Merge Disappoints, Suspends Guidance (revised)
Merge Healthcare (NASDAQ:MRGE) reported loss of 2 cents per share in the first quarter of fiscal 2012, slightly up from the year-ago loss of 4 cents per share. However, adjusted EPS came in at 3 cents in the reported quarter, in line with the prior-year adjusted EPS but ahead of the Zacks Consensus Estimate of break-even.
Total revenue during the quarter stood at $61.0 million, up 16% year over year but down 4.8% sequentially. Total revenue also missed the Zacks Consensus Estimate by $6 million. While reporting the quarter’s result, Merge also announced changes in its operations. From now on, the company has been fragmented in two new operating groups, namely Merge Healthcare and Merge DNA (Data & Analytics). The company also announced changes to the roles and responsibilities of a number of senior executives, including the re-assumption of the CFO role by Steve Oreskovich.
The company believes with the operational alteration it will be able to better focus on its two primary end users, providers and consumers. These operational changes were needed as the company shifted from traditional perpetual software license arrangement to subscription-based pricing in order to meet the purchasing requirements of the company’s clients in better way.
Merge primarily derives revenues from three segments – software and others, professional services, and maintenance and EDI. The three segments registered annualized growth of 22.0% to $22.7 million, 11.9% to $9.4 million and 12.4% to $28.9 million, respectively, during the quarter. Recurring revenues in the quarter were nearly 57.5% of net sales versus 65% in the year-ago quarter.
Gross margin in the quarter was 59.02% versus 58.03% in the year-ago quarter, up 99 basis points (bps) year over year. However, gross margin in the reported quarter contracted 368 bps sequentially. Adjusted operating margin (excluding the impact of certain one-time expenses) contracted 170 bps on a year-over-year basis and 320 bps sequentially to 14.5% during the quarter.
Merge exited the quarter with cash (including restricted cash) of $39.8 million compared with $39.3 million at the end of fiscal 2011.Net cash provided by operating activities in the first quarter was $2.1 million as against $6.9 million in the year-ago quarter.
With the shift from traditional perpetual software license arrangement to subscription model in the first quarter of 2012 with the introduction of Merge Honeycomb solution at the RSNA trade show, Merge witnessed greater demand for its offerings. However, with the subscription model, the company anticipates lower upfront revenue, but expects to incur more over the contract term. Although the company expects year-over-year revenue growth in fiscal 2012, the subscription pricing changed its initial 2012 revenue expectations. As a result, the company suspended its previous revenues guidance.
On the back of a disappointing first quarter and uncertainty related to operational changes, share price of Merge plummeted 36.2% to $2.52. We remain concerned about declining Medicare reimbursement for advanced medical imagingthat has negatively affected hospital and imaging clinic revenues, thereby reducing demand for imaging-related software and services offered by Merge. Moreover, Merge’s growth prospect is highly dependent on capital investments by hospitals for advanced imaging solutions, which are in turn tied to the general economic condition.
The presence of big players like General Electric Co (NYSE:GE) and McKesson Corporation (NYSE:MCK) has made the diagnostic imaging market highly competitive. However, we still believe in the immense potential of Merge in the huge and growing market for diagnostic imaging, especially with government’s emphasis on HIT and an ageing population.
Presently, Merge retains a short-term Zacks #3 Rank (Hold), which also corresponds to our long-term Neutral recommendation on the stock.
(NOTE: We are re-issuing this article to correct a mistake, namely that we had erroneously mentioned Steve Oreskovich was resigning from Merge Healthcare, which is untrue. We regret the error.)