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. Forward-looking statements usually describe our expected future business and financial outlook or performance, and often contain words such as "will," "believes," "intends," "anticipates," "expects," "plans," "seeks," and similar expressions. Forward-looking statements, by their nature, address matters that are, to varying degrees, uncertain and subject to various known and unknown risks. For us, particular uncertainties and risks that could cause actual results to differ materially from our forward-looking statements include: market acceptance and performance of our products and services; the impact of competitive products and pricing; possible delays in the implementation of our managed services offering; the risks and effects of our recent changes in our executive and Board leadership, including the costs and expenses related to severance payments made to departing officers; the risks and effects of our recent securities issues, including the issuance of certain senior secured notes; the past restatement of our financial statements and other actions that may be taken or required as a result of such restatement; our ability to generate sufficient cash from operations to meet future operating, financing and capital requirements, including repayment obligations with respect to our outstanding indebtedness; risks associated with our prior delays in filings with the SEC or our ability to continue to meet the listing requirements of The NASDAQ Stock Market; the costs, risks and effects of various pending legal proceedings and investigations, including the formal investigation being conducted by the Securities and Exchange Commission and the pending settlement of certain class action lawsuits; and other risk factors detailed in our filings with the Securities and Exchange Commission. These uncertainties and risks may cause our actual future results to be materially different than those expressed in our forward-looking statements. 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 on our Annual Report on Form 10-K for the year ended December 31, 2007. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. We undertake no obligation to update such forward-looking statements or any of such risks, uncertainties and other factors.

In light of our financial and liquidity positions, the fact that our 2007 financial statements included a going concern qualification and the recent completion of our financing transaction, Management's Discussion and Analysis is presented in the following order:
· Overview

· Recent Events

· Liquidity and Capital Resources

· Critical Accounting Policies

· Results of Operations

· Material Off Balance Sheet Arrangements

Overview

We develop medical imaging and information management software and deliver related services. We have reorganized our operating business units, effective July 1, 2008. The relevant portions of the EMEA (formerly known as Merge Europe, Middle East and Africa) operation, which sells to the end-user healthcare market in Europe, the Middle East and Africa, has been allocated between the Merge Fusion (formerly known as Merge Healthcare North America) and Merge OEM (formerly known as Cedara) business units. Merge OEM primarily sells software products, developer toolkits and custom engineering services to Original Equipment Manufacturers and Value Added Resellers world-wide. These customers develop, manufacture or resell medical imaging software or devices. Merge Fusion primarily sells directly to the end-user healthcare market consisting of hospitals, imaging centers and specialty clinics located in the U.S., Canada and Europe, the Middle East and Africa and also distributes certain products through the Internet via our website.

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 Merge Fusion 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, such as orthopaedic practices that offer imaging services.

Recent Events

The following significant events either have an impact on our financial results for the periods presented or are of note to our financial condition:

· In July 2008, we ceased operations in our Merge Healthcare Teleradiology Services Private Limited (India) subsidiary, as disclosed in Note 9 of notes to condensed consolidated financial statements.

· On August 29, 2008, we completed the sale of our CSSI subsidiary, as disclosed in Note 9 of notes to condensed consolidated financial statements.

· On October 16, 2008, the NASDAQ Stock Market ("NASDAQ") issued Alert #2008-005 which immediately suspended enforcement of the NASDAQ rules requiring a minimum $1.00 per share closing bid price as well as minimum market value of publically held shares. The suspension will remain in effect through Friday, January 16, 2009 and as a result, NASDAQ will not take any action to delist any securities during the suspension period.

Liquidity and Capital Resources

Our cash and cash equivalents were $14.4 million at September 30, 2008, an increase of approximately $0.4 million, or 3.0%, from our balance of $14.0 million at December 31, 2007 and a decrease of approximately $6.3 million, or 30.4%, from our balance of $20.7 million at June 30, 2008. In addition, our working capital was $3.5 million at September 30, 2008, an increase of $2.6 million from our working capital of $0.9 million at December 31, 2007 and an increase of $2.0 million from our working capital of $1.5 million at June 30, 2008.

On June 4, 2008 we received cash of $16.6 million as proceeds, net of transaction costs and prepaid interest, upon closing of a private placement transaction with Merrick RIS, LLC ("Merrick"). Of the funds received, $3.3 million has been used to pay our portion of the shareholder lawsuit settlement and derivative lawsuit settlement (see Note 7 of notes to condensed consolidated financial statements) in the third quarter of 2008, and $3.8 million has been used to pay employee termination costs in the third quarter of 2008. The remainder will be used to fund our operations, including future payments related to employee termination costs accrued as of September 30, 2008 (see Note 8 of notes to condensed consolidated financial statements).

Operating Cash Flows

Cash used in operating activities was $17.0 million during the nine months ended September 30, 2008, compared to $21.5 million during the nine months ended September 30, 2007. Our negative operating cash flow during the nine months ended September 30, 2008 was primarily due to the loss from operations (excluding non-cash depreciation, amortization and impairment expense of $5.1 million, share-based compensation of $3.8 million, tradename impairment charges of $1.1 million and loss on disposal of our subsidiaries of $1.7 million), the timing of payments for legal fees and insurance recoveries in connection with the class action, derivative and other lawsuits and restructuring related payments.

We anticipate that we will pay approximately $1.7 million over the next several quarters for termination benefits and contract exit costs in connection with our restructuring initiatives. Termination benefits and contract exit costs paid in the third quarter of 2008 were $4.0 million.

Contractual Obligations

Total outstanding commitments under our operating leases at September 30, 2008
(in thousands), were as follows:

                                       18
--------------------------------------------------------------------------------
  Index

                                                            Payment due by period
                                        Less than                                           More than
Contractual Obligations    Total         1 Year         1 - 3 Years       3 - 5 Years        5 Years
Operating leases          $  2,283     $     1,176     $       1,043     $          64     $         -
Note Payable                15,000               -            15,000                 -               -
Total                     $ 17,283     $     1,176     $      16,043     $          64     $         -

The above obligations do not include lease payments related to facilities that we have either ceased to use or abandoned as of September 30, 2008, as the related obligations for such facilities have been recorded as restructuring related accruals in our condensed consolidated balance sheet as of September 30, 2008. The note payable bears interest at 13.0% per annum, payable quarterly in arrears. The note payable contains various operating and financial covenants, including a requirement that we have positive adjusted EBITDA for the last fiscal quarter of 2008 and cumulatively thereafter through the term of the note payable.

We do not have any other significant long-term obligations, contractual obligations, lines of credit, standby letters of credit, guarantees, standby repurchase obligations or other commercial commitments.

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. However, any projections of future cash inflows and outflows are subject to uncertainty. We have undertaken certain initiatives that we believe will increase our revenues and decrease our costs, including the reorganization during the second quarter of 2008 as previously discussed, the disposal of certain non-core subsidiaries and related operations and personnel reductions undertaken in the first and second quarters of 2008. Although we believe the remaining financing funds and operational initiatives that we have undertaken as discussed in Notes 2, 8, 9 and 11 of the notes to condensed consolidated financial statements are sufficient, these activities alone may not be adequate to fund our future business and strategic objectives. Based on these circumstances and the current economic environment, management may or may not conclude in our Annual Report on Form 10-K that there exists substantial doubt about our ability to continue as a going concern.

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, because of the low trading price of our Common Stock, 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. Any projections of future cash inflows and outflows are subject to uncertainty. In particular, our uses of cash in 2008 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 our outstanding legal and regulatory proceedings, and potential merger and acquisition activities. 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, 2007 and in this Quarterly Report on Form 10-Q.

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, allowance for doubtful accounts, software capitalization, other long-lived assets, intangible asset valuation, share-based compensation expense, income taxes, guarantees and loss contingencies. There have been no significant changes during the three months ended September 30, 2008 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 for the year ended December 31, 2007.

Results of Operations

Three Months Ended September 30, 2008 Compared to the Three Months Ended
September 30, 2007

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 September 30,                              Change
                          2008             %    (1)        2007             %    (1)         $               %

Net sales:
Software and other      $   7,398          50.6 %       $    6,927          49.3 %       $      471           6.8 %
Services and
maintenance                 7,218          49.4 %            7,127          50.7 %               91           1.3 %
Total net sales            14,616         100.0 %           14,054         100.0 %              562           4.0 %
Cost of sales:
Software and other          1,314          17.8 %            1,576          22.8 %             (262 )       -16.6 %
Services and
maintenance                 2,528          35.0 %            3,571          50.1 %           (1,043 )       -29.2 %
Amortization and
impairment                    742            NM (2)          5,142            NM (2)         (4,400 )       -85.6 %
Total cost of sales         4,584          31.4 %           10,289          73.2 %           (5,705 )       -55.4 %
Gross margin
Software and other          5,342          72.2 % (3)          209           3.0 % (3)        5,133            NM (2)
Services and
maintenance                 4,690          65.0 %            3,556          49.9 %            1,134          31.9 %
Total gross margin         10,032          68.6 %            3,765          26.8 %            6,267         166.5 %
Operating expenses:
Sales and marketing         1,824          12.5 %            4,463          31.8 %           (2,639 )       -59.1 %
Product research and
development                 2,931          20.1 %            5,294          37.7 %           (2,363 )       -44.6 %
General and
administrative              3,483          23.8 %            7,454          53.0 %           (3,971 )       -53.3 %
Goodwill and
tradename impairment,
restructuring and
other expenses               (205 )        -1.4 %          123,134            NM (2)       (123,339 )      -100.2 %
Depreciation,
amortization and
impairment                    654           4.5 %            5,338          38.0 %           (4,684 )       -87.7 %
Total operating costs
and expenses                8,687          59.4 %          145,683            NM (2)       (136,996 )       -94.0 %
Operating income
(loss)                      1,345           9.2 %         (141,918 )          NM (2)        143,263        -100.9 %
Other income
(expense), net               (648 )        -4.4 %               78           0.6 %             (726 )          NM (2)
Income (loss) before
income taxes                  697           4.8 %         (141,840 )          NM (2)        142,537        -100.5 %
Income tax expense
(benefit)                     269           1.8 %             (286 )        -2.0 %              555        -194.1 %
Net income (loss)       $     428           2.9 %       $ (141,554 )          NM (2)     $  141,982        -100.3 %

(1) Percentages are of total net sales, except for cost of sales and gross margin, which are based upon related net sales.

(2) NM denotes percentage is not meaningful.

(3) Gross margin for software and other sales includes amortization expense recorded in cost of sales.

Net Sales

Net sales, by business unit, are indicated as follows:

                                   Three Months Ended September 30,                   Change
                                2008          %          2007         %           $             %
  Merge OEM
  Software and other         $    4,223       28.9 %   $  2,732       19.4 %   $  1,491        54.6 %
  Services and maintenance        2,428       16.6 %      2,273       16.2 %        155         6.8 %
  Total net sales                 6,651       45.5 %      5,005       35.6 %      1,646        32.9 %
  Merge Fusion
  Software and other              3,175       21.7 %      4,195       29.8 %     (1,020 )     -24.3 %
  Services and maintenance        4,790       32.8 %      4,854       34.5 %        (64 )      -1.3 %
  Total net sales                 7,965       54.5 %      9,049       64.4 %     (1,084 )     -12.0 %
  Total net sales            $   14,616                $ 14,054                $    562

We have reorganized our operating business units, effective July 1, 2008. The relevant portions of the EMEA (formerly known as Merge Europe, Middle East and Africa) operation have been allocated between the remaining business units of Merge Fusion (formerly known as Merge Healthcare North America) and Merge OEM (formerly known as Cedara). As a result, we no longer separately report EMEA revenues.

Software and Other Sales. Total software and other sales for the three months ended September 30, 2008 were $7.4 million, an increase of $0.5 million, or 6.8%, from $6.9 million for the three months ended September 30, 2007. The increase in software and other sales results from an increase in OEM sales of $1.5 million, primarily due to recognition of software revenue upon delivery of, or relief from delivery of, certain products or services associated with contracts signed in prior periods. This is offset by a decrease in Fusion sales of $1.0 million, as a result of revenue recognition on two large projects in the three months ended September 30, 2007, compared to one large project in the three months ended September 30, 2008.

Service and Maintenance Sales. Total service and maintenance sales for the three months ended September 30, 2008 were $7.2 million, an increase of $0.1 million, or 1.3%, from $7.1 million for the three months ended September 30, 2007. Service and maintenance sales recognized through our Merge OEM business unit increased $0.2 million, while service and maintenance sales recognized through our Merge Fusion business unit decreased $0.1 million.

Gross Margin

Gross Margin - Software and Other Sales. Gross margin on software and other sales was $5.3 million for the three months ended September 30, 2008, an increase of approximately $5.1 million, from $0.2 million for the three months ended September 30, 2007. Gross margin as a percentage of software and other sales, increased to 72.2% for the three months ended September 30, 2008 from 3.0% for the three months ended September 30, 2007. The increase in gross margin is primarily due to a $4.1 million impairment related to our purchased and capitalized software development costs recorded in the three months ended September 30, 2007, which also resulted in a corresponding reduction in the software amortization run rate during 2008 because of the impairment, as well as cost controls that were implemented in the second quarter of 2008. Excluding the impairment charge, the gross margin as a percentage of sales was 62.8% for the three months ended September 30, 2007. The remainder of the increase is attributable to greater software and other sales from our OEM business unit, which generally consists of software-only contracts at higher margins.

Gross Margin - Services and Maintenance Sales. Gross margin on services and maintenance sales was $4.7 million for the three months ended September 30, 2008, an increase of $1.1 million, or 31.9%, from $3.6 million for the three months ended September 30, 2007. Gross margin as a percentage of services and maintenance sales, increased to 65.0% for the three months ended September 30, 2008 from 49.9% for the three months ended September 30, 2007. The increases are primarily due to a $0.7 million decrease in headcount-related expenses as a result of our restructuring activities, and a $0.2 million decrease in third party support costs.

Sales and Marketing

Sales and marketing expense decreased $2.7 million, or 59.1%, to approximately $1.8 million for the three months ended September 30, 2008 from $4.5 million for the three months ended September 30, 2007. As a result of our restructuring initiatives in 2008, salaries, commissions and other related expenses (including travel and entertainment) decreased by $1.8 million and share-based compensation expense decreased by $0.3 million. In addition, we incurred $0.2 million less in direct marketing costs for the three months ended September 30, 2008 compared to the three months ended September 30, 2007 as a result of cost containment efforts. Also, the three months ended September 30, 2007 includes $0.3 million of sales and marketing incurred by the French subsidiary, which we disposed of on April 11, 2008.

Product Research and Development

Product research and development expense decreased approximately $2.4 million, or 44.6%, to $2.9 million for the three months ended September 30, 2008 from $5.3 million for the three months ended September 30, 2007. Decreased expenses for the three months ended September 30, 2008 were primarily attributable to a $2.1 million reduction in salaries, related expenses (including travel and entertainment) and third party service costs, as well as a decrease of $0.2 million of share-based compensation expense, all of which were a result of our restructuring initiatives in 2008. In addition, the three months ended September 30, 2007 included $0.2 million of product research and development expenses incurred by the French subsidiary, which we disposed of on April 11, 2008.

General and Administrative

General and administrative expense decreased approximately $4.0 million, or 53.3%, to $3.5 million for the three months ended September 30, 2008 from $7.5 million for the three months ended September 30, 2007. Decreased expenses were primarily attributable to a $1.8 million decrease in legal, accounting and other professional fees associated with the settlement of the class action lawsuit and prior restatement of financial statements, a $1.3 million decrease in salaries and related expenses (including travel and entertainment) and a share-based compensation expense decrease of $0.4 million, all of which were a result of our restructuring initiatives in 2008. In addition, the three months ended September 30, 2007 included $0.2 million of general and administrative expenses were incurred by the French subsidiary, which we disposed of on April 11, 2008.

Goodwill and Tradename Impairment, Restructuring and Other Expenses

We recorded a $0.2 million gain in goodwill and tradename impairment, restructuring, and other expenses for the three months ended September 30, 2008, primarily due to the $0.1 million gain on the sale of CSSI, and a $0.1 decrease in restructuring expenses due to changes in original estimates related to the initiative announced in June 2008. As discussed in Note 9 to the condensed consolidated financial statements, during the three months ended September 30, 2007, we concluded that all of our goodwill was impaired, and recorded an impairment charge of $122.4 million, and also concluded that trade names associated with our Cedara Software Corp. business transaction were impaired, and recorded an impairment charge of $0.8 million.

Depreciation, Amortization and Impairment

Depreciation, amortization and impairment expense decreased approximately $4.6 million, or 87.7 %, to $0.7 million for the three months ended September 30, 2008 from $5.3 million for the three months ended September 30, 2007. The decrease is primarily attributable to a $4.3 million impairment of customer relationships in the three months ended September 30, 2007, and $0.3 million reduction in the amortization run rate during 2008 due to the impairment.

Other Income (Expense), Net

Other income (expense), net decreased by approximately $0.7 million to $0.6 million of net expense for the three months ended September 30, 2008 compared to $0.1 million of income for the three months ended September 30, 2007. The net expense for the three months ended September 30, 2008 is primarily due to $0.8 million of interest expense and amortization of issuance costs and note discount associated with the $15.0 million note payable issued on June 4, 2008 pursuant to the Merrick financing transaction as discussed in Note 2 to the condensed consolidated financial statements.

Income Tax Expense (Benefit)

During the three months ended September 30, 2008 we recorded income tax expense resulting in an effective tax rate of 38.6%. The net income tax expense recorded during the three months ended September 30, 2008 is primarily attributable to income taxes payable in India and capital gains taxes payable in India resulting from the sale of CSSI which we were not able to offset with either U.S. or Canadian losses. During the three months ended September 30, 2007 we recorded an income tax benefit resulting in an effective tax rate of (0.2)%. Our effective . . .