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MRGE > SEC Filings for MRGE > Form 10-Q on 4-Nov-2013All Recent SEC Filings

Show all filings for MERGE HEALTHCARE INC

Form 10-Q for MERGE HEALTHCARE INC


4-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 10­K for the year ended December 31, 2012 and in Item 1A of Part II of our Quarterly Report on Form 10-K for the quarter ended June 30, 2013. 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, 2012.

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 provider practices to large 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 revenue by expanding our solution footprint with existing customers, as only a small percent currently have more than one of our enterprise solutions.
We have two operating groups which constitute reportable operating segments.
Merge Healthcare, which represents about 82% of our 2013 total revenues, markets, sells and implements interoperability, imaging and clinical solutions to healthcare providers. Merge DNA (Data and Analytics), representing 18% of our revenues, focuses on the emergence of consumerism in healthcare, including health stations, clinical trials software and other consumer-focused solutions.

Merge Healthcare primarily generates revenue from the sale of software (including upgrades), hardware, professional services, maintenance and electronic data interchange (EDI) services. The majority of total revenue continues to be generated through perpetual license agreements with our customers. Merge DNA derives the vast majority of its revenue from software, professional services and hosting through subscription arrangements. Under perpetual license agreements, the software, hardware and professional services are considered to be sources of non-recurring revenue and related backlog. The backlog of non-recurring revenue was $22.3 million and $31.1 million as of September 30, 2013 and 2012, respectively. Subscription-based pricing arrangements include contract elements that are payable by our customers over a number of years. Generally, these contracts will include a minimum image volume and/or dollar commitment. As such, revenue from these transactions is recognized ratably over an extended period of time. Subscription arrangements are contracts structured with monthly payments (including leases), clinical trials or renewable annual software contracts (with very high renewal rates).
As of September 30, 2013 subscription revenue backlog was $69.5 million, compared to $40.3 million at September 30, 2012. This significant increase is the result of our strategic plan to continue to move to a subscription model.
Due to the variability in timing and length of maintenance renewals, we do not track backlog for maintenance and EDI.


Index
In the second quarter of 2013, we entered into a new senior secured credit facility consisting of a six-year term loan (the Term Loan) of $255 million issued at 99% of the Term Loan amount and a five-year revolving credit facility (the Revolving Credit Facility) of up to $20 million as contracted in a Credit Agreement. While the borrowings under the Credit Agreement are variable, we made an election pursuant to the Credit Agreement with respect to the interest period pursuant to which the Term Loan will bear interest at a fixed rate of 6.00% for the remainder of 2013. As part of this transaction, we incurred $4.7 million of debt issuance related costs, which will be amortized over the life of the Term Loan. The Term Loan replaces $252 million of Senior Secured Notes that bore interest at 11.75% (Notes), which we retired at the same time the Term Loan was issued. We recorded charges for $5.2 million of unamortized debt issuance costs, $1.7 million of unamortized net debt discount and $16.9 million of early retirement costs associated with the extinguishment of the Notes.

We believe that certain macro events that occurred earlier in 2013 continue to impact our operating results (together with those of others in our industry), primarily:
· We believe that among larger hospitals and health systems, infrastructure spending was adversely affected by lower patient volume that started to appear in the first quarter and that carried through to the third quarter. Accordingly, we believe that some of our largest clients and prospects decided to decelerate their infrastructure spending processes by pushing decisions into the future.

· The March 1, 2013 budget sequester included $11 billion in Medicare cuts, or 2%, that were applied across all of healthcare.

· We believe that many large organizations changed focus to the upcoming transition from ICD-9 to ICD-10 as an industry-wide belief that the deadlines for converting to ICD-10 would be extended was dispelled when it was announced on June 17, 2013 that the deadline for conversion would remain Oct. 1, 2014. This caused many clients and prospects to temporarily delay decisions on any projects not directly related to their transition to ICD-10.

While we continue to see an increase in the overall average selling price of our primary offerings in 2013, these events have continued to result in delays in the timing of larger deals as well as a change in the construct of the agreements that leads to revenue being recognized over an extended period of time. To ensure we maintain a continued, disciplined approach of cost alignment to sales expectations, we reorganized our leadership team and sales organization to focus on the imaging & interoperability, cardiology and clinical trials markets in the third quarter. We incurred a restructuring charge of $1.2 million and anticipate a minimum of $5 million of annualized savings from these actions, primarily in sales & marketing expenses, as we had previously built up the team in anticipation of better market conditions. Since we believe that strong market opportunities still exist over the long-term for our products and the solutions we have innovated, these actions do not impact our product research and development costs as we have decided to continue to enhance and further our market-leading solutions as validated by sources such as KLAS, and other independent sources. These most recently include a Product Leadership Award from Frost & Sullivan for iConnect® Enterprise Clinical Platform and, for the second straight year, the global leader in VNA according to IHS.


Index
Business Segments
The following tables provide operating group information for our two reportable
operating segments, Merge Healthcare and Merge DNA, for the periods indicated,
based on GAAP reported information (all amounts are in thousands, except
percentage

Merge Healthcare     Three Months Ended                                          Nine Months Ended
Segment                 September 30                     Change                    September 30                  Change
                      2013          2012          $             %               2013          2012           $             %
Net sales:
Software and
other              $   11,291     $ 17,854     $ (6,563 )      -36.8 %       $  43,243     $  56,911       (13,668 )      -24.0 %
Professional
Services                6,335        7,808       (1,473 )      -18.9 %          21,580        20,873           707          3.4 %
Maintenance and
EDI                    26,872       27,158         (286 )       -1.1 %          81,523        82,694        (1,171 )       -1.4 %
Total net sales        44,498       52,820       (8,322 )      -15.8 %         146,346       160,478       (14,132 )       -8.8 %
Expenses               42,995       43,447         (452 )       -1.0 %         131,798       131,675           123          0.1 %
Segment income     $    1,503     $  9,373     $ (7,870 )      -84.0 %       $  14,548     $  28,803     $ (14,255 )      -49.5 %

Merge DNA            Three Months Ended                                         Nine Months Ended
Segment                 September 30                  Change                      September 30                   Change
                       2013          2012          $            %               2013          2012            $            %
Net sales:
Software and
other              $    8,066     $  3,378     $  4,688        138.8 %       $  17,564     $  12,340     $   5,224         42.3 %
Professional
Services                4,112        3,469          643         18.5 %          12,542         9,700         2,842         29.3 %
Maintenance and
EDI                       569          727         (158 )      -21.7 %           1,620         1,740          (120 )       -6.9 %
Total net sales        12,747        7,574        5,173         68.3 %          31,726        23,780         7,946         33.4 %
Expenses                9,847        8,746        1,101         12.6 %          28,085        25,643         2,442          9.5 %
Segment income
(loss)             $    2,900     $ (1,172 )   $  4,072        NM      (1)   $   3,641     $  (1,863 )   $   5,504        NM      (1)

(1) NM = Not meaningful

These results exclude costs such as public company costs, certain corporate costs (amortization expense that is not specific to a segment), net interest expense and income taxes.


Index
The following tables provide GAAP sales generated by non-recurring, subscription and maintenance and EDI revenue sources by segment for the periods indicated and non-recurring and subscription backlog as of September 30, 2013 and 2012, respectively (all amounts are in thousands, except percentages):

                                          Three Months Ended September 30, 2013
                               Healthcare                  DNA                     Total
       Revenue Source        $            %           $            %           $            %
      Maintenance & EDI   $ 26,872        60.4 %   $    569         4.5 %   $ 27,441        48.0 %
      Subscription           1,524         3.4 %      7,996        62.7 %      9,520        16.6 %
      Non-recurring         16,102        36.2 %      4,182        32.8 %     20,284        35.4 %
      Total               $ 44,498       100.0 %   $ 12,747       100.0 %   $ 57,245       100.0 %

                                          Three Months Ended September 30, 2012
                               Healthcare                  DNA                     Total
       Revenue Source        $            %           $            %           $            %
      Maintenance & EDI   $ 27,158        51.4 %   $    727         9.6 %   $ 27,885        46.2 %
      Subscription           2,329         4.4 %      6,847        90.4 %      9,176        15.2 %
      Non-recurring         23,333        44.2 %          -         0.0 %     23,333        38.6 %
      Total               $ 52,820       100.0 %   $  7,574       100.0 %   $ 60,394       100.0 %



                                           Nine Months Ended September 30, 2013
                              Healthcare                   DNA                      Total
      Revenue Source         $            %           $            %            $            %
     Maintenance & EDI   $  81,523        55.7 %   $  1,620         5.1 %   $  83,143        46.7 %
     Subscription            4,792         3.3 %     23,746        74.9 %      28,538        16.0 %
     Non-recurring          60,031        41.0 %      6,360        20.0 %      66,391        37.3 %
     Total               $ 146,346       100.0 %   $ 31,726       100.0 %   $ 178,072       100.0 %

                                           Nine Months Ended September 30, 2012
                              Healthcare                   DNA                      Total
      Revenue Source         $            %           $            %            $            %
     Maintenance & EDI   $  82,694        51.5 %   $  1,740         7.3 %   $  84,434        45.8 %
     Subscription           10,053         6.3 %     19,290        81.1 %      29,343        15.9 %
     Non-recurring          67,731        42.2 %      2,750        11.6 %      70,481        38.3 %
     Total               $ 160,478       100.0 %   $ 23,780       100.0 %   $ 184,258       100.0 %



                                           Backlog as of September 30, 2013
                             Healthcare                  DNA                     Total
       Revenue Source      $             %          $            %           $            %
       Subscription     $ 13,162        37.1 %   $ 56,370       100.0 %   $ 69,532        75.7 %
       Non-recurring      22,347        62.9 %          -         0.0 %     22,347        24.3 %
       Total            $ 35,509       100.0 %   $ 56,370       100.0 %   $ 91,879       100.0 %

                                           Backlog as of September 30, 2012
                             Healthcare                  DNA                     Total
       Revenue Source      $            %           $            %           $            %
       Subscription     $ 10,860        25.9 %   $ 29,453       100.0 %   $ 40,313        56.5 %
       Non-recurring      31,078        74.1 %          -         0.0 %     31,078        43.5 %
       Total            $ 41,938       100.0 %   $ 29,453       100.0 %   $ 71,391       100.0 %


Index
Results of Operations

Three Months Ended September 30, 2013 Compared to the Three Months Ended
September 30, 2012
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 September 30,                           Change
                         2013            %       (1 )   2012            %       (1 )     $             %

Net sales:
Software and other     $  19,357          33.8 %      $  21,232          35.2 %      $  (1,875 )        -8.8 %
Professional
services                  10,447          18.3 %         11,277          18.7 %           (830 )        -7.4 %
Maintenance and EDI       27,441          47.9 %         27,885          46.1 %           (444 )        -1.6 %
Total net sales           57,245         100.0 %         60,394         100.0 %         (3,149 )        -5.2 %
Cost of sales:
Software and other        11,702          60.5 %          9,006          42.4 %          2,696          29.9 %
Professional
services                   6,248          59.8 %          6,524          57.9 %           (276 )        -4.2 %
Maintenance and EDI        6,875          25.1 %          7,277          26.1 %           (402 )        -5.5 %
Depreciation and
amortization               1,804           3.2 %          2,049           3.4 %           (245 )       -12.0 %
Total cost of sales       26,629          46.5 %         24,856          41.2 %          1,773           7.1 %
Total gross margin        30,616          53.5 %         35,538          58.8 %         (4,922 )       -13.8 %

Gross margin by net
sales category (2)
Software and other         7,655          39.5 %         12,226          57.6 %         (4,571 )       -37.4 %
Professional
services                   4,199          40.2 %          4,753          42.1 %           (554 )       -11.7 %
Maintenance and EDI       20,566          74.9 %         20,608          73.9 %            (42 )        -0.2 %

Operating expenses:
Sales and marketing        8,526          14.9 %         10,808          17.9 %         (2,282 )       -21.1 %
Product research and
development                8,017          14.0 %          8,266          13.7 %           (249 )        -3.0 %
General and
administrative             9,654          16.9 %          7,783          12.9 %          1,871          24.0 %
Acquisition-related
expenses                     173           0.3 %           (762 )        -1.3 %            935        -122.7 %
Restructuring and
other expenses             2,054           3.6 %            830           1.4 %          1,224         147.5 %
Depreciation and
amortization               2,652           4.6 %          2,651           4.4 %              1           0.0 %
Total operating
costs and expenses        31,076          54.3 %         29,576          49.0 %          1,500           5.1 %
Operating income            (460 )        -0.8 %          5,962           9.9 %         (6,422 )      -107.7 %
Other income
(expense), net            (4,119 )        -7.2 %         (8,104 )       -13.4 %          3,985         -49.2 %
Loss before income
taxes                     (4,579 )        -8.0 %         (2,142 )        -3.5 %         (2,437 )       113.8 %
Income tax expense
(benefit)                   (478 )        -0.8 %          1,684           2.8 %         (2,162 )      -128.4 %
Net loss               $  (4,101 )        -7.2 %      $  (3,826 )        -6.3 %      $    (275 )         7.2 %

(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.

Net Sales

Software and Other Sales. Total software and other sales in 2013 were $19.4 million, a decrease of $1.9 million, or 8.8%, from $21.2 million in 2012.
Software and other sales decreased primarily due to a $6.6 million decrease in our Healthcare operating group, driven by the continued delay in customer buying in the quarter. This decrease was offset by the sale of kiosks for $4.1 million during the quarter in our DNA operating group. Revenue recognized from software and other sales may vary significantly on a quarterly basis.


Index
Professional Services Sales. Total professional services sales in 2013 were $10.4 million, a decrease of $0.9 million, or 7.4%, from $11.3 million in 2012.
Sales decreased by $1.5 million in the Healthcare segment due to delayed customer purchasing that first impacted the business in the second quarter. 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 2013 were $27.4 million, a decrease of $0.5 million, or 1.6%, from $27.9 million in 2012.

Gross Margin

Gross Margin - Software and Other Sales. Gross margin on software and other sales was $7.7 million in 2013, a decrease of $4.5 million, or 37.4%, from $12.2 million in 2012. Gross margin as a percentage of software and other sales decreased to 39.5% in 2013 from 57.6% in 2012, primarily due to the decrease in software revenue, which is at much greater margins than hardware. 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 $4.2 million in 2013, a decrease of $0.6 million, or 11.7%, from $4.8 million in 2012. Gross margin as a percentage of professional service sales decreased to 40.2% in 2013 from 42.1% in 2012. 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 $20.6 million in 2013, consistent with gross margin in 2012. Gross margin as a percentage of maintenance and EDI sales increased to 74.9% in 2013 from 73.9% in 2012 as we continued to focus on controlling third party costs.

Depreciation and Amortization

Depreciation and amortization expense decreased 12.0%, to $1.8 million in 2013 from $2.0 million in 2012 mainly due to assets that became fully depreciated.

Sales and Marketing
Sales and marketing expense decreased $2.3 million, or 21.1%, to $8.5 million in 2013 from $10.8 million in 2012 primarily from the restructuring activity undertaken in the third quarter of 2013. As a percentage of net sales, sales and marketing expense decreased by 3.0% to 14.9% in 2013. Product Research and Development

Product research and development expense decreased $0.3 million, or 3.0%, to $8.0 million in 2013 from $8.3 million in 2012. As a percentage of net sales, product research and development expense increased by 0.3% to 14.0% in 2013.

General and Administrative

General and administrative expense increased $1.9 million, or 24.0%, to $9.7 million in 2013 from $7.8 million in 2012 primarily due to non-cash charges of $1.3 million as a result of the settlement surrounding an insignificant acquisition and $0.9 million associated with stock consideration provided for the settlement of a lawsuit that existed at the time of an insignificant acquisition. As a percentage of net sales, general and administrative expenses increased by 4.0% to 16.9%.

Restructuring and Other Expenses

Restructuring and other expenses increased $1.3 million, or 147.5%, to $2.1 million in 2013 from $0.8 million in 2012. The 2013 expense of $2.0 million was due to our restructuring and reorganization of our leadership team and sales organization.

Depreciation and Amortization

Depreciation and amortization expense of $2.7 million in 2013 is consistent with 2012.

Other Expense, Net

Other expense decreased $4.0 million, to $4.1 million in 2013 from $8.1 million in 2012 primarily due to a decrease in interest expense related to our debt refinancing in 2013.


Index
Income Tax Expense (Benefit)

In 2013, we recorded an income tax benefit of $0.5 million, compared to expense of $1.7 million recorded in 2012. 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 foreign jurisdictions in which we operate.

Nine Months Ended September 30, 2013 Compared to the Nine Months Ended September 30, 2012

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.

                                   Nine Months Ended September 30,                             Change
                         2013            %       (1)     2012            %       (1)       $             %

Net sales:
Software and other     $  60,807          34.1 %       $  69,251          37.6 %       $  (8,444 )       -12.2 %
Professional
services                  34,122          19.2 %          30,573          16.6 %           3,549          11.6 %
Maintenance and EDI       83,143          46.7 %          84,434          45.8 %          (1,291 )        -1.5 %
Total net sales          178,072         100.0 %         184,258         100.0 %          (6,186 )        -3.4 %
Cost of sales:
Software and other        33,107          54.4 %          29,003          41.9 %           4,104          14.2 %
Professional
services                  19,175          56.2 %          18,522          60.6 %             653           3.5 %
Maintenance and EDI       22,328          26.9 %          23,840          28.2 %          (1,512 )        -6.3 %
Depreciation and
amortization               5,425           3.0 %           5,829           3.2 %            (404 )        -6.9 %
Total cost of sales       80,035          44.9 %          77,194          41.9 %           2,841           3.7 %
Total gross margin        98,037          55.1 %         107,064          58.1 %          (9,027 )        -8.4 %

Gross margin by net
sales category (2)
Software and other        27,700          45.6 %          40,248          58.1 %         (12,548 )       -31.2 %
Professional
services                  14,947          43.8 %          12,051          39.4 %           2,896          24.0 %
Maintenance and EDI       60,815          73.1 %          60,594          71.8 %             221           0.4 %

Operating expenses:
Sales and marketing       28,982          16.3 %          32,473          17.6 %          (3,491 )       -10.8 %
Product research and
development               24,988          14.0 %          24,251          13.2 %             737           3.0 %
Gneral and
administrative            25,567          14.4 %          23,822          12.9 %           1,745           7.3 %
Acquisition-related
expenses                     600           0.3 %           2,444           1.3 %          (1,844 )       -75.5 %
Restructuring and
other expenses             3,856           2.2 %             830           0.5 %           3,026         364.6 %
Depreciation and
amortization               7,899           4.4 %           8,183           4.4 %            (284 )        -3.5 %
Total operating
costs and expenses        91,892          51.6 %          92,003          49.9 %            (111 )        -0.1 %
Operating income           6,145           3.5 %          15,061           8.2 %          (8,916 )       -59.2 %
Other income
(expense), net           (41,614 )       -23.4 %         (23,219 )       -12.6 %         (18,395 )        79.2 %
. . .
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