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| MRGE > SEC Filings for MRGE > Form 10-Q on 6-Aug-2012 | All Recent SEC Filings |
6-Aug-2012
Quarterly Report
Cautionary Note Regarding Forward-Looking Statements
The discussion below contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E of the Exchange Act. We have used words such as "believes," "intends," "anticipates," "expects" and similar expressions to identify forward-looking statements. These statements are based on information currently available to us and are subject to a number of risks and uncertainties that may cause our actual results of operations, financial condition, cash flows, performance, business prospects and opportunities and the timing of certain events to differ materially from those expressed in, or implied by, these statements. These risks, uncertainties and other factors include, without limitation, those matters discussed in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2011. Except as expressly required by the federal securities laws, we undertake no obligation to update such factors or to publicly announce the results of any of the forward-looking statements contained herein to reflect future events, developments, or changed circumstances, or for any other reason. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing in our Annual Report on Form 10-K and Item 1A, "Risk Factors" for the year ended December 31, 2011.
Management's Discussion and Analysis is presented in the following order:
· Overview
· Business Segments
· Results of Operations
· Liquidity and Capital Resources
· Material Off Balance Sheet Arrangements
· Critical Accounting Policies
Overview
We develop software solutions that facilitate the sharing of images to create a more effective and efficient electronic healthcare experience for patients and physicians. Our solutions are designed to help solve some of the most difficult challenges in health information exchange today, such as the incorporation of medical images and diagnostic information into broader healthcare IT applications, the interoperability of proprietary software solutions, the profitability of outpatient imaging practices and the ability to improve the efficiency and cost effectiveness of our customers' businesses. Our ability to innovate has driven consistent expansion of solutions and services and entry into new markets.
Our solutions optimize processes for healthcare providers ranging in size from single-doctor practices to health systems, to the sponsors of clinical trials and medical device manufacturers. These solutions are licensed by more than 1,500 hospitals, 6,000 clinics and labs, 250 medical device manufacturers and by top pharmaceutical companies world-wide. We believe that we have an opportunity to grow revenues by expanding our solution footprint with existing customers, as only a small percent currently have more than one of our enterprise solutions.
In the second quarter of 2012, we announced the creation of two operating groups to provide better focus on our two primary end users, providers and consumers. The operating group named Merge Healthcare represents approximately 85% of our total revenue and markets, sells and implements interoperability, imaging and clinical solutions to healthcare providers. Merge DNA (Data & Analytics) represents about 15% of total revenues and focuses on the emergence of consumerism in healthcare, including consumer health stations, data capture software and other consumer-focused solutions. As a result of this change, effective in the second quarter of 2012, we have two reportable segments.
We primarily generate revenue from the sale of software (including upgrades), hardware, professional services, maintenance and Electronic Data Interchange (EDI) services. Today, the majority of our revenue is generated through perpetual license agreements with our customers. Under this type of arrangement, the software, hardware and professional services are considered to be sources of non-recurring revenue and related backlog. Our backlog of non-recurring revenue was approximately $28.3 million as of June 30, 2012. We also generate revenue through subscription-based pricing arrangements in which software, hardware and professional services are payable by our customers over a number of years. Generally, these contracts will include a minimum volume and/or dollar commitment. As such, revenue from these transactions is recognized ratably over an extended period of time. Subscription arrangements include, but are not limited to, contracts structured with monthly payments (including leases), long-term clinical trials or renewable annual software contracts (with very high renew rate). As a result of recent buying trends of our customers, we have begun to see an increase in the demand for subscription-based arrangements. Due to the length of sales cycles with our customers, we would expect these types of arrangements to become more prevalent in the second half of 2012 and beyond. In the second quarter of 2012, subscription revenue was approximately 15.0% of total net sales and subscription revenue backlog as of June 30, 2012 was $34.1 million.
Business Segments
Effective in the second quarter of 2012, we have reportable segments which we have designated Merge Healthcare and Merge DNA. We evaluate the performance of these segments based on their respective revenues and segment operating income, which excludes certain corporate costs, interest expense, amortization of issuance and note discount costs and income taxes.
The following tables provide segment information for the periods indicated, based on GAAP reported information:
Merge Healthcare Three Months Ended Six Months Ended
Segment June 30, Change June 30, Change
2012 2011 $ % 2012 2011 $ %
Net sales:
Software and
other $ 20,314 $ 17,554 $ 2,760 15.7 % $ 39,057 $ 36,225 $ 2,832 7.8 %
Service 6,808 5,667 1,141 20.1 % 13,064 9,654 3,410 35.3 %
Maintenance 27,220 27,438 (218 ) -0.8 % 55,535 53,025 2,510 4.7 %
Total net sales 54,342 50,659 3,683 7.3 % $ 107,656 $ 98,904 8,752 8.8 %
Expenses 44,226 38,572 5,654 14.7 % 88,211 77,886 10,325 13.3 %
Segment income $ 10,116 $ 12,087 $ (1,971 ) -16.3 % $ 19,445 $ 21,018 $ (1,573 ) -7.5 %
Three Months Ended Six Months Ended
Merge DNA Segment June 30, Change June 30, Change
2012 2011 $ % 2012 2011 $ %
Net sales:
Software and other $ 4,948 $ 85 $ 4,863 NM $ 8,962 $ 85 $ 8,877 NM
Service 3,048 4,848 (1,800 ) -37.1 % 6,232 9,261 (3,029 ) -32.7 %
Maintenance 548 - 548 NM 1,014 14 1,000 NM
Total net sales 8,544 4,933 3,611 73.2 % $ 16,208 $ 9,360 6,848 73.2 %
Expenses 9,713 4,980 4,733 95.0 % 16,916 9,494 7,422 78.2 %
Segment loss $ (1,169 ) $ (47 ) $ (1,122 ) NM $ (708 ) $ (134 ) $ (574 ) NM
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The following tables provide GAAP sales generated by non-recurring, subscription and maintenance and EDI revenue sources by segment for the periods indicated in 2012 and non-recurring and subscription backlog as of June 30, 2012:
Three Months Ended June 30, 2012 Six Months Ended June 30, 2012
Healthcare DNA Total Healthcare DNA Total
Revenue Source $ % $ $ % $ % $ % $ % $ %
Maintenance & EDI $ 27,220 50.1 % $ 548 6.4 % $ 27,768 44.2 % $ 55,535 51.6 % $ 1,014 6.3 % $ 56,549 45.7 %
Subscription 3,807 7.0 % 5,603 65.6 % 9,410 15.0 % 7,666 7.1 % 12,444 76.8 % 20,110 16.2 %
Non-recurring 23,315 42.9 % 2,393 28.0 % 25,708 40.9 % 44,455 41.3 % 2,750 17.0 % 47,205 38.1 %
Total $ 54,342 100.0 % $ 8,544 100.0 % $ 62,886 100.0 % $ 107,656 100.0 % $ 16,208 100.0 % $ 123,864 100.0 %
Backlog as of June 30, 2012
Healthcare DNA Total
Revenue Source $ % % $ % $ %
Subscription $ 11,895 29.6 % $ 22,207 100.0 % $ 34,102 54.7 %
Non-recurring 28,266 70.4 % 6 0.0 % 28,272 45.3 %
Total $ 40,161 100.0 % $ 22,213 100.0 % $ 62,374 100.0 %
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Results of Operations
Three Months Ended June 30, 2012 Compared to the Three Months Ended June 30,
2011
The following table sets forth selected, summarized, unaudited, consolidated
financial data for the periods indicated, as well as comparative data showing
increases and decreases between the periods. All amounts, except percentages,
are in thousands.
Three Months Ended June 30, Change
2012 % (1) 2011 % (1) $ %
Net sales:
Software and other $ 25,262 40.2 % $ 17,639 31.7 % $ 7,623 43.2 %
Professional services 9,856 15.7 % 10,515 18.9 % (659 ) -6.3 %
Maintenance and EDI 27,768 44.2 % 27,438 49.4 % 330 1.2 %
Total net sales 62,886 100.0 % 55,592 100.0 % 7,294 13.1 %
Cost of sales:
Software and other 11,468 45.4 % 4,681 26.5 % 6,787 145.0 %
Professional services 6,012 61.0 % 5,016 47.7 % 996 19.9 %
Maintenance and EDI 7,915 28.5 % 6,687 24.4 % 1,228 18.4 %
Depreciation and
amortization 1,901 3.0 % 2,347 4.2 % (446 ) -19.0 %
Total cost of sales 27,296 43.4 % 18,731 33.7 % 8,565 45.7 %
Total gross margin 35,590 56.6 % 36,861 66.3 % (1,271 ) -3.4 %
Gross margin by net
sales category (2)
Software and other 13,794 54.6 % 12,958 73.5 % 836 6.5 %
Professional services 3,844 39.0 % 5,499 52.3 % (1,655 ) -30.1 %
Maintenance and EDI 19,853 71.5 % 20,751 75.6 % (898 ) -4.3 %
Operating expenses:
Sales and marketing 10,743 17.1 % 7,853 14.1 % 2,890 36.8 %
Product research and
development 8,450 13.4 % 7,017 12.6 % 1,433 20.4 %
General and
administrative 7,409 11.8 % 8,264 14.9 % (855 ) -10.3 %
Acquisition-related
expenses 2,844 4.5 % 375 0.7 % 2,469 NM( 3)
Depreciation,
amortization and
impairment 2,725 4.3 % 5,223 9.4 % (2,498 ) -47.8 %
Total operating costs
and expenses 32,171 51.2 % 28,732 51.7 % 3,439 12.0 %
Operating income 3,419 5.4 % 8,129 14.6 % (4,710 ) -57.9 %
Other income
(expense), net (7,177 ) -11.4 % (7,788 ) -14.0 % 611 -7.8 %
Income (loss) before
income taxes (3,758 ) -6.0 % 341 0.6 % (4,099 ) NM( 3)
Income tax expense 2,121 3.4 % 2,026 3.6 % 95 4.7 %
Net loss $ (5,879 ) -9.3 % $ (1,685 ) -3.0 % $ (4,194 ) 248.9 %
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(1) Percentages are of total net sales, except for cost of sales and gross margin, which are based upon related net sales.
(2) Depreciation and amortization expenses are excluded from these gross margin calculations.
(3) NM denotes percentage is not meaningful.
Net Sales
Software and Other Sales. Total software and other sales in 2012 were $25.2 million, an increase of $7.6 million, or 43.2%, from $17.6 million in 2011. Software and other sales increased $2.8 million in our Healthcare segment, primarily due to an increase in hardware sales related to our iConnect solutions, and $4.8 million in our DNA segment, primarily due to $3.6 million in sales of health stations. Software and hardware orders are typically fulfilled, and revenue recognized, in either the quarter signed or the following two quarters. Revenue recognized from software and other sales may vary significantly on a quarterly basis.
Professional Services Sales. Total professional services sales in 2012 were $9.8 million, a decrease of $0.7 million, or 6.3%, from $10.5 million in 2011. Sales decreased $1.8 million in our DNA segment, primarily due to our clinical trials sales having a larger software license component than 2011. This decrease was offset by a $1.1 million increase in Healthcare segment sales due to a greater number of projects with revenue recognized in 2012 compared to 2011. Revenue recognized from professional services sales generally lags software and other sales by one or two quarters due to the timing of when such services are performed compared to when the products are delivered.
Maintenance and EDI Sales. Total maintenance and EDI sales in 2012 were $27.7 million, an increase of $0.3 million, or 1.2%, from $27.4 million in 2011 primarily due to maintenance revenue related to new customer contracts in our Healthcare segment which exceeded the rate of attrition from our existing maintenance customer base.
Gross Margin
Gross Margin - Software and Other Sales. Gross margin on software and other sales was $13.8 million in 2012, an increase of $0.8 million, or 6.5%, from $13.0 million in 2011. Gross margin as a percentage of software and other sales decreased to 54.6% in 2012 from 73.5% in 2011, due to an increase in hardware sales, which are at lower margins than software only sales. Hardware sales were 45% of software and other sales in 2012 compared to 19% in 2011. We expect gross margin on software and other sales to fluctuate depending on the mix of sales among our products.
Gross Margin - Professional Service Sales. Gross margin on professional service sales was $3.8 million in 2012, a decrease of $1.7 million, or 30.1%, from $5.5 million in 2011. Gross margin as a percentage of professional service sales decreased to 39.0% in 2012 from 52.3% in 2011, primarily due to the billable utilization of our professional services resources. As the majority of professional services costs are fixed, we expect gross margins to fluctuate depending on billable utilization of these resources.
Gross Margin - Maintenance and EDI Sales. Gross margin on maintenance and EDI sales was $19.9 million in 2012, a decrease of $0.9 million, or 4.3%, from $20.8 million in 2011. Gross margin as a percentage of maintenance and EDI sales decreased to 71.5% in 2012 compared to75.6% in 2011. The margin in 2011 was higher than usual and we would expect future gross margin to be fairly consistent with 2012.
Depreciation and Amortization. Depreciation and amortization expense decreased $0.4 million, or 19.0%, to $1.9 million in 2012 from $2.3 million in 2011, primarily due to a decrease in amortization related to certain intangible assets which became fully amortized in the second quarter of 2011.
Sales and Marketing
Sales and marketing expense increased $2.9 million, or 36.8%, to $10.7 million in 2012 from $7.8 million in 2011. As a percentage of net sales, sales and marketing expense increased by 3.0% to 17.1% due to efforts throughout 2011 to increase sales headcount, which resulted in greater personnel-related costs than the prior year, as well as continued investment to enhance the Merge brand in 2012.
Product Research and Development
Product research and development expense increased $1.4 million, or 20.4%, to $8.4 million in 2012 from $7.0 million in 2011, primarily due to an increase in headcount and related expenses. As a percentage of net sales, product research and development increased by 0.8% to 13.4%. We expect that our quarterly product research and development expense as a percentage of sales will remain relatively constant in 2012.
General and Administrative
General and administrative expense decreased $0.9 million, or 10.3%, to $7.4 million in 2012 from $8.3 million in 2011. As a percentage of net sales, general and administrative expenses decreased by 3.1% to 11.8% primarily due to $0.7 million in bonus expense recorded in 2011 compared to no such expense in 2012. We expect to leverage the current level of general and administrative expenses during 2012.
Acquisition-related Expenses
The increase in acquisition-related expenses in 2012 is due to a $2.5 million change in contingent consideration related to an insignificant acquisition.
Depreciation, Amortization and Impairment
Depreciation and amortization expense decreased $2.5 million, or 47.8%, to $2.7 million in 2012 from $5.2 million in 2011, primarily due to a $2.8 million charge for the impairment of trade names associated with certain products upon completion of a product rebranding initiative in the second quarter of 2011.
Other Income (Expense), Net
Net other expense decreased $0.6 million in 2012, primarily due to an unrealized gain of $1.1 million on an equity investment in 2012, versus a $0.4 million gain on the sale of an equity investment in 2011. Also, net other expense increased by $1.4 million in 2012 due to interest expense and amortization of issuance costs and note discount associated with our $52.0 million in additional Senior Secured Notes issued in June 2011. This amount was offset by $1.4 million in debt issue costs incurred in 2011.
Income Tax Expense (Benefit)
In 2012, we recorded income tax expense of $2.1 million, resulting in an effective tax rate of (56.4)%, compared to $2.0 million of income tax expense recorded in 2011. The effective tax rates for 2012 and 2011 differ from the statutory rate primarily due to non-cash income tax expense being recorded for profitable foreign operations that cannot be offset by unprofitable U.S. domestic operations requiring a full valuation allowance and the deferred effect of tax deductible goodwill amortization. Our expected effective income tax rate is volatile and may move up or down with changes in, among other items, operating income and the results of changes in tax laws and regulations of the U.S. and the foreign jurisdictions in which we operate.
Six Months Ended June 30, 2012 Compared to the Six Months Ended June 30, 2011
The following table sets forth selected, summarized, unaudited, consolidated
financial data for the periods indicated, as well as comparative data showing
increases and decreases between the periods. All amounts, except percentages,
are in thousands.
Six Months Ended June 30, Change
2012 % (1) 2011 % (1) $ %
Net sales:
Software and other $ 48,019 38.8 % $ 36,310 33.5 % $ 11,709 32.2 %
Professional services 19,296 15.6 % 18,915 17.5 % 381 2.0 %
Maintenance and EDI 56,549 45.7 % 53,039 49.0 % 3,510 6.6 %
Total net sales 123,864 100.0 % 108,264 100.0 % 15,600 14.4 %
Cost of sales:
Software and other 19,997 41.6 % 11,258 31.0 % 8,739 77.6 %
Professional services 11,904 61.7 % 10,079 53.3 % 1,825 18.1 %
Maintenance and EDI 16,598 29.4 % 14,651 27.6 % 1,947 13.3 %
Depreciation and
amortization 3,780 3.1 % 4,846 4.5 % (1,066 ) -22.0 %
Total cost of sales 52,279 42.2 % 40,834 37.7 % 11,445 28.0 %
Total gross margin 71,585 57.8 % 67,430 62.3 % 4,155 6.2 %
Gross margin by net
sales category (2)
Software and other 28,022 58.4 % 25,052 69.0 % 2,970 11.9 %
Professional services 7,392 38.3 % 8,836 46.7 % (1,444 ) -16.3 %
Maintenance and EDI 39,951 70.6 % 38,388 72.4 % 1,563 4.1 %
Operating expenses:
Sales and marketing 21,667 17.5 % 16,546 15.3 % 5,121 31.0 %
Product research and
development 16,042 13.0 % 13,769 12.7 % 2,273 16.5 %
General and
administrative 16,046 13.0 % 14,854 13.7 % 1,192 8.0 %
Acquisition-related
expenses 3,206 2.6 % 479 0.4 % 2,727 NM( 3)
Restructuring and
other expenses - 0.0 % (36 ) 0.0 % 36 -100.0 %
Depreciation,
amortization and
impairment 5,532 4.5 % 7,873 7.3 % (2,341 ) -29.7 %
Total operating costs
and expenses 62,493 50.5 % 53,485 49.4 % 9,008 16.8 %
Operating income 9,092 7.3 % 13,945 12.9 % (4,853 ) -34.8 %
Other income
(expense), net (15,108 ) -12.2 % (14,348 ) -13.3 % (760 ) 5.3 %
Loss before income
taxes (6,016 ) -4.9 % (403 ) -0.4 % (5,613 ) NM( 3)
Income tax expense 1,726 1.4 % 2,871 2.7 % (1,145 ) -39.9 %
Net loss $ (7,742 ) -6.3 % $ (3,274 ) -3.0 % $ (4,468 ) 136.5 %
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(1) Percentages are of total net sales, except for cost of sales and gross margin, which are based upon related net sales.
(2) Depreciation and amortization expenses are excluded from these gross margin calculations.
(3) NM denotes percentage is not meaningful.
Net Sales
Software and Other Sales. Total software and other sales in 2012 were $48.0 million, an increase of $11.7 million, or 32.2%, from $36.3 million in 2011. Software and other sales increased $2.8 million in our Healthcare segment, primarily due to an increase in hardware sales related to our iConnect solutions, and $8.9 million in our DNA segment, primarily due to $5.8 million in sales of health stations as well as a $3.1 million increase in software license revenue. Software and hardware orders are typically fulfilled, and revenue recognized, in either the quarter signed or the following two quarters. Revenue recognized from software and other sales may vary significantly on a quarterly basis.
Professional Services Sales. Total professional services sales in 2012 were $19.3 million, an increase of $0.4 million, or 2.0%, from $18.9 million in 2011. Professional services sales in our Healthcare segment increased $3.4 million, primarily due to a greater number of projects with revenue recognized in 2012 compared to 2011. This increase was offset by a decrease of $3.0 million in our DNA segment, primarily due to product enhancements that resulted in less professional services being required while the overall contract value remained constant in 2012. Revenue recognized from professional services sales generally lags software and other sales by one or two quarters due to the timing of when such services are performed compared to when the products are delivered.
Maintenance and EDI Sales. Total maintenance and EDI sales in 2012 were $56.5 million, an increase of $3.5 million, or 6.6%, from $53.0 million in 2011 primarily due to maintenance revenue related to new contracts in our Healthcare segment which exceeded the rate of attrition from our existing maintenance customer base.
Gross Margin
Gross Margin - Software and Other Sales. Gross margin on software and other sales was $28.0 million in 2012, an increase of $3.0 million, or 11.9%, from $25.0 million in 2011. Gross margin as a percentage of software and other sales decreased to 58.4% in 2012 from 69.0% in 2011, due to an increase in hardware sales, which are at lower margins than software only sales. Hardware sales were 41% of software and other sales in 2012 compared to 24% in 2011. We expect gross margin on software and other sales to fluctuate depending on the mix of sales among our products.
Gross Margin - Professional Service Sales. Gross margin on professional service sales was $7.4 million in 2012, a decrease of $1.4 million, or 16.3%, from $8.8 million in 2011. Gross margin as a percentage of professional service sales decreased to 38.3% in 2012 from 46.7% in 2011, primarily due to the billable utilization of our professional services resources. As the majority of professional services costs are fixed, we expect gross margins to fluctuate depending on billable utilization of these resources.
Gross Margin - Maintenance and EDI Sales. Gross margin on maintenance and EDI sales was $40.0 million in 2012, an increase of $1.6 million, or 4.1%, from $38.4 million in 2011. Gross margin as a percentage of maintenance and EDI sales decreased to 70.6% in 2012 compared to 72.4% in 2011.
Depreciation and Amortization. Depreciation and amortization expense decreased $1.0 million, or 22.0%, to $3.8 million in 2012 from $4.8 million in 2011, primarily due to a decrease in amortization related to certain intangible assets which became fully amortized in the second quarter of 2011.
Sales and Marketing
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