling Diagnostic
Imaging, Inc. ("Sterling"), the Eastman Kodak Company ("Kodak"), Agfa-Gevaert
N.V. (a division of Bayer Corporation) ("Agfa"), Fuji Photo Film Co., Ltd.
("Fuji") and Konica Medical Corporation ("Konica"). Such OEMs historically
designed their medical imaging devices to include proprietary communications
protocols and internal data formatting technology unique to each company's
products.
To date, no single OEM has been able to maintain a commanding
technological position in all facets of diagnostic imaging. Generally, medical
institutions have focused on diagnostic quality, cost, reliability or other
attributes of specific devices in making their capital expenditure decisions
rather than on acquiring a full suite of equipment from a single OEM. As a
result, the existing equipment base includes numerous OEM-specific
communications protocols and data formats that have historically precluded
devices manufactured by different OEMs, and sometimes by the same OEM, from
communicating with each other or with various image-using devices.
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This incompatibility has typically required the purchase of redundant
hardware systems, thereby increasing costs. For example, a separate medical film
printer or workstation usually must be connected directly to each digital x-ray,
MRI or CT device in a hospital radiology or other diagnostic imaging center
department instead of being shared by several such devices.
In non-medical communications network environments, equipment owners,
systems integrators and competing OEM vendors have been relatively free to
modify proprietary equipment in order to make such equipment connect with
devices manufactured by third party OEMs. However, after-market modification of
medical imaging devices generally is not practical, since such devices are
subject to government regulation due to patient safety concerns. Further, OEMs
have the ability to void the warranty on their equipment if modified by third
parties not approved by the OEM.
OEM SUPPORT AGREEMENTS
In recent years, OEMs have increasingly recognized that their
OEM-specific communications protocols and data formats of their legacy devices
have interfered with the connectivity needs of their customers. The Company has
successfully negotiated agreements under which such OEMs have supplied the
Company with the technical specifications and software algorithms necessary for
communicating with these legacy products. Such OEMs have additionally agreed to
notify the Company of any updates to their technical specifications and
software. Currently, the Company has signed agreements with over 20 OEMs
including GE, Philips, Picker, Siemens and Toshiba, representing more than 90%
of the diagnostic imaging device market. These agreements have permitted the
Company to develop products that directly address the connectivity problems
associated with legacy image-producing and image-using devices. The Company
considers its access to the proprietary communications protocols and the data
formatting technologies of these OEMs, while not exclusive, to be a substantial
competitive advantage for its business.
NETWORK COMMUNICATIONS PROTOCOLS FOR MEDICAL IMAGING APPLICATIONS
In order to solve the imaging device connectivity problem and
eventually to replace the proprietary communications protocols and data formats
discussed above, a joint committee of the American College of Radiology ("ACR")
and the National Electrical Manufacturers' Association ("NEMA") was formed in
1984 to create an open standard method of describing and communicating medical
images over a network. The joint committee includes representatives of many of
the major companies in the medical imaging industry including Siemens, Philips,
GE, Picker, Kodak, Agfa, and the Company. Version 3.0 of the DICOM standard was
released in 1992 and has become the first medical data communications standard
to be adopted worldwide. Recently ACR and NEMA agreed to create an independent
DICOM Standards Committee to continue the ongoing work of developing DICOM. The
contents of the DICOM standard are determined by the consensus of the membership
of the DICOM Standards Committee, which now includes representatives of
biomedical professional organizations, manufacturers, trade associations, other
standards development organizations, and governmental agencies worldwide. The
activities of the Committee are administered by NEMA, and the Committee owns the
DICOM standard. The development and use of DICOM has made possible the efficient
collection and management of clinical data that is produced and used by medical
imaging devices.
William C. Mortimore, the Company's President, has been a member of the
ACR/NEMA joint committee since its establishment in 1984. In addition, several
other Company employees, as well as employees of certain of the Company's
competitors, occupy leadership positions on this committee and the Standard's
working groups. The Company has found that its leadership in the setting of
standards for medical communications protocols has provided important
technological and strategic insights that have facilitated the successful
development and deployment of its products and services.
PRODUCTS AND SERVICES
The Company's products and services available today include: (i)
MergeWorks(TM) Connectivity Products --for retrofitting legacy medical
image-producing and image-using devices thereby rendering such devices capable
of communicating over a DICOM network; (ii) OEM Interface Products --
connectivity software tool kits and interface
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board products that enable original equipment manufacturers ("OEMs") to
manufacture new radiology image-producing and image-using devices capable of
directly communicating with the DICOM standard; (iii) Networked Image Management
Products - networked DICOM-compatible products which provide for the selection,
processing, storage and distribution of specific diagnostic images and
associated information, and the integration of the imaging department with the
EPR; and (iv) Clinical Systems Integration Services -- systems integration for
the design and installation of DICOM networks and information systems, including
training, design assistance, testing, and project management services.
MergeWorks(TM) Connectivity Products
The Company sells MergeWorks(TM) Connectivity Products for retrofitting
legacy medical image-producing and image-using devices thereby rendering such
devices capable of communicating over a DICOM network. These products address
the incompatibility of proprietary communications protocols used by medical
image-producing and image-using devices by converting the output from a
customer's existing equipment base of image-producing devices into the DICOM
standard format. Once in DICOM, such data can be made generally available on a
network and can be converted into the particular proprietary language required
by any image-using device on the network. The Company's MergeWorks Connectivity
Products permit an institution to continue to benefit from its often substantial
installed base of legacy equipment and devices and realize the efficiencies of a
network without incurring a large up-front capital cost as would be the case
with a large scale PACS solution. The Company's MergeWorks Connectivity Products
include:
Image Acquisition - MergeBOX(TM) -- The Company developed and
introduced its first MergeBOX in 1989. The MergeBOX converter comprises
software and hardware that transforms data generated by legacy
image-producing devices into the DICOM standard or other desired formats.
Image data converted by the MergeBOX into DICOM can be transmitted over a
network for (i) printing on a DICOM-networked laser film printer; (ii)
processing, manipulation and viewing at video display stations; (iii) remote
access to images for telemedicine, the practice of medical diagnostics and
recommendation of treatment from remote locations by the use of
telecommunications; and (iv) incorporation of images into an electronic
image information management system or an EPR. MergeBOX is available for
hundreds of different models of diagnostic image-producing devices.
Image Printing - MergeAPS(TM) -- The MergeAPS print server permits
DICOM formatted data to be converted into the proprietary language of a wide
variety of legacy medical laser film printers. The MergeAPS print server
plays a key role in transforming stand-alone medical laser film printers to
shared devices on a network, thereby eliminating the need for individual
printers for each image-producing device. In addition, the MergeAPS print
server contains a limited storage capacity permitting images to be retained
for a short period of time for re-printing.
OEM Interface Products
The Company sells software tool kits and interface board products that
it uses in its own products to other OEMs, allowing them to manufacture new
radiology image-producing and image-using devices capable of directly
communicating with the DICOM standard. The Company's OEM Interface Products
include:
OEM Connectivity -- MergeCOM-3(TM) Software -- The MergeCOM-3 software
tool kit permits OEMs to design image-producing and image-using devices
capable of communicating directly in the DICOM format thereby rendering such
equipment network-ready and avoiding the need for the MergeBOX. The Company
has over 180 licensing agreements with OEMS of imaging devices. The
MergeCOM-3 software tool kit is available for over 35 different computer
platforms, representing nearly all of the technologies currently employed in
medical imaging devices.
OEM Connectivity -- Interface Boards -- The Company's board level
interface products are sold to OEMs that want to build into their products
at the design stage the ability to connect to other OEMs' proprietary
systems, with or without DICOM conversion. The Company's interface boards
are also an integral part of several of the Company's products such as some
models of the MergeBOX converter and the MergeAPS print server. Direct
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sales of interface boards to OEMs for inclusion in their own equipment
permits the Company to achieve economies of scale in interface board
production.
Networked Image Management Products
Image Storage -- MergeARK(TM) -- The MergeARK DICOM image archive plugs
into a DICOM-compatible network. MergeARK can acquire images and related
clinical information from any number of image sources including
image-producing devices, displays and workstations and laser filmer print
servers. Images can be stored permanently, in diagnostic quality on CDs or
other archival media, for later retrieval over the network, for such
applications as film reprints, supporting the EPR and telemedicine. Without
the DICOM standardization provided by the Company's products, each
incompatible device would require its own dedicated archive. The MergeARK
digital image archive is fully scalable: a user can upgrade the size of the
archive incrementally through the installation of additional modular storage
devices.
Image Management -- CaseWorks(TM) -- The CaseWorks radiology workflow
management tool builds on the Company's MergeWorks product line to manage
the large volume of image data generated in radiology departments and other
diagnostic imaging centers and to facilitate the integration of such data
into the EPR. Because of their clinical expertise and diagnostic experience,
radiologists are best positioned to determine specific images that are
pertinent for inclusion in the patient file from among the large number of
images generated for a patient. Historically, radiologists have favored the
use of film rather than computer workstations for diagnosis. The CaseWorks
management tool directly addresses this preference by allowing radiologists
to continue to use film as a primary diagnostic medium while facilitating
the electronic selection of images for inclusion in the EPR. During the
process of collecting and preparing images for printing on film for
diagnosis, each image is assigned a unique, machine-readable identifier
(similar to a bar code) which is printed next to each image. A radiologist
can prepare a case by selecting the images to be included in the EPR using
the MergePoint hand-held device. Thereafter, the selected images can be
retrieved, along with the text report, from the MergeARK archive by various
participants in the health care system. The CaseWorks management tool also
supports dictation within the MergePoint hand-held device. The Company added
dictation as a feature to the first CaseWorks product release, and therefore
delayed development beyond the originally scheduled 1998 release date.
CaseWorks is in clinical trial, and is expected to be available for sale in
the second quarter of 1999.
In 1996, in anticipation of the introduction of the CaseWorks
management tool, the Company entered into an agreement with a technology
supplier under which the Company was granted a worldwide exclusive license
to duplicate and distribute decoding software embedded in hand-held readers.
The Company was also granted a worldwide exclusive license to duplicate and
distribute encoding software used by the Company in recording identifying
marks on x-ray film. Exclusivity under this agreement will lapse on November
1, 2000. Thereafter, in the event that the Company ceases to distribute both
licensed products for a period of twenty-four months, any license in effect
will automatically terminate. The Company has been granted two United States
patents related to the CaseWorks and also has patents pending in several
foreign countries. See "Intellectual Property."
Image Management - ReportWorks(TM) (previously described as Report
Manager)- The Company is developing a report server for automated assembly
and secure distribution of radiology reports containing text and pertinent
diagnostic image data, such as those provided by CaseWorks. These reports
can be published in a variety of media including facsimile, telemedicine and
hypertext markup language (HTML), a format for intranet and internet
applications. The development of ReportWorks was delayed as lower than
expected sales caused the Company to redirect available cash away from this
project. The Company expects ReportWorks to be available for sale by the end
of 1999.
Management Information Integration - TechWorks(TM) -- Accurate
identification of a particular patient's images is paramount for electronic
image information management and inclusion of images in an EPR. TechWorks,
as a stand-alone plug-in component or as an upgrade to an existing MergeBOX,
will allow the technologist operating an image-generating device to interact
with the hospital information system to insure accuracy in the scheduling,
registration and data capture of a particular patient's imaging study.
TechWorks is expected to be available for sale in the second quarter of
1999.
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Information Integration - MergePort(TM) - MergePort is a plug-in
electronic gateway that allows patient registration and demographic
information from hospital information systems to be shared with a DICOM
imaging network, and reports and images from a DICOM imaging network to be
shared with a hospital information system. MergePort is in clinical trial
and is expected to be available for sale in the second quarter of 1999.
Clinical Systems Integration Services
Since 1996, the Company has offered clinical systems integration
services to radiology departments, imaging centers, OEMs and VARs. Such services
include PACS consulting, DICOM training, DICOM conformance testing and project
management. The Company's consultants and trainers are active participants and
leaders in the DICOM, HL-7 and other medical standards committees. This activity
promotes the image of the Company as a solution provider, and facilitates the
sale of the Company's component products.
STRATEGY
The Company's goal is to become a leading provider of connectivity and
information management solutions that facilitate the integrating of medical
imaging devices into complete medical imaging information management systems.
The Company intends to achieve this objective through the implementation of the
following strategy:
Sell MergeWorks Connectivity Products for retrofitting legacy radiology
image-producing and image-using devices.
The majority of the Company's current revenue is generated through the
sale of devices that enable existing radiology image-producing and image-using
equipment to connect to a DICOM network. The Company expects sales of such
devices to grow as (i) radiology departments and other diagnostic imaging
centers that have no DICOM capability or that are partially DICOM-compliant
retrofit additional existing machines with the Company's products, and (ii)
radiology departments and other diagnostic imaging centers install new DICOM
networks that require the retrofitting of all or some of their existing
equipment base with the Company's products. According to a study commissioned by
the Company and conducted by Technology Marketing Group, a diagnostic imaging
market consulting organization located in Des Plaines, Illinois, the number of
radiology departments at hospitals that can use the Company's products totals
approximately 5,500 in the United States and 17,000 internationally. Within
these facilities, there is an estimated total installed base of approximately
250,000 image-producing and image-using devices.
Sell OEM Interface Products for new radiology image-producing and
image-using devices.
The Company currently sells software tool kits that enable
manufacturers of new radiology image-producing and image-using devices to
connect their machines directly to a DICOM network. The Company expects sales of
such software tool kits and interface boards to grow as manufacturers of
radiology image-producing and image-using devices upgrade and expand their
current product lines. According to the Technology Marketing Group study, the
estimated annual sales of new radiology image-producing and image-using machines
totals approximately 11,000 units in the United States and 33,000 units
internationally.
Sell Networked Image Management Products to users of DICOM networks.
The Company is developing Networked Image Management Products that
enable radiologists to select and mark for retrieval specific selections of
medical imaging data. These products are anticipated to reduce the amount of
data required to be shared over a network and facilitate the development of the
EPR. The Company expects to market these products to radiology departments and
other diagnostic imaging centers that are already connected to a DICOM network,
including networks provided by the Company.
Sell Clinical Systems Integration Services.
The Company offers its customers Clinical Systems Integration Services
that range from training and consulting engagements without any sales of the
Company's component products to the project management of a large-scale system
consisting of products from the Company and other vendors.
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Expand the Company's Product and Service Offerings to Other Image-Intensive
Departments in Medical Institutions.
Many devices in medical institutions produce or use images that need to
be viewed, transmitted and stored. Departments that use devices of this type
include radiotherapy, endoscopy, pathology, urology, mammography and dialysis.
The Company already has a prominent position in radiotherapy as a supplier of
DICOM technologies to the majority of vendors.
The Company believes that machines used by radiology and such other
departments will ultimately be connected to the hospital's information network
and that images produced by these machines will eventually be stored in an EPR.
The Company intends to develop connectivity products for such devices by
applying its expertise in standardized communications protocols to bridge the
gap between DICOM and HL-7, the developing standard for hospital information
technology networks, and by leveraging its strong relationships with the
manufacturers of medical image-producing and image-using devices. Certain
employees of the Company have been: (i) members of the ACR/NEMA DICOM standard
setting joint committee since its formation in 1984; (ii) active members of the
HL-7 standard setting committee for hospital administrative information networks
since 1994; and (iii) core members of the Andover Working Group since 1997.
Employees of certain competitors maintain membership in the HL-7 committee, but
no employees of the Company's competitors are core members of the Andover
Working Group. The Andover Working Group, sponsored by Hewlett-Packard, was
formed in 1995 to develop specific implementations of medical data communication
standards. The primary activities of the Andover Working Group have been
conducted by approximately twenty-five core members. The core members that
represent diagnostic imaging are Philips and the Company. The initial
accomplishment of the Andover Working Group has been agreement on an
implementation of a subset of HL-7.
Expand the Company's System Solutions Approach to Europe and the Far East
Historically the Company has sold a substantial amount of its component
technologies to OEM and VAR customers outside the United States. Foreign OEM/VAR
sales accounted for 40% of total OEM/VAR sales in 1998.
The system solutions approach has contributed strongly to the overall
growth of the Company and has accounted for 30%, 55% and 69% of total domestic
sales in 1996, 1997 and 1998, respectively. In 1998, the Company deployed sales
personnel in Germany and the Netherlands to extend sales of system solutions to
the European Union. Three sales people are focused on sales of system solutions
in Europe as of March 26, 1999. Depending on the level of success, the Company
intends to expand this approach in the Far East.
SALES, MARKETING AND DISTRIBUTION
The Company markets its products and services to four types of
customers: (i) OEMs that typically design and manufacture standard model devices
such as MRI, CT and CR (computed radiography) scanners, and digital x-ray
machines and other products that are not customized by the OEM for the
individual customer; (ii) VARs that design and implement customized solutions,
typically utilizing products manufactured by third parties, for their customers'
particular needs; (iii) dealers that act as retail distributors to end-users of
products manufactured by third parties; and (iv) end user customers that
purchase clinical information systems directly from the Company. The medical
imaging device market is dominated by a limited number of high volume vendors
with multiple divisions. As a result, depending on the specific product being
sold and how it will be utilized, different divisions of a single customer, each
with separate relationships with the Company, may fall into more than one of the
types of customers listed above.
The Company markets its MergeWorks Connectivity Products to VARs,
dealers and end-users. The MergeWorks Connectivity Products enable VARs to
connect the image-producing and image-using devices manufactured by different
OEMs into the customized solutions that they market to their customers. Dealers
market the MergeWorks Connectivity Products directly to end-users typically as
part of a catalog of medical imaging related products.
The Company markets its Networked Image Management Products to dealers
and end-users as information management tools to be used over a radiology
department's network.
The Company markets its MergeCOM-3 software tool kit directly to OEMs
through more than 180 licensing agreements with such OEM/VARS. Utilizing the
MergeCOM-3 software tool kit and the Company's interface boards, OEMs are able
to build DICOM capability directly into their products at the design stage. To a
more limited extent, the Company licenses the MergeCOM-3 software tool kit to
end-users that have in-house systems integration capability.
7
<PAGE> 10
The Company's marketing relationships with OEMs are based in large part
on its long-standing relationships with the engineering and research and
development personnel of such OEMs. Such relationships have grown from the
Company's past success in negotiating OEM Support Agreements (see "OEM Support
Agreements") with such OEMs and the Company's participation in the ACR/NEMA
DICOM joint committee. Because of the limited number of medical imaging device
OEMs, the Company relies heavily on repeat sales to such OEMs. The Company's
marketing efforts with respect to VARs are focused on direct sales efforts and
advertising to the sales engineering personnel of such VARs that design and sell
customized end-user solutions. The Company has worked to leverage its
relationships with the technical personnel of such VARs to support its VAR sales
efforts. At December 31, 1998 the Company employed four sales professionals to
market to OEMs and VARs. Net sales to OEMs and VARs accounted for 70% of the
Company's net sales in 1996, 59% for 1997 and 50% in 1998.
The Company's end-user sales initiative is predominantly focused on
sales through dealers. The Company has cultivated relationships with dealers
that permit Company personnel to participate in presentations to potential
customers. Pursuant to such relationships, once an end-user sale is made, the
Company sells its products to the dealer for resale to the end-user. The Company
markets to dealers and end-users through direct sales efforts, advertising and
repeat business generated by its customer support efforts. At December 31, 1998,
the Company employed eight sales professionals that market to dealers and
end-users. Net sales to end-users accounted for 30% of the Company's net sales
in 1996, 41% for 1997 and 50% for 1998. The Company believes that net sales to
end-users as a percentage of total net sales will increase in the future.
The Company supports its general marketing efforts by exhibiting its
products directly to customers in major trade shows, through its Internet
site and through direct customer support. With respect to trade shows, the
Company exhibits its products at the Radiological Society of North America
annual meeting and the European Congress of Radiology and occasionally other
regional trade shows. Because the medical imaging industry is dominated by a few
large participants, such trade shows, which employees of most such participants
attend, are viewed by the Company as an integral part of its marketing strategy.
The Company's Internet site (www.merge.com) was established in 1995
and currently averages approximately 70,000 hits per month and provides access
to the Company's marketing materials, technical product information and its
technical support staff.
The Company's technical support staff conducts a service training
course for OEM and VAR personnel on a regular basis, providing the Company's
customers with the expertise needed to install and support the Company's
products. The Company seeks to respond quickly to customer requests for
technical support and service through a telephone hotline, on-line remote
service support, which is a capability built into the MergeWorks Connectivity
and Networked Image Management Product lines, and overnight exchange of
defective parts or products. The Company provides a limited one-year parts or
factory repair warranty on its products. Although the Company's warranty policy
permits customers to return the Company's products in the event of malfunction,
product returns to date have not been significant.
An important component of the Company's business plan includes
increasing sales to customers located outside the United States. The Company
operates a sales office in the Netherlands and, as of December 31, 1998, employs
twelve full-time staff in Europe who perform sales and technical customer
support roles. The Company also has engaged a full time consultant in Japan to
perform sales and customer support roles.
The Company sells a majority of its products to a relatively limited
number of OEMs, VARs and dealers. Aggregate sales to the Company's ten largest
customers represented approximately 68% of the Company's net sales in 1996, 74%
in 1997 and approximately 70% in 1998. During 1997, Picker and Philips accounted
for approximately 23% and 14%, respectively, of the Company's net sales. For
1998, Picker and Konica accounted for approximately 18% each of the Company's
net sales. There can be no assurance that the Company's current customers will
continue to place orders with the Company or that the Company will be able to
obtain orders from new customers. The loss of any one or more of the Company's
major customers could materially adversely affect the Company's business and
operating results.
MANUFACTURING
The Company's manufacturing activities consist primarily of assembling
and testing hardware components and subassemblies acquired from vendors, and
loading and testing the Company's software products. Certain components are
designed by the Company to its specifications and manufactured by outside
vendors. The Company operates under the Good Manufacturing Practices promulgated
by the FDA and is a registered medical device manufacturer. In addition, the
Company has recently received ISO 9001:EN46001 certification for its design and
development, production, installation and servicing processes.
8
<PAGE> 11
The Company purchases industry standard parts and components for the
assembly of its products, generally from multiple vendors. The Company has
elected to rely on a limited number of subcontractors for certain subassembly
functions in order to achieve more advantageous pricing through increased
volume. However, the Company believes that additional subcontractors are
available to perform these subassembly functions. The Company maintains good
relationships with its vendors and, to date, has not experienced any material
supply problems. Any substantial problems with suppliers, however, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
COMPETITION
The markets for the Company's products are highly competitive. Many of
the Company's customers purchase products from both the Company and its
competitors. The Company currently competes primarily with DeJarnette Research
Systems, Inc. ("DeJarnette") in the retrofitting of legacy medical systems to
enable DICOM standard connectivity. The MergeCOM-3 software tool kit primarily
competes directly with DeJarnette and Mitra Imaging Inc. ("Mitra"), and
indirectly with the Radiological Society of North America, which offers a
version of DICOM, that was originally developed by Mallinckrodt Institute of
Radiology, as "freeware" available to be downloaded without charge from the
Internet, but which offers more limited features and no user support.
In the application of MergeWorks Connectivity Products specifically for
hardcopy film networks, which includes MergeAPS and MergeBOX products, the
Company competes with film vendors, including Kodak, Agfa, Sterling and Imation.
However, since the MergeAPS print server works with any of the laser film
printers available from these vendors, these companies have also purchased the
Company's products when they have needed networked filming solutions involving
their competitors' products. The Company expects competition to increase in the
future from existing competitors and from other companies that may enter the
Company's existing or future markets. In addition, although many PACS
manufacturers are currently customers of the Company, the Company faces
competition from PACS manufacturers. The Company could face competition from
networking equipment and telecommunications manufacturers if these companies
were either to develop DICOM capability for their products or purchase products
which provide DICOM capability from one of the Company's competitors.
The Company could also face competition from a number of companies in
the health care information technology sector, including, without limitation,
Dynamic Healthcare Technologies, Inc. and Lanvision Systems, Inc. Many of the
Company's current and potential competitors have greater resources than those of
the Company in areas including finance, research and development, intellectual
property and marketing. Many of these competitors also have broader product
lines and longer standing relationships with medical imaging customers than
those of the Company.
The Company believes that its ability to compete successfully depends
on a number of factors both within and outside of its control, including
applications innovation; product quality and performance; price; experienced
sales, marketing and service organizations; rapid development of new products
and features; continued active involvement in the development of DICOM and other
medical communication standards; and product and policy decisions announced by
its competitors. There can be no assurance that the Company will be able to
compete successfully with its existing or any new competitors.
INTELLECTUAL PROPERTY
The Company received U.S. Patent number 5,740,248 for Caseworks on
April 14, 1998 and will receive a second patent in April, 1999. The Company has
also filed a Regional European patent application and foreign patent
applications on CaseWorks in Australia, Canada, Czech Republic, Finland, Japan,
Korea, New Zealand and Norway. However, the Company generally does
not rely on patent protection with respect to its products. Instead, the Company
relies on a combination of copyright and trade secret law, employee and third
party nondisclosure agreements and other protective measures to protect
intellectual property rights pertaining to its systems and technology. There can
be no assurance, however, that applicable copyright or trade secret law or these
agreements will provide meaningful protection in the event of any unauthorized
use, misappropriation or disclosure of the Company's copyrights, trade secrets,
know-how or other proprietary information.
9
<PAGE> 12
In addition, the laws of certain foreign countries do not protect the
Company's intellectual property rights to the same extent as do the laws of the
United States. There can be no assurance that third parties will not assert
patent, copyright or other intellectual property infringement claims against the
Company with respect to its products or technology or other matters. There may
be third party patents, copyrights and other intellectual property relevant to
the Company's systems and technology which are not known to the Company.
Although no third party has asserted that the Company is infringing such third
party's patents, copyrights or other intellectual property, there can be no
assurance that litigation asserting such claims will not be initiated, that the
Company would prevail in any such litigation, or that the Company would be able
to obtain any necessary licenses on reasonable terms if at all. Any such claims
against the Company, with or without merit, as well as claims initiated by the
Company against third parties, can be time-consuming and expensive to defend or
prosecute and to resolve. To date, the Company has not initiated any
intellectual property infringement claims and, to the Company's knowledge, no
such claims have been asserted against it.
In the year 2000, many existing computer programs that use only two
digits (rather than four) to identify a year in the date field could fail or
create erroneous results if not corrected. This computer program flaw is
expected to affect virtually all companies and organizations. The Company cannot
quantify the potential costs and uncertainties associated with this computer
program flaw at this time, but does not anticipate that the effect of this
computer program flaw on the operations of the Company will be significant.
However, the Company may be required to spend time and monetary resources
addressing any necessary computer program changes. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
GOVERNMENT REGULATION
The manufacturing and marketing of the Company's products are subject
to government regulation as medical devices in the United States by the Food and
Drug Administration ("FDA") and in other countries by corresponding foreign
regulatory authorities.
The process of obtaining and maintaining required regulatory clearances
and approvals is lengthy, expensive and uncertain. The Company believes that its
success depends upon commercial sales of improved versions of its products,
certain of which cannot be marketed in the United States and other regulated
markets unless and until the Company obtains clearance or approval from the FDA
and its foreign counterparts.
The Company has registered as a medical device manufacturer with the
FDA. The Company is inspected on a routine basis by the FDA to determine
compliance with the FDA's Quality System Regulation and other applicable
regulations.
The FDA generally requires that a manufacturer seeking to market a new
medical device or an existing medical device for a new indication obtain either
a premarket notification clearance under Section 510(k) of the Federal Food,
Drug and Cosmetic Act (the "FDC Act") if the product is substantially equivalent
to a product existing at May 28,1976, or a premarket approval under the FDC Act
("PMA") prior to the introduction of such product into the market. Certain
medical devices are exempt from premarket notification clearance by the FDA.
Material changes to existing medical devices are also subject to FDA review and
clearance or approval prior to commercialization in the United States. The
Company is currently relying on the Section 510(k) premarket notification method
to obtain governmental clearance ("510(k) clearance") to market its medical
devices in the United States.
Although it is believed to be a shorter, less costly means of
satisfying the requirements of the FDC Act than the process to obtain a PMA, the
process of obtaining a 510(k) clearance generally requires supporting data,
which can be extensive and extend the regulatory review process for a
considerable length of time. All models of the Company's systems that are
commercially available, other than the software toolkits, have received 510(k)
clearance. The software toolkits are not freestanding products and are
incorporated as components of other medical devices. The manufacturer of the
completed medical device is responsible for obtaining any required clearance or
approval from the FDA. The CaseWorks management tool and the MergePort and
Report Works integration tools are currently under development. Their regulatory
status and premarket submission requirements will be determined when product
development is completed. There can be no assurance that 510(k) clearance, if
necessary, for any future product or modifications of existing products will be
granted by the FDA within a reasonable time frame, if at all. Furthermore, the
FDA may require that a request for 510(k) clearance be supported by data from
clinical trials demonstrating "substantial equivalence" and the safety and
effectiveness of the device, which may prolong the Section 510(k) notification
review period for a particular device or may result in a finding that the
product does not meet the substantially equivalent test, so that a full PMA
could be required.
10
<PAGE> 13
The Food and Drug Administration Modernization Act of 1997 (the
"Amendment") was enacted on November 21, 1997, and became effective on February
19, 1998. The Amendment is designed, in part, to facilitate the FDA's premarket
notification clearance process for new products. The Company believes that the
new regulatory policy may enable device-makers to introduce new products more
quickly. However, the extent to which the Amendment will speed the FDA's
clearance process is not known at this time.
Failure to comply with applicable regulatory requirements could result,
among other things, in warning letters, seizures of products, total or partial
suspension of production, refusal of the government to grant market clearance or
pre-market approval, withdrawal of approvals or criminal prosecution.
The Company is also subject to other federal, state and local laws and
regulations relating to safe working conditions and manufacturing practices. The
extent of government regulation that might result from any future legislation or
administrative action cannot be predicted. Failure to comply with regulatory
requirements could have a material adverse effect on the Company's business,
financial condition and results of operations.
Sales of the Company's products outside the United States are subject to
foreign regulatory requirements that vary from country to country. Additional
approvals from foreign regulatory authorities may be required, and there can be
no assurance that the Company will be able to obtain foreign marketing approvals
on a timely basis or at all, or that it will not be required to incur
significant costs in obtaining or maintaining its foreign regulatory approvals.
In Europe, the Company has obtained the certificates necessary to enable the CE
Mark, a non-expiring, international symbol of adherence to quality assurance
standards promulgated by the European Union and compliance with applicable
European Union Medical Device Directives, to be affixed to the Company's
products for sales in member countries. Failure to obtain or maintain any
necessary certifications or foreign regulatory approvals or any other failure to
comply with regulatory requirements outside the United States could have a
material adverse effect on the Company's business, financial condition and
results of operations.
EMPLOYEES
As of December 31, 1998, the Company had 85 employees, including 28
employees in research and development, ten in manufacturing, 14 in quality
control, service and support, 12 in sales, ten in sales and marketing support
activities and 11 in general administration and finance. Twelve of the Company's
full-time employees reside in Europe performing sales and technical customer
support roles. The Company also relies on several part-time employees and
consultants. None of the Company's employees is represented by a collective
bargaining agreement nor has the Company experienced a work stoppage. Management
believes that the Company's relationship with its employees is good.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company's principal facilities are located in Milwaukee, Wisconsin,
in an approximately 14,000 square-foot office leased through September 2004 at a
rate of approximately $213,000 per year. The Company also leases a sales,
administrative and service support office in Nuenen, The Netherlands. The
Company anticipates that additional space will be required as its business
expands and believes that it will be able to obtain suitable space as needed.
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
11
<PAGE> 14
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock commenced trading on the Nasdaq Small Cap
Market System on January 29, 1998, under the symbol MRGE.
The following table sets forth for the periods indicated, the high and
low closing sale prices of the Company's common stock as reported by Nasdaq.
<TABLE>
<CAPTION>
COMMON STOCK MARKET PRICES
1998 4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
- ------------------------------------ -------------------------------------- ------------------ ------------------
<S> <C> <C> <C> <C>
High................................ $2.000 $3.938 $6.500 $6.563
Low................................. $0.938 $1.375 $3.125 $6.000
</TABLE>
According to the transfer agent records, the Company has 107
stockholders of record as of March 19, 1999. The Company estimates that there
are in excess of 1,200 beneficial holders of its Common stock.
DIVIDEND POLICY
The Company has not paid any cash dividends on its Common Stock since
its formation. The Company does not currently intend to declare or pay any cash
dividends on the Common Stock in the foreseeable future and anticipates that
earnings, if any, will be used to finance the development and expansion of its
business.
The Company also anticipates that it may in the future seek to obtain a
loan, revolving credit agreement or other financing arrangement, the terms of
which may prohibit the declaration and payment of dividends without prior lender
approval. Any payment of future dividends and the amounts thereof will be
dependent upon the Company's earnings, financial requirements and other factors
deemed relevant by the Company's Board of Directors, including the Company's
contractual obligations.
RECENT SALES OF UNREGISTERED SECURITIES; USE OF PROCEEDS FROM REGISTERED
SECURITIES
In January 1998, the Company completed an initial public offering of
1,900,000 shares of common stock at an offering price of $6.00 per share. On
February 27, 1998, H.C. Wainwright & Co., Inc. exercised an overallotment option
and offered an additional 285,000 shares to the public at $6.00 per share. As a
result of the initial public offering, the Company received net proceeds of
approximately $11,800,000. The net proceeds of the offering were used to repay
in full the outstanding principal and interest on the $2,000,000 note with
Sirrom Capital, to redeem 424,757 shares of stock held by Alpha Capital
Venture Partners at $1.90 per share and to terminate unexercised warrants
held by Sirrom Capital for $196,000. In 1998 the Company also applied
approximately $5,000,000 of the net proceeds to general working capital.
In 1995 and 1996, the Company issued an aggregate of 1,229,148 shares
of its Common Stock to 29 accredited investors in a private placement at $1.48
per share. The Company received consideration in connection with this private
placement of $205,000 in 1995 and $1,610,000 in 1996. In connection with such
private offering, Robert T. Geras, a Director of the Company, purchased 182,848
shares at the same price offered to other investors. Mr. Warren B. Cozzens, a
former director, also purchased 257,342 shares in this private offering. These
amounts reflect the total offering price. There were no underwriting discounts
or commissions in this sale. This sale was exempt from registration as a
non-public offering of securities under Regulation D, promulgated under
Section 4(2) of the Securities Act. No general solicitation or general
advertising was made in connection with this private placement, and each of the
purchasers in this private placement had the opportunity to ask questions of
officers of, and to obtain information from, the Company.
12
<PAGE> 15
Effective May 1996, the Company converted $222,712 of $686,064
subordinated and junior subordinated notes of indefinite maturity and bearing
interest at a rate equal to the prime rate plus 3% for the subordinated notes
and prime rate plus 4% for the junior subordinated notes payable to Mr. Geras,
Mr. Cozzens, Mr. Mitchell D. Goldsmith, Mr. Phillip J. Hanrahan, Mr. Thomas
Jennings, Ms. Mary Jennings, Mr. Christopher Kalmus, Mr. Henry Kuehn, Mr.
Jeffrey Lane, Mr. Michael Lechter, Mr. Terry Mikkelson, Mr. Michael Regenfuss,
Mr. Luke E. Sims, and Mr. Frederick P. Stratton, Jr. (the "Shareholder Notes")
and related accrued interest into 191,766 shares of Common Stock. In addition,
the Company discharged the remaining $463,352 of the Shareholder Notes and
related accrued interest to Alpha Capital Venture Partners with the issuance of
33,861 shares of Common Stock and a cash payment of $375,000. This sale was
exempt from registration as a non-public offering of securities under Regulation
D, promulgated under Section 4(2) of the Securities Act.
Effective July 7, 1996, the Company's shareholders approved and adopted
the 1996 Stock Option Plan for employees of the Company (the "1996 Plan") which
currently provides for the grant of options to purchase, in the aggregate, up to
1,015,826 shares of Common Stock. The 1996 Plan provides for the grant to
employees of incentive stock options ("ISOs") and non-qualified stock options.
As of the date hereof, options to purchase 908,806 shares of Common Stock at
exercise prices ranging from $1.48 to $6.00 per share have been granted and are
outstanding under the 1996 Plan. The transaction described above was exempt from
registration under Rule 701, promulgated under Section 3(b) of the Securities
Act.
On June 30, 1997, Registrant entered into a Loan Agreement, as modified
by the Merge/Sirrom Revised Modification Agreement dated as of October 30, 1997
(the "Sirrom Note Agreement") with Sirrom under which it issued (1) a Secured
Promissory Note dated June 30, 1997 in favor of Sirrom in the principal amount
of two million dollars ($2,000,000) (the "Sirrom Note"), and (ii) a Stock
Purchase Warrant issued to Sirrom dated June 30, 1997, as modified by the
Merge/Sirrom Revised Modification Agreement dated as of October 30, 1997 (the
"Sirrom Warrant"). In connection with and in consideration of the Sirrom Note
Agreement, Sirrom was granted the right to acquire for nominal consideration, a
base amount of 145,256 shares of the Common Stock.
By agreement dated October 30, 1997, the Company and Sirrom agreed that
upon the expected closing of the IPO: (i) the Sirrom Note would be paid in full;
(ii) the Sirrom Warrant would be exercised as to 75% (108,942) of the original
number of shares issuable under it; (iii) Sirrom will not offer, pledge, sell,
contract to sell, grant any option for the sale of, or otherwise dispose of,
directly or indirectly any securities of the Company for a period of 180 days
following the date of the IPO without the prior written consent of the
Representative; (iv) Sirrom's right to purchase 25% (36,314) of the original
number of shares issuable under the Sirrom Warrant would be terminated; (v) the
put option in favor of Sirrom would be canceled; (vi) a termination fee of
approximately $196,000 would be paid to Sirrom; and (vii) the Company agreed to
file a registration statement to register shares issued to Sirrom pursuant to
the Sirrom Warrant within 120 days of the closing of the initial public
offering, provided in no event would such registration statement be declared
effective until at least 180 days following the initial closing of an initial
public offering of the Common Shares.
The amount of the Sirrom Termination Fee was determined through arm's
length negotiations between the Company and Sirrom based on factors including
the Company's interest in eliminating uncertainty with respect to its future
equity-related liabilities and Sirrom's interest in receiving cash in return for
relinquishing its put option. Upon the closing of the IPO, the Sirrom Warrant
was exercised under the terms of the October 30, 1997 agreement.
The issuance of the Sirrom Note and the Sirrom Warrant were exempt from
regulation under Section 4(2) of the Securities Act.
Effective January 28, 1998, the Company established a stock option plan
for nonemployee directors of Merge Technologies Incorporated which provides for
the granting of a maximum of 100,000 shares of common stock. Under this plan,
options have an exercise price equal to the fair market value of the stock at
the date of grant and expire 10 years and one day from the date of grant. On
February 4, 1998, 60,000 options were granted under this plan, which vest as to
one third of such shares on each of the first, second and third anniversaries of
the date of issuance.
Except as otherwise indicated, the transaction described above were
exempt from registration under Section 4(2) of the Securities Act. No general
solicitation or general advertising was made in connection with any of the
transactions described above, and each of the purchasers in these transactions
had the opportunity to ask questions of officers of, and to obtain information
from, the Company.
13
<PAGE> 16
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Merge Technologies Incorporated is an international provider of
clinical information systems integration solutions for healthcare organizations.
Current offerings include software, hardware, and integration component products
that facilitate networking and information management of image-producing and
image-using devices in diagnostic radiology. A hospital or an imaging center can
use Merge Technologies' components to create a communications bridge between
incompatible devices, permit radiologists to use video images on electronic
workstations or film as a diagnostic medium and create a diagnostic-quality
electronic archive of imaging results. In addition, the Company's products can
convert the data generated by medical imaging devices into concise electronic
reports with relevant images that may be distributed in a health care
organization's information network or included in an electronic patient record
("EPR").
The Company's products and services available today include: (i)
MergeWorks(TM) Connectivity Products --for retrofitting legacy medical
image-producing and image-using devices thereby rendering such devices capable
of communicating over a DICOM network; (ii) OEM Interface Products --
connectivity software tool kits and interface board products that enable
original equipment manufacturers ("OEMs") to manufacture new radiology
image-producing and image-using devices capable of directly communicating with
the DICOM standard; (iii) Networked Image Management Products - networked
DICOM-compatible products which provide for the selection, processing, storage
and distribution of specific diagnostic images and associated information, and
the integration of the imaging department with the EPR; and (iv) Clinical
Systems Integration Services -- systems integration for the design and
installation of DICOM networks and information systems, including training,
design assistance, testing, and project management services.
The components of the Company's net sales by product line are as
follows for 1998, 1997 and 1996.
<TABLE>
<CAPTION>
PRODUCT LINE 1998 1997 1996
------------ -------- -------- ---------
(in thousands)
<S> <C> <C> <C>
MergeWorks Connectivity Products.............. $6,530 $7,308 $4,454
OEM Interface Products....................... 2,594 2,122 1,457
Networked Image Management Products........... 171 -- --
Clinical Systems Integration Services........ 374 286 474
------- ------- --------
$9,669 $9,716 $6,385
</TABLE>
The Company further classifies its sales by application type. Component
Technologies (formerly referred to as OEM Sales) are products sold primarily
through OEMs and value added resellers ("VARs") which integrate Merge's products
into their own product offerings in order to increase the functionality of their
equipment or systems. System Solutions (formerly referred to as End-User Sales)
are complete networked imaging applications using a combination of Merge
components. System Solutions are sold to end-users either directly or through
distributors under the Merge brand name. Component Technologies and
System Solutions sales were as follows for 1998, 1997 and 1996.
<TABLE>
<CAPTION>
APPLICATION 1998 1997 1996
----------- -------- ------- -------
(in thousands)
<S> <C> <C> <C>
Component Technologies...................... $4,847 $5,705 $4,470
System Solutions............................ 4,822 4,011 1,915
------------ --------- -----------
$9,669 $9,716 $6,385
</TABLE>
14
<PAGE> 17
As illustrated above, System Solutions sales have increased during the
last three years, primarily due to increased distribution in the United States.
The Company began in 1998 to deploy sales personnel in Germany and the
Netherlands to extend sales of System Solutions to the European Union. It has
also made a significant investment in new product development of image
management tools to extend the capabilities of the Company's System Solutions.
Sales of Component Technologies products declined in 1998 as the
Company focused on realizing the potential of the System Solutions sales
opportunity. The decrease in Component Technologies sales was also due in part
to reduced sales to one major OEM customer. The Company has reorganized its
sales staff to provide better focus on both Component Technologies and System
Solutions sales in 1999.
The Company recognizes revenue on hardware products and software tool
kits at the time of shipment to the customer as product delivery is considered
complete at that time and no significant Company obligations exist with respect
to delivery or customer acceptance following shipment. Fees for software
run-time licensing are recognized ratably over the related contract period.
Software maintenance charges are deferred and recognized on a straight-line
basis over the contract support period, which is generally one year.
Cost of goods sold consists of purchased components and the
amortization of software development. For the assembly of its products, the
Company generally purchases industry standard components from multiple vendors.
The Company capitalizes software development expense once technological
feasibility has been established in accordance with Statement of Financial
Accounting Standards No. 86, Accounting for the Costs of Computer Software to be
Sold, Leased or Otherwise Marketed. Capitalized software is amortized over the
expected life of the related product, which typically is five years.
Product research and development expense consists primarily of the
compensation and related overhead expense of software and hardware engineers and
engineering management personnel. In 1998, 1997 and 1996, the Company's research
and development expense was $1,831,000 $1,616,000, and $1,391,000, respectively.
Product innovation is considered important to the Company's success and the
Company expects to continue to increase research and development expense in
absolute dollars. However, in the future, assuming that net sales increase such
expenditures are not expected to increase proportionally in relation to net
sales.
General and administrative expense includes the salaries and related
costs of administrative, finance, information services and general management
personnel, plus corporate overhead such as facility rental, insurance,
depreciation, stockholder relations, and legal and accounting expenses. The
Company believes that general and administrative expense will decline as a
percentage of net sales in the future.
RESULTS OF OPERATIONS
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Net sales. Net sales decreased by $47,000 or 0.5% to $9,669,000 in 1998
from $9,716,000 in 1997. Net sales of MergeWorks Connectivity Products decreased
12% to $6,465,000 in 1998 from $7,308,000 in 1997, primarily due to decreased
net sales of component products to OEMs. Net sales of OEM Interface Products,
which include software and interface boards, grew by 22% to $2,594,000 in 1998
from $2,122,000 in 1997. Clinical Systems Integration Services net sales
increased by 31% to $375,000 in 1998 from $286,000 in 1997. The Company
introduced its Networked Image Management Systems line of products in 1998 with
the commercial release of MergeARK, a medical image archival system, and
reported net sales of $171,000 in this category.
Cost of goods sold. Cost of goods sold consists of purchased components
and the amortization of purchased and developed software. The cost of purchased
components as a percentage of net sales in 1998 increased to approximately 27%
compared to 24% in 1997, reflecting higher sales discounts for certain of the
Company's products in certain distribution channels. Amortization of purchased
and developed software increased to $816,000 or 8% of net sales in 1998 from
$614,000 or 6% of net sales in 1997 due to commencement of amortization on
several new products. Amortization of purchased and developed software is
expected to increase moderately in 1999 in dollar terms; however amortization is
a fixed cost, and as net sales increase, amortization expense is expected to
decrease as a percentage of net sales.
15
<PAGE> 18
Gross profit. Gross profit decreased by 7% to $6,250,000 in 1998 from
$6,740,000 in 1997. As a percentage of net sales, gross profit decreased to 65%
for 1998 from 69% for 1997.
Sales and marketing. Sales and marketing expense increased by 51% to
$3,961,000 in 1998 from $2,621,000 in 1997. In 1998, the Company retained
additional field sales and service personnel in order to support the Company's
goal of additional market penetration. The sales and marketing department staff
increased to 21 persons as of December 31, 1998 from 17 persons as of December
31, 1997. The Company also increased its service engineering staff to 13 persons
as of December 31, 1998 from eight persons as of December 31, 1997.
Product research and development. Research and development expense
increased by 13% to $1,831,000 in 1998 from $1,616,000 in 1997. The increase in
research and development expense consists primarily of compensation to
additional product engineers engaged in software design and the development of
specialized computer hardware. The Company believes that advanced technology is
a key element in the success of its business, and it expects to continue to
increase its research and development expenditures in dollar terms. However, in
the future, research and development expense is expected to be a declining
percentage of net sales as net sales increase.
General and administrative. General and administrative expense
increased by 65% to $2,578,000 in 1998 from $1,563,000 in 1997. The increase was
due to: (i) additional expenses associated with operating as a publicly held
company, including legal, audit and stockholder relations services, directors
and officers insurance, and preparing, filing and publishing periodic and other
reports, (ii) expenses related to expanded administrative services at the
European branch, including hiring additional personnel, (iii) establishment of
an information services group responsible for internal computer systems, and
(iv) increases in facility rental, depreciation and other overhead.
Total other income (expense). Total other income (expense) changed to
$244,000 in 1998 from ($1,148,000) in 1997. In 1998, the Company had interest
income of $263,000 as a result of the investment of funds raised in the
Company's initial public offering, which occurred on January 29, 1998. In 1997,
interest expense of $1,088,000 was incurred, including $872,000 in noncash
interest expense for amortization of a discount on the outstanding note held by
Sirrom Capital Corporation. See "Liquidity and Capital Resources."
Income taxes. The Company incurred income tax expense of $44,000 in
1998, due primarily to alternative minimum tax and state income tax liabilities.
The Company did not pay federal income taxes or recognize an income tax benefit
in 1997 despite incurring a loss for financial reporting purposes due to
continued losses and uncertainty as to future realization of a tax benefit and
due to the nondeductibility of certain financing charges.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Net sales. Net sales increased by 52% to $9,716,000 in 1997 from
$6,385,000 in 1996. Net sales of MergeWorks Connectivity Products accounted for
the largest increase, rising by 64% to $7,308,000 in 1997 from $4,454,000 in
1996, primarily due to increased distribution of products to end-users through
dealers. Sales of OEM Interface Products grew by 46% to $2,122,000 in 1997 from
$1,457,000 in 1996. Clinical Systems Integration Services sales decreased by 40%
to $286,000 in 1997 from $474,000 in 1996 as the Company redirected its
resources to meet an increased demand for MergeWorks Connectivity Products and
OEM Interface Products during 1997.
Cost of goods sold. Cost of goods sold consists of purchased components
and the amortization of purchased and developed software. The cost of purchased
components as a percentage of net sales in 1997 decreased to approximately 24%
compared to 25% in 1996, reflecting higher sales discounts for certain of the
Company's products in certain distribution channels which were partially offset
by lower material costs.
16
<PAGE> 19
Gross profit. Gross profit increased by 56% to $6,740,000 in 1997 from
$4,309,000 in 1996. As a percentage of net sales, gross profit increased to 69%
for 1997 from 68% for 1996.
Sales and marketing. Sales and marketing expense increased by 73% to
$2,621,000 in 1997 from $1,519,000 in 1996. In 1997, the Company retained
additional field sales staff to market and support increasing customer demand
for image-acquisition and image-printing applications resulting in growth of the
sales and marketing department staff to 17 persons as of December 31, 1997 from
six persons as of December 31, 1996. Such personnel are engaged in sales and
marketing activities through the OEM/VAR channel and in support of end-user
distribution via dealers. The Company expects to continue to make additions to
its sales force in order to increase net sales.
Product research and development. Research and development expense
increased by 16% to $1,616,000 in 1997 from $1,391,000 in 1996. The increase in
research and development expense consists primarily of compensation to
additional product engineers engaged in software design and the development of
specialized computer hardware. The Company believes that advanced technology is
a key element in the success of its business, and it expects to continue to
increase its research and development expenditures in absolute dollars. However,
research and development expense is expected to be a declining percentage of net
sales as net sales increase.
General and administrative. General and administrative expense
increased by 28% to $1,563,000 in 1997 from $1,221,000 in 1996. The increase was
due primarily to additional overhead expense required to generate and support
higher sales. General and administrative expense declined as a percentage of net
sales to 16% in 1997 from 19% in 1996. The Company expects general and
administrative expense to increase in 1998 due to additional fixed costs
associated with operations as publicly held company. Such fixed costs include
legal, audit and investor relations services, directors and officers insurance,
and preparing, filing and publishing periodic and other reports. However, total
general and administrative expense is expected to decline as a percentage of net
sales.
Total other expense, net. Total other expense, net increased to
$1,148,000 in 1997 from $97,000 in 1996. $872,000 of this expense represents a
nonrecurring noncash interest expense for amortization of a discount on the
outstanding note held by Sirrom Capital Corporation. See "Liquidity and Capital
Resources."
Extraordinary gain. In May 1996, the Company discharged $463,000 of
subordinated notes, and related accrued interest, with the issuance of 33,861
shares of Common Stock and a cash payment of $375,000. An extraordinary gain of
$169,000 was realized in connection with such discharge.
INCOME TAXES
The Company did not pay federal income taxes or recognize an income tax
benefit in 1997 and 1996 despite incurring losses for financial reporting
purposes due to continued losses and uncertainty as to future realization of a
tax benefit . In addition, in 1997 the Company did not recognize an income tax
benefit partially due to the nondeductibility of certain financing charges.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by (used in) operating activities was $(2,505,000),
$793,000 and $172,000 in 1998, 1997 and 1996, respectively. The use of cash in
1998 was due to a net loss of $1,920,000 as well as cash outflows associated
with reductions in accounts payable achieved using a portion of the IPO proceeds
and increases in inventory purchased in anticipation of higher sales. The
increase in net positive cash flow in 1997 was due to a 200% increase in
operating earnings before depreciation and amortization expense, offset in part
by cash outflows associated with higher levels of inventory and increases in
accounts receivable.
17
<PAGE> 20
Investing activities include net additions to capital equipment of
$850,000, $499,000 and $320,000, and additions to capitalized software of
$1,549,000, $1,005,000 and $766,000 in 1998, 1997 and 1996, respectively. In
1998,1997 and 1996, the Company also used $16,000 $3,000 and $288,000 of cash,
respectively, to invest in the purchase of a software license for technology
used in the CaseWorks Networked Image Management product.
Cash provided by financing activities for 1998, 1997 and 1996 was
$8,157,000 $856,000 and $1,341,000, respectively. In 1998, the Company received
net proceeds of approximately $11,800,000 from the sale of 2,185,000 shares of
common stock at $6.00 per share of stock in an initial public offering. In 1997,
the Company received cash of $2,000,000 from a loan agreement with Sirrom
Capital and applied $655,000 of the proceeds to repayment of a revolving credit
facility with Biltmore Investor's Bank.
In 1995 and 1996, the Company issued an aggregate of 1,229,148 shares
of Common Stock in a private placement completed in 1996 at $1.48 per share; the
Company received consideration in connection with this private placement of
$205,000 in 1996 and $1,610,000 in 1995. Effective May 1996, the Company
converted $222,712 of $686,064 subordinated notes payable to shareholders (the
"Shareholder Notes") and related accrued interest into 191,766 shares of Common
Stock. Also, in 1996, the Company discharged the remaining $463,352 of the
Shareholder Notes and related accrued interest with the issuance of 33,861
shares of the Common Stock and a cash payment of $375,000. The Company increased
its net borrowings in 1996 under its lending facilities by $503,000. In 1995,
the Company drew $250,000 from its bank line of credit and borrowed an
additional $150,000 from two shareholders.
The Company had cash and cash equivalents of $3,660,000 and $428,000,
and working capital of $6,325,000 and $(1,972,000) at the end of 1998 and 1997,
respectively. Working capital in 1998 includes $1,777,000 in accounts receivable
and $1,951,000 in inventory. The working capital deficit in 1997 was due to a
$2,000,000 note, which represented a current liability due to the anticipated
repayment in full with proceeds from the initial public offering. This note was
issued in June 1997 to Sirrom Capital Corporation to replace the Company's
working capital bank line. The Sirrom note bore interest at 13.5%, payable
monthly from August 1997 through May 2002, with the principal and any remaining
interest due in June, 2002. This note was repaid in full in February, 1998 using
a portion of the net proceeds of the initial public offering.
The Company believes that net proceeds from the initial public offering
in 1998, together with December 31, 1998 cash and internally generated funds
will satisfy for at least 12 months the Company's projected requirements for
sales and distribution, research and development, working capital and
administrative expenses. Thereafter, if cash generated from operations is
insufficient to satisfy the Company's projected requirements, or if the
Company elects to use funds for acquisitions or other matters, the Company may
be required to sell additional equity or debt securities or obtain additional
bank financing or other credit facilities. The Company is currently negotiating
with a bank to arrange for a line of credit, however, it is anticipated that
if the loan is not finalized in 1999, no material adverse effect will be
realized by the Company as internally generated cash flows are expected to be
sufficient to support operations in 1999.
YEAR 2000
In the year 2000, many existing computer programs that use only two
digits, rather than four, to identify a year in the date field could fail or
create erroneous results if not corrected. All Merge products have received a
Year 2000 compliance evaluation. Merge will continue to test its current and
future products on an ongoing basis, applying its Year 2000 compliance criteria.
The Company will include into its procedure any modifications that are
incorporated into the compliance process during its implementation.
All Merge manufacturing equipment and critical facilities equipment
have been determined to be Year 2000 compliant. Key service providers have
provided to the Company Year 2000 compliance statements which indicate that they
either have Year 2000 compliant internal systems or that their systems are
expected to be Year 2000 compliant during 1999. The Company has also commenced a
program to verify that its materials suppliers have effective Year 2000
compliance processes. The vendor evaluations under this program are expected to
be completed during the third quarter of 1999.
18
<PAGE> 21
The following product have been determined to meet the Company's Year
2000 compliance criteria: MergeCOM-3(TM), MergeARK(TM), and MergeDPM(TM),
MergeVPI(TM), MergeDPI(TM) and MergeAPS(TM). A software upgrade for Year 2000
compliance is available through the Merge service department for versions of
MergeVPI, MergeVPI and MergeAPS shipped prior to March, 1999.
MergeMVPs connect to legacy image equipment, and the data output of a
MergeMVP is largely dependent upon that received from the source equipment. As a
result, when connected to a device such as a CT or MR imaging device that is not
Year 2000 compliant, the data output from an MVP may not be Year 2000 compliant
due to development issues that the Company cannot control. Nevertheless, the
majority of MergeMVP products in current production meet the Company's Year 2000
compliance criteria. The Company offers upgrades at no charge on MVPs shipped
beginning in 1998 in which Merge software is not compliant. The Company also
will offer for sale to imaging device manufacturers engineering services to
correct Year 2000 problems inherent to their software through programs installed
on MergeMVPs. In the fourth quarter of 1998, the first of such upgrades was sold
to a customer. The Company anticipates additional sales of Year 2000 upgrades
but it expects that such sales will not be significant in 1999.
The Company believes based on its successful completion of Year 2000
upgrades for its MergeMVP(TM), MergeVPI, MergeDPI, and MergeAPS products
that the possibility of experiencing significant technical delays in further
Year 2000 product upgrades is remote. However, if the Company does experience an
unanticipated delay, it may elect to refrain from offering for sale certain
products. Should Year 2000 development projects be canceled due to such
technical delays, product development engineers would be assigned to other
projects which the Company believes would generate comparable revenues. The
Company evaluates progress on Year 2000 development at regular intervals in
order to ensure that development costs do not exceed the original estimate.
Costs associated with Year 2000 upgrades in 1998 were approximately $20,000 and
they are expected not to exceed $80,000 in 1999. A Year 2000 upgrade is
considered to be no more complicated than any other upgrade for a Merge product,
so no significant change in the rate of calls for customer support is expected.
The Company cannot quantify its risk for potential additional Year 2000
compliance costs at this time, but it anticipates that the effect of this
computer program flaw on the operations of the Company will be not be
significant. However, the Company may be required to spend time and monetary
resources addressing any necessary computer program changes.
In the Company's assessment, the most reasonably likely worst case
scenario caused by Year 2000 issues relates to potential redirection of hospital
information technology budgets for solving Year 2000 problems unrelated to Merge
product offerings. Should expenses for an institution's Year 2000 remediation
exceed its budget allocation, funds that would have been invested in networking
and image management products (such as those sold by Merge) may be reallocated
to Year 2000 fixes. The Company may, in that circumstance, encounter delays in
anticipated orders. Should order delays occur, the Company would market its
products to other customers with funds available in their capital equipment
budgets. Management currently believes that order delays due to external Year
2000 problems will not have a material impact on the Company's future financial
performance. The Company is continuing to develop a contingency plan for
maintaining revenues in the event of order delays caused by Year 2000 issues.
19
<PAGE> 22
ITEM 7. FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
BOARD OF DIRECTORS
MERGE TECHNOLOGIES INCORPORATED:
We have audited the accompanying consolidated balance sheets of Merge
Technologies Incorporated and subsidiary (Company) as of December 31, 1997 and
1998, and the related consolidated statements of operations, shareholders'
equity, cash flows and comprehensive income for each of the years in the
three-year period ended December 31, 1998. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on those consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of December 31, 1997 and 1998, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
1998, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Chicago, Illinois
February 3, 1999
20
<PAGE> 23
MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1997 1998
---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................... $ 428,271 $ 3,659,879
Accounts receivable, net of allowance for doubtful accounts of $74,000 and
$25,000 at December 31, 1997 and 1998, respectively ......................... 1,822,817 1,777,344
Inventory ................................................................... 1,178,493 1,951,160
Prepaid expenses ............................................................ 32,861 361,773
Other current assets ........................................................ 18,557 62,095
----------- -----------
Total current assets .......................................................... 3,480,999 7,812,251
----------- -----------
Property and equipment: .......................................................
Computer equipment .......................................................... 1,388,119 2,072,656
Office equipment ........................................................... 255,539 426,153
----------- -----------
1,643,658 2,498,809
Less accumulated depreciation ............................................... 646,381 1,054,554
----------- -----------
Net property and equipment .................................................... 997,277 1,444,255
License agreement, net of accumulated amortization of $73,557 and $150,643 at
December 31,1997 and 1998, respectively ..................................... 217,753 157,055
Purchased and developed software, net of accumulated amortization of
$2,370,344 and $3,057,339 at December 31, 1997 and 1998, respectively ....... 2,601,685 3,463,824
Other intangibles, net of accumulated amortization of $15,814 and $21,754 at
December 31,1997 and 1998, respectively ..................................... 43,573 37,633
Deferred financing fees, net of accumulated amortization of $63,370 and $ -- at
December 31,1997 and 1998, respectively ..................................... 285,068 --
Other ......................................................................... 13,008 13,008
----------- -----------
7,639,363 $12,928,026
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable.......................................................... $2,000,000 $ --
Accounts payable...................................................... 1,587,113 778,307
Current portion of obligations under capital leases.................... 54,612 12,564
Customer deposits...................................................... 39,182 149,593
Put options related to redeemable common stock and stock warrants..... 1,289,887 --
Accrued interest...................................................... 22,500 --
Accrued wages......................................................... 354,637 418,388
Other accrued liabilities.............................................. 104,773 128,449
---------- -----------
Total current liabilities................................................ 5,452,704 1,487,301
---------- -----------
Obligations under capital leases, excluding current portion.............. 26,516 18,137
---------- -----------
Total liabilities..................................................... 5,479,220 1,505,438
---------- -----------
Shareholders' equity
Preferred stock, $0.01 par value: authorized 5,000,000, no shares
issued................................................................. -- --
Common stock, $0.01 par value: authorized 30,000,000, issued and
outstanding 3,908,063 shares at December 31, 1997, and 5,778,216 at
December 31, 1998..................................................... 39,081 57,782
Additional paid-in capital ............................................ 2,732,631 13,931,432
Accumulated deficit.................................................... (668,628) (2,588,598)
Other comprehensive income - cumulative translation adjustment......... 57,059 21,972
---------- ----------
Total shareholders' equity ............................................ 2,160,143 11,422,588
---------- ----------
Total liabilities and shareholders' equity.............................. $7,639,363 $12,928,026
========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
21
<PAGE> 24
MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
---------------------------------------
1996 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
Net sales.......................................... $ 6,384,659 $ 9,716,112 $ 9,669,172
Cost of goods sold:
Purchased components............................. 1,626,882 2,362,248 2,602,867
Amortization of purchased and
developed software.............................. 449,015 613,980 816,358
----------- ---------- ----------
Total cost of goods sold........................... 2,075,897 2,976,228 3,419,225
----------- ---------- ----------
Gross profit....................................... 4,308,762 6,739,884 6,249,947
----------- ---------- ----------
Operating costs and expenses:
Sales and marketing.............................. 1,519,301 2,621,152 3,960,546
Product research and development................. 1,391,264 1,616,486 1,830,560
General and administrative....................... 1,220,901 1,563,369 2,578,482
Professional fees related to proposed financing.. 363,964 -- --
----------- ---------- ----------
Total operating costs and expenses................. 4,495,430 5,801,007 8,369,588
----------- ---------- ----------
Operating income (loss)............................ (186,668) 938,877 (2,119,641)
----------- ---------- ----------
Other income (expense):
Interest expense................................. (134,121) (1,088,079) (40,718)
Interest income.................................. 11,016 19,197 262,486
Other, net....................................... 26,580 (79,021) 21,876
----------- ---------- ----------
Total other income (expense)....................... (96,525) (1,147,903) 243,644
---------- ---------- ----------
Loss before income taxes and extraordinary item.... (283,193) (209,026) (1,875,997)
Income taxes....................................... -- -- 43,973
----------- ---------- ----------
Loss before extraordinary item..................... (283,193) (209,026) (1,919,970)
Extraordinary gain on extinguishment of debt....... 169,514 -- --
----------- ---------- ----------
Net loss........................................... (113,679) (209,026) (1,919,970)
=========== ========== ==========
Basic & diluted loss per share before
extraordinary item................................ $ (0.08) $ (0.05) $ (0.34)
Basic & diluted loss per share..................... $ (0.03) $ (0.05) $ (0.34)
=========== ========== ==========
Shares used to compute basic and diluted
Loss per share..................................... 3,464,989 3,902,993 5,608,255
=========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements
22
<PAGE> 25
MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
NOTE
RECEIVABLE
IN
CONNECTION RETAINED
ADDITIONAL WITH EARNINGS CUMULATIVE TOTAL
COMMON STOCK PAID-IN PURCHASE OF (ACCUMULATED TRANSLATION SHAREHOLDERS'
SHARES AMOUNT CAPITAL COMMON STOCK DEFICIT) ADJUSTMENT EQUITY
------ ------ ------- ------------ -------- ---------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 ... 2,580,914 $ 25,810 $ 1,194,806 $ -- $ (345,923) $ -- $ 874,693
--------- --------- ------------ ---------- ----------- -------- ------------
Sale of common stock ........... 1,090,319 10,903 1,599,097 (150,000) -- -- 1,460,000
Fees incurred in connection with
the sale of common stock ....... -- -- (223,721) -- -- -- (223,721)
Interest on note receivable in
connection with purchase of
common stock................. -- -- 8,972 (8,972) -- -- --
Conversion of subordinated notes
payable to common stock...... 225,628 2,256 330,914 -- -- -- 333,170
Offset of note payable to
shareholder with note receivable
in connection with purchase of
common stock................. -- -- -- 158,972 -- -- 158,972
Accretion of put value ......... -- -- (138,298) -- -- -- (138,298)
Forfeiture of put feature ...... -- -- 82,337 -- -- -- 82,337
Net loss ....................... -- -- -- -- (113,679) -- (113,679)
Foreign currency translation
adjustment ..................... -- -- -- -- -- 1,213 1,213
--------- --------- ------------ ---------- ----------- -------- ------------
Balance at December 31, 1996 ... 3,896,861 $ 38,969 $ 2,854,107 $ -- $ (459,602) $ 1,213 $ 2,434,687
--------- --------- ------------ ---------- ----------- -------- ------------
Exercise of stock options ...... 11,202 112 8,138 -- -- -- 8,250
Accretion of put value ......... -- -- (129,614) -- -- -- (129,614)
Net loss ....................... -- -- -- -- (209,026) -- (209,026)
Foreign currency translation
adjustment .................. -- -- -- -- -- 55,846 55,846
--------- --------- ------------ ---------- ----------- -------- ------------
Balance at December 31, 1997 ... 3,908,063 $ 39,081 $ 2,732,631 $ -- $ (668,628) $ 57,059 $ 2,160,143
--------- --------- ------------ ---------- ----------- -------- ------------
Exercise of stock options ...... 1,016 10 1,490 -- -- -- 1,500
Sale of common stock ........... 2,185,000 21,850 13,088,150 -- -- -- 13,110,000
Exercise of call option ........ (424,757) (4,248) (802,344) -- -- -- (806,592)
Payment of warrant termination
fee ......................... -- -- 21,788 -- -- -- 21,788
Exercise of stock warrant ...... 108,942 1,089 (1,089) -- -- -- --
IPO related fees ............... -- -- (2,181,121) -- -- -- (2,181,121)
Accretion of put value ......... -- -- 1,072,003 -- -- -- 1,072,003
Payout of fractional shares .... (48) -- (291) -- -- -- (291)
Payment for stock warrant ...... -- -- 215 -- -- -- 215
Net loss ....................... -- -- -- -- (1,919,970) -- (1,919,970)
Foreign currency translation
adjustment .................. -- -- -- -- -- (35,086) (35,086)
--------- --------- ------------ ---------- ----------- -------- ------------
Balance at December 31, 1998 ... 5,778,216 $ 57,782 $ 13,931,432 $ -- $(2,588,598) $ 21,973 $ 11,422,589
========= ========= ============ ========== =========== ======== ============
</TABLE>
See accompanying notes to consolidated financial statements
23
<PAGE> 26
MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss .................................................................... $ (113,679) $ (209,026) $ (1,919,970)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities
Depreciation and amortization ............................................. 625,719 934,649 1,178,193
Amortization of discount on Sirrom Loan ................................... -- 871,538 --
Provision for doubtful accounts receivable ................................ 44,000 (3,162) 169,166
Expenses related to services performed .................................... 160,000 -- --
Extraordinary gain on extinguishment of debt .............................. (169,514) -- --
Change in assets and liabilities:
Accounts receivable .................................................... (756,289) (319,422) (123,693)
Inventory .............................................................. (155,508) (774,000) (772,667)
Prepaid expenses ....................................................... -- -- (338,347)
Accounts payable ....................................................... 604,638 56,984 (808,806)
Accrued expenses ....................................................... 140,049 169,408 121,390
Customer deposits ...................................................... (189,121) 33,887 110,412
Other .................................................................. (18,779) 31,743 (121,082)
------------ ------------ ------------
Net cash provided by (used in) operating activities ........................... 171,516 792,599 (2,505,404)
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment ......................................... (319,569) (499,065) (850,262)
Development of software ..................................................... (765,640) (1,005,218) (1,549,133)
Purchase of license agreement ............................................... (288,100) (3,210) (16,388)
------------ ------------ ------------
Net cash used in investing activities ......................................... (1,373,309) (1,507,493) (2,415,783)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from loan agreement with Sirrom .................................... -- 2,000,000 --
Repayment of loan agreement with Sirrom ..................................... -- -- (2,000,000)
Financing fees associated with loan agreement with Sirrom ................... -- (63,371) --
Financing fees related to IPO ............................................... -- (285,068) --
Proceeds from revolving credit agreement .................................... 753,000 470,000 --
Repayment of revolving credit agreement ..................................... (250,000) (1,223,000) --
Repayment of subordinated notes payable to shareholders and related
interest .................................................................... (375,000) -- --
Issuance of common stock, net of expenses ................................... 1,236,279 -- 11,213,656
Proceeds from exercise of stock options ..................................... -- 8,255 1,715
Payment for call of common stock ............................................ -- -- (806,592)
Payment of warrant termination fee .......................................... -- -- (196,096)
Principal payments under capital leases ..................................... (23,724) (50,749) (55,316)
------------ ------------ ------------
Net cash provided by financing activities ..................................... 1,340,555 856,067 8,157,367
------------ ------------ ------------
Effect of exchange rate changes on cash ....................................... -- -- (4,572)
Net increase in cash and cash equivalents ..................................... 138,762 141,173 3,231,608
Cash and cash equivalents, beginning of period ................................ 148,336 287,098 428,271
------------ ------------ ------------
Cash and cash equivalents, end of period ...................................... $ 287,098 $ 428,271 $ 3,659,879
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest ........................................................ $ 195,252 $ 209,403 $ 61,088
NON CASH FINANCING AND INVESTING ACTIVITIES
Property and equipment acquired through capital leases ........................ 16,502 59,493 4,889
Repayment of subordinated notes payable and related interest through issuance
of common stock ............................................................. 333,170 -- --
Accretion of put options related to redeemable common stock and stock
warrants .................................................................... 138,298 129,614 --
Forfeiture of put options related to redeemable common stock .................. (82,337) -- --
Issuance of note to shareholder in consideration for services ................. 158,972 -- --
</TABLE>
See accompanying notes to consolidated financial statements
24
<PAGE> 27
MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1996 1997 1998
--------------- --------------- ---------------
<S> <C> <C> <C>
Net loss............................................. $(113,679) $(209,026) $(1,919,970)
Other comprehensive income (loss) - cumulative
translation adjustment............................. 1,213 55,846 (35,086)
------------ ------------ -------------
Comprehensive net loss............................... $(112,466) $(153,180) $(1,955,056)
============ ============ =============
</TABLE>
See accompanying notes to consolidated financial statements
25
<PAGE> 28
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of Operations
Merge Technologies Incorporated and its wholly-owned subsidiary design,
manufacture, market, and support hardware and software products used in networks
for the storage, management, and distribution of medical imaging data. The
Company's products connect diverse medical equipment and systems, providing
increases in efficiency and productivity for hospitals and clinics. The Company
sells its products primarily in the United States as well as internationally.
(b) Principles of Consolidation
The consolidated financial statements include the financial statements
of Merge Technologies Incorporated and its wholly-owned subsidiary. All
significant inter-company balances and transactions have been eliminated in
consolidation.
(c) Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments with original maturities of three months or less
to be cash equivalents.
(d) Inventory
Inventory, consisting principally of raw materials and finished goods,
is stated at the lower of cost or market. Cost is determined using the first-in,
first-out method.
(e) Property and Equipment
Property and equipment are stated at cost. Equipment under capital
leases is stated at the present value of minimum lease payments.
Depreciation on property and equipment is calculated on the
straight-line method over the estimated useful lives of the assets. Useful lives
of the Company's major classes of property and equipment are: for computer
equipment five years for assets placed in service prior to December 31, 1997 and
three years for assets acquired in 1998; and seven years for office equipment.
Equipment held under capital leases and leasehold improvements are amortized
using the straight line method over the shorter of the lease term or estimated
useful life of the asset.
(f) Purchased and Developed Software
All research and development costs incurred prior to the point at which
management believes a project has reached "technological feasibility" are
expensed. Engineering costs incurred subsequent to reaching technological
feasibility are capitalized and reported at the lower of unamortized cost or net
realizable value. Amortization of purchased and developed software is provided
on a product-by-product basis over the expected economic life of the related
software, generally five years, using the straight-line method. This method
results in greater amortization than the method based on the ratio that current
gross revenues for a product bear to the total of current and anticipated future
gross revenues for that product.
The Company assesses the recoverability of these costs each period by
determining whether the unamortized capitalized costs can be recovered through
future net operating cash flows.
26
<PAGE> 29
(g) Fair Value of Financial Instruments and Long-Lived Assets
The Company's financial instruments include cash and cash equivalents,
accounts receivable, notes payable, accounts payable, and certain accrued
expenses. The carrying amounts approximate fair value because of the short
maturity of these instruments.
On January 1, 1996, the Company adopted SFAS No. 121, Acounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,
under which the Company has reviewed long-lived assets and certain intangible
assets and determined that their carrying values as of December 31, 1998 are
recoverable in future periods.
(h) Other Intangibles
Other intangibles represent the excess of purchase price over fair
value of net assets acquired and the customer list acquired through the
acquisition of Signal Stream Technologies, Inc. (note 2) and is amortized on a
straight-line basis over ten years, the expected period to be benefited.
The Company assesses the recoverability of this intangible asset by
determining whether the amortization of the balance over its remaining life can
be recovered through undiscounted future operating cash flows of the acquired
operation. The amount of impairment, if any, is measured based on projected
discounted future operating cash flows using a discount rate reflecting the
Company's average cost of funds. The assessment of the recoverability will be
impacted if estimated future operating cash flows are not achieved.
(i) Deferred Financing Fees
Deferred financing fees are amortized over the expected term of the
related debt.
(j) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating losses and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
The Company files a consolidated Federal income tax return with its
subsidiary.
(k) Stock Option Plan
Prior to January 1, 1996, the Company accounted for its stock option
plan in accordance with the provisions of Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense would be recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted SFAS No. 123, Accounting
for Stock-Based Compensation, which permits entities to recognize as expense
over the vesting period the fair value of all stock-based awards on the date of
grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the
provision of APB Opinion No. 25 and provide pro forma disclosures for employee
stock option grants made in 1995 and future years as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions required by SFAS No. 123.
27
<PAGE> 30
(l) Revenue Recognition
Revenue from product sales is recognized upon shipment. No significant
Company obligations exist with regard to delivery or customer acceptance
following shipment. Revenues from software maintenance are deferred and
recognized ratably over the contract period, which is generally one year.
(m) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires Company management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(n) Loss Per Share
Basic earnings per share is based on the weighted average number of
common shares outstanding and excludes the dilutive effect of unexercised
dilutive potential common shares. Diluted earnings per share is based on the
weighted average number of common shares outstanding and includes the dilutive
effect of unexercised potential common shares. Because the Company reported a
net loss for the years ended December 31, 1996, 1997 and 1998, per share amounts
have been presented under the basic method only.
Had the Company reported net earnings for the years ended December 31,
1996, 1997 and 1998, the weighted average number of shares outstanding would
have potentially been diluted by the following common equivalent securities (not
assuming the effects of applying the treasury stock method to outstanding stock
options):
<TABLE>
<CAPTION>
1996 1997 1998
---------------- ---------------- ---------------
<S> <C> <C> <C>
Stock options......................... 776,944 958,100 968,806
Warrants.............................. 60,536 145,256 190,000
================ ================ ===============
837,480 1,103,356 1,158,806
================ ================ ===============
</TABLE>
(o) Stock Dividend
On September 25, 1997, the Company declared a 6.77217-for-one stock
split, effective as of the date of declaration of effectiveness of the initial
public offering, which occurred January 29, 1998. The stock split was effected
as a stock dividend of 5.77217 shares per share of common stock. The
accompanying consolidated financial statements and notes have been restated to
reflect this change in capital structure.
(p) Reclassifications
Where appropriate, certain items relating to the prior years have been
reclassified to conform to the presentation in the current year.
(2) LICENSE AGREEMENT
The Company entered into an agreement in 1996 with a technology
supplier under which the Company has been granted a worldwide non-exclusive
license to duplicate and distribute encoding software used by the Company in
recording identifying marks on x-ray film. The Company was also granted a
worldwide exclusive license to duplicate and distribute decoding software
embedded in hand held readers. This exclusivity will lapse on November 1, 2000.
In the event that the Company ceases to distribute both licensed products for a
period of twenty-four months, any license in effect will automatically
terminate.
In addition to the initial payments for the licenses of $288,100, the
Company is obligated to pay a royalty based upon the number of the products
distributed. The agreement is being amortized over the expected period of
benefit, 47 months. No products subject to royalty were sold in 1996, 1997 or
1998. Accumulated amortization was approximately $74,000 and $147,000 for the
years ended December 31, 1997 and 1998, respectively.
28
<PAGE> 31
(3) INDEBTEDNESS
(a) Note Payable to Bank
The Company entered into a $1,250,000 Revolving Credit Agreement
("Agreement") with a bank in June 1996. The Agreement replaced a $250,000 bank
line of credit. Availability of loans under the Agreement were subject to a
borrowing base calculated on inventory and account receivable. The loans bore
interest at the bank's reference rate, as defined in the Agreement, plus 0.5%.
The Agreement was collateralized by all assets of the Company. At December 31,
1996, the Company was in default with respect to several of the Agreement's
restrictive covenants and the note payable to bank was due on demand. The
interest rate was increased to the default rate, which represents the bank's
reference rate plus 5.5% (13.75% at December 31, 1996).
During 1997, the Agreement was amended to reduce the credit limit to
$753,000 in conjunction with a forbearance agreement entered into with the bank.
Under the forbearance agreement, the officers and certain shareholders of the
Company provided personal guarantees. On March 18, 1997, the Company and the
bank entered into a reinstatement agreement under which the credit limit was
increased to $1,000,000 and a term loan of $250,000 was established. In June
1997, the principal and interest outstanding under this note payable to bank
were paid in full.
The Company incurred interest expense on bank debt of $40,000, $44,000
and $0 in 1996, 1997 and 1998, respectively.
(b) Subordinated Notes Payable to Shareholders
Effective May 1996, the Company converted $222,712 of $686,064
subordinated notes payable to shareholders ("Notes") and related accrued
interest into 191,766 shares of common stock. In addition, the Company settled
the remaining $463,352 of Notes and related accrued interest with the issuance
of 33,861 shares of the Company's common stock and a cash payment of $375,000.
The Company realized an extraordinary gain on the settlement.
Interest expense incurred on subordinated notes payable to shareholders
was approximately $39,700 for the year ended December 31, 1996.
(c) Note Payable
In June 1997, the Company entered into a $2,000,000 Loan Agreement with
Sirrom Capital Corporation ("Sirrom"). The Loan Agreement bore interest at a
stated rate of 13.5% payable monthly from August 1997 through May 2002, with
principal and any remaining interest due in June 2002. The Loan Agreement
granted Sirrom a security interest in substantially all of the Company's assets.
In connection with the Loan Agreement, the Company issued stock
purchase warrants expiring in July 2002, granting Sirrom the right to purchase
145,256 shares of the Company's common stock at $0.001 per share. Additional
warrants would be issued as follows if the principal were outstanding on the
specified dates: June 2000 -- 58,498; June 2001 -- 60,056; and June 2002 --
61,667.
The stock purchase warrants were subject to a put option whereby Sirrom
could sell the warrants to the Company in the 30-day period prior to the
expiration date of the warrants. The put option price was equal to the fair
market value of the common stock issuable under the warrants.
The Company assigned a value of $871,538 to the warrants issued, which
is reflected as a debt discount and put warrant liability, based on the value of
the common stock on the date of the transaction. The debt discount was fully
amortized to interest expense during 1997.
29
<PAGE> 32
Proceeds from the Loan Agreement were used to fully pay the principal
and interest outstanding on the note payable to bank (note 4 (a)), and were also
available to repurchase certain outstanding shares of the Company's common
stock, and provide additional working capital for sales, marketing, and product
development expenditures.
The note payable and related interest were paid in full in February
1998, with proceeds from the Company's initial public offering (note 12).
Interest expense in connection with the Sirrom Loan Agreement was
$135,000 and $24,000 in 1997 and 1998, respectively.
(4) EMPLOYEE BENEFIT PLAN
The Company maintains a contributory deferred profit-sharing plan
(401(k)) covering employees who meet minimum service requirements and have
elected to participate. Company contributions, which are at the discretion of
the Board of Directors, totaled $30,800, $46,100 and $73,600 for the years ended
December 31, 1996, 1997 and 1998, respectively.
(5) INCOME TAXES
The provision for income tax consists of the following for the years
ended December 31, 1996, 1997 and 1998.
<TABLE>
<CAPTION>
PROVISION SUMMARY:
<S> <C> <C> <C>
1996 1997 1998
---- ---- ----
Current:
Federal...................... -- -- $28,000
State........................ -- -- 16,000
------- ------- -------
Total Current...... -- -- 44,000
Deferred:
Federal...................... -- -- --
State........................ -- -- --
------- ------- -------
Total Deferred..... -- -- --
======= ======= =======
TOTAL -- -- $44,000
======= ======= =======
</TABLE>
Actual income taxes vary from the expected income taxes (computed by
applying the statutory income tax rate of 34% to loss before income taxes and
extraordinary item) as a result of the following:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------------------------------
1996 1997 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Expected tax expense (benefit)......................................... $ (96,000) $ (71,000) $(638,000)
Total Increase (decrease) in income taxes resulting from............... -- --
Nondeductible amortization and acquired in-process
technology........................................................ 50,000 -- --
Change in the beginning of the year balance of the -- -- --
valuation allowance for federal deferred tax assets -- -- --
allocated to income tax expense.............................. 140,000 (409,000) 767,000
Research and experimentation credit............................... (137,000) (180,000) (132,000)
Nondeductible financing costs.................................... 318,000 8,000
Nondeductible expenses........................................... 42,000 14,000 5,000
Foreign tax credits............................................... -- (19,000) --
State and local income taxes, net of federal income tax
benefit........................................................... (10,000) 51,000 10,000
Other............................................................. 11,000 296,000 24,000
---------- ---------- ----------
Actual tax expense..................................................... $ -- $ -- $ 44,000
========== ========== ===========
</TABLE>
30
<PAGE> 33
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31, 1997 and
1998 are presented below:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1997 1998
------------- -------------
<S> <C> <C>
Deferred tax assets:
Accounts receivable, principally due to allowance for doubtful accounts........ 24,000 40,000
Accrued wages.................................................................. 94,000 136,000
Research and experimentation credit carryforward............................... 760,000 934,000
Other credit carryforwards..................................................... -- 29,000
Net operating loss carryforwards............................................... 268,000 1,097,000
Other.......................................................................... 87,000 59,000
------------ ------------
Total gross deferred tax assets...................................................... 1,233,000 2,295,000
Less valuation allowance....................................................... (23,000) (793,000)
------------ ------------
Net deferred tax asset.......................................................... 1,210,000 1,502,000
------------ ------------
Deferred tax liabilities:
Property and equipment, principally due to differences in
depreciation................................................................ (88,000) (68,000)
Software development costs...................................................... (978,000) (1,347,000)
Intellectual property........................................................... (128,000) (73,000)
Customer list................................................................... (16,000) (14,000)
Total gross deferred liabilities..................................................... 1,210,000 1,502,000
=========== ===========
Net deferred taxes................................................................... $ -- $ --
=========== ===========
</TABLE>
The net change in the total valuation allowance for the years ended
December 31, 1996, 1997 and 1998 was an increase (decrease) of $79,000,
$(409,000), and $770,000 respectively. In assessing the realizability of
deferred tax assets, management considers whether it is more likely than not
that some portion or all of the deferred tax assets will not be realized. The
ultimate realization of deferred tax assets is dependent upon the generation of
future taxable income during the periods in which those differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment. Based upon the level of historical taxable income,
management believes it is more likely than not the Company will realize the
benefits of these deductible differences net of the existing valuation
allowances.
The amount of the deferred tax asset considered realizable, however,
could be reduced in the near term if estimates of future taxable income during
the carryforward period are reduced
At December 31, 1998, the Company had federal net operating loss
carryforwards and research credits carryforwards approximating $2,790,000 and
$726,000, respectively, and state net operating loss carryforwards and research
credit carryforwards of $2,800,000 and $208,000, respectively. These losses and
credits are available to offset future taxable income and tax, if any. The
federal amounts expire in varying amounts beginning in 2008 and 2005
respectively, and continuing through 2018 and 2013, respectively. The state net
operating losses and research credits expire in varying amounts beginning in
2011 and continuing through 2013. A portion of the income tax loss carryforwards
and credits are subject to certain limitations which could impair the Company's
ability to utilize the benefits of these losses and credits in the future. In
addition, if certain substantial changes in the Company's ownership should
occur, there could be an additional annual limitation on the amount of the
carryforwards which could be utilized.
31
<PAGE> 34
(6) LEASES
The Company is obligated under various capital leases for computer
equipment that expire at various dates during the next four years. The gross
amount of computer equipment under capitalized leases and related depreciation
in the following periods was: at December 31, 1996, equipment $95,000 and
accumulated depreciation $27,400; at December 31, 1997, $154,700 and accumulated
depreciation $52,400; and at December 31, 1998 equipment $72,500 and accumulated
depreciation $32,500.
The Company has a noncancelable operating lease for its main office
facility. The lease is for an eight year term expiring in August 2004. The
Company can terminate the lease after the expiration of the fourth year, subject
to certain termination costs. Total rent expense associated with this lease for
the years ended December 31, 1996, 1997 and 1998 was approximately $116,000,
$160,000 and $199,000, respectively. Future minimum lease payments under
noncancelable operating leases (with initial or remaining lease terms in excess
of one year) and future minimum capital lease payment as of December 31, 1998,
are:
<TABLE>
<CAPTION>
OPERATING CAPITAL
--------- -------
<S> <C> <C>
1999...................................................................... $219,074 $15,100
2000...................................................................... 208,306 9,063
2001...................................................................... 202,867 9,063
2002...................................................................... 202,867 2,266
2003...................................................................... 202,867
Later years, through 2004................................................. 135,245
---------- -------
Total minimum lease payments.............................................. $1,171,226 $35,492
==========
Less amount representing interest....................................... 4,791
-------
Present value of net minimum capital lease payments....................... 30,701
Less current installments of obligations under capital leases.......... 12,564
-------
Obligations under capital leases, excluding current installments.......... $18,137
=======
</TABLE>
(7) SHAREHOLDERS' EQUITY
(a) Common and Preferred Stock
In June, 1998, the Company's shareholders voted to amend the Company's
Articles to increase the number of authorized shares of common stock of the
Company from 10,000,000 to 30,000,000.
(b) Stock Redemption Agreement
In May 1995, the Company entered into a Stock Redemption Agreement ("SR
Agreement") with the former Class B shareholders and the former Class B option
holders. Under the terms of the SR Agreement, the Company could redeem all (but
not less than all) of the former Class B shares and the shares of common stock
that could be acquired by the exercise of former Class B options at $1.53 per
share (the "call option"). The Company's call option was to expire on March 1,
1997.
32
<PAGE> 35
These shares were also subject to a put option exercisable by the
former Class B shareholders, to put their shares back to the Company (for cash)
at the book value of the Company, which is defined as assets less the sum of
liabilities and preferred stock paid-in capital, all as defined under GAAP,
divided by the number of common shares, as of the last day of the fiscal quarter
next preceding the date that the notice of exercise of this option is sent. The
put option was to be effective June 1997 through June 1998. The Company recorded
the redemption price of the common stock subject to the put feature by adjusting
interest expense and the put option liability . The put option was to be
effective June, 1997 through June, 1998.
In March 1997, the Company amended the SR Agreement to extend the
Company's call option and the holder's put option through October 1998. The call
price ranged from $1.56 to $2.37 and the put price ranged from $0.71 to $1.52
As of December 31, 1995 there were 616,674 shares of former Class B
stock and 60,536 former Class B options outstanding which were subject to call
and put rights. In April 1996, the number of shares and options subject to the
call and put options was reduced to 424,757 and 13,253, respectively, as a
provision of the conversion of the Notes into common shares (see note 4). In
April, 1997, the 13,253 options subject to the call and put expired. In February
1998, the Company exercised its call option with respect to the 424,757 shares
for a price of $1.90 a share.
In February 1998, put options held by Alpha Capital Venture Partners
and Sirrom Capital expired. The Company recorded the expiration of the put
options by reversing the put option liability and adjusting additional paid-in
capital in the amount of $1,072,003.
(c) Initial Public Offering
On January 29, 1998, the Company completed an initial public offering
of 1,900,000 shares of common stock at an offering price of $6.00 per share. On
February 27, 1998, the underwriter exercised its overallotment option and
offered an additional 285,000 shares to the public at $6.00 per share. As a
result of the initial public offering, the Company received net proceeds of
approximately $11,800,000 and increased its total shares of common stock
outstanding by 2,185,000 shares. The net proceeds of the offering were used to
repay in full the outstanding principal and interest on the $2,000,000 note with
Sirrom Capital, to redeem 424,757 shares of stock held by Alpha Capital Venture
Partners at $1.90 per share, and to terminate an unexercised warrant held by
Sirrom Capital for $196,000 and for general working capital.
(d) Stock Option Plan
The Company maintains a stock option plan for employees of Merge
Technologies Incorporated which provides for the granting of a maximum of
2,015,826 shares of common stock. Under this plan, options have an exercise
price equal to the fair market value of the stock at the date of grant. The
majority of the options vest 25% immediately with the remaining vesting over a
three-year period. The options granted under this plan expire six years from the
date of grant. There were no option grants to employees in 1998.
In 1998, the Company established a stock option plan for nonemployee
directors of Merge Technologies Incorporated which provides for the granting of
a maximum of 100,000 shares of common stock. Under this plan, options have an
exercise price equal to the fair market value of the stock at the date of grant.
Options granted under this plan in 1998 vest as to one third of such shares on
each of the first, second and third anniversaries of the date of issuance. The
options granted under this plan expire 10 years and one day from the date of
grant.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions used
for grants in 1996 and 1997: expected option lives of four years, expected
volatility and dividend yield of 0%, and a risk-free interest rate 5.63% and
6.13%. For grants made in 1998, the following assumptions were used: expected
option lives of 10 years, expected volatility of 45%, dividend yield of 0% and a
risk-free interest rate of 4.64%. The weighted average grant-date fair value of
options calculated using the Black-Scholes model was $0.29, $1.29 and $3.77 for
options granted in 1996, 1997 and 1998, respectively.
33
<PAGE> 36
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its plans. All options under the plans have been granted at
exercise prices not less than the market value at the date of the grant. Had the
Company determined compensation cost based on the fair value at the grant date
for its stock options under SFAS No. 123, the Company's net loss would have been
increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
Net loss
<S> <C> <C> <C>
As reported............................... $(113,679) $(209,026) $(1,919,970)
Pro forma................................. (177,000) (347,026) (2,092,741)
Basic and diluted net loss per share
As reported............................... $ (0.03) $ (0.05) $ (0.34)
Pro forma................................. (0.04) (0.09) (0.37)
</TABLE>
Pro forma net loss reflects only options granted in 1996, 1997 and
1998. Therefore, the full impact of calculating compensation cost for stock
options under SFAS No. 123 is not reflected in the pro forma net loss amounts
presented above because compensation cost is reflected over the options' vesting
period of three years and compensation cost for options granted prior to January
1, 1995 is not considered. A summary of stock options is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
WEIGHTED FAIR VALUE
AVERAGE OF
EXERCISE OPTIONS
NUMBER PRICE GRANTED
------ -------- ----------
<S> <C> <C> <C>
Options outstanding, December 31, 1995.................. 60,536 $ 0.33
Options granted......................................... 776,944 1.48 $ 0.29
--------- --------
Options outstanding, December 31, 1996.................. 837,480 1.39
Options granted......................................... 251,925 0.74 1.29
Options exercised...................................... (11,201) 6.00
Options forfeited....................................... (120,104) 0.96
--------- --------
Options outstanding, December 31, 1997................. 958,100 2.67
Options granted......................................... 60,000 6.00 3.77
Options exercised....................................... (1,016) 1.48
Options lapsed.......................................... (48,278) 4.16
--------- ---------
Options outstanding, December 31, 1998.................. 968,806 $ 2.80
========= =========
Options exercisable, December 31, 1998.................. 698,288 $ 2.50
========= =========
</TABLE>
34
<PAGE> 37
The following table summarizes information about stock options outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ ------------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE EXERCISE AVERAGE
EXERCISE NUMBER OF CONTRACTUAL PRICE NUMBER OF SHARES EXERCISE
PRICES SHARES LIFE PRICE
------------ ---------------- ------------- ----------------- ----------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
$1.48 685,505 3.80 $1.48 540,161 $1.48
$6.00 283,301 5.30 6.00 158,127 6.00
---------------- ------------- ----------------- ----------------- ---------------
968,806 4.24 $2.80 698,288 $2.50
================ ================= ================
</TABLE>
(e) Warrants
In June 1997, the Company entered into a $2,000,000 Loan Agreement with
Sirrom Capital Corporation (Sirrom"). In connection with the Loan Agreement, the
Company issued stock purchase warrants expiring in July 2000, granting Sirrom
the right to purchase 145,256 shares of the Company's common stock at $0.001 per
share. In February, 1998, Sirrom exercised 108,942 warrants and the remaining
36,314 warrants were terminated upon payment of $196,096 by the Company.
(f) Note Issued in Conjunction with Purchase of Common Stock
In June 1996, the Company issued a $160,000 note to a shareholder in
consideration for services the shareholder performed in assisting the Company
with raising capital. The note was due on January 1, 1997, and was non-interest
bearing. Effective December 31, 1996, the note payable to the shareholder was
discharged against a note due to the Company from the shareholder in connection
with the purchase of common stock.
In June 1996, the shareholder of the Company issued a $200,000
non-interest bearing note due on or before June 1, 1999 to purchase 135,443
shares of the Company's common stock at $1.48 per share, the fair market value
of the stock on the date of the note. The present value of the note was
$150,000. The Company has recognized interest income on the note at an imputed
interest rate of 10%. Effective December 1996, the note receivable was offset
with a note payable by the Company to the shareholder.
(8) GEOGRAPHIC AND BUSINESS AND CREDIT CONCENTRATION
Foreign sales, denominated in U.S. dollars, accounted for approximately
37%, 37%, and 36% of the Company's net sales for the years ended December 31,
1996, 1997, and 1998, respectively. Sales in foreign currency represented 6.2%
of the Company's net sales for the year ended December 31, 1998. The Company's
raw materials are readily available and the Company is not dependent on a single
supplier or only a few suppliers.
In March 1996, the Company established a sales office in Nuenen, The
Netherlands. Revenues for The Netherlands sales office were approximately
$660,000, $2,800,000 and $2,700,000 in the years ended December 31, 1996, 1997
and 1998, respectively. The value of long-lived assets in service at the Nuenen
sales office was not material in 1997 and 1998.
The Company had two customers and one distributor that accounted for
15%, 10%, and 26%, respectively, of consolidated net sales for the year ended
December 31, 1996. The Company had one customer and one distributor that
accounted for 14% and 23%, respectively, of consolidated net sales for the year
ended December 31, 1997 and two distributors that accounted for 18% each of
consolidated net sales for the year ended December 31, 1998. Accounts receivable
from one distributor accounted for approximately 38% of outstanding consolidated
amounts at December 31, 1997. Accounts receivable from two distributors
accounted for 19% and 12%, respectively, of outstanding consolidated amounts at
December 31, 1998.
35
<PAGE> 38
(9) PROFESSIONAL FEES RELATED TO PROPOSED FINANCING
The Company incurred and expensed $364,000 in fees in preparation for
an initial public offering in 1996 that was canceled.
(10) CONSULTING AGREEMENT
In June 1996, the Company entered into a three- year consulting
agreement with one of its shareholders for financing and other business
services. Pursuant to the terms of the consulting agreement, the shareholder was
paid $3,500 per month during the term of the agreement plus out-of-pocket
expenses. In the opinion of management of the Company, such fee was
representative of the fee the Company would be required to pay an independent
third-party to receive similar financing and other business services. The
Company and the shareholder terminated this consulting agreement effective upon
closing of the initial public offering.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable
PART III
Certain information required by Part III is omitted from this Report
because the Registrant will file its definitive proxy statement pursuant to
Section 240.14a-101 (the "Proxy Statement") not later than 120 days after the
end of the year covered by this Report, and certain information included therein
is incorporated herein by reference.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION. 16(A) OF THE EXCHANGE ACT
The information required by this item is incorporated by reference to
the information set forth under the caption "Management" in the Company's Proxy
Statement for the 1999 Annual Meeting of Stockholders.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to
the information set forth under the caption "Management - Executive
Compensation" in the Company's Proxy Statement for the 1999 Annual Meeting of
Stockholders.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to
the information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the Company's Proxy Statement for the 1999
Annual Meeting of Stockholders.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to
the information set forth under the caption "Directors and Executive Officers"
in the Company's Proxy Statement for the 1999 Annual Meeting of Stockholders.
36
<PAGE> 39
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit No.
3.1 Articles of Incorporation of Registrant (1)
3.2 Amended and Restated By-Laws of Registrant as of February 3, 1998
(2)
4.1 Stock Purchase Warrant issued June 30, 1997 by Registrant to
Sirrom Capital Corporation (1)
4.2 Form of Lock-Up Agreement (1)
4.3 Common Stock Certificate (1)
4.4 Representative's Warrant (2)
10.1 Employment Agreement dated September 1, 1997 between Registrant
and William C. Mortimore (1)
10.2 Merge/Sirrom Revised Modification Agreement dated as of October
30, 1997 (1)
10.3 OEM Purchase Agreement between Registrant and Philips Medical
Systems Nederland B.V. dated September 24, 1994 and First
Amendment dated June 4, 1996 (1)
10.4 Distribution Agreement with Picker International, Inc. (1)
10.5 1996 Stock Option Plan for Employees of Registrant dated May 13,
1996 (1)
10.6 Office Lease for West Allis enter dated May 24, 1996 between
Registrant and Whitnall Summit Company, LLC, together with
Supplement Office Space Lease dated July 3, 1997 (1)
10.7 Alpha Capital Venture Partners Limited Agreement dated March 1,
1997 (1)
10.8 1998 Stock Option Plan For Directors (2)
21 Subsidiaries of Registrant (1)
27.1 Financial Data Schedule
- --------------------------------------------------------------------------------
(1) Incorporated by reference to Registration Statement on Form SB-2
(No. 333-39111) effective January 29, 1998.
(2) Incorporated by reference to Annual Report on Form 10-KSB dated
May 5, 1998.
(b) No Reports on Form 8-K were filed during the fourth fiscal quarter.
37
<PAGE> 40
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange of
1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
REGISTRANT
MERGE TECHNOLOGIES INCORPORATED
Date: March 31, 1999 By: /s/ William C. Mortimore
WILLIAM C. MORTIMORE
President and Chief Executive
Officer
Date: March 31, 1999 By: /s/ Colleen M. Doan
COLLEEN M. DOAN
Chief Financial Officer, Treasurer
and Secretary
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
Date: March 31, 1999 By: /s/ Robert T. Geras
ROBERT T. GERAS
Director and Chairman of Board of
Directors
Date: March 31, 1999 By: /s/ Robert A. Barish
ROBERT A. BARISH, M.D.
Director
Date: March 31, 1999 By: /s/ Dennis Brown
DENNIS BROWN
Director
Date: March 31, 1999 By: /s/ Michael D. Dunham
MICHAEL D. DUNHAM
Director
Date: March 31, 1999 By: /s/ Douglas S. Harrington
DOUGLAS S. HARRINGTON, M.D.
Director
Date: March 31, 1999 By: /s/ Kevin E. Moley
KEVIN E. MOLEY
Director
38
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,659,879
<SECURITIES> 0
<RECEIVABLES> 1,983,692
<ALLOWANCES> 206,348
<INVENTORY> 1,951,160
<CURRENT-ASSETS> 7,812,251
<PP&E> 2,498,809
<DEPRECIATION> 1,054,554
<TOTAL-ASSETS> 12,928,026
<CURRENT-LIABILITIES> 1,487,301
<BONDS> 0
0
0
<COMMON> 13,989,214
<OTHER-SE> (2,566,626)
<TOTAL-LIABILITY-AND-EQUITY> 12,928,026
<SALES> 0
<TOTAL-REVENUES> 9,669,172
<CGS> 3,419,225
<TOTAL-COSTS> 8,369,588
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 40,718
<INCOME-PRETAX> (1,875,997)
<INCOME-TAX> 43,973
<INCOME-CONTINUING> (1,919,970)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,919,970)
<EPS-PRIMARY> 0
<EPS-DILUTED> (0.34)
</TABLE>
