Accounting & Tax

Merge Cites Controls Problems

Merge Healthcare says former managers "circumvented" accounting controls.
Marie LeoneAugust 31, 2006

Software maker Merge Technologies disclosed yesterday that material weaknesses in several areas of internal controls resulted in a $1.9 million overstatement in net income for the three month period ending March 21, 2005, and a $7.8 million balance sheet hit.

The company, which does business as Merge Healthcare and generates $37 million in sales annually, cited material weaknesses related to the company’s general control environment, revenue recognition, accounting for income taxes, and accounting for business combinations, as being the cause of the adjustments, according to a regulatory filing.

The breakdown in controls over financial reporting led to “material misstatements” in financial results for the last three quarters of 2005, and for the fiscal years 2004, 2003, and 2002, said the company.

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Officials blamed the deficiencies on former senior managers who did not “set a proper ethical tone,” said the filing, which noted that “certain of the former members of our management were directly involved in circumventing our accounting controls.”

Although the filing did not name the executives, the company did list several senior-level resignations as part of its material weakness remediation plan. As previously reported on CFO.com, the resignations included Richard Linden, former president and CEO; William Mortimore, former interim CEO; Scott Veech, former CFO; and David Noshay, former senior vice president of strategic business development.

Other remediation efforts will focus on instituting an internal audit function and appointing a director of internal audit, strengthening the role of independent directors by determining that one of the non-employee directors will service as chairman of the board, and enhancing the company’s contract review process.

In January, the company received a number of anonymous letters primarily alleging improprieties relating to its financial reporting, fulfillment of customer contracts and disclosure practices, according to its regulatory filing. In response, the audit committee hired the law firm of Sidley Austin LLP and forensic accounting firm Alvarez & Marsal to conduct an independent investigation of the allegations.

Later in the year, the company revealed that it was a target of an informal inquiry by the Securities and Exchange Commission, and that it would restate its results for the quarters ended June 30, 2005, and September 30, 2005, “due to certain material errors.” Then, on July 3, the company said its audit committee had since determined that it would need to restate its results for the four years ended 2005 because of improper accounting and financial reporting practices.

Until a new CEO is named, management will report to the audit committee.