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Merge Healthcare Incorporated (MRGE - Analyst Report) reported first-quarter 2014 adjusted net income per share of 3 cents, bouncing back from a loss of 3 cents incurred in the year-ago quarter. Reported net loss of $0.32 million or break-even results per share in the first quarter compared favorably with the year-ago net loss of $6.48 million or loss of 7 cents per share.    

Quarter in Detail

Total revenue in the reported quarter declined 19.9% year over year to $50.9 million. On a pro forma basis, sales declined 20.2% year over year to $51.1 million, lagging the Zacks Consensus Estimate of $52 million. Of the total revenue, 66% was generated from subscription and other predictable sources. Subscription backlog grew 23% over the prior-year quarter, with improvements in both the Merge Healthcare and DNA segments.

Segments in Detail

Merge Healthcare primarily derives revenues from three segments – Software and others (29.5% of total sales in the quarter), Professional services (20.5%), and Maintenance and EDI (49.9%). Maintenance and EDI registered revenues of $25.3 million, down 9.2%. Likewise, the Software and others segment also experienced a decline of 36.0% to $15.1 million. Revenues in the Professional services segment plunged 13.5% year over year to $10.5 million as well.

Operational Update

Total costs (excluding depreciation and amortization) fell 26.4% year over year to $19.4 million. First-quarter adjusted gross margin expanded a massive 332 basis points (bps) from the year-ago quarter to 61.9%.

Sales and marketing expenses were down 22.8% year over year (to $8.0 million) while product research and development expenses declined 11.1% (to $7.6 million) on a year-over-year basis. General and administrative expenses, however, increased 3.4% from the year-ago quarter (to $7.4 million).

However, adjusted operating profit stood at $8.5 million, down 23.9% year over year leading to an 88 bps contraction in adjusted operating margin. The adjustments excluded restructuring and acquisition-related costs, depreciation and amortization.

Financial Update

Merge Healthcare exited the quarter with cash (including restricted cash) of $19.8 million, compared with $19.7 million at the end of 2013. Cash generated from business operations was $9.8 million versus $8.7 million in the year-ago quarter.

2014 Outlook

The company provided an update on its guidance for 2014. Merge still expects net sales in 2014 to remain in the range of $212–$225 million (essentially flat with the 2013 number), leading to adjusted net income per share in the range of 9 cents to 13 cents, down from the earlier range of 16 cents to 21 cents. The Zacks Consensus Estimate for revenues of $214 million remains near the lower end of the guided range.

Our Take

Poor first-quarter top-line results combined with a declining operating margin and a lowered earnings outlook for 2014 at Merge Healthcare continue to disappoint us. On a positive note, increase in subscription-based backlog was the highlight of the quarter. On the other hand, Merge Healthcare’s growth prospects are highly subject to capital investments by hospitals for advanced imaging solutions, which are in turn, dependent upon generic economic conditions.

Zacks Rank

Currently, the stock carries a Zacks Rank #4 (Sell). Some of the better-ranked stocks in the broader medical industry are Cardinal Health, Inc. (CAH - Analyst Report), Hologic Inc. (HOLX - Analyst Report) and The Cooper Companies Inc. (COO - Analyst Report), all carrying a Zacks Rank #2 (Buy).

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