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Merge Healthcare Incorporated (MRGE - Analyst Report) reported second-quarter 2014 adjusted net income per share of 4 cents, bouncing back from a loss of a penny incurred in the year-ago quarter. Reported net loss of $4.0 million or loss of 4 cents per share in the second quarter compared favorably with the year-ago net loss of $28.1 million or loss of 30 cents per share.   

However, this positive piece of news failed to boost investors’ confidence. The company’s share price has dropped 2% since the announcement of the second quarter results to close at $2.46 yesterday.

 

Quarter in Detail

Total revenue in the reported quarter declined 5.9% year over year to $53.8 million. On a pro forma basis, sales declined 6.1% year over year to $54.1 million, ahead of the Zacks Consensus Estimate of $53 million. Of the total revenue, 64% was generated from subscription maintenance & EDI. Subscription backlog grew 12% to $54.6 million 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 (33.5% of total sales in the quarter), Professional services (18.9%), and Maintenance and EDI (47.6%). Maintenance and EDI registered revenues of $25.6 million, down 7.9%. Likewise, the Professional services segment also experienced a decline of 11.9% to $10.2 million. Revenues in the Software and others segment edged up 0.8% year over year to $18.0 million as well.

Operational Update

Total costs (excluding depreciation and amortization) fell 6.3% year over year to $21.9 million. Second-quarter adjusted gross margin expanded 17 basis points (bps) from the year-ago quarter to 59.2%.

Sales and marketing expenses were down 19.3% year over year (to $8.1 million) while product research and development expenses declined 13.2% (to $7.3 million) on a year-over-year basis. General and administrative expenses slashed a huge 27.4% from the year-ago quarter (to $6.4 million). All these led to a 20% decline in total operating cost (adjusted) to $21.9 million in the reported quarter.

Accordingly, adjusted operating profit stood at $10.0 million, a huge 55.8% jump year over year leading to a 736 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 $23.9 million, compared with $19.7 million at the end of 2013. Cash generated from business operations was $8.3 million, down from $10.6 million in the year-ago quarter.

2014 Outlook

The company reiterated its top-line guidance for 2014. Merge 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. The Zacks Consensus Estimate for revenues of $214 million is close to the lower end of the guided range.

Our Take

Although second quarter revenues at Merge beat the Zacks Consensus Estimate by a whisker, the widening loss over the past few quarters remains a cause of concern. The year-over-year sales decline also continues to disappoint us.

On a positive note, increase in subscription-based backlog was the highlight of the quarter. Significant increase in operating profit was another upside. According to Merge, its first half revenues coincide with almost half of the midpoint of its full year 2014 revenue guidance.

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. The company believes that its addressable market has stabilized.

Zacks Rank

Currently, the stock carries a Zacks Rank #3 (Hold). Some of the better-ranked stocks in the broader medical industry are AmSurg Corp. (AMSG - Analyst Report), Gentiva Health Services Inc. and RadNet, Inc. (RDNT - Snapshot Report), all carrying a Zacks Rank #2 (Buy).