Strong Quarter for Merge - Analyst Blog

Merge Healthcare (MRGE) reported net loss per share of 6 cents in the third quarter of fiscal 2010 compared with loss of 2 cents in the year-ago period. However, after adjusting for certain items, the company reported an EPS of 4 cents, surpassing both the Zacks Consensus Estimate and the prior-year quarter by 3 cents.

Merge reported revenues of $45.2 million, up 167.5% from $16.9 million in the year-ago period. Results for the reported quarter include sales of AMICAS, which was acquired in April 2010. However, adjusted revenue was $48.5 million, higher than the year-ago quarter's adjusted revenue of $45.7 million and the Zacks Consensus Estimate of $43 million. The company derives revenues from three sources – software and others, professional services, and maintenance and EDI − which recorded an annualized growth of 66.7% to $12.9 million, 77.1% to $6.8 million and 380% to $25.4 million, respectively. Recurring revenues were greater than 65% of net sales during the quarter, unchanged from the year-ago quarter.

Merge also made some changes to its top management. The company announced its new CEO, Jeffrey Surges, who was the president of sales at Allscripts Healthcare (MDRX), a Merge partner. Surges' predecessor, Justin Dearborn, will now focus on the company's international business.

The overall US health IT (HIT) market witnessed a dramatic change in February 2009 with the passing of the Health Information Technology for Economic and Clinical Health (HITECH) Act, as part of the American Recovery and Reinvestment Act (ARRA), an economic stimulus bill. According to the HITECH Act, almost $20 billion will be spent on health care providers who can demonstrate by 2011 that they are using HIT applications in meaningful ways to reduce the overall healthcare costs. The incentives will be offered for a period of 4−5 years after which physicians will be penalized for not adopting proper measures.

We are encouraged to note that Merge has witnessed an improvement in the overall industry trends. Though initially confusing, the requirements to qualify for the funds are now becoming clearer, helping health providers make the necessary purchases.

Merge has made several acquisitions over the past few years, the latest being the acquisition of AMICAS Inc. for approximately $248 million, which will benefit the company in the long term. While Merge is primarily focused on outpatient imaging sites in the radiology information system, picture archiving and communication systems (RIS/PACS market), AMICAS earns revenues from outpatient imaging sites as well as radiology, cardiology, and enterprise solutions in the hospital market.

Outlook

For 2011, Merge expects to record $235−$240 million of adjusted revenue, well above the Zacks Consensus Estimate of $205 million.

Recommendation

There is immense potential in the diagnostic imaging market, especially with the government's emphasis on HIT and an ageing population. The acquisition of AMICAS has transformed Merge into a stronger company, with an expanded product portfolio.  However, the presence of many big players has made the diagnostic imaging market highly competitive.

For the long term, we have a Neutral rating on Merge Healthcare. The stock retains a Zacks #3 Rank (Hold) for the short term.