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Merge Posts Disappointing 2Q Earnings

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Merge Healthcare Incorporated reported net loss of 30 cents per share in the second quarter of 2013, wider than the year-ago net loss of 6 cents per share. Considering stock-based compensation as regular expense for the company, adjusted loss per share in second quarter was a penny, worse than the year-ago adjusted break-even level per share.

Quarter in Detail

Total revenue declined 9.1% year over year to $57.2 million. On a pro forma basis, sales were $57.6 million, well below the Zacks Consensus Estimate of $66 million. The company noted that its subscription-based pricing model, which was launched in the first quarter of 2012, generated 17% of total revenue in the reported quarter with 82% rise in subscription backlog in the quarter.

In the reported quarter, Merge inked 12 fresh iConnect contracts with well-regarded healthcare systems in the U.S. On the other hand, the company’s Merge Cardiology solutions gained traction with 17 new contracts.

Merge primarily derives revenues from three segments – software and others (26% of total sales in the quarter), professional services (21.3%), and maintenance and EDI (48.5%). While maintenance and EDI remained flat at $27.8 million, the software and other businesses registered decline of 29.2% to $23.6 million and professional services rose 17.2% to $11.6 million in the quarter.

Total costs (excluding depreciation and amortization) increased 7.8% year over year to $23.4 million. Second-quarter adjusted gross margin declined 50 basis points (bps) from the year-ago quarter to 59.1%.

Sales and marketing expenses in the quarter were down 6.1% (to $10.1 million) while product research and development expenses remained flat (at $8.4 million) on a year-over-year basis. General and administrative expenses increased 19.2% year over year (to $8.8 million). As a result, adjusted operating expenses rose 2.9% year over year to $27.4 million. However, the company’s adjusted operating margin expanded 220 bps to 11.2% in the quarter.

Merge exited the quarter with cash (including restricted cash) of $16.8 million, compared with $35.9 million at the end of 2012. Cash from business operations improved 3.9% year over year to $10.6 million in the second quarter.

Our View

Merge reported disappointing results in the second quarter. The widening loss over the past few quarters is another cause of concern. Moreover, the company’s growth prospects are highly dependent on capital investments by hospitals for advanced imaging solutions, which are in turn tied to the general economic conditions.

Although fresh contracts are expected to improve results going forward, we are wary about consistently weak quarterly performances over the past several quarters. The stock currently carries a Zacks Rank #4 (Sell).

While we prefer to avoid Merge, we are positive about other stocks such as Cyberonics Inc. , Thoratec Corp. and Alere Inc. . These stocks carry Zacks Rank #1 (Strong Buy).

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