Star Equity Holdings, Inc. (STRR) Q3 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the Digirad Corporation Third Quarter 2016 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Risa Lindsay with Digirad. Thank you, Ms. Lindsay. You may begin.

Thank you, Doug and thank you all for joining us this morning. If you didn’t receive a copy of our press release and would like one, please contact our office at 858-726-1600 after the call and we will be happy to get you one. Also this call is being broadcast live over the Internet and maybe accessed at Digirad’s website via www.digirad.com. Shortly after the call, a replay will also be available on the company’s website. I would like to remind everyone that certain statements made during this conference call, including the question-and-answer period, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. These forward-looking statements include statements about the company’s revenues, costs and expenses, margin, operations, financial results, acquisitions and other topics related to Digirad’s business strategy and outlook. These forward-looking statements are based on current assumptions and expectations and involve risks and uncertainties that could cause actual events and financial performance to differ materially. Risks and uncertainties include, but are not limited to, business and economic conditions, technological change, industry trends, changes in the company’s market and competition. More information about the risks and uncertainties is available in the company’s filings with the U.S. Securities and Exchange Commission, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K as well as today’s press release. The information discussed on this morning’s conference call should be used in conjunction with the consolidated financial statements and notes included in those reports and speak only as of the date of this call. The company undertakes no obligation to update these forward-looking statements. Hosting the call today from Digirad is President and CEO, Matt Molchan. Joining Matt this morning is Jeff Keyes, Digirad’s CFO. Matt and Jeff will discuss the 2016 third quarter financial results, update us on the company’s strategy and comment on the company’s outlook. A question-and-answer period will then follow. With that, I would like to turn the call over to Matt Molchan. Good morning, Matt.

Good morning, Risa. Thank you. Good morning, everyone and thank you all for joining us today for our third quarter 2016 results conference call. Overall, the third quarter was a good quarter for Digirad with revenues of $31.1 million, a year-over-year growth of 96%; and an adjusted EBITDA of $3.6 million, a 61% growth year-over-year. We did experience issues this quarter in our products businesses related to the timing of equipment sales and some part-related costs, but as we announced today, we expect this to sellout by the end of the year and remain confident in our full year financial guidance. Our recent acquisition of DMS Health on January 1 is going well and we are nearly complete with our planned integration activities, with full competition expected by the end of the year. As a reminder, DMS Health is an integrated healthcare services company that is headquartered in Fargo, North Dakota and operates in two primary business segments, mobile healthcare, which includes mobile fixed site and provisional diagnostic imaging and mobile healthcare solutions throughout the United States, with their biggest concentration of customers in the upper Midwest and medical devices sales and services or MDSS, which sells and services primarily Philips medical equipment through their exclusive relationship with Philips Healthcare. After a quick business-by-business update, I will start with our service businesses, which includes diagnostic services and mobile healthcare. Our diagnostic services business, which includes our in-office mobile diagnostic imaging activities, Digirad Imaging Solutions or DIS and our cardiac monitoring business, Telerhythmics, both continue to perform well overall. Diagnostic services performed well year-over-year benefiting from higher volume from existing customers as well as volume from new customers increasing overall revenues approximately 1%. Our mobile healthcare business, which was a part of our DMS acquisition also performed well in the third quarter putting up solid revenue numbers of $11.8 million. As a reminder, mobile healthcare provides trailer-based mobile healthcare solutions to small and regional sized hospitals throughout the United States. It currently offers MRI, CT, PET/CT and other flexible and convenient mobile healthcare solutions. We are continuing to explore a variety of relevant trailer-based mobile healthcare solutions and believe some might be able to be integrated within the business over time providing potential new revenue streams. Now, on to our product businesses, which include diagnostic imaging and medical device sales and services. Our diagnostic imaging business is making solid project – progress on all its strategic initiatives, but did experience lower revenues year-over-year primarily associated with the timing of camera sales. We have also said – we have always said that our product business can be subjected to the timing of customer buying decisions and diagnostic imaging experienced that this quarter. However, we fully expect that they will have a great fourth quarter which they entered with a strong backlog and pipeline of camera sales. From a business operations perspective, we are continuing with the small hardware and software enhancements we previously announced to allow our cameras to gain higher reach in the marketplace. We deployed our new software on most models in Q3 where the hardware enhancements will be completed by Q2 of next year. Once ready, these initiatives will take sometime before they gain full traction. Therefore in the meantime, we will continue to manufacture and sell our existing high-quality nuclear imaging cameras in our current markets. Our MDSS business, which was a part of the DMS Health acquisition, had an outstanding third quarter, posting revenues of $4.6 million ending the quarter with an outstanding backlog of medical device products, particularly in the ultrasound and patient monitoring lines. MDSS did experience some volatility in underlying parts cost this quarter. We believe this is timing related and should not be a factor in our full year results. As a reminder, our MDSS business has an exclusive relationship with Philips Healthcare to provide product sales, installation, warranty and product support within a specific geographical area in the Upper Midwest region of the United States. They primarily sell imaging systems and patient monitoring systems and provide support to imaging systems within that same general region. We generate revenues and commissions from these product sales and also generate revenue by directly servicing Philips imaging equipment in the region. As stated each quarter, our overall corporate strategy at Digirad is to focus on three main areas for growth. Area #1 is acquisitions. Our goal is to acquire companies that fit within our business model of providing healthcare solutions on an as-needed, when-needed and where-needed basis in a very financially disciplined manner. Area #2 is adding new services to our portfolio that we can provide through our current distribution channels. And Area #3, organic growth within our existing portfolio of services and channels. Now, that most of the integration efforts are nearly complete for DMS Health, Jeff and I can spend more time looking at potential acquisitions. We are continuing to track an array of tuck-in acquisitions. As always, if the right opportunities present themselves that are a great value for our shareholders, then we will move on these opportunities. If they are not, then we will continue to do what our core purpose is, run our great businesses, generate cash and create shareholder value. Now, I would turn the call over to Jeff for his comments and a more detailed financial update for the quarter and year. Jeff?

Good morning, everyone. In the earnings release today and in my comments, I make references to both GAAP results as well as adjusted results. The adjusted results for non-GAAP do not include nonrecurring charges such as those associated with acquisition integration and purchase intangible asset amortization. In addition, I will make references to adjusted EBITDA, which is also a non-GAAP measure that further excludes depreciation, amortization, interest taxes and stock-based compensation. We believe the presentation of these non-GAAP measures, along with our GAAP financial statements and reconciliations provide a more thorough analysis of our ongoing financial performance. You can find the reconciliation of our results on a GAAP versus non-GAAP basis in the earnings news release today. As I previously discussed, we closed on – as previously discussed, we closed on DMS Health on January 1, 2016. The results of DMS operations are included in our results for the entire quarter and for the year-to-date period since January 1. Total revenue for the third quarter of 2016 was $31.1 million compared to $15.9 million for the same period last year, with the largest impact being the inclusion of DMS Health business units, mobile healthcare and MDSS within our results. Revenues for these new business units contribute a total of $11.8 million and $4.6 million respectively to our overall revenue for the quarter. Revenues for diagnostic services were $12.1 million compared to $12 million for the third quarter of last year. And revenues for diagnostic imaging were $2.7 million compared to $3.9 million for their third quarter of last year. Our overall gross profit percentage in the third quarter of 2016 was 26.7% compared to 30.3% in last year’s third quarter. In diagnostic services, the gross profit percentage for the third quarter was 20.5% compared to 23.2% in last year’s third quarter. In our diagnostic imaging business, the gross profit percentage was 43.5% compared to 52.1% in the prior year third quarter. Overall, the revenue increase in our diagnostic services business was positively impacted by a higher volume of service days ran in the third quarter of 2016 compared to the prior year, primarily from new business activity. This was partially offset with an unfavorable mix of cardiac monitoring service revenue from our Telerhythmics business as we continue to educate our customers of the benefits of telemetry monitoring services, which provide much more comprehensive data and information than event monitoring services. As Matt mentioned earlier, diagnostic imaging’s overall revenue and gross margin was impacted by the timing of the cameras sold as well as some unusual scrap costs incurred during the period. During the third quarter, we sold less cameras than anticipated, but do expect the volume in the fourth quarter to make up for this third quarter performance based on our strong backlog and pipeline going into the fourth quarter. Our mobile healthcare business produced revenue of $11.8 million with a gross profit percentage of 19%, while MDSS had revenue of $4.6 million with a gross profit percentage of 52.9%. We do generally expect the gross profit percentage for mobile healthcare to be in the mid-20% range and MDSS to be in the mid-50% range, though MDSS can vary somewhat depending on the timing of product sales and commission revenues related to our exclusive Philips relationship. During the quarter, our mobile healthcare business gross profit percentage was lower than our expectations based on the timing and utilization of our underlying assets. We engaged in more sub-lease activity to address shorter term provisional work versus owned assets, which typically do not produce the same margin levels. We do experience some seasonality in our businesses and notwithstanding other factors, the fourth and the first quarters are our slower quarters, with the second and third quarters being our higher revenue quarters. Further, we also expect the seasonality trend to be consistent with the inclusion of DMS Health as we move forward. The mobile healthcare business experiences most of the same seasonality concepts as diagnostic services and MDSS business experience timing concepts based on timing of equipments sold similar to diagnostic imaging. Notwithstanding acquisitions, we would expect this trend to continue as we move forward. During the third quarter, we incurred closing and integration cost for DMS Health of around $100,000. We expect to incur approximately $250,000 for the remaining portion of 2016, putting us right plan for our full year expectations. Moving on to bottom line results for the third quarter. Adjusted net income was $1 million or $0.05 per diluted share compared to $1.5 million or $0.08 per diluted share in the third quarter of last year. Adjusted EBITDA was $3.6 million for the third quarter of 2016 compared to $2.2 million in the third quarter of last year. During the quarter, we did adjust the carrying value of our Perma-Fix Medical investment by $414,000, reflecting the sustained lower-level value of the stock price as traded in the market. Though a development stage company, we remain excited about our Perma-Fix Medical investment and are pleased they recently announced another round of financing to continue their development process of non-enriched uranium sources for medical imaging isotopes. Today, we also reaffirmed our 2016 financial guidance, which is to produce revenues of between $125 million and $130 million, adjusted diluted earnings per share of between $0.30 and $0.35 per share and adjusted EBITDA of between $17 million and $18 million. As a reminder, we have a credit facility with Wells Fargo that was used to help fund the acquisition of DMS Health. The credit facility has three components. A line of credit with a borrowing base of up to $12.5 million, which bears the interest at LIBOR plus 2%; tranche A, with a borrowing base of up to $20 million, which bears interest at LIBOR plus 2.5% and amortizes over 7 years; and tranche B has a total borrowing of $7.5 million bears interest at LIBOR plus 5% and amortizes over 3 years. At September 30, our weighted average interest rate on our overall credit facility was 3.6% and the total principal balance outstanding was $23.3 million. Our net debt position less all cash and equivalents, securities available for sale and related restricted cash was $16.6 million. Also at September 30, we had no outstanding balance in our line of credit, leaving availability of $5.3 million per our credit agreement. Also during the third quarter, we were able to make 3 extra payments totaling approximately $600,000 on our tranche B debt, which carries the highest interest rate of our entire credit facility. Going forward, we may make extra payments on our credit facility depending on cash needs and the goal of deploying our cash for the highest and best use relative to capital allocation and value. And finally today, we announced our regular quarterly cash dividend of $0.05 per share that will be paid on November 28 to shareholders of record on November 17. Now, I would like to turn the call over to the operator for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Andrew D’Silva with B. Riley. Please proceed with your question. Andrew D’Silva: Good morning and thanks for taking my call. Just to start off with the service segments, I was under the impression that Q3 was seasonally a strong quarter, particularly for the various service segments that you have, but it was down from Q1 and Q2. Are there any macros that are negative right now or any long-term indicators that you are focused on related to that or just a one-off quarter or did you lose any customers off pricing pressure? Anything that you can maybe discuss in a little bit more detail will be helpful.

Yes, good morning Andrew. Yes, for – the DIS business actually was up quarterly over quarter. The mobile healthcare business, we – what we are finding is our traditional DIS business, we are very familiar with in terms of the – how that business would work in terms of the secular nature and so we did experience a higher third quarter for DIS. But for mobile healthcare, it works a little – we are finding it works a little bit different. They were pretty much subject to it seemed like a greater number of cancellations over in the July – the month of July due to vacations and whatnot. And so we are still gathering more information about DMS Health and the cyclical nature of their revenue streams as it compares to our DIS businesses that we are more familiar with. Andrew D’Silva: But – go ahead…

Really out of the ordinary, Andrew, it just was that we did – we were not anticipating that they were going to have that much of a volume based hit. As I think we have discussed in the past, the mobile healthcare unit, a lot of the contracts that we use in mobile healthcare are based on a per patient nature whereas our DIS mobile business is more based on a lease model. So, it gives you more a fixed price than your – the mobile healthcare. So, I think what we are experiencing there is just some differences within those two businesses and how they would relate in terms of the cyclical nature of both of those businesses. Andrew D’Silva: But historically speaking, Q3 should be strong consolidated going forward as you make your projections, Q2 and Q3, correct? And we shouldn’t make any dramatic...

Yes, Q2 and Q3 should be our stronger quarters overall as a combined unit. Now, a lot of it as you look at it product sales will vary, but yes overall for the services business, Q3 and Q – Q2 and Q3 would be your higher quarter traditionally, that’s correct. Andrew D’Silva: And we should expect, I suppose that this quarter or next quarter coming up, Q4, since we are in Q4 now we should be sequentially above Q3? I mean, you implied that equipment sales were down, but pushed out a quarter. And then obviously, the third quarter had, on a consolidated basis, weaker service revenues. So, is that a fair assumption?

Yes, it is. Andrew D’Silva: Okay, great. Last question just about cross-selling opportunities related to DMS. Have you established or identified any at this point or is there just too much competition between brands where it doesn’t make sense to pursue that right now?

Well, I mean I think it’s more of we are – in terms of integration, we are still – this is obviously a major acquisition for Digirad doubling the size of our business. I am still getting our arms around a lot of the particulars of the businesses. In terms of cross-selling though, there are a couple that we have identified that are kind of the low hanging fruit that we are pursuing in terms of strategic relationships that the old Digirad had and that the old DMS business had and leveraging those strategic relationships to see if there is opportunity to cross-sell. But there is no – there is nothing that we can report at this time in terms of that success, but it’s certainly something that we have now begun the process of looking at those low hanging fruit opportunities and that we anticipate that we will have some success into the future. Andrew D’Silva: Okay, great. Well, thanks for taking my questions and good luck to the rest of year.

Thank you, Andrew.

Thanks, Andy.

Our next question comes from the line of Ross Taylor from Somerset Capital. Please proceed with your question.

Thank you. Could you give us a little bit more color on both the backlog and the pipeline such as the size of the backlog, the time horizon to realization in the backlog on the equipment side?

Yes, good morning, Ross.

Good morning. How are you doing?

Good. Doing good. Yes, the third quarter, especially as you compare year-over-year, was a down quarter for our diagnostic imaging camera sales, but it was not for the lack of opportunity. We feel like we have a very strong pipeline as we enter into the fourth quarter of this year. It’s – I think what we are experiencing is that our diagnostic imaging cameras that we are selling, the majority of our – the purchasers of our cameras are now hospitals whereas in the past, they were individual cardiology offices or larger cardiology practices. And as we get in tune with the sales cycle of a hospital, our ability to close the deals is really much more – it’s much more complicated and much longer sales cycle than it would be selling into an individual cardiology practice. So I think that’s what we are starting – we have been experiencing some disruption. But we do feel, based on our pipeline, based on the positive purchasing that we are – feelings that we are getting from our customers, that we should have the best fourth quarter, the best quarter in diagnostic imaging history. So, we do have a large pipeline. We feel very confident that we are going to be able to close out on that pipeline and that’s why we have not changed any of our financial guidance for the year, because we do feel we will have a very strong fourth quarter based on what we currently have and have sold already in the fourth quarter.

And you would expect that, the margins, to hold with historic norms in that space?

That’s correct. We do expect that.

So, that’s obviously what’s driving the upside in your earnings number. Because your guidance basically is looking at a 4Q, which is $0.08 to $0.13 in adjusted EBITDA, but because of the substantially higher margin in that business, that’s what would be driving it if we are getting the high-end – if we get better sales out of that space.

You are correct.

Okay, great. Thank you very much. Good luck.

Thank you.

Our next question comes from the line of Larry Haimovitch with HMTC. Please proceed with your question.

Hey, good morning, Jeff. Good morning, Matt.

Good morning.

So, just following up with lot of the – some of the other questions I had have already been asked. But you mentioned acquisitions and I was a bit surprised that you are looking – starting to look at acquisitions again given that from my perspective at least you are still digesting the big bite you took about a year ago, 9 months ago. Talk a little bit more about the acquisitions. I realize you did say, Matt, you are looking at tuck-ins, but I would just like to get a better understanding of your philosophy and feeling right now about future acquisitions?

Yes, I think we are always taking a look at what opportunities are in front of us, right? So there is – we know that we have a, what we feel, is a pretty large supply of tuck-in acquisition opportunities that we are aware of that we continue to monitor. And we feel like that the – in order for us to execute those opportunities at the correct financial metrics that we want to use in our acquisition model, that we would – we have to continue to monitor, but it’s going to be based on the timing of the seller. And so we are monitoring those situations. I am not trying to say that we are doing anything more aggressively to close in acquisition. We are only going to close those acquisitions that we feel will make sense for our company and makes sense for our shareholders at the right metrics. So, it’s more of a statement to say we really have been passively monitoring over the past 6 to 7 months and we are starting to ramp up again where we can more aggressively monitor more contact with those opportunities and see if we could flush out future deals. But we are certainly not going to pay for an acquisition beyond the metrics that we have set for ourselves and for – which we feel will provide the greatest return to our company and to our shareholders.

That’s a good answer, Matt and that’s helpful answer I should say. So, what you are really saying as I hear it is it’s kind of business as usual. You have always had – you have always been very opportunistic. You have always been very price sensitive and you continue to just look at opportunities. And perhaps, one will pop up where the seller is motivated enough to sell at a reasonable price and perhaps not?

Correct. Yes, correct statement.

Okay, great. And then on the guidance you didn’t change your guidance even though Q3 was a little light. It sounds like you have enough confidence in the equipment business that it’s going to rebound in Q4 and you will make up whatever little shortfall happened in Q3. Is that a fair way to interpret what you are saying?

That’s correct, Larry.

Okay, great. That’s what I thought. Okay, thanks guys.

Alright. Thank you.

[Operator Instructions] Our next question comes from the line of Mitra Ramgopal with Sidoti & Company. Please proceed with your question.

Yes, hi, good morning. If we look at the decline in gross margin, I was wondering if you could give us a sense. Had you gotten the product sales you were anticipating and if the costs that you saw in the quarter were more normalized, but the gross margins have been similar to 2Q or even the year ago period?

Yes, they would be very similar, Mitra, absolutely, if we were able to execute on those sales, correct.

Okay, thanks.

By the way, Mitra.

Yes, nice to hear from you, again.

And Mitra, I think the other thing to mention is we did indicate in the call that we had some unusual parts costs that went through for our MDSS business as well as our diagnostic imaging business. Those don’t always go through smoothly over the course of the year, so that certainly impact the margins. But notwithstanding that and the product sales, we would have been right around the same levels.

Okay. Thanks for the color. And I know, Matt, we have talked about acquisitions and you have talked about tuck-in opportunities. As we think about that, is it more about expanding your geographical presence or is it more about ancillary opportunities or just consolidating what you already have?

Yes, I mean, it’s little bit of both in terms of – we are looking at a number of different opportunities within the same spaces that we are – the majority and what we call – we would feel are the sweet spot are those mom-and-pop type companies that are already using our Digirad cameras and have created a service business within their geographic region. Those would be ideally much like our MD Office Solutions acquisition earlier last year. And we – so we will continue to be looking for those whether that be geographic expansion or even some that might even be within our current areas that we are – adjacent to the current areas that we are in or even within the areas that we are currently offering DIS Services. It’s mostly within our DIS space that we are looking for those opportunities and around the idea of in-office imaging or in-office healthcare solutions that will be used as needed, when needed and where needed. That’s the sweet spot we feel right now in terms of those types of tuck-in acquisitions that would help us continue to grow our business.

Okay, thanks. And coming back to the DMS acquisition, I believe you have mentioned in the past what really significant cost synergies you are expecting from it, but more potential, as you alluded to earlier in the call, some low hanging fruit from a revenue standpoint. That’s something we really should be expecting more in 2017 and beyond?

Correct. That’s correct. Yes, we weren’t anticipating anything here in 2016, but you are correct. I mean those types of synergies – now, roughly we are – I mean, as we brought on DMS, they were – their main operations are in a different – the upper Midwest of the United States where our other services business is really, that was a hole in our coverage area. So, there will be opportunities that we can see, like we mentioned before, cross-selling opportunities, but really concentrating really on some of the strategic accounts that we have within both of those businesses and how we might be able to cross-sell other opportunities. That’s really what we are focused at. So not across the board, every salesperson involved, but more so in just those strategic relationships and how we might be able to really create a model. And we might be able to push out to the rest, but really, to concentrate on the strategic accounts first and that’s what we – we are doing that now and we should see some returns on that in 2017.

Okay, thanks. And finally, I know you have talked about the VA as an opportunity over the long-term. I don’t know if you have any update on that?

Yes. I mean, it continues to be an opportunity for our mobile healthcare division of DMS where we are working with the VA on gender-specific mobile healthcare solutions. Definitely, this is something that we feel – there has been money appropriated for this type of pilot program that DMS – that we feel we will have opportunity to participate in. We are currently attacking that opportunity through contractually, politically and clinically. So, we are working through our relationships with the VA as they look to determine exactly how they will spend their 2017 budgets. There has been appropriation made specifically for this gender-specific product program, but it’s still ultimately up to the VA in how they will spend their budget. So, we are working closely with them. We should have further information over the next two quarters as to the outcome of those discussions.

Okay. Thanks again for taking the questions.

Thank you.

There are no other questions in the queue. I would like to turn the call back over to management for closing comments.

Thanks, Doug. As always, we appreciate all our shareholders and your continued feedback and support. We are very excited about our business and our future. Jeff and I look forward to discussing our results and business update with you next quarter for our full year results. Thank you.

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.