UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to                 

MERGE TECHNOLOGIES INCORPORATED

(Exact name of Registrant as specified in its charter.)

Wisconsin		39-1600938
(State or other jurisdiction of		(IRS Employer Identification No.)
incorporation or organization)
6737 West Washington Street, Suite 2250, Milwaukee, WI 53214-5650
(Address of principal executive offices)                                (zip code)

(414) 977-4000
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 o   No þ

     Indicate by check mark whether the Registrant is a large accelerated filer, accelerated filer or a non-accelerated filer (see definition of accelerated filer and large accelerated filer as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer  o       Accelerated filer þ      Non-accelerated filer   o

     Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o   No  þ

     As of December 26, 2007, the Registrant had 33,937,695 shares of Common Stock outstanding.

 

 

INDEX

		Page
Explanatory Note – Restatement of Financial Information			ii
PART I – FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets (Unaudited)			1
Condensed Consolidated Statements of Operations (Unaudited)			2
Condensed Consolidated Statements of Cash Flows (Unaudited)			3
Condensed Consolidated Statements of Comprehensive Loss (Unaudited)			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			32
Item 4. Controls and Procedures			32
PART II – OTHER INFORMATION
Item 1. Legal Proceedings			35
Item 1A. Risk Factors			36
Item 4. Submission of Matters to a Vote of Security Holders			37
Item 5. Other Information			37
Item 6. Exhibits			38
EX-10.1 AMENDMENT TO EMPLOYMENT AGREEMENT DATED DECEMBER 27, 2007
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32 SECTION 906 CERTIFICATIONS OF THE CEO AND CFO

 i 

MERGE TECHNOLOGIES INCORPORATED

     This Quarterly Report on Form 10-Q for the three and six months ended June 30, 2007 includes a restated consolidated balance sheet as of June 30, 2006, restated consolidated statements of operations and consolidated statements of comprehensive loss for the three and six months ended June 30, 2006, and a restated consolidated statement of cash flows for the six months ended June 30, 2006. We will not file an amended Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006. See Item 1, “Financial Statements” in Part I of this Quarterly Report on Form 10-Q, including Note 2 of the notes to consolidated financial statements, for more information concerning these restatements. This Quarterly Report on Form 10-Q should be read in conjunction with our Annual Report on Form 10-K/A for the year ended December 31, 2006, and our Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2007.

 ii 

PART I

Item 1. Condensed Consolidated Financial Statements

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES

		June 30,				December 31,
		2007				2006
ASSETS
Current assets:
Cash and cash equivalents		$	29,708			$	45,945
Accounts receivable, net of allowance for doubtful accounts and sales returns of $2,788 and $2,553 at June 30, 2007 and December 31, 2006, respectively			16,981				16,427
Inventory			2,588				2,164
Prepaid expenses			2,054				1,660
Deferred income taxes			196				196
Other current assets			1,082				812
Total current assets			52,609				67,204
Property and equipment:
Computer equipment			5,787				5,017
Office equipment			1,950				1,919
Leasehold improvements			1,677				1,460
			9,414				8,396
Less accumulated depreciation			5,325				4,456
Net property and equipment			4,089				3,940
Purchased and developed software, net of accumulated amortization of $13,372 and $11,235 at June 30, 2007 and December 31, 2006, respectively			14,652				16,628
Customer relationships, net of accumulated amortization of $5,105 and $3,966 at June 30, 2007 and December 31, 2006, respectively			8,371				9,511
Goodwill			124,231				124,231
Deferred income taxes			4,536				4,326
Other assets			9,292				9,035
Total assets		$	217,780			$	234,875
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other accrued liabilities		$	10,313			$	10,857
Accrued wages			5,072				6,162
Income taxes payable			—				4,398
Deferred revenue			20,751				18,686
Total current liabilities			36,136				40,103
Deferred income taxes			502				502
Deferred revenue			2,770				3,712
Income taxes payable			5,358				—
Other			330				633
Total liabilities			45,096				44,950
Shareholders’ equity:
Preferred stock			—				—
Common stock, $0.01 par value: 100,000,000 shares authorized: 32,219,846 shares and 29,291,030 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively			322				293
Common stock subscribed; 8,354 shares and 5,242 shares at June 30, 2007 and December 31, 2006, respectively			52				33
Additional paid-in capital			453,852				451,130
Accumulated deficit			(283,854	)			(263,390	)
Accumulated other comprehensive income			2,312				1,859
Total shareholders’ equity			172,684				189,925
Total liabilities and shareholders’ equity		$	217,780			$	234,875

See accompanying notes to unaudited condensed consolidated financial statements.

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
						(As restated)								(As restated)
Net sales:
Software and other		$	6,693			$	18,643			$	14,863			$	28,167
Services and maintenance			7,343				12,794				15,047				19,410
Total net sales			14,036				31,437				29,910				47,577
Cost of sales:
Software and other			1,445				4,716				3,442				6,376
Services and maintenance			3,450				3,789				6,970				7,475
Amortization			1,633				1,068				2,695				2,345
Total cost of sales			6,528				9,573				13,107				16,196
Gross profit			7,508				21,864				16,803				31,381
Operating costs and expenses:
Sales and marketing			4,654				5,233				9,387				10,454
Product research and development			5,412				4,839				10,795				9,682
General and administrative			6,900				6,389				14,439				12,274
Goodwill impairment, restructuring and other expenses			209				214,124				1,006				214,146
Depreciation and amortization			1,034				1,142				2,036				2,184
Total operating costs and expenses			18,209				231,727				37,663				248,740
Operating loss			(10,701	)			(209,863	)			(20,860	)			(217,359	)
Other income (expense):
Interest expense			(18	)			(21	)			(63	)			(25	)
Interest income			352				696				802				1,356
Other, net			(362	)			(216	)			(315	)			(196	)
Total other income (expense)			(28	)			459				424				1,135
Loss before income taxes			(10,729	)			(209,404	)			(20,436	)			(216,224	)
Income tax expense (benefit)			11				1,615				25				115
Net loss		$	(10,740	)		$	(211,019	)		$	(20,461	)		$	(216,339	)
Net loss per share — basic		$	(0.32	)		$	(6.27	)		$	(0.60	)		$	(6.43	)
Weighted average number of common shares outstanding — basic			33,914,974				33,637,779				33,900,410				33,636,285
Net loss per share — diluted		$	(0.32	)		$	(6.27	)		$	(0.60	)		$	(6.43	)
Weighted average number of common shares outstanding — diluted			33,914,974				33,637,779				33,900,410				33,636,285

See accompanying notes to unaudited condensed consolidated financial statements.

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES

		Six Months Ended
		June 30,
		2007				2006
						(As restated)
Cash flows from operating activities:
Net loss		$	(20,461	)		$	(216,339	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			4,731				4,529
Share-based compensation			2,556				1,922
Goodwill impairment charge			—				214,095
Provision for doubtful accounts receivable and sales returns, net of recoveries			383				130
Deferred income taxes			(197	)			174
Changes in operating assets and liabilities:
Accounts receivable			(937	)			8,319
Inventory			(425	)			(176	)
Prepaid expenses			(392	)			(91	)
Accounts payable and other accrued liabilities			(847	)			(142	)
Accrued wages			(1,091	)			(1,040	)
Deferred revenue			1,123				(13,929	)
Other			863				1,171
Net cash used in operating activities			(14,694	)			(1,377	)
Cash flows from investing activities:
Purchases of property, equipment, and leasehold improvements			(1,038	)			(549	)
Purchased technology			—				(367	)
Capitalized software development			(726	)			(1,322	)
Net cash used in investing activities			(1,764	)			(2,238	)
Cash flows from financing activities:
Proceeds from exercise of stock options and employee stock purchase plan			215				25
Net cash provided by financing activities			215				25
Effect of exchange rates on cash and cash equivalents			6				1
Decrease in cash and cash equivalents			(16,237	)			(3,589	)
Cash and cash equivalents, beginning of period			45,945				64,278
Cash and cash equivalents, end of period		$	29,708			$	60,689
Supplemental disclosures of cash flow information:
Cash paid for income taxes, net of refunds		$	(15	)		$	69
Equity securities received in sales transactions		$	—			$	2,010

See accompanying notes to unaudited condensed consolidated financial statements.

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
						(As restated)								(As restated)
Net loss		$	(10,740	)		$	(211,019	)		$	(20,461	)		$	(216,339	)
Translation adjustment, net of income taxes			3				(1	)			(9	)			(1	)
Unrealized gain (loss) on marketable securities, net of income taxes			367				10				467				(48	)
Comprehensive net loss		$	(10,370	)		$	(211,010	)		$	(20,003	)		$	(216,388	)

See accompanying notes to unaudited condensed consolidated financial statements.

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited and in thousands, except for share and per share data)

(1) Basis of Presentation and Significant Accounting Policies

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for reporting on Form 10-Q. Accordingly, certain information and notes required by United States of America generally accepted accounting principles (“GAAP”) for complete financial statements are not included herein. These interim statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K/A for the year ended December 31, 2006 of Merge Technologies Incorporated, a Wisconsin corporation, and its subsidiaries and affiliates (which we sometimes refer to collectively as “Merge Healthcare,” “we,” “us” or “our”).

     Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.  The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should we be unable to continue as a going concern. We have generated losses from operations over the past six consecutive quarters.  We have undertaken several actions during the last twelve months that we expect will increase our revenues and decrease our costs in the future, including our restructuring initiative implemented in the fourth quarter of 2006. However, for the six months ended June 30, 2007, our loss from operations amounted to $20,860 and our cash and cash equivalents has decreased from $45,945 at December 31, 2006 to $29,708 at June 30, 2007 and we currently have no credit facility. As a result, we are currently completely dependent on available cash and operating cash flow to meet our other capital needs. We are also considering a wide range of financing alternatives including equity offerings, assets sales or debt financing in order to satisfy liquidity needs beyond 2007. If adequate funds are not available or are not available on acceptable terms, our ability to continue as a going concern, to fund our new teleradiology business, take advantage of unanticipated opportunities, develop or enhance service or products or otherwise respond to competitive pressures may be significantly limited. 

     Our accompanying unaudited condensed consolidated financial statements reflect all adjustments, which are, in the opinion of management, necessary for a fair presentation of our financial position and results of operations. Such adjustments are of a normal recurring nature unless otherwise noted. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future period.

     Our consolidated financial statements are prepared in accordance with U.S generally accepted accounting principles. These accounting principles require us to make certain estimates, judgments 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. We believe that the estimates, judgments and assumptions are reasonable, based on information available at the time they are made. Actual results could differ materially from those estimates.

(a) Reclassifications

     Where appropriate, certain reclassifications have been made to the prior year’s financial statements to conform to the current year presentation. Specifically, we reclassified $244 and $530 for the three and six months ended June 30, 2006, respectively, of expense from “product research and development” to “software and other cost of sales” within the Condensed Consolidated Statements of Operations to conform to current year presentation.

(b) Accounting for uncertainty in income taxes

     On January 1, 2007, we adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109 (“FIN No. 48”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 109, “Accounting for Income Taxes.” This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The pronouncement also provides guidance on de-recognition, classification, interest and penalties, accounting in interim

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

periods, disclosure and transition. Pursuant to FIN No. 48, we have reclassified as noncurrent, unrecognized tax benefits not expected to be paid within one year. The impact of adopting FIN No. 48 had the cumulative effects explained in Note 8 below.

     In May 2007, the FASB issued staff position FIN No. 48-1, “Definition of Settlement in FASB Interpretation No. 48” (“FSP FIN No. 48-1”) which amended FIN No. 48 to provide guidance about how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. Under FSP FIN No. 48-1, a tax position could be effectively settled through an examination by a taxing authority. Since adoption, we have applied FIN No. 48 in a manner consistent with the provisions of FSP FIN No. 48-1.

(c) Presentation of sales tax in statement of operations

     On January 1, 2007, we adopted Emerging Issues Task Force (“EITF”) No. 06-3, How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (That Is, Gross Versus Net Presentation) (“EITF No. 06-3”), which discusses taxes imposed on, and imposed concurrent with, a specific revenue-producing transaction between a seller and its customer. It requires entities to disclose, if significant, on an interim and annual basis for all periods presented: (a) the accounting policy elected for these taxes; and (b) the amounts of the taxes reflected gross (as revenue) in the income statement. We account for sales taxes on a net basis, and EITF No. 06-3 did not have a material impact on our condensed consolidated financial statements for the three and six months ended June 30, 2007.

(2) Restatement of Consolidated Financial Statements

     On August 13, 2007, we announced that the audited financial statements for the years ended December 31, 2006, 2005 and 2004 and other financial information included in our Annual Report on Form 10-K for the year ended December 31, 2006 and the unaudited financial statements included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 should no longer be relied upon. The errors identified in previously issued financial statements are described below.

     Revenue Recognition

     We have determined that our previously filed financial statements contained errors resulting from the incorrect recognition of revenue on software license arrangements with 12 customers that were signed between July of 2003 and June of 2004 following the acquisition of RIS Logic. As a result, we determined that the revenue associated with these arrangements should have been recognized ratably over the lesser of the maintenance period or the economic life of the software following the first productive use of the software at the customer site. The original value of these contracts, excluding the multiple years of maintenance, aggregated approximately $2,000.

     Goodwill and Deferred Income Taxes

     In connection with the accounting for the acquisition of Cedara in June of 2005, we did not appropriately record purchase accounting for deferred income taxes. As a result, both acquired goodwill and net deferred tax liabilities were overstated. The impact of these purchase accounting adjustments recorded in the consolidated financial statements included herein have been restated.

     Other Adjustments

     We have also restated for other errors generally related to our accrual for bonuses, accrual for state and franchise taxes, accrual for subsequent credit memos, and correction of clerical errors in accumulating and recording transactions. These adjustments included changes to the following financial statement line items: revenue, as well as related accounts including cost of goods sold, accounts receivable and related reserves, and deferred revenue; accrued wages; various operating expenses; goodwill; other assets; accumulated other comprehensive income; income tax expense; and income taxes payable.

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

     The following tables summarize the impact of the restatements on our consolidated balance sheet as of June 30, 2006, statements of operations for the three and six months ended June 30, 2006, and statement of cash flows for the six months ended June 30, 2006, and should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K/A for the year ended December 31, 2006, and our Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2007. Explanations for adjustments (a) through (d) in the following tables may be found on the last page of this Note 2. To the extent that an individual balance sheet or statement of operations line item classification has been affected by more than one adjustment as described in (a) through (d), and one of such adjustments is greater than $1,000, each adjustment is listed separately. The restatement also affected Notes 4, 7, and 8 to our consolidated financial statements.

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

		June 30, 2006								June 30, 2006
		(As reported)				(Adjustments)				(As restated)
ASSETS
Current assets:
Cash and cash equivalents		$	60,689							$	60,689
Accounts receivable, net			15,359				(511	)(b)			14,848
Inventory			2,616								2,616
Prepaid expenses			2,670								2,670
Deferred income taxes			5,652				639	(b,c)			6,291
Other current assets			555								555
Total current assets			87,541				128				87,669
Net property and equipment			4,078								4,078
Purchased and developed software, net			18,752								18,752
Acquired intangibles, net			10,650								10,650
Goodwill			131,092				(176	)(b,d)			130,916
Other assets			9,238				181	(b)			9,419
Deferred income taxes			2,442				6,256	(d)
							61	(b)			8,759
Total assets		$	263,793			$	6,450			$	270,243
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	5,552							$	5,552
Accrued wages			4,829								4,829
Other accrued liabilities			3,418				138	(b)			3,556
Deferred revenue			15,935				359	(a)			16,294
Income taxes payable			3,894				338	(b,c)			4,232
Total current liabilities			33,628				835				34,463
Deferred income taxes							2,015	(d)			2,015
Deferred revenue			4,671				542	(a)			5,213
Other			420								420
Total liabilities			38,719				3,392				42,111
Total shareholders’ equity			225,074				3,058				228,132
Total liabilities and shareholders’ equity		$	263,793			$	6,450			$	270,243

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

		Three Months Ended June 30, 2006
		(As reported)				(Adjustments)				(As restated)
Net sales:
Software and other		$	18,770			$	(127	)(a,b)		$	18,643
Services and maintenance			12,952				(158	)(a,b)			12,794
Total net sales			31,722				(285	)			31,437
Cost of sales:
Software and other			4,714				2	(a)			4,716
Services and maintenance			3,787				2	(a)			3,789
Amortization			1,068								1,068
Total cost of sales			9,569				4				9,573
Gross profit			22,153				(289	)			21,864
Operating costs and expenses:
Sales and marketing			5,233								5,233
Product research and development			4,839								4,839
General and administrative			6,345				44	(b)			6,389
Goodwill impairment, restructuring and other expenses			219,462				(5,338	) (d)			214,124
Depreciation and amortization			1,142								1,142
Total operating costs and expenses			237,021				(5,294	)			231,727
Operating loss			(214,868	)			5,005				(209,863	)
Other income (expense):
Interest expense			(21	)							(21	)
Interest income			696								696
Other, net			(216	)							(216	)
Total other income			459								459
Loss before income taxes			(214,409	)			5,005				(209,404	)
Income tax expense (benefit)			1,360				255	(b,c,d)			1,615
Net loss		$	(215,769	)		$	4,750			$	(211,019	)
Net loss per share — basic		$	(6.41	)		$	0.14			$	(6.27	)
Weighted average number of common shares outstanding — basic			33,637,779								33,637,779
Net loss per share — diluted		$	(6.41	)		$	0.14			$	(6.27	)
Weighted average number of common shares outstanding — diluted			33,637,779								33,637,779

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

		Six Months Ended June 30, 2006
		(As reported)				(Adjustments)				(As restated)
Net sales:
Software and other		$	28,315			$	(148	)(a,b)		$	28,167
Services and maintenance			19,603				(193	)(a,b)			19,410
Total net sales			47,918				(341	)			47,577
Cost of sales:
Software and other			6,372				4	(a)			6,376
Services and maintenance			7,473				2	(a)			7,475
Amortization			2,345								2,345
Total cost of sales			16,190				6				16,196
Gross profit			31,728				(347	)			31,381
Operating costs and expenses:
Sales and marketing			10,454								10,454
Product research and development			9,682								9,682
General and administrative			12,186				88	(b)			12,274
Goodwill impairment, restructuring and other expenses			219,484				(5,338	)(d)			214,146
Depreciation and amortization			2,184								2,184
Total operating costs and expenses			253,990				(5,250	)			248,740
Operating loss			(222,262	)			4,903				(217,359	)
Other income (expense):
Interest expense			(25	)							(25	)
Interest income			1,356								1,356
Other, net			(196	)							(196	)
Total other income			1,135								1,135
Loss before income taxes			(221,127	)			4,903				(216,224	)
Income tax benefit			(458	)			573	(b,c,d)			115
Net loss		$	(220,669	)		$	4,330			$	(216,339	)
Net loss per share — basic		$	(6.56	)		$	0.13			$	(6.43	)
Weighted average number of common shares outstanding — basic			33,636,285								33,636,285
Net loss per share — diluted		$	(6.56	)		$	0.13			$	(6.43	)
Weighted average number of common shares outstanding — diluted			33,636,285								33,636,285

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

MERGE TECHNOLOGIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

		Six Months Ended June 30, 2006
		(As reported)				(Adjustments)				(As restated)
Cash flows from operating activities:
Net loss		$	(220,669	)		$	4,330			$	(216,339	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			4,529								4,529
Provision for doubtful accounts receivable and sales returns, net of recoveries			(95	)			225	(b)			130
Deferred income taxes			(373	)			547	(c,d)			174
Stock compensation expenses			1,922								1,922
Goodwill and trade name impairment charge			219,433				(5,338	)(d)			214,095
Changes in operating assets and liabilities:
Accounts receivable			8,363				(44	)(b)			8,319
Inventory			(176	)							(176	)
Prepaid expenses			(91	)							(91	)
Accounts payable			(444	)							(444	)
Accrued wages			(1,040	)							(1,040	)
Other accrued liabilities			213				89	(b)			302
Deferred revenue			(14,095	)			166	(a,b)			(13,929	)
Other			1,146				25	(b,c)			1,171
Net cash used in operating activities			(1,377	)							(1,377	)
Net cash used in investing activities			(2,238	)							(2,238	)
Net cash provided by financing activities			25								25
Effect of exchange rates on cash and cash equivalents			1								1
Net decrease in cash and cash equivalents			(3,589	)							(3,589	)
Cash and cash equivalents, beginning of period			64,278								64,278
Cash and cash equivalents, end of period		$	60,689							$	60,689

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

(3)

Other Intangibles

     Our intangible assets, other than capitalized software development costs, subject to amortization are summarized as of June 30, 2007 as follows:

		Weighted
		Average
		Remaining				Gross
		Amortization				Carrying				Accumulated
		Period (Years)				Amount				Amortization
Purchased technology			3.2			$	16,990			$	(7,635	)
Customer relationships			3.7				13,476				(5,105	)
Patents			8.8				141				(17	)
Total			3.5			$	30,607			$	(12,757	)

     Purchased technology amortization expense, which is being recorded in cost of sales ratably over the life of the related intangible asset, was $753 for the three months ended June 30, 2007 and 2006, and $1,506 for the six months ended June 30, 2007 and 2006. Customer relationships and patent amortization expense, which is being recorded ratably over the life of the related intangible asset in depreciation and amortization included in operating costs and expenses, was $569 for the three months ended June 30, 2007 and 2006, and $1,139 for the six months ended June 30, 2007 and 2006, respectively.

     Estimated aggregate amortization expense for the remaining periods is as follows:

For the remaining six months of the year ended			2007			$	2,508
For the year ended			2008				4,811
			2009				4,405
			2010				4,279
			2011				1,786
		Thereafter					61

     As of June 30, 2007, we had gross capitalized software development costs of $10,893 and accumulated amortization of $5,720. The weighted average remaining amortization period of capitalized software development costs was 2.8 years as of June 30, 2007. During the six months ended June 30, 2007 and 2006, we capitalized software development costs of $726 and $1,322, respectively. Amortization expense related to developed software of $880 and $315 was recorded to cost of sales during the three months ended June 30, 2007 and 2006, respectively. Amortization expense related to developed software of $1,189 and $839 was recorded to cost of sales during the six months ended June 30, 2007 and 2006, respectively. Amortization expense included the impairment of certain of our capitalized software projects of $556 during the three and six months ended June 30, 2007, due to significant risk of technological obsolescence associated with certain projects, the majority of which were still in development at the time of impairment. Amortization expense included the impairment of certain of our capitalized software projects of $169 during the six months ended June 30, 2006, as we no longer anticipated future sales of such products.

(4)

Earnings Per Share

     Basic earnings per share is computed by dividing income (loss) available to the holders of our Common Stock by the weighted average number of shares outstanding. Diluted earnings per share reflects the potential dilution that could occur based on the exercise of stock options, except for stock options with an exercise price of more than the average market price of our Common Stock, because such exercise would be anti-dilutive. The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended June 30, 2007 and 2006:

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

		Three Months Ended June 30,								Six Months Ended June 30,
		2007				2006				2007				2006
						(As restated)								(As restated)
Numerator:
Net loss		$	(10,740	)		$	(211,019	)		$	(20,461	)		$	(216,339	)
Denominator for net loss per share — basic and diluted			33,914,974				33,637,779				33,900,410				33,636,285
Net loss per share — basic and diluted		$	(0.32	)		$	(6.27	)		$	(0.60	)		$	(6.43	)

     The weighted average number of shares of Common Stock outstanding used to calculate basic net loss per share includes exchangeable share equivalent securities of 1,756,168 and 4,568,155 for the three months ended June 30, 2007 and 2006, respectively. The weighted average number of shares of Common Stock outstanding used to calculate basic net loss per share includes exchangeable share equivalent securities of 2,935,907 and 4,934,796 for the six months ended June 30, 2007 and 2006, respectively.

     As a result of the losses during the three months ended June 30, 2007 and 2006, incremental shares from the assumed conversion of employee stock options totaling 58,219 and 532,244, respectively, have been excluded from the calculation of diluted loss per share as their inclusion would have been anti-dilutive. As a result of the losses during the six months ended June 30, 2007 and 2006, incremental shares from the assumed conversion of employee stock options totaling 58,233 and 722,378, respectively, have been excluded from the calculation of diluted loss per share as their inclusion would have been anti-dilutive.

     For the three months ended June 30, 2007 and 2006, options to purchase 3,102,431 and 2,076,730 shares of our Common Stock, respectively, had exercise prices greater than the average market price of our Common Stock, and, therefore, are not included in the above calculations of net loss per share. For the six months ended June 30, 2007 and 2006, options to purchase 3,272,431 and 448,122 shares of our Common Stock, respectively, had exercise prices greater than the average market price of our Common Stock, and, therefore, are not included in the above calculations of net loss per share.

(5)

Share-Based Compensation

     We maintain four stock-based employee compensation plans (including our employee stock purchase plan) and one director option plan under which we grant options to acquire shares of our Common Stock to certain employees, non-employees, non-employee directors and to existing stock option holders in connection with the consolidation of option plans following an acquisition. Options generally have an exercise price equal to the fair market value of our Common Stock at the date of grant, with the exception of the options granted in 2005 to replace existing Cedara Software Corp. options (“Replacement Options”). The Replacement Options, which we granted pursuant to the merger agreement, had the same economic terms as the Cedara options that they replaced, as adjusted for the conversion ratio and currency. The majority of these options vest over a three or four–year period and have a contractual life of six years.

     We maintain an employee stock purchase plan that allows eligible employees to purchase shares of our Common Stock through payroll deductions of up to 10% of eligible compensation on an after-tax basis. The price eligible employees pay per share of Common Stock is at a 5% discount from the market price at the end of each calendar quarter.

     The following table summarizes share-based compensation expense related to share-based awards subject to SFAS No. 123(R), Share-Based Payment (“SFAS No. 123(R)”) recognized during the three and six months ended June 30, 2007 and 2006, respectively:

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
Share-based compensation expense included in the statement of operations:
Services and maintenance (cost of sales)		$	121			$	135			$	228			$	271
Sales and marketing			331				235				595				626
Product research and development			315				321				616				693
General and administrative			595				(146	)			1,105				404
Total			1,362				545				2,544				1,994
Tax expense (benefit)			—				(71	)			—				105
Share-based compensation expense, net of tax		$	1,362			$	616			$	2,544			$	1,889
Increase in basic loss per share		$	0.04			$	0.02			$	0.08			$	0.06
Increase in diluted loss per share		$	0.04			$	0.02			$	0.08			$	0.06

     The differences between the amounts recorded as share-based compensation expense in the statements of operations and the amounts of share-based compensation recorded as additional paid-in capital during the three months ended June 30, 2007 and 2006 of $3 and $17, respectively, and during the six months ended June 30, 2007 and 2006 of $12 and $33, respectively, was attributed to share-based compensation incurred by product research and development personnel who worked on capitalizable software development projects during these periods.

     During the three months ended June 30, 2007, we granted 1,026,483 options with a weighted average exercise price of $5.17 per share. The majority of these options vest over four years. We used the Black-Scholes option pricing model to estimate fair value, based on the date of grant and utilizing similar assumptions as disclosed in our Annual Report on Form 10-K/A for the year ended December 31, 2006. These options had a weighted average fair value of $2.66 per share, related expense of $230 recorded in the three months ended June 30, 2007 and unrecognized compensation cost of $2,255 as of June 30, 2007.

(6)

Restructuring

     The following table shows our restructuring activity during the six months ended June 30, 2007:

		Accrued
		Restructuring
Balance at December 31, 2006		$	1,997
Charges to expense			1,016
Payments			(2,505	)
Balance at June 30, 2007		$	508

     At June 30, 2007, the remaining costs consist of termination benefits and as such are primarily classified within accrued wages.

(7)

Segment Information

     Late in 2006, we reorganized our business. We established three distinct business units: Merge Healthcare North America, which primarily sells directly to the end-user healthcare market comprised of hospitals, imaging centers and specialty clinics located in the U.S. and Canada and also distributes certain products through the Internet via our website; Cedara Software, our original equipment manufacturer (“OEM”) business unit, which primarily sells to OEMs and value added resellers (“VARs”), comprised of companies that develop, manufacture or resell

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

medical imaging software or devices; and Merge Healthcare EMEA, which sells to the end-user healthcare market in Europe, the Middle East and Africa.

     SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”), establishes annual and interim reporting standards for operating segments of a company. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenues, and its major customers. Our principal executive officer has been identified as the chief operating decision maker in assessing the performance and the allocation of resources within the Company. Our principal executive officer relies on the information derived from our financial reporting process, which now includes revenue by business unit and consolidated operating results and consolidated assets. As we do not have discrete financial information available for our business units, we operate as a single segment for reporting purposes as prescribed by SFAS No. 131. We are in the process of developing systems and processes to obtain discrete financial information for our three business units which is intended to be used by our chief operating decision maker. At the time that the information becomes available to assess performance and allocate resources, this new information will be disclosed.

The following tables provide revenue from our business units for the three months ended June 30, 2007 and 2006, respectively:

		Three Months Ended June 30, 2007
										Merge
		Merge Healthcare				Cedara				Healthcare
		North America				Software				EMEA				Total
Net sales:
Software and other		$	2,901			$	3,253			$	539			$	6,693
Service and maintenance			5,115				1,743				485				7,343
Total net sales		$	8,016			$	4,996			$	1,024			$	14,036

		Three Months Ended June 30, 2006
		(As restated)
										Merge
		Merge Healthcare				Cedara				Healthcare
		North America				Software				EMEA				Total
Net sales:
Software and other		$	15,824			$	2,415			$	404			$	18,643
Service and maintenance			10,735				1,868				191				12,794
Total net sales		$	26,559			$	4,283			$	595			$	31,437

     The following tables provide revenue from our business units for the six months ended June 30, 2007 and 2006, respectively:

		Six Months Ended June 30, 2007
										Merge
		Merge Healthcare				Cedara				Healthcare
		North America				Software				EMEA				Total
Net sales:
Software and other		$	7,674			$	6,175			$	1,014			$	14,863
Service and maintenance			10,700				3,602				745				15,047
Total net sales		$	18,374			$	9,777			$	1,759			$	29,910

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

		Six Months Ended June 30, 2006
		(As restated)
										Merge
		Merge Healthcare				Cedara				Healthcare
		North America				Software				EMEA				Total
Net sales:
Software and other		$	20,167			$	7,444			$	556			$	28,167
Service and maintenance			15,329				3,690				391				19,410
Total net sales		$	35,496			$	11,134			$	947			$	47,577

(8) Income Taxes

     We adopted the provisions of FIN No. 48 on January 1, 2007. The total amount of unrecognized tax benefits as of the date of adoption was $5,747 (as restated). We recognize interest and penalties in the provision for income taxes. Total accrued interest and penalties as of January 1, 2007 was $182 (as restated). The adoption of FIN No. 48 did not result in an adjustment to retained earnings due to the full valuation allowance maintained on our deferred tax assets.

     The total amount of unrecognized tax benefits at January 1, 2007 that, if recognized, would affect the effective tax rate from continuing operations is $2,647 (as restated). The remainder of unrecognized tax benefits, if recognized, would result in a decrease to goodwill. We do not anticipate a significant change to the total amount of unrecognized tax benefits within the next twelve months.

     We are subject to taxation in the U.S. and Canada federal jurisdictions, various state and other foreign jurisdictions. With few exceptions, we are no longer subject to U.S. Federal, state, local or foreign examinations by tax authorities for years before 2003. There was no material change in the total unrecognized tax benefits during the six months ended June 30, 2007.

(9) Commitments and Contingencies

     Between March 22, 2006 and April 26, 2006, seven putative securities class action lawsuits were filed in the United States District Court for the Eastern District of Wisconsin, on behalf of a class of persons who acquired shares of our Common Stock between August 2, 2005 and March 16, 2006. On November 22, 2006, the Court consolidated the seven cases, appointed the Southwest Carpenters Pension Trust to be the lead plaintiff and approved the Trust’s choice of its lead counsel. The lead plaintiff filed the consolidated amended complaint on March 21, 2007. Defendants in the suit currently include us, Richard A. Linden, our former President and Chief Executive Officer, Scott T. Veech, our former Chief Financial Officer, David M. Noshay, our former Senior Vice President of Strategic Business Development, and KPMG LLP, our independent public accountants. The consolidated amended complaint arises out of our restatement of our financial statements, as well as our investigation of allegations made in anonymous letters received by us. The lawsuits allege that we and the other defendants violated Section 10 (b) and that the individuals violated Section 20(a) of the Securities Exchange Act of 1934, as amended. The consolidated amended complaint seeks damages in unspecified amounts. The defendants filed motions to dismiss on July 16, 2007. The plaintiff filed its response brief on November 14, 2007. Defendant’s deadline to file its response to plaintiff’s filing is January 14, 2008. We intend to continue vigorously defending the lawsuit.

     On August 28, 2006, a derivative action was filed in the Circuit Court of Milwaukee County, Civil Division, against Messrs. Linden and Veech, William C. Mortimore (our founder, former Chairman and Chief Strategist, who served as our interim Chief Executive Officer from May 15, 2006 to July 2, 2006) and all of the then-current members of our Board of Directors. The plaintiff filed an amended complaint on June 26, 2007, among other things, adding Mr. Noshay as a defendant. The plaintiff alleges that (a) each of the individual defendants breached fiduciary duties to us by violating generally accepted accounting principles, willfully ignoring problems with accounting and

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

internal control practices and procedures and participating in the dissemination of false financial statements; (b) we and the director defendants failed to hold an annual meeting of shareholders for 2006 in violation of Wisconsin law; (c) Directors Barish, Geras and Hajek violated insider trading prohibitions and that they misappropriated material non-public information; (d) a claim of corporate waste and gift against Directors Hajek, Barish, Reck, Dunham and Lennox who were members of the Compensation Committee at the time of the restatement; and (e) claims of unjust enrichment and insider selling against Messrs. Linden, Veech, Noshay and Mortimore. The plaintiffs ask for unspecified amounts in damages and costs, disgorgement of certain compensation and profits against certain defendants as well as equitable relief. In response to the filing of this action, our Board of Directors formed a Special Litigation Committee, which Committee was granted full authority to investigate the allegations of the derivative complaint and determine whether pursuit of the claims against any or all of the individual defendants would be in our best interest. The Special Litigation Committee’s investigation is substantially complete. The defendants filed a motion to dismiss on August 17, 2007, and such motion has been fully briefed by both parties. A hearing on the motion to dismiss had been scheduled for January 8, 2008; however, the hearing has been postponed and has not yet been rescheduled.

     On April 27, 2006, we received an informal, nonpublic inquiry from the SEC requesting voluntary production of documents and other information. The inquiry principally relates to our announcement on March 17, 2006 that we would revise our results of operations for the fiscal quarters ended June 30, 2005 and September 30, 2005, as well as our investigation of allegations made in anonymous letters received by us. The SEC advised us that the inquiry should not be interpreted as an adverse reflection on any entity or individual involved, nor should it be interpreted as an indication by the SEC that any violation of the federal securities laws has occurred. On July 10, 2007, we were advised by SEC Staff that the SEC has issued a formal order of investigation in this matter. We have been cooperating and continue to cooperate fully with the SEC. At this time, however, it is not possible to predict the outcome of the investigation nor is it possible to assess its impact on our financial condition or results of operations.

     We, and our subsidiaries, are from time to time parties to legal proceedings, lawsuits and other claims incident to our business activities. Such matters may include, among other things, assertions of contract breach or intellectual property infringement, claims for indemnity arising in the course of our business and claims by persons whose employment has been terminated. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. Consequently, we are unable to ascertain the ultimate aggregate amount of monetary liability, amounts which may be covered by insurance or recoverable from third parties, or the financial impact with respect to these matters as of the date of this report.

     We have non-cancelable operating leases (with initial lease terms in excess of one year) at various locations, including building leases entered into during 2007 for new facilities located in Atlanta, GA and Pune, India. Total future minimum lease payments are as follows:

For the remaining six months for the year ended			2007			$	1,255
For the year ended			2008				2,431
			2009				1,886
			2010				880
			2011				605
		Thereafter					1,156
		Total				$	8,213

     These contractual obligations are net of sub-lease income that is contractually owed to us of $90 in the remaining six months of 2007 and $180 in 2008 and 2009.

(10) Recent Accounting Pronouncements

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure eligible items at fair value at specified election dates. Pursuant to SFAS No. 159, a business entity is required to report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; is irrevocable (unless a new election date occurs); and is applied only to entire instruments and not to portions of instruments. SFAS No. 159 is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We are currently evaluating the impact of SFAS No. 159 on our financial statements, should we choose the fair value option effective as of the beginning of our fiscal year 2008.

     In June 2007, the FASB issued EITF No. 07-3, Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development Activities (“EITF No. 07-3”). The scope of EITF No. 07-3 is limited to nonrefundable advance payments for goods and services related to research and development activities. The issue is whether such advanced payments should be expensed as incurred or capitalized. EITF No. 07-3 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We do not believe that EITF No. 07-3 will have a material impact on our financial condition or results of operations.

     In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141R”).  SFAS No. 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date.  SFAS No. 141R is effective for an entity for business combinations for which the acquisition date is on or after the annual reporting period beginning December 15, 2008. We do not believe SFAS No. 141 will have a material impact on our financial condition or results of operations.

          In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS No. 160”).  SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements.  SFAS No. 160 is effective as of the beginning of an entity’s first fiscal year that begins after December 15, 2008. We do not believe SFAS No. 160 will have a material impact on our financial condition or results of operations.

(11) Subsequent Events

Impairment of Long-Lived Assets

     We review goodwill and indefinite lived intangible assets for impairment annually, as of December 31 of each year. In addition, we test an intangible asset or group for impairment between annual tests whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. Goodwill of a reporting unit is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

     During the three months ended September 30, 2007, several material events occurred that resulted in an environment of uncertainty creating significant business challenges, and diverted the attention of certain board members and management from our business operations for periods of time. These events included the announcement that several of our previously issued financial statements would require restatement, the possible delisting of our common stock from the NASDAQ Global Market and the continued adverse impact on our bookings and anticipated revenue of the Deficit Reduction Act. These events, which either did not exist or the impact of which was not known as of June 30, 2007, resulted in circumstances which indicated that we may not be able to recover the intangible assets’ carrying amounts or that the fair value of our single reporting unit does not support the carrying value of goodwill.

     In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we performed Step I of the impairment test by estimating the Company’s fair value beginning with what we considered to be the most reliable and readily available indicator of fair value, that being the quoted market prices of our shares of common stock. The results of Step I of the impairment test indicated that we have an impairment of our goodwill since the carrying

Merge Technologies Incorporated and Subsidiaries
Notes to Consolidated Financial Statements (continued)
(Unaudited and in thousands, except for share and per share data)

value of our single reporting unit exceeded the reporting unit’s estimated fair value. We are in the process of completing Step II to measure the amount of impairment loss relating to goodwill, by comparing the implied fair value of our reporting unit goodwill with the carrying amount of that goodwill. While we are still in the process of finalizing our Step II measurements utilizing the assistance of independent valuation specialists, on December 20, 2007, management and our audit committee concluded that all, or substantially all, of our goodwill has been impaired, thus leading to a non-cash goodwill impairment charge during the three months ended September 30, 2007. Our other intangible assets are also being evaluated, though any potential impairment has not been quantified at this time.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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,” “intends,” “anticipates,” “expects” and similar expressions 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 II of this Quarterly Report on Form 10-Q and in Item 1A. of Part I of our Annual Report on Form 10-K/A for the year ended December 31, 2006 and the following factors: market acceptance and performance of the Company’s new products and services, including the Company’s teleradiology product and services; delay in the offering of the Company’s teleradiology product and services; the Company’s ability to attract and retain qualified radiologist consultants; risks and effects of the past and current restatement of financial statements of the Company and other actions that may be taken or required as a result of such restatement; the Company’s ability to generate sufficient cash from operations to meet future operating, financing and capital requirements; costs and risks involved with financing alternatives including equity offerings, asset sales or debt financing; the Company’s inability to timely file reports with the Securities and Exchange Commission; risks associated with the Company’s inability to meet the requirements of The NASDAQ Stock Market for continued listing, including possible delisting; costs, risks and effects of legal proceedings and investigations, including the formal investigation being conducted by the Securities and Exchange Commission and class action, derivative, and other lawsuits; the uncertainty created by and the adverse impact on relationships with customers, potential customers, suppliers and investors potentially resulting from, and other risks associated with, the changes in the Company’s senior management; the impact of competitive products and pricing; continued negative effects of the DRA (Deficit Reduction Act of 2005); risks related to regulatory and other legal compliance with applicable health care laws, regulations, government agency pronouncements and judicial and quasi-judicial rulings; limited acceptance of digital modalities and RIS-PACS and workflow technologies; the Company’s ability to integrate acquisitions; changing economic conditions; credit and payment risks associated with end-user sales; the Company’s dependence on major customers; and the Company’s dependence on key personnel. 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 unaudited condensed consolidated financial statements and notes thereto appearing elsewhere in this report and the audited consolidated financial statements and notes thereto appearing in our Annual Report on Form 10-K/A for the year ended December 31, 2006.

Restatement of Consolidated Financial Statements

     On August 13, 2007, we announced that the audited financial statements for the years ended December 31, 2006, 2005 and 2004 and other financial information included in our Annual Report on Form 10-K for the year ended December 31, 2006 and the unaudited financial statements included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 should no longer be relied upon. The errors identified in previously issued financial statements are described below.

     Revenue Recognition

     We have determined that our previously filed financial statements contained errors resulting from the incorrect recognition of revenue on software license arrangements with 12 customers that were signed between July of 2003 and June of 2004 following the acquisition of RIS Logic. As a result, we determined that the revenue associated with these arrangements should have been recognized ratably over the lesser of the maintenance period or the economic life of the software following the first productive use of the software at the customer site. The original value of these contracts, excluding the multiple years of maintenance, aggregated approximately $2 million.

     Goodwill and Deferred Income Taxes

     In connection with the accounting for the acquisition of Cedara in June of 2005, we did not appropriately record purchase accounting for deferred income taxes. As a result, both acquired goodwill and net deferred tax liabilities were overstated. The impact of these purchase accounting adjustments recorded in the consolidated financial statements included herein have been restated.

     Other Adjustments

     We have also restated for other errors generally related to our accrual for bonuses, accrual for state and franchise taxes, accrual for subsequent credit memos, and correction of clerical errors in accumulating and recording transactions. These adjustments included changes to the following financial statement line items: revenue, as well as related accounts including cost of goods sold, accounts receivable, and deferred revenue; accrued wages; various operating expenses; goodwill; other assets; accumulated other comprehensive income; income tax expense; and income taxes payable.

     Please refer to Note 2 of our unaudited consolidated financial statements for a discussion of the restatement of our previously filed consolidated balance sheets as of June 30, 2006, and our statements of operations and statements of cash flows for the three and six months ended June 30, 2006.

     We, by means of our Annual Report on Form 10K/A, have restated previously issued unaudited consolidated financial statements and will not amend our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006. See Note 2 of notes to consolidated financial states for a discussion of the restatement of our previously filed balance sheets as of June 30, 2006 and our statements of operations for the three and six months ended June 30, 2006, and our statement of cash flows for the six months ended June 30, 2006. The information that was previously filed for the quarter ended June 30, 2006 is superseded by the information contained in this Quarterly Report on Form 10-Q, and the financial statements and related financial information contained in such previously filed report should no longer be relied upon.

Overview

     Operating under the name Merge Healthcare, we develop medical imaging and information management software and deliver related services. Late in 2006, we reorganized our business and established three distinct business units: Merge Healthcare North America, which primarily sells directly to the end-user healthcare market comprised of hospitals, imaging centers and specialty clinics located in the U.S. and Canada and also distributes certain products through the Internet via our website; Cedara Software, our OEM business unit, which primarily sells software products, developer toolkits and custom engineering services to OEMs and VARs, comprised of companies that develop, manufacture or resell medical imaging software or devices; and Merge Healthcare EMEA, which sells to the end-user healthcare market in Europe, the Middle East and Africa.

     Healthcare providers continue to be challenged by declining reimbursements, competition and reduced operating profits brought about by the increasing costs of delivering healthcare services. In the U.S., we are focusing our direct sales efforts on single and multi-site imaging centers that complete more than 10,000 studies per year, small-to-medium sized hospitals (fewer than 400 beds), and certain specialty clinics like orthopedic practices that offer imaging services.

     We have aggressively expanded our product offerings through our acquisitions of eFilm in 2002, RIS Logic in 2003 and AccuImage in January 2005, and our business combination with Cedara Software Corp. (including its subsidiary, eMed Technologies, Inc.) in June 2005.

     We continue to face challenges including the formal investigation being conducted by the SEC and class action and other lawsuits. In addition, we continue to execute on several initiatives that were started in late 2006, including our right-sizing and reorganization, our onshore / offshore global software engineering and support delivery model and significant changes to our senior management. However, we believe that it will take time for these initiatives and hirings to have an impact on our net sales and operating income. Although we continue to believe that the DRA will ultimately be a catalyst in U. S. end-user customers moving to a filmless environment, we believe that the DRA has had a larger negative impact to our target market and our net sales during 2007 than we had originally

anticipated. For a more detailed discussion of these items see Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q.

     We have generated losses from operations over the past six consecutive quarters. We have undertaken several actions during the last 12 months that we expect will increase our revenues and decrease our costs in the future, including our restructuring initiative implemented in the fourth quarter of 2006. However, for the six months ended June 30, 2007, our loss from operations amounted to $20,860 and our cash and cash equivalents has decreased from $45,945 at December 31, 2006 to $29,708 at June 30, 2007 and we currently have no credit facility. As a result, we are currently completely dependent on available cash and operating cash flow to meet our other capital needs. We are also considering a wide range of financing alternatives including equity offerings, assets sales or debt financing in order to satisfy liquidity needs beyond 2007. If adequate funds are not available or are not available on acceptable terms, our ability to continue as a going concern, to fund our new teleradiology business, take advantage of unanticipated opportunities, develop or enhance service or products or otherwise respond to competitive pressures may be significantly limited.

     We review goodwill and indefinite lived intangible assets for impairment annually, as of December 31 of each year. In addition, we test an intangible asset or group for impairment between annual tests whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying amount. Goodwill of a reporting unit is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. During the three months ended September 30, 2007, several material events occurred that caused us to test for impairment between annual tests. While we are still in the process of finalizing our assessment of the fair value utilizing the assistance of independent valuation specialists, it is likely that all, or substantially all, of our goodwill will be impaired, thus leading to a goodwill impairment charge during the three months ended September 30, 2007.

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 under different assumptions or conditions.

     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, allowance for doubtful accounts, software capitalization, other long-lived assets, goodwill and other intangible asset valuation, share-based compensation expense, income taxes, guarantees and loss contingencies. There have been no significant changes during the three months ended June 30, 2007 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 10-K/A for the year ended December 31, 2006, filed on December 27, 2007.

Results of Operations

Three Months Ended June 30, 2007 Compared to the Three Months Ended June 30, 2006

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
		2007				%(1)				2006				%(1)				$				%
		(As restated)
Net sales:
Software and other		$	6,693				47.7	%		$	18,643				59.3	%		$	(11,950	)			-64.1	%
Services and maintenance			7,343				52.3	%			12,794				40.7	%			(5,451	)			-42.6	%
Total net sales			14,036				100.0	%			31,437				100.0	%			(17,401	)			-55.4	%
Cost of sales:
Software and other			1,445				21.6	%			4,716				25.3	%			(3,271	)			-69.4	%
Services and maintenance			3,450				47.0	%			3,789				29.6	%			(339	)			-8.9	%
Amortization			1,633			NM		(2)			1,068			NM		(2)			565				52.9	%
Total cost of sales			6,528				46.5	%			9,573				30.5	%			(3,045	)			-31.8	%
Gross margin
Software and other			3,615				54.0	%(3)			12,859				69.0	%(3)			(9,244	)			-71.9	%
Services and maintenance			3,893				53.0	%			9,005				70.4	%			(5,112	)			-56.8	%
Total gross margin			7,508				53.5	%			21,864				69.5	%			(14,356	)			-65.7	%
Operating expenses:
Sales and marketing			4,654				33.2	%			5,233				16.6	%			(579	)			-11.1	%
Product research and development			5,412				38.6	%			4,839				15.4	%			573				11.8	%
General and administrative			6,900				49.2	%			6,389				20.3	%			511				8.0	%
Goodwill impairment, restructuring and other expenses			209				1.5	%			214,124				681.1	%			(213,915	)		NM		(2)
Depreciation and amortization			1,034				7.4	%			1,142				3.6	%			(108	)			-9.5	%
Total operating costs and expenses			18,209				129.7	%			231,727				737.1	%			(213,518	)			-92.1	%
Operating loss			(10,701	)			-76.2	%			(209,863	)			-667.6	%			199,162				94.9	%
Other income (expense), net			(28	)			-0.2	%			459				1.5	%			(487	)			-106.1	%
Loss before income taxes			(10,729	)			-76.4	%			(209,404	)			-666.1	%			198,675				94.9	%
Income tax expense (benefit)			11				0.1	%			1,615				5.1	%			(1,604	)			-99.3	%
Net loss		$	(10,740	)			-76.5	%		$	(211,019	)			-671.2	%		$	200,279				94.9	%