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MERGE HEALTHCARE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[July 30, 2014]

MERGE HEALTHCARE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Note Regarding Forward-Looking Statements The discussion below contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E of the Exchange Act. We have used words such as "believes," "anticipates," "forecasts," "projects," "could," "plans," "expects," "may," "will," "would," "intends," "estimates" and similar expressions, whether in the negative or affirmative, to identify forward-looking statements. These statements are based on information currently available to us and are subject to a number of risks and uncertainties that may cause our actual results of operations, financial condition, cash flows, performance, business prospects and opportunities and the timing of certain events to differ materially from those expressed in, or implied by, these statements. These risks, uncertainties and other factors include, without limitation, those matters discussed in Item 1A of Part I of our Annual Report on Form 10­K for the year ended December 31, 2013.



Except as expressly required by the federal securities laws, we undertake no obligation to update such factors or to publicly announce the results of any of the forward-looking statements contained herein to reflect future events, developments, or changed circumstances, or for any other reason. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing in our Annual Report on Form 10-K and Item 1A, "Risk Factors" for the year ended December 31, 2013.

Management's Discussion and Analysis is presented in the following order: · Overview · Business Segments · Results of Operations · Liquidity and Capital Resources · Material Off Balance Sheet Arrangements · Critical Accounting Policies Overview We develop software solutions that facilitate the sharing of images to create a more effective and efficient electronic healthcare experience for patients and physicians. Our solutions are designed to help solve some of the most difficult challenges in health information exchange today, such as the incorporation of medical images and diagnostic information into broader healthcare IT applications, the interoperability of proprietary software solutions, the profitability of outpatient imaging practices and the ability to improve the efficiency and cost effectiveness of our customers' businesses. These solutions optimize processes for healthcare providers ranging in size from single provider practices to large health systems, to the sponsors of clinical trials and medical device manufacturers. We believe that our ability to innovate has driven consistent expansion of solutions and services and assisted our entry into new markets.


We operate under two reportable operating segments: Merge Healthcare and Merge DNA. Our Merge Healthcare segment represents about 85% of our year-to-date total revenues and markets, sells and implements interoperability, imaging and clinical solutions to healthcare providers. Our Merge DNA (Data and Analytics) segment represents the other 15% of revenues and focuses on data capture software for clinical trials and other solutions. We evaluate the performance of each operating group based on their respective revenues and operating income.

Our Merge Healthcare segment primarily generates revenue from the sale of software (including upgrades), hardware, professional services, maintenance and electronic data interchange (EDI) services. Our Merge DNA segment derives the vast majority of its revenue from software, professional services, and hosting through subscription arrangements. The majority of total revenue continues to be generated through perpetual license agreements with our customers. Under perpetual license agreements, the software, hardware and professional services are considered to be sources of non-recurring revenue and related backlog. The backlog of non-recurring revenue was approximately $23.2 million and $24.9 million as of June 30, 2014 and 2013, respectively.

Subscription-based pricing arrangements include contract elements that are payable by our customers over a number of years. Year-to-date, subscription revenue was approximately 16% of total net sales. Generally, these contracts include a minimum image volume and/or dollar commitment. As such, revenue from these transactions is recognized ratably over an extended period of time.

Subscription arrangements include, but are not limited to, contracts that are structured with monthly payments (including leases), clinical trials or renewable annual software contracts (with very high renewal rates). As of June 30, 2014, subscription revenue backlog was $54.6 million, compared to $48.9 million at June 30, 2013. Due to the variability in timing and length of maintenance renewals, we do not track backlog for maintenance and EDI.

16-------------------------------------------------------------------------------- Index In the second quarter of 2014, we completed a debt refinancing that resulted in a new six-year term loan (the Term Loan) of $235 million at a 7.00% interest rate. The Term Loan replaced an existing term loan (the Prior Term Loan) at a 6.00% interest rate with more restrictive financial ratio covenants, which was terminated upon completion of the debt refinancing. Proceeds from the Term Loan were used to repay the aggregate principal outstanding under the Prior Term Loan in addition to funding related transaction costs. The Prior Term Loan had an outstanding balance of $230.1 million as of April 29, 2014, and we recorded a non-cash charge of $4.8 million in the second quarter of 2014 associated with its extinguishment. The Prior Term Loan, completed in the second quarter of 2013, replaced Senior Secured Notes (which were at an 11.75% interest rate). In the second quarter of 2013, we recorded a charge of $23.8 million, including $7.0 million of non-cash expenses, for the early extinguishment of the Notes.

Business Segments The following tables provide operating group information for the periods indicated, based on GAAP reported information (all amounts are in thousands, except percentages): Merge Healthcare Three Months Ended Six Months Ended Segment June 30, Change 2014 vs. 2013 June 30, Change 2014 vs. 2013 2014 2013 $ % 2014 2013 $ % Net sales: Software and other $ 13,599 $ 14,127 $ (528 ) -3.7 % $ 24,741 $ 31,952 $ (7,211 ) -22.6 % Professional services 7,304 7,190 114 1.6 % 14,380 15,245 (865 ) -5.7 % Maintenance and EDI 25,298 27,293 (1,995 ) -7.3 % 50,309 54,651 (4,342 ) -7.9 % Total net sales 46,201 48,610 (2,409 ) -5.0 % 89,430 101,848 (12,418 ) -12.2 % Expenses 40,018 44,649 (4,631 ) -10.4 % 77,231 88,800 (11,569 ) -13.0 % Segment income $ 6,183 $ 3,961 $ 2,222 56.1 % $ 12,199 $ 13,048 $ (849 ) -6.5 % Three Months Ended Six Months Ended Merge DNA Segment June 30, Change 2014 vs. 2013 June 30, Change 2014 vs. 2013 2014 2013 $ % 2014 2013 $ % Net sales: Software and other $ 4,422 $ 3,752 $ 670 17.9 % $ 8,363 $ 9,498 $ (1,135 ) -11.9 % Professional services 2,867 4,362 (1,495 ) -34.3 % 6,280 8,430 (2,150 ) -25.5 % Maintenance and EDI 324 469 (145 ) -30.9 % 644 1,051 (407 ) -38.7 % Total net sales 7,613 8,583 (970 ) -11.3 % 15,287 18,979 (3,692 ) -19.5 % Expenses 6,045 7,674 (1,629 ) -21.2 % 12,931 18,238 (5,307 ) -29.1 % Segment income $ 1,568 $ 909 $ 659 72.5 % $ 2,356 $ 741 $ 1,615 217.9 % 17-------------------------------------------------------------------------------- Index The following tables provide GAAP sales generated by non-recurring, subscription and maintenance and EDI revenue sources by segment for the periods indicated and non-recurring and subscription backlog as of June 30, 2014 and 2013 (all amounts are in thousands, except percentages): Net Sales Three Months ended June 30, 2014 Healthcare DNA Total Revenue Source $ % $ % $ %Maintenance & EDI $ 25,298 54.7 % $ 324 4.2 % $ 25,622 47.6 % Subscription 1,653 3.6 % 7,246 95.2 % 8,899 16.5 % Non-recurring 19,250 41.7 % 43 0.6 % 19,293 35.9 % Total $ 46,201 100.0 % $ 7,613 100.0 % $ 53,814 100.0 % 85.9 % 14.1 % Net Sales Three Months ended June 30, 2013 Healthcare DNA Total Revenue Source $ % $ % $ % Maintenance & EDI $ 27,293 56.1 % $ 469 5.5 % $ 27,762 48.5 % Subscription 1,595 3.3 % 8,075 94.1 % 9,670 16.9 % Non-recurring 19,722 40.6 % 39 0.4 % 19,761 34.6 % Total $ 48,610 100.0 % $ 8,583 100.0 % $ 57,193 100.0 % 85.0 % 15.0 % Net Sales Six Months ended June 30, 2014 Healthcare DNA Total Revenue Source $ % $ % $ % Maintenance & EDI $ 50,309 56.2 % $ 644 4.2 % $ 50,953 48.7 % Subscription 2,924 3.3 % 14,168 92.7 % 17,092 16.3 % Non-recurring 36,197 40.5 % 475 3.1 % 36,672 35.0 % Total $ 89,430 100.0 % $ 15,287 100.0 % $ 104,717 100.0 % 85.4 % 14.6 % Net Sales Six Months ended June 30, 2013 Healthcare DNA Total Revenue Source $ % $ % $ % Maintenance & EDI $ 54,651 53.7 % $ 1,051 5.5 % $ 55,702 46.1 % Subscription 3,268 3.2 % 15,750 83.0 % 19,018 15.7 % Non-recurring 43,929 43.1 % 2,178 11.5 % 46,107 38.2 % Total $ 101,848 100.0 % $ 18,979 100.0 % $ 120,827 100.0 % 84.3 % 15.7 % Backlog as of June 30, 2014 Healthcare DNA Total Revenue Source $ % $ % $ % Subscription $ 13,067 36.0 % $ 41,492 100.0 % $ 54,559 70.2 % Non-recurring 23,203 64.0 % - 0.0 % 23,203 29.8 % Total $ 36,270 100.0 % $ 41,492 100.0 % $ 77,762 100.0 % 46.6 % 53.4 % Backlog as of June 30, 2013 Healthcare DNA Total Revenue Source $ % $ % $ % Subscription $ 11,517 31.7 % $ 37,432 100.0 % $ 48,949 66.3 % Non-recurring 24,866 68.3 % - 0.0 % 24,866 33.7 % Total $ 36,383 100.0 % $ 37,432 100.0 % $ 73,815 100.0 % 49.3 % 50.7 % 18-------------------------------------------------------------------------------- Index Results of Operations Three Months Ended June 30, 2014 Compared to the Three Months Ended June 30, 2013 The following table sets forth selected, summarized, unaudited, consolidated financial data for the periods indicated, as well as comparative data showing increases and decreases between the periods. All amounts, except percentages, are in thousands.

Three Months Ended June 30, Change 2014 % (1) 2013 % (1) $ % Net sales: Software and other $ 18,021 33.5 % $ 17,879 31.3 % $ 142 0.8 % Professional services 10,171 18.9 % 11,552 20.1 % (1,381 ) -12.0 % Maintenance and EDI 25,622 47.6 % 27,762 48.5 % (2,140 ) -7.7 % Total net sales 53,814 100.0 % 57,193 100.0 % (3,379 ) -5.9 % Cost of sales: Software and other 9,085 50.4 % 9,638 53.9 % (553 ) -5.7 % Professional services 6,017 59.2 % 6,394 55.3 % (377 ) -5.9 % Maintenance and EDI 6,831 26.7 % 7,370 26.5 % (539 ) -7.3 % Depreciation and amortization 1,677 3.1 % 1,810 3.2 % (133 ) -7.3 % Total cost of sales 23,610 43.9 % 25,212 44.1 % (1,602 ) -6.4 % Total gross margin 30,204 56.1 % 31,981 55.9 % (1,777 ) -5.6 % Gross margin by net sales category (2) Software and other 8,936 49.6 % 8,241 46.1 % 695 8.4 % Professional services 4,154 40.8 % 5,158 44.7 % (1,004 ) -19.5 % Maintenance and EDI 18,791 73.3 % 20,392 73.5 % (1,601 ) -7.9 % Operating expenses: Sales and marketing 8,140 15.1 % 10,088 17.6 % (1,948 ) -19.3 % Product research and development 7,335 13.6 % 8,447 14.8 % (1,112 ) -13.2 % General and administrative 6,404 11.9 % 8,829 15.4 % (2,425 ) -27.5 % Acquisition-related expenses - 0.0 % 158 0.3 % (158 ) -100.0 % Restructuring and other expenses - 0.0 % 573 1.0 % (573 ) -100.0 % Depreciation and amortization 2,563 4.8 % 2,594 4.5 % (31 ) -1.2 % Total operating costs and expenses 24,442 45.4 % 30,689 53.7 % (6,247 ) -20.4 % Operating income 5,762 10.7 % 1,292 2.3 % 4,470 346.0 % Other expense, net (9,038 ) -16.8 % (28,700 ) -50.2 % 19,662 -68.5 % Loss before income taxes (3,276 ) -6.1 % (27,408 ) -47.9 % 24,132 -88.0 % Income tax (benefit) expense 675 1.3 % 712 1.2 % (37 ) -5.2 % Net loss $ (3,951 ) -7.3 % $ (28,120 ) -49.2 % $ 24,169 -85.9 % (1) Percentages are of total net sales, except for cost of sales and gross margin, which are based upon related net sales.

(2) Depreciation and amortization are excluded from these gross margin calculations.

Net Sales Software and Other Sales. Total software and other sales in 2014 were $18.0 million, an increase of $0.1 million, or 0.8%, from $17.9 million in 2013.

Software and other sales decreased by $0.5 million in the Merge Healthcare operating segment in 2014 and increased $0.7 million in the Merge DNA segment during the same period. The Merge DNA segment sales increased by $1.6 million for clinical trials revenue from a platform enhancement introduced in late 2012 which entails more transaction-based software fees and less service required to configure the platform, which offset the decrease in subscription revenue from the sale of health stations in the prior year as we exited this low margin product line throughout 2013. Software and hardware orders are typically fulfilled, and revenue recognized, in either the quarter signed or the following few quarters. Revenue recognized from software and other sales may vary significantly on a quarterly basis.

19-------------------------------------------------------------------------------- Index Professional Services Sales. Total professional services sales in 2014 were $10.2 million, a decrease of $1.4 million, or 12.0%, from $11.6 million in 2013. Sales decreased $1.5 million in the Merge DNA segment as a result of the clinical trials platform introduced in late 2012 that has resulted in a shift in revenue mix from services to software. Revenue recognized from professional services sales generally lags software and other sales by one to three quarters due to the timing of when such services are performed compared to when the products are delivered.

Maintenance and EDI Sales. Total maintenance and EDI sales in 2014 were $25.6 million, a decrease of $2.1 million, or 7.7%, from $27.8 million in 2013, due to a decrease in software maintenance support sales as we exited certain product lines in the Merge Healthcare segment throughout 2013.

Gross Margin Gross Margin - Software and Other Sales. Gross margin on software and other sales was $8.9 million in 2014, an increase of $0.7 million, or 8.4%, from $8.2 million in 2013. Gross margin as a percentage of software and other sales increased to 49.6% in 2014 from 46.1% in 2013, primarily due to improved hardware gross margins. Hardware sales were 44.2% of software and other sales in 2014 compared to 42.7% in 2013. We expect gross margin on software and other sales to fluctuate depending on our product sales mix.

Gross Margin - Professional Service Sales. Gross margin on professional service sales was $4.2 million in 2014, a decrease of $1.0 million, or 19.5%, from $5.2 million in 2013. Gross margin as a percentage of professional service sales decreased to 40.8% in 2014 from 44.7% in 2013, primarily due to the billable utilization of our professional services resources. As the majority of professional services costs are fixed, we expect gross margins to fluctuate depending on billable utilization of these resources.

Gross Margin - Maintenance and EDI Sales. Gross margin on maintenance and EDI sales was $18.8 million in 2014, a decrease of $1.6 million, or 7.9% from $20.4 million in 2013. Gross margin as a percentage of maintenance and EDI sales was 73.3% in 2014, compared to 73.5% in 2013. The gross margin dollar change occurred as a result of product lines exited throughout 2013.

Depreciation and Amortization - Cost of Sales Depreciation and amortization expense decreased 7.3%, to $1.7 million in 2014 from $1.8 million in 2013 mainly due to assets that became fully depreciated in the prior year.

Sales and Marketing Sales and marketing expense decreased $1.9 million, or 19.3%, to $8.1 million in 2014 from $10.1 million in 2013. As a percentage of net sales, sales and marketing expense decreased by 2.5% to 15.1%, primarily due to lower headcount and headcount related costs related to prior restructuring initiatives.

Product Research and Development Product research and development expense decreased $1.1 million, or 13.2%, to $7.3 million in 2014 from $8.4 million in 2013. The decrease is primarily due to enhancements to our product development and quality assurance processes in the fourth quarter of 2013, which allowed us to more efficiently engineer our solutions and lower our expenses as well as capitalize, and thus not recognize as an expense, software development costs of $0.4 million in 2014 compared to zero costs capitalized in 2013. As a percentage of net sales, product research and development expense decreased by 1.2%, to 13.6% in 2014.

General and Administrative General and administrative expense decreased $2.4 million, or 27.5%, to $6.4 million in 2014 from $8.8 million in 2013. The decrease is primarily due to a decrease of $1.5 million in compensation (including stock-based compensation) and related benefits and a decrease of $0.6 million in bad debt expense. As a percentage of net sales, general and administrative expenses decreased by 3.5% to 11.9% in 2014.

Restructuring and Other Expenses There were no restructuring and other expenses in 2014. The 2013 expense of $0.6 million was related to restructuring initiatives.

20-------------------------------------------------------------------------------- Index Depreciation and Amortization Depreciation and amortization expense was unchanged at $2.6 million. As a percentage of net sales, depreciation and amortization was 4.8% in 2014 compared to 4.5% in 2013.

Other Expense, Net Other expense consists primarily of loss on extinguishment of debt and interest expense. During 2014 and 2013, we refinanced our debt and incurred losses on debt extinguishment of $4.8 million and $23.8 million, respectively. See note 6 of the notes to condensed consolidated financial statements for additional information pertaining to the refinancing of our debt. Interest expense decreased to $4.2 million in 2014 from $5.1 million in 2013, due to a decrease in the amount of principal indebtedness outstanding from 2013 to 2014 and a decrease in the average interest rate during 2014 compared to 2013.

Income Tax Expense In 2014 and 2013, we recorded income tax expense of $0.7 million. The income tax benefit or expense in any period results from mix of profit or loss in the U.S. and Canadian operations compared to expected results for the full year or period , state income taxes, valuation allowance establishment or releases, and the deferred effect of tax deductible goodwill amortization. The current period expense includes a benefit related to releasing the valuation allowance on a separate legal entity's state jurisdictions. The separate legal entity is in a three year cumulative pre-tax book income position and we have met internal policies in order to rely on income forecasts specific to the legal entity.

Only state income taxes resulted in cash tax payments in each year. The effective income tax rate may vary significantly due to changes in, among other items, operating income by jurisdiction and the results of changes in tax laws and regulations of the U.S. and foreign jurisdictions in which we operate.

21-------------------------------------------------------------------------------- Index Six Months Ended June 30, 2014 Compared to the Six Months Ended June 30, 2013 The following table sets forth selected, summarized, unaudited, consolidated financial data for the periods indicated, as well as comparative data showing increases and decreases between the periods. All amounts, except percentages, are in thousands.

Six Months Ended June 30, Change 2014 % (1) 2013 % (1) $ % Net sales: Software and other $ 33,104 31.6 % $ 41,450 34.3 % $ (8,346 ) -20.1 % Professional services 20,660 19.7 % 23,675 19.5 % (3,015 ) -12.7 % Maintenance and EDI 50,953 48.7 % 55,702 46.1 % (4,749 ) -8.5 % Total net sales 104,717 100.0 % 120,827 100.0 % (16,110 ) -13.3 % Cost of sales: Software and other 15,186 45.9 % 21,405 51.6 % (6,219 ) -29.1 % Professional services 12,364 59.8 % 12,919 54.6 % (555 ) -4.3 % Maintenance and EDI 13,794 27.1 % 15,459 27.8 % (1,665 ) -10.8 % Depreciation and amortization 3,272 3.1 % 3,620 3.0 % (348 ) -9.6 % Total cost of sales 44,616 42.6 % 53,403 44.2 % (8,787 ) -16.5 % Total gross margin 60,101 57.4 % 67,424 55.8 % (7,323 ) -10.9 % Gross margin by net sales category (2) Software and other 17,918 54.1 % 20,045 48.4 % (2,127 ) -10.6 % Professional services 8,296 40.2 % 10,756 45.4 % (2,460 ) -22.9 % Maintenance and EDI 37,159 72.9 % 40,243 72.2 % (3,084 ) -7.7 % Operating expenses: Sales and marketing 16,147 15.4 % 20,454 16.9 % (4,307 ) -21.1 % Product research and development 14,915 14.2 % 16,972 14.0 % (2,057 ) -12.1 % General and administrative 13,764 13.1 % 15,948 13.2 % (2,184 ) -13.7 % Acquisition-related expenses 26 0.0 % 427 0.4 % (401 ) -93.9 % Restructuring and other expenses - 0.0 % 1,802 1.5 % (1,802 ) -100.0 % Depreciation and amortization 5,045 4.8 % 5,247 4.3 % (202 ) -3.8 % Total operating costs and expenses 49,897 47.6 % 60,850 50.4 % (10,953 ) -18.0 % Operating income 10,204 9.7 % 6,574 5.4 % 3,630 55.2 % Other expense, net (13,174 ) -12.6 % (37,460 ) -31.0 % 24,286 -64.8 % Loss before income taxes (2,970 ) -2.8 % (30,886 ) -25.6 % 27,916 -90.4 % Income tax (benefit) expense 656 0.6 % 3,727 3.1 % (3,071 ) -82.4 % Net loss $ (3,626 ) -3.5 % $ (34,613 ) -28.6 % $ 30,987 -89.5 % (1) Percentages are of total net sales, except for cost of sales and gross margin, which are based upon related net sales.

(2) Depreciation and amortization are excluded from these gross margin calculations.

Net Sales Software and Other Sales. Total software and other sales in 2014 were $33.1 million, a decrease of $8.3 million, or 20.1%, from $41.5 million in 2013.

Software and other sales in the Merge Healthcare operating segment decreased by $7.2 million, primarily due to delays in customer buying decisions. The $1.1 million decrease in sales in the Merge DNA segment was the result of $2.7 million of increased clinical trials revenue for the reasons previously mentioned, which was offset by the sale of health stations for $2.0 million in the first quarter of the prior year as we exited this low margin product line throughout 2013. The exit of the health station product line also resulted in decreased subscription revenue of $1.6 million in 2014 compared to 2013.

Professional Services Sales. Total professional services sales in 2014 were $20.7 million, a decrease of $3.0 million, or 12.7%, from $23.7 million in 2013. Sales decreased $0.8 million in the Merge Healthcare segment due to fewer installation projects in 2014 compared to 2013. Sales in the Merge DNA segment decreased $2.2 million as a result of the clinical trials platform introduced in late 2012 that has resulted in a shift in revenue mix from services to software.

Maintenance and EDI Sales. Total maintenance and EDI sales in 2014 were $51.0 million, a decrease of $4.7 million, or 8.5%, from $55.7 million in 2013, due to a decrease in software maintenance support sales as we exited certain product lines in the Merge Healthcare segment throughout 2013.

22-------------------------------------------------------------------------------- Index Gross Margin Gross Margin - Software and Other Sales. Gross margin on software and other sales was $17.9 million in 2014, a decrease of $2.1 million, or 10.6%, from $20.0 million in 2013. Gross margin as a percentage of software and other sales increased to 54.1% in 2014 from 48.4% in 2013, primarily due to a decrease in the percentage of hardware sales, which are at lower margins than software.

Hardware sales were 39.7% of software and other sales in 2014 compared to 43.3% in 2013, primarily due to the aforementioned health station sales.

Gross Margin - Professional Service Sales. Gross margin on professional service sales was $8.3 million in 2014, a decrease of $2.5 million, or 22.9%, from $10.8 million in 2013. Gross margin as a percentage of professional service sales decreased to 40.2% in 2014 from 45.4% in 2013, primarily due to the billable utilization of our professional services resources.

Gross Margin - Maintenance and EDI Sales. Gross margin on maintenance and EDI sales was $37.2 million in 2014, a decrease of $3.1 million, or 7.7% from $40.2 million in 2013. Gross margin as a percentage of maintenance and EDI sales was 72.9% in 2014, compared to 72.2% in 2013. These changes occurred as a result of product lines exited throughout 2013.

Depreciation and Amortization - Cost of Sales Depreciation and amortization expense decreased 9.6%, to $3.3 million in 2014 from $3.6 million in 2013 mainly due to assets that became fully depreciated in the prior year.

Sales and Marketing Sales and marketing expense decreased $4.3 million, or 21.1%, to $16.1 million in 2014 from $20.5 million in 2013. As a percentage of net sales, sales and marketing expense decreased by 1.5% to 15.4%, primarily due to lower headcount and headcount related costs related to prior restructuring initiatives.

Product Research and Development Product research and development expense decreased $2.1 million, or 12.1%, to $14.9 million in 2014 from $17.0 million in 2013. The decrease is primarily due to enhancements to our product development and quality assurance processes in the fourth quarter of 2013, which allowed us to more efficiently engineer our solutions and lower our expenses as well as capitalize, and thus not recognize as an expense, software development costs of $1.0 million in 2014 compared to zero in 2013.

General and Administrative General and administrative expense decreased $2.2 million, or 13.7%, to $13.8 million in 2014 from $15.9 million in 2013. The 2013 expense includes a favorable non-cash settlement of a legal matter totaling $2.5 million.

Excluding this item, general and administrative expenses decreased by $4.7 million in 2014 due to decreases of $2.6 million in compensation (including stock-based compensation) and related benefits and $1.3 million in bad debt expense. General and administrative expense as a percentage of net sales was 13.1% in 2014. Excluding the favorable non-cash settlement of a legal matter, general and administrative expense as a percentage of net sales would have been 15.3% in 2013.

Restructuring and Other Expenses There were no restructuring and other expenses in 2014. The 2013 expense of $1.8 million was related to restructuring initiatives and included costs surrounding the end of life of certain non-core products.

Depreciation and Amortization Depreciation and amortization expense decreased $0.2 million, or 3.8%, to $5.0 million in 2014 from $5.2 million in 2013, due to the overall decrease in amortization on certain intangible assets which are amortized on a basis consistent with the expected cash flows from such assets (as opposed to a straight-line basis) and assets that became fully depreciated in the prior year.

Other Expense, Net Other expense consists primarily of loss on extinguishment of debt and interest expense. During 2014 and 2013, we refinanced our debt and incurred losses on debt extinguishment of $4.8 million and $23.8 million, respectively. See note 6 of the notes to condensed consolidated financial statements for additional information pertaining to the refinancing of our debt. Interest expense decreased to $8.4 million in 2014 from $13.3 million in 2013, due to a decrease in the amount of principal indebtedness outstanding from 2013 to 2014 and a decrease in the average interest rate during 2014 compared to 2013. In addition, other expense included a $0.4 million unfavorable fair value adjustment of an investment in 2013.

23-------------------------------------------------------------------------------- Index Income Tax Expense In 2014, we recorded income tax expense of $0.7 million, compared to income tax expense of $3.7 million in 2013. The income tax benefit or expense in any period results from mix of profit or loss in the U.S. and Canadian operations compared to expected results for the full year or period, state income taxes, valuation allowance establishment or releases, and the deferred effect of tax deductible goodwill amortization. The current period expense includes a benefit related to releasing the valuation allowance on a separate legal entity's state jurisdictions. The separate legal entity is in a three year cumulative pre-tax book income position and we have met internal policies in order to rely on income forecasts specific to the legal entity. Only state income taxes resulted in cash tax payments in each year. The effective income tax rate may vary significantly due to changes in, among other items, operating income by jurisdiction and the results of changes in tax laws and regulations of the U.S.

and foreign jurisdictions in which we operate.

Liquidity and Capital Resources Our cash and cash equivalents were $23.9 million at June 30, 2014, an increase of $4.1 million from our balance at December 31, 2013. In addition, our working capital was $5.5 million at June 30, 2014, a decrease of $6.4 million from our working capital of $11.9 million at December 31, 2013. We used cash generated from successful collection activities to pay down our debt principal well ahead of schedule in the first quarter of 2014. In the second quarter of 2014 we refinanced our debt and gained flexibility in managing our future financing needs.

Operating Cash Flows Cash provided by operating activities was $14.6 million in 2014, compared to cash provided by operating activities of $1.4 million in 2013. The net loss in 2014 of $3.6 million includes non-cash expenses of $17.7 million. Additionally, $0.2 million was paid related to prior year restructuring activities during 2014 and there is $0.7 million remaining to be paid in future periods.

Investing Cash Flows Cash used in investing activities was $2.9 million in 2014, compared to cash used in investing activities of $0.8 million in 2013. The increase of $2.1 million is primarily due to the purchase of computer equipment, the acquisition of purchased technology and the capitalization of software development costs in 2014.

Financing Cash Flows Cash used in financing activities was $7.3 million in 2014, compared to cash used in financing activities of $19.6 million in 2013. The change is primarily due to the repayment of $8.6 million of principal on our debt in 2014 and the $20.7 million of costs associated with the refinancing of our debt in 2013.

Contractual Obligations Total outstanding commitments as of June 30, 2014, were as follows (in thousands): Payment due by period Less than More than Contractual Obligations Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years Operating leases $ 13,561 $ 2,308 $ 3,446 $ 2,764 $ 5,043 Capital leases (including interest) 627 572 55 - - Acquisition obligations 932 811 121 - - Term loan (including interest and fees) 319,043 28,167 53,875 50,497 186,504 Patent license obligation 1,250 125 250 250 625 Other notes payable (including interest) 62 12 32 18 - Total $ 335,475 $ 31,995 $ 57,779 $ 53,529 $ 192,172 The above obligations include lease payments involving facilities that we use and those we have either ceased to use or previously abandoned. At June 30, 2014, we do not have any other significant long-term obligations, contractual obligations, lines of credit, standby letters of credit and guarantees, standby repurchase obligations or other commercial commitments.

24-------------------------------------------------------------------------------- Index As of June 30, 2014, approximately $1.5 million of our cash balance was held by our foreign subsidiaries. We may need to accrue and pay taxes if we choose to repatriate these funds.

General We believe our current cash and cash equivalent balances will be sufficient to meet our operating, financing and capital requirements through at least the next 12 months, including interest payments due under the Term Loan, which we entered into in the second quarter of 2014 (the proceeds of which were primarily used to repay the Prior Term Loan and fees associated with the Term Loan). However, any projections of future cash inflows and outflows are subject to uncertainty. In the event that it is necessary to raise additional capital to meet our short term or long term liquidity needs, such capital may be raised through additional debt, equity offerings or sale of certain assets. If we raise additional funds through the issuance of equity, equity-related or debt securities, such securities may have rights, preferences or privileges senior to those of our common stock. Furthermore, the number of shares of any new equity or equity-related securities that may be issued may result in significant dilution to existing shareholders. In addition, the issuance of debt securities could increase the liquidity risk or perceived liquidity risk that we face. We cannot, however, be certain that additional financing, or funds from asset sales, will be available on acceptable terms. If adequate funds are not available or are not available on acceptable terms, we will likely not be able to take advantage of opportunities, develop or enhance services or products or respond to competitive pressures. In particular, our uses of cash in 2014 and beyond will depend on a variety of factors such as the costs to implement our business strategy, the amount of cash that we are required to devote to defend and address any legal or regulatory proceedings, and potential merger and acquisition activities. In connection with the repayment of the Prior Term Loan, we terminated the Revolving Credit Facility.

For a more detailed description of risks and uncertainties that may affect our liquidity, see Item 1A., "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013.

Material Off Balance Sheet Arrangements We have no material off balance sheet arrangements.

Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed consolidated financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, our management evaluates these estimates. We base our estimates and judgments on our experience, our current knowledge (including terms of existing contracts), our beliefs of what could occur in the future, our observation of trends in the industry, information provided by our customers and information available from other sources. Actual results may differ materially from these estimates.

We have identified the following accounting policies and estimates as those that we believe are most critical to our financial condition and results of operations and that require management's most subjective and complex judgments in estimating the effect of inherent uncertainties: revenue recognition, allowances for sales returns and doubtful accounts, intangible assets and goodwill, share-based compensation expense, income taxes, guarantees and loss contingencies. There have been no significant changes in the quarterly period ended June 30, 2014 in our method of application of these critical accounting policies. For a complete description of our critical accounting policies, please refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our Annual Report on Form 10­K for the year ended December 31, 2013.

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