We have downgraded Merge Healthcare (MRGE) to Underperform with a target price of $5.25.
Merge reported an adjusted EPS of 3 cents in the first quarter of fiscal 2011, below the year-ago quarter’s 5 cents. Although revenues were $52.7 million for the quarter, formidably up from the year-ago quarter’s revenue of $20 million, this is not comparable since the reported quarter included revenues from AMICAS, subsequent to its acquisition on April 28, 2010. However, revenues were higher than the Zacks Consensus Estimate of $51 million.
We are pleased with Merge’s huge market potential based on the various incentives proposed by the HITECH Act. Also we believe Merge’s iConnect platform with its interoperability infrastructure holds immense potential.
However, the company’s growth prospect is highly dependent on capital investments by hospitals for advanced imaging solutions, which in turn is tied to general economic conditions. Consequently, to better penetrate the market, Merge has improved its sales force, thereby increasing its operating expenses. As a result, margins continue to remain under pressure.
Gross margin contracted by 950 basis points hit by 244.5% jump in total cost of sales during the quarter. Adjusted operating margin (excluding the impact of certain one-time expenses) was down by 196 bps to 16.2% during the quarter. We expect the pressure on margins to continue given the company’s various effortsto drive the growth.
In addition we are also apprehensive about Merge’s continuous increase in expenses while financing the acquisition of AMICAS. The company issued $200 million of senior secured notes (due 2015) in April 2010 which resulted in a higher interest expense in later quarters.
During the first quarter of 2011, the company recorded $6.5 million of net interest expense compared to net interest income of $0.01 million in the year-ago period.
Firthermore, the presence of many big players like General Electric (GE) and McKesson Corporation (MCK) has made the diagnostic imaging market highly competitive.
GENL ELECTRIC (GE): Free Stock Analysis Report
MCKESSON CORP (MCK): Free Stock Analysis Report
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