Merge Healthcare banks on upside of reimbursement cuts

March 26, 2007

The Deficit Reduction Act may have a short-term impact on purchases by imaging centers, but tightening reimbursements may, over the long haul, be promising for technologies that improve productivity. Merge Healthcare’s president and CEO Ken Rardin is banking on it, as the company prepares for next month’s rollout of Fusion MX, the latest version of its PACS/RIS, followed by a marketing blitz aimed at convincing prospects that PACS/RIS is the way to go.

The Deficit Reduction Act may have a short-term impact on purchases by imaging centers, but tightening reimbursements may, over the long haul, be promising for technologies that improve productivity. Merge Healthcare's president and CEO Ken Rardin is banking on it, as the company prepares for next month's rollout of Fusion MX, the latest version of its PACS/RIS, followed by a marketing blitz aimed at convincing prospects that PACS/RIS is the way to go.

"The return on investment in this business is substantial because of the almost immediate impact of these systems on productivity, workflow, and labor content," Rardin told DI SCAN. "Especially, look at radiologists. You're talking $400,000 on up for their (annual) cost. You start to get an ROI real quick if you can offset the hire of one radiologist through improved productivity."

The company will tout Fusion MX as the means for such gains. Its 64-bit processing reduces wait time when loading large images. It excels at handling time-intensive MR exams, such as breast MR, as well as studies conducted on the latest multislice CT systems.

In the next few weeks, Merge staff will begin training on a sales tool that, given site-specific data, will demonstrate exactly how much a customer can expect to make by investing in Fusion MX. Then they will hit the road, doing site evaluations and running analyses of workflow and cost structure for prospective clients.

"We'll tell them how much it will cost them every month they don't have our PACS/RIS," Rardin said. "And we'll do it on our nickel. That will get their attention."

To get in the door, Merge staff may pitch case studies, such as the one of Meridian Regional Imaging, whose 17 freestanding imaging centers reduced overall labor per read by 60% and cut overall operating expenses from 34% to 30% after implementing a Merge PACS/RIS. More than a year after the installation, a 50% increase in exam volume at Meridian was being handled with no increase in staff.

Some 4600 small hospitals and 6000 imaging centers in the U.S. make up the company's target market for the new product. Five states stand out for their potential to generate sales to imaging centers. Florida, California, New York, Texas, and Pennsylvania together account for more than 2500 such centers. This is about 44% of the U.S. imaging center marketplace, according to a study, conducted by Verispan in 2005, cited by Rardin.

Education is the key to winning sales among U.S. imaging centers, most of which have yet to modernize with PACS/RIS, according to Rardin. The same is true of hospitals with fewer than 300 beds, which are more than 80% of U.S. hospitals.

Convincing new prospects that Merge products will pave the way to a better bottom line is the road Merge hopes to travel to its own profitability. Hammered last year by accounting problems that took until this year to resolve, the publicly traded company saw its share price tank from above $25 in March 2006 to about $5 today. A dramatic decline in revenues from all operations, continuing high expenses, and market confusion over the company's strategy have led to customer concern about the viability of Merge, Rardin said, hamstringing sales efforts.

The company recently has begun to rein in costs, cutting excess staff in the U.S. while outsourcing work to offshore sites, consolidating PACS/RIS vis a vis its Fusion MX introduction, and finishing the integration of software developer Cedara. Cedara was acquired in 2005 but not fully absorbed into Merge until now.

These efforts, along with an anticipated jump in sales from the pending marketing surge, could soon turn the company's red ink to black. Rardin predicts that Merge will return to profitability by this year's fiscal fourth quarter, which ends Dec. 31. This is a tall order for a company that lost $27 million on revenues of $13.2 million in the fourth quarter of 2006, revenues that were barely more than half those of the year-earlier period.

Much of this loss, however, was due to a goodwill impairment, trade name impairment, and restructuring charge of $11.3 million related primarily to the "right-sizing" initiative announced in November 2006. Rardin uses this fact to argue that the company is making the hard decisions that will get it back on track and keep it there. Rardin has been able to make these decisions, ironically, because of the dismal quarterlies the company has turned in over the last year.

"We don't have short-term earnings pressure," he said. "We are making very prudent investments that we might not have been willing to make, if we had three more cents per share this quarter or next. Our shareholders and analysts on Wall Street are allowing us some time, and we're going to use it to do things right."