Many in healthcare have been wondering what is going on at the Chicago-based Merge Healthcare these days. The company, which specializes in solutions around imaging informatics and the vendor-neutral archive, has seen two high-profile departures in the space of less than one month. First, CEO Jeffrey Surges resigned on Aug. 9, following disappointing second-quarter results. Then on Aug. 26, the company announced that Michael W. Ferro, Jr. had resigned as chairman of the board and as a director, effective immediately.
The company announced on that date that Dennis Brown would be named as the company’s new chairman, also effective immediately, while Justin Dearborn, who had headed up the company’s clinical trials platform division, took over as CEO upon Surges’ resignation on Aug. 9.
Just before Surges’ resignation, Merge had reported that its sales decreased to $57.2 million ($57.6 million on a pro forma basis) in the second quarter of 2013, from $62.9 million ($63.4 million on a pro forma basis) in the second quarter of 2012.
In an industry-exclusive interview, Steven Tolle, 45, who joined Merge Healthcare in November 2010 as senior vice president, and who became chief product officer for the company on Aug. 9, spoke with HCI Editor-in-Chief Mark Hagland regarding the various developments within Merge, and his perspectives on the future prospects of the organization. Below are excerpts from that interview.
What’s going on these days at Merge Healthcare? Do the departures of Messrs. Surges and Ferro signal anything worrisome that we should know about?
Well, the two departures are largely unrelated. Jeff Surges came to Merge Healthcare in 2010 from Allscripts; he was already on the board of Merge, and was asked by Michael to come in as CEO. They saw image interoperability at the time as a growing opportunity; we still think it is. So if you think about meaningful use Stages 2 and 3, and EMR [electronic medical record] adoption, being able to easily link to images is going to be a mandate, and is also going to be a market-driven need. And so we made a significant investment in products, like our iConnect portfolio, which just won a Frost & Sullivan award [Frost & Sullivan, the research company, on Aug. 27 recognized Merge Healthcare with its 2013 North America Frost & Sullivan Award for Product Leadership in Interoperability Solutions, for its iConnect® enterprise clinical platform], thinking we would be ready with a large sales organization with these products in 2013, so we’d be prepared for meaningful use Stage 2 in 2014. A couple of things happened: one of them was sequester [the federal budget sequester of 2013]. We didn’t know at the beginning of the year that that $11 billion would be taken out of the healthcare system.
So those decisions about making investments in imaging—we didn’t foresee that some of those decisions might be made uncomfortable as a result of the sequester. So we had a number of key sales stall. And we had invested in a larger salesforce and marketing dollars in anticipation of the market opening up in early 2013. That didn’t happen; our Q1 was OK and our Q2 was not OK. So Jeff made the decision with Michael that it was time for him to depart.
In terms of Jeff’s background, it was really in private-equity companies and in getting them ready for sale. We realized that the market wasn’t going to be there, and we had stopped our process in terms of strategic options, since we had been approached by a number of funds looking to potentially invest in or acquire the company, but ultimately, our board decided that the offers we had received were ultimately unsatisfactory. So we announced that in Q1; and in Q2, we had a bad quarter, and had to make changes [including the Surges resignation].
So we haven’t reduced any of our investments in product; we know that meaningful use is going to happen. And we know that because of the tipping point of EMR usage, that physicians are going to need our products. So what we’ve done is to reorganize our company into three business units: clinical trials, because we have a clinical trials platform; cardiology; and imaging, called our iConnect business unit. And these three units, run by presidents of those units, give us flexibility. So really, we’re going to act and behave like three small companies, with three P&Ls, and much more focused sales organizations.
Is that reorganization of salesforces and development teams effective now already?
Correct. We put that in place as of August 9. And so we still have 65 quota-carrying salespeople in the field, but they’re in much more tightly integrated teams. For example, we have a vendor-neutral archive team, with a sales lead, an architect, a pre-sales consultant helping us design a solution, and a networking and hardware expert. So I can send a “SWAT team” into a deal, and they can get that done. So they look and act like a small company. I’ve got a similar strategy for orthopedics, for ophthalmology, and radiology/PACS [picture archiving and communications systems]. And then the cardiology business is of course completely focused on cardiology. So by creating this level of focus, it allows experts from our company to go toe to toe with experts from other companies.
The reality is that this is a full-replacement market [for PACS systems]. And a full-replacement strategy is always difficult to execute. So having teams of experts in place will be of benefit to the company. And because we know that the interoperability market is opening for imaging, we’re also launching a new product at the end of the year, the iConnect Network, which will reach 300,000 physicians.
How does Honeycomb [Merge’s imaging connectivity solution] fit into this?
Honeycomb is our cloud-based archive for our customers to use if they don’t want to create their own archive, while iConnect is the customer-on-premise version of the archive. Which choice customer organizations make just depends on whether they want to create storage themselves, or pay for storage on a per-study basis in the cloud.
And so we’re launching this business for the radiology market first before the end of the year, because of their radiology-based interoperability needs. So we’re still here.
Were the executive departures a signal that the vendor market is becoming more unstable now?
Well, Michael’s decision was unrelated to anything else. He’s the majority shareholder in the company. He’s a private-equity guy. And I think he’s looking at opportunities. So Michael’s departure from the chairmanship and the board just signals that he wants to look at other private-equity opportunities.
Merge is often compared to Allscripts, Athena, Cerner, and NextGen [based in Chicago, Watertown, Mass., Kansas City, and Horsham, Pa.], since they’re all public companies. The thing is that Allscripts, Athena, Cerner, and NextGen are buoyed by the artificial rollout of EMR upgrades every cycle. In our case, we’re talking about good old-fashioned selling: I’m going to save you hard dollars on storage costs, on having to build fewer interfaces to the EMRs. We do have a billing system we sell, but our core systems are PACS and VNA, and those are unaffected by ICD-10. So our sales activity is challenging, because we have to prove value in order for anyone to spend money with us right now.
Is it your sense that hospital and health system CIOs and CFOs are saying they’ll only spend on things that will bring them meaningful use dollars, right now?
In a hospital setting, yes. Now, I am opening their eyes a bit when I talk about referral leakage. The average referring physician is worth $1.5 million to the hospital, and their imaging market is a very competitive market. In the case of imaging, hospitals are in competition with other imaging providers in the market to get doctors to refer to them. So when we sell things to them like our iConnect access, and soon, our iConnect Network, I can talk with them about referring physician loyalty more than just about imaging, though it’s about that, too.
Now, in the hospital market, we’re not selling a lot of PACS, though I believe that market will open up after the MU process. We are making some inroads though, on interoperability. Top of the list for them is ICD-10. But we do have some ability to open some eyes on interoperability. On the ambulatory side or cardiology, we have fewer challenges. But hospitals and radiology aren’t spending money unless they have to. So we’re having to convince them that they’re going to get some return for investment. And Agfa and GE and McKesson don’t have to report their data they we do, because they’re not publicly traded as an imaging company; they’re part of a larger company in that regard, and they’ve probably seen some slowdowns, too.
What will happen in the next year for Merge?
The way I see it happening is that as hospitals get further into their ICD-10 and meaningful use preparations and talk with their vendors, they’ll quickly realize there’s a capacity problem. So it comes down to, meaningful use has two mentions of imaging: CPOE [computerized physician order entry], and a menu option. CPOE is core, so anyone going for meaningful use has to do order entry on 30 percent or more of their orders, including imaging. And doctors expect something in return for participating in CPOE. So the demand by doctors will intensify. They’ll demand that if they’re doing something in the EMR, why aren’t they getting something back in the EMR, rather than a fax. And for meaningful use, it’s all or nothing for the doctor; there’s no partial credit. So if they’re going for meaningful use and their imaging provider doesn’t help them, they’ll go elsewhere.
The menu option is a little bit more complicated, because it says that 10 percent of images have to be available electronically using certified technology. The problem is that no vendor knows which 10 percent the doctor wants to see. So the practical reality is that you have to enable 100 percent of images. Every hospital has three circles of doctors: first circle is the ones you own. The second circle is doctors with tight affiliations, such as those collaborating through an ACO, etc. It’s that third circle that is worrisome, because it’s doctors with fewer close ties. You’re trying to sign them up for HIEs [health information exchanges], etc., but it’s hard to prove return on investment.
Take for example the Chicago metropolitan area: there are 100 imaging providers in this area, including the hospitals and imaging centers, 10,000 physicians, and 100 different EMR vendors, or versions of products. So if you did the math and let’s say all those doctors went for meaningful use; you’d have to build 1 million interfaces! And it’s never going to happen. So there’s going to be a real-world wake-up call very quickly that says, how will I do this without losing that referring physician’s loyalty? We think we can capitalize on that, but it’s just a matter of how fast that market will open. Because there’s a mandate as part of meaningful use, and a mandate as part of EMR adoption that will drive this, regardless. We just didn’t anticipate the sequester. So we’re still bullish on the opportunity, but this was the right time to refocus and to reorganize our sales strategy and teams.