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Merge Healthcare Incorporated (MRGE - Analyst Report) reported net loss of 7 cents per share in the first quarter of 2013, worse than the year-ago net loss of 2 cents per share. Considering stock-based compensation and interest expense as regular expense for the company, adjusted loss per share in first quarter was 3 cents, a huge disappointment when compared to the year-ago adjusted earnings of 3 cents per share. Higher costs leading to margin pressure and higher share count worsened the loss at Merge. 
 
Total revenues edged up 4.3% year over year to $63.6 million. On a pro forma basis, sales inched up 3.9% to $64 million, in line with the Zacks Consensus Estimate. The company noted that its subscription-based pricing model, which was launched in the first quarter of 2012, generated 15% of total revenue in the first quarter with 16% rise in subscription backlog in the quarter.
 
Quarter in Detail
 
Merge inked 11 fresh iConnect contracts with well-regarded healthcare systems in the U.S. On the other hand, the company’s Merge HoneyComb solutions gained traction with 7 new contracts. 
 
Merge primarily derives revenues from three segments – software and others (37.1% of total sales in the quarter), professional services (19%), and maintenance and EDI (43.9%). Barring maintenance and EDI, which recorded year-over-year growth of 3.1% to $27.9 million, the software and other business, and professional services registered decline of 3.5% to $23.6 million and 28.7% to $12.1 million, respectively, in the quarter.
 
Total cost (excluding depreciation and amortization) increased 14.2% year over year to $28.2 million. First-quarter adjusted gross margin declined a massive 360 basis points (bps) from the year-ago quarter to 58.5%.
 
Sales and marketing expenses in the quarter were down 5.1% (to $10.4 million) while product research and development expenses jumped 12.3% (to $8.5 million) on a year-over-year basis. General and administrative expenses dipped 17.6% year over year (to $7.1 million). As a result, adjusted operating expenses declined 4.2% year over year to $26 million. Consequently, the company’s adjusted operating margin expanded 10 bps to 17.7% in the quarter.
 
Merge exited the quarter with cash (including restricted cash) of $44.5 million, compared with $35.9 million at the end of 2012. 
 
Our Take
 
Merge continues to depend on the hospital capital expenditure environment and reimbursement rates for advanced medical imaging. Thus, the demand for the company’s solutions is highly dependent on the macroeconomic environment in the U.S. 
 
Nonetheless, Merge serves a lucrative market with multi-million dollar opportunities for its offerings. Meanwhile, client wins and bookings growth is also encouraging. Recent findings also demonstrate immense growth potential in the U.S. and overseas market for the company.
 
Currently, the stock carries a Zacks Rank #2 (Buy). Other healthcare Zacks Rank #2 stocks that warrant a look are Intuitive Surgical Inc. (ISRG - Analyst Report), Accuray Inc. (ARAY - Analyst Report) and Abiomed Inc. (ABMD - Analyst Report). 

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