Merge wipes $15M from backlog after discovering ex-employee faked contracts

The past year was tough for Merge Healthcare ($MRGE). An anticipated private equity takeover never happened, and in August disastrous results prompted a 46% fall in its stock. Now Merge faces fresh misery after an investigation revealed an ex-employee falsified deals worth more than $15 million.

Having uncovered the deceit of its former eClinical salesperson during an internal review, Merge had to wipe the deals from its backlog, shrinking the pipeline of future business at its data and analytics unit as of Sept. 30 by 27%. The employee--who resigned in September--falsified deals with an apparent value of $5.8 million and $9.4 million in 2012 and 2013, respectively. Merge thinks the employee made up the deals to hit sales quotas and net an extra $250,000 in commission.

The fakery dates back to the quarter ending June 30, 2012, when Merge added $277,000 in made-up business to its backlog. In subsequent quarters the scale of the falsification grew, topping $5 million in the last quarter of the 2012 calendar year and then never dropping below $2 million. No companies were ever invoiced for the fake contracts. Merge has now changed its commission scheme so sales staff are rewarded upon invoicing and collection of cash, not when the contract is first signed.

Even so, Merge warns there can be no guarantee that sales staff won't try similar tricks in the future. The fate of the ex-employee could provide a further deterrent. Merge has referred the case to the U.S. Attorney's Office for the Northern District of Illinois and is considering legal action. The company itself could face legal action, with Zeldes Haeggquist & Eck, LLP Law Offices of Howard G. Smith both investigating whether Merge violated federal securities law.

The saga is a sour twist for Merge's eClinical unit, which has outperformed the rest of the business. Sales were up 39% year-on-year in the third quarter, compared to a 5% fall for the company overall. The eClinical improvement occurred after Merge moved its clinical trial tools to a software-as-a-service sales model. While the contract falsification means the backlog isn't as big as previously thought, Merge still expects revenue at its eClinical unit to grow by at least 20% in 2014.

- check out Reuters' take
- here's Merge's release
- read Zeldes' case
- and Smith's investigation