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Dismal Q3 Earnings for Merge, Revs Down Y/Y

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Merge Healthcare Incorporated   reported  third quarter adjusted net income per share  of 1 cents, a slight improvement from the loss earned in the year ago quarter. However, the reported net loss of 4 cents per share in the third quarter of 2013, coincided with the same figure incurred a year ago.

Quarter in Detail

Total revenues declined 5.2% year over year to $57.2 million. On a pro forma basis, sales were $57.7 million, down 5.4% year over year. Of the total revenues, 66% was generated through subscription and other predictable sources. The Merge Honeycomb Archive, a cloud-based archiving solution with a subscription pricing model, gained momentum in the quarter. Subscription backlog grew 73% over the prior year quarter, with improvements in both Merge Healthcare and DNA segments. A 15% upsurge was also witnessed in the healthcare subscription.
Segments in Detail

Merge primarily derives revenues from three segments – software and others (33.8 % of total sales in the quarter), Professional services (18.2%), and Maintenance and EDI (47.9%). While maintenance and EDI registered revenues of $27.4 million, the software and other segment experienced a decline of 8.8% to $19.3 million from $21.2 million in the year ago quarter. Revenues in the Professional services segment dropped 7% year over year to $10.4 million in the reported quarter.

Operational Update

Total costs (excluding depreciation and amortization) increased 8.7% year over year to $24.8 million. Third-quarter adjusted gross margin contracted a massive 560 basis points (bps) from the year-ago quarter to 56.6%.

Sales and marketing expenses were down 21.1% year over year (to $8.5 million) while product research and development expenses remained flat (at $8.1 million) on a year-over-year basis. General and administrative expenses increased 24.03% from the year ago quarter (to $9.65 million).

Adjusted operating income decreased 41.2% year over year to $6.4 million. The adjustments exclude restructuring and acquisition-related costs, depreciation and amortization. The adjusted operating margin stood at 11.1% of net sales as compared to 18% in the year-ago quarter.

Financial Update

Merge exited the quarter with cash (including restricted cash) of $20.2 million, compared with $35.9 million at the end of 2012. Cash generated from business operations improved 66% to $15.3 million as compared to $9.2 million in the year ago quarter.

Our Take

Merge reported discouraging results in the third quarter. The declining sales of the company is a cause of alarm. However, despite a challenging quarter it achieved significant improvements in cash collections and also repaid more than $6 million as a part of its debt. Increase in the subscription-based backlog and implementation of a company-wide strategy for ICD-10 were the highlights of the quarter. On the other hand, Merge’s growth prospects are highly subject to capital investments by hospitals for advanced imaging solutions, which are in turn dependent upon general economic conditions.

Currently the stock carries a Zacks Rank # 3 (Hold). A better-performing stock in the MedInfo systems industry is Medidata Solutions, Inc. (MDSO - Free Report) which sports a Zacks Rank #2 (Buy).Other medical instruments stocks that are worth a look include CryoLife Inc. (CRY - Free Report) carrying a Zacks Rank #1 (Strong Buy) and Echo Therapeutics, Inc. carrying a Zacks Rank #2 (Buy).

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