Introduction
An attractive area to look for potential turnaround investments is in the software space. Along with a plunging share price, what usually grabs our attention in a depressed software equity is a steady recurring revenue base, high gross margins, a strong balance sheet, and minimal capital spending needs. Couple that with a low valuation and a fresh management team with the skills to stabilize the core business, plus the vision to lead the firm into new growth opportunities, and you’ve got a potentially attractive investment situation.

Merge Healthcare (MRGE) is a pretty classic case of the above investment scenario. The firm’s ascent from late 2000 to late 2005 was dramatic, taking the share price from a touch above $0.50 to a $30 intraday peak (that equaled an approximately $1b market capitalization.). The fall, largely prompted by an accounting scandal, and new government reimbursement programs, was just as spectacular, taking the shares right back down to the sub-$1 level in 2008, equaling a market capitalization of $14m.

Despite its bruised financial reputation, however, Merge maintains a formidable foothold in medical imaging and information management software. Further, a new team has come on board, injecting both capital and relevant turnaround know-how. Most importantly, financial results have already shown a marked improvement, with the company reporting positive operating income in the latest quarter, the new management team’s first full quarter, after nearly two years of losses.

Continued positive financial results, as well as potential renewed interest in healthcare-related technology companies, given President-Elect Obama’s support for electronic medical records and other efficiency-enhancing technologies in healthcare, make Merge an interesting turnaround to watch over the next 1 to 3 years.

To get a better sense of where the company’s been and where it’s headed, we sat down recently with Justin C. Dearborn, Merge Healthcare’s new CEO. Before we get to the interview, here are some background facts and financial figures to help put the investment case for Merge in its proper context.

Merge’s Business
Merge began life as an integrator of non-digital medical imaging devices (x-rays, CT scanners, etc.). Through a series of acquisitions, the firm moved into medical imaging and information management software, selling both directly to hospitals, imaging centers and clinics via its Merge Fusion division, and indirectly through medical device original equipment manufacturers [OEMs] via its Cedara division (now known as Merge OEM).

The basic value that Merge provides is that its imaging solutions help to reduce the film, paper, labor costs and time involved in managing and distributing medical images and information, which helps increase profitability for imaging centers and ultimately helps improve patient care.

In addition, the company’s OEM team develops custom-engineered software applications and development tools for the global medical imaging and information markets, thereby helping customers develop and launch innovative medical imaging technologies. Merge’s technology and expertise span all the major digital imaging modalities, including computed tomography (“CT”), magnetic resonance imaging (“MRI”), digital x-ray, mammography, ultrasound, echo-cardiology, angiography, nuclear medicine, positron emission tomography (“PET”) and fluoroscopy.

Though the total worldwide size of the market in which MRGE operates is difficult to estimate, Millennium Research Group, an international market research firm, has reported that in 2005, the U.S. market for Picture Archiving and Communication Systems (“PACS”), and Radiology Information Systems (“RIS”) was valued at over $1.5 billion. By 2010, this market in the U.S. was expected to grow to over $3.0 billion. This gives definition to a small part of the entire global medical imaging and information market.

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