Greetings, and welcome to the Digirad Corporation Third Quarter 2015 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. With that being said, I would now like to turn the conference over to your host, Rica Lindsey. Thank you. Ms. Lindsey. You may begin. .

Thank you, Tim, 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'll happy to get you one. Also, this call is being broadcast live over the Internet and may be 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, restructuring efforts, 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 2015 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'd like to turn the call over to Matt Molchan. Good morning, Matt. .

Good morning, Rica. Thank you. Good morning, everyone, and thank you all for joining us today for our third quarter 2015 results conference call. We are pleased to be talking to you after completion of another good quarter here at Digirad.

During the quarter we increased our consolidated revenues year-over-year by over 14% and increased our adjusted EBITDA by 30%. And, of course, we are very excited about our DMS Health acquisition announcement a few weeks ago, which I will go into more detail in a few minutes. .

Now for a quick business by business update. Our Diagnostic Services business, which includes our mobile diagnostic imaging activities, DIS, and our cardiac monitoring business Telerhythmics are collectively performing well.

DIS kept up good solid volume during the quarter, as we continue to push forward with our efforts to grow that business organically. Additionally, our recent MD Office acquisition has performed very well, since becoming a part of DIS.

Overall, during the quarter, we gained new customers and new volume, but we continue to experience pricing pressure in certain markets that is affecting our ability to fully capitalize on that new volume. We will continue to combat these pricing pressures, but it has affected our margins to a certain extent. .

Our Telerhythmics business had a great quarter, growing its revenue off its second quarter totals by a significant amount in producing the highest revenue quarter since we acquired them. We continue to be excited about this business and its prospects.

We are working hard at our cross-selling efforts within our current customer base and maximizing the cost efficiency from the business as we move forward..

Our Diagnostic Imaging business performed well during the quarter, increasing its revenue by 27%, and closing on several good margin camera deals. Of course, our quarter-by-quarter revenues within our Diagnostic Imaging business can vary based on the mix and timing of deals closed.

But I can say that we are very excited with its progress and more importantly its current pipeline of deals going out the next few quarters. As we discussed last quarter we are still putting effort into developing international markets, and we have made continued progress on that initiative during the quarter.

We plan to continue to push this initiative as we move forward, along with our domestic efforts with the belief that the international market could develop into meaningful revenue over the next few years. Again, all in all, our businesses have performed very well during the quarter.

Based on this progress, we are still very confident that we'll achieve within our 2015 financial guidance range..

As a refresher, our overall corporate strategy is to focus on 3 main areas for growth. Area number one, acquisitions. Our goal is to acquire companies that fit within our business model of providing diagnostic products and health care related services on as needed, when needed and where needed basis in a very financially disciplined manner.

Area number two, adding new services to our portfolio that we can provide to our current distribution channels. And area number three, organic growth within our existing portfolio of services and channels. .

Regarding acquisitions, we announced our intent to acquire DMS Health a few weeks ago, we continue to move forward on closing that deal and still expect to complete it before the end of the year. We are very excited about this acquisition and the scale it brings to our company.

As we have stated previously, DMS Health Technologies is an integrated health care services company that is headquartered in Fargo, North Dakota. They provide mobile, fixed-site and interim diagnostic imaging throughout the United States with their biggest concentration of customers in the upper Midwest.

DMS' primary customer class is small and regional hospitals. DMS offers their customers a variety of imaging modalities not currently offered by Digirad, including PET/CT, MRI and CT among others. .

In addition, DMS has an exclusive contract with Philips North America to provide sales and service on a variety of Phillips imaging and monitoring products in the upper Midwest region of United States. .

Of course, during the quarter, Jeff and I also spent a good amount of time looking at number of other potential acquisitions and there continues to be a number of interesting acquisition targets that are in various stages.

As we have stated before, the timing and size of these deals vary, but we believe there is still a lot of opportunity, as long as we can secure these deals at the right financial metrics. In the near term, most all of our effort is going to be focused on closing and integrating DMS Health as that is our #1 priority.

However, we'll continue to look at other interesting acquisitions, but only if they are the right opportunity for Digirad. .

Now I'd like to turn the call over to Jeff to give a more detailed financial update for the quarter.

Jeff?.

Good morning, everyone. In the earnings release today and in my comments, I will make references to both GAAP results as well as adjusted results. The adjusted results are non-GAAP and do not include nonrecurring charges such as those associated with restructuring activities or purchased intangible asset amortization.

In addition, I will make references to adjusted EBITDA, which is also a non-GAAP measure that further excludes interest, taxes, depreciation and amortization and stock-based compensation.

We believe the presentation of these non-GAAP measures along with our GAAP financial measures and reconciliations provide a more thorough analysis of our ongoing financial performance. You can find the reconciliations of our results on a GAAP versus non-GAAP basis in the earnings news release..

I'll start with a brief summary of the quarter's activity. Total revenue for the third quarter of 2015 was $15.9 million compared to $13.9 million for the same period last year.

Revenues for Diagnostic Services, which includes the acquisition of MD Office Solutions in March of this year, were $12 million compared to $10.8 million for the third quarter of last year. Diagnostic Imaging revenue was $3.9 million for the third quarter compared to $3.1 million in the third quarter of last year.

Our overall gross margin percentage in the third quarter of 2015 was 30.3%, which was down compared to the 31.8% in last year's third quarter..

In Diagnostic Services, the gross margin percentage for the third quarter of 2015 was 23.2% compared to 25.5% in last year's third quarter. In our Diagnostic Imaging business, the gross margin percentage in the third quarter of 2015 was 52.1% compared to 54% last year.

Overall, the gross margin percentage in Diagnostic Services was impacted by pricing pressure we have experienced in some markets, mainly from competitive forces. .

In Diagnostic Imaging our gross margin was primarily, impacted by the timing of the mix of cameras sold. In Diagnostic Imaging overall, we continue to enjoy reduced manufacturing costs primarily, from the benefit of some previously reserved inventory reserves that were released, created from our restructuring in early 2013.

As we move forward into 2016, most of this previously reserved inventory will be worked through and these releases will not positively impact the margin as much as we move forward..

As a reminder, we do experience some seasonality in our business. And notwithstanding other factors, the fourth and the first quarters are slower quarters, with the second and third quarters being our higher revenue quarters. Of course, we also experience some volatility in revenues and earnings based on the timing of our nuclear imaging camera sales.

Notwithstanding acquisitions, we would expect this trend to continue as we move forward..

At the end of September, cash and cash equivalents and available-for-sale securities totaled $19.9 million, which was a decrease from our June 30 balance of $21.7 million.

During the quarter, the business did produce good cash flow, which was offset by normal working capital changes, payment of our regular cash dividend and a $1 million investment in Perma Fix Medical we previously announced..

Moving on to the bottom line results for the third quarter. Adjusted net income was $1.5 million or $0.08 per diluted share, compared to $1.2 million or $0.06 per diluted share in the third quarter last year. Adjusted EBITDA was $2.2 million for the third quarter of 2015, an increase from the $1.7 million in the third quarter last year.

One noteworthy impact that was included in our financial results but adjusted out of our adjusted results was the impact of our releasing previously reserved deferred tax assets associated with our net operating loss carryforwards.

As we have discussed previously, we have approximately $93 million of federal NOLs as of December 31, 2014, that can be utilized to offset taxable income as we move forward. However, based on our prior history of losses, these benefits totaling approximately $35 million on a tax effected basis were all reserved for accounting purposes.

Based on our continued profitability and other factors considered for accounting purposes, we concluded a -- conducted a detailed analysis of our deferred tax reserves and determined it was appropriate to release approximately 50% of our reserves, which resulted in recognition of approximately $18.2 million of deferred tax benefit during the quarter.

For this analysis and reserve release, we are not allowed to consider potential future acquisitions of the business or significant operational changes.

Of course, if we were able to acquire other businesses that increased our taxable income position, we would have to reconsider this analysis and determine if it was appropriate to adjust our estimated deferred tax reserve position..

Moving on to our 2015 financial guidance. As Matt mentioned earlier, we expect to achieve within our financial guidance range as we announced earlier this year, which was to produce revenue of between $61 million and $63 million, adjusted earnings per share of $0.19 to $0.21 per share and adjusted EBITDA at $6.5 billion to $6.9 million. .

Next, following up on the comments Matt made on DMS Health earlier, I thought I would take a moment to add further color on the timing of the close of the acquisition, our plans and some questions I have received since our announcement. First, we still expect to close DMS Health -- close the DMS Health acquisition before the end of the year.

The timing of the close is based on closing our loan with Wells Fargo, the transfer of some radiopharmaceutical licenses with the various state and federal agencies and receipt of some required information to file with the SEC.

Of course, all these activities are normal and customary of a transaction of this nature and size, and we expect to complete the items with no complications. As we previously announced, beyond integrating some back-office activity, we plan to run DM.

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we will work on ways to integrate some of the operations of the respective businesses, though only if and when that makes sense. Our most immediate goals are to ensure that we have a smooth transition of the business and maintain all the quality customers that DMS Health has today..

Next, I've been asked about our anticipated pro forma annualized metrics that we presented as a part of the announcement of DMS Health.

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produce over $125 million in revenue and over $17 million of adjusted EBITDA on an annualized basis. Of course, we are providing these high-level metrics knowing the acquisition has not been closed, and we are still completing a full mapping of all the synergies between the 2 companies.

Having said that, some people have taken these metrics and simply subtracted them from Digirad's currently announced guidance range to derive a pro forma of DMS Health on a stand-alone basis, an exercise I can certainly understand.

However, I would simply state that our pro forma annualized metrics are prepared at a very high level to provide you with the minimum levels we expect the combined business to perform at, and our expectation is that the combined business will have the opportunity to perform above these levels.

After we have closed the acquisition, you can expect us to announce financial guidance for both companies for the 2016 calendar year..

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the business and if there are other risks or concepts associated with the business that have not been communicated or disclosed. Regarding the purchase price, we have been -- we believe we have paid or will pay a fair value for the business in the market and related to the potential buyers that were available to purchase such a business.

Regarding risk, certainly, no business is without risk, but we believe with our health care services operational experience, along with our experience in running diagnostic imaging services businesses and the exceptional team at DMS Health, the risk is largely mitigated. .

We are buying a company that is poised for further growth, in particular with the management team changes that have been made at DMS Health over the last 2 years. The business is being sold cash-free and debt-free, and we do expect to run all business activities we are acquiring going forward.

From our perspective, we will obtain a quality business, and we believe it is an outstanding value for our shareholders. Finally, this morning we also announced our regular quarterly cash dividend of $0.05 per share that will be paid on November 27 to shareholders of record on November 16. Now I'd like to turn the call back over to Matt. .

Thanks, Jeff. I would like to close by saying we continue to be on the right track for growth in all of our core businesses. We have the right overall model for the health care industry today and where we see it moving in the future.

We are very excited about the pending acquisition of DMS Health as it will help further our impact and our position in the health care industry. As this quarter has proven these continue to be very exciting times for Digirad, and we are taking every step to capitalize on our opportunities. .

Now I'd like to turn the call back over to our operator Tim for any questions. .

[Operator Instructions] Our first question comes from the line of Larry Haimovitch from HMTC. .

a, it is not a cash -- there's no cash involved. Of course, this is strictly a bookkeeping thing. Could you give us a little more background, what -- I mean this is a big number, was there anything to do with DMS coming onboard that had to do with the timing of this because this is a large amount of your NOLs.

So I'm just trying to understand a little more about what you were really thinking here. .

Great question, Larry. The way the accounting works on your NOLs is that there's a tax benefit value associated with those NOLs.

If it's perceived based on a lot of metrics, both qualitative and quantitative, that you can't utilize those NOLs, then you have to reserve them for accounting purposes, and that's exactly how it has been for Digirad over the last many years.

When you get to a point of profitability, there are some hurdles that you have to jump from an accounting standpoint to be able to analyze those to potentially release some of those reserves. And one of those concepts is 3 years of cumulative earnings history, and Digirad achieved that in the third quarter.

So it was an appropriate time to review our reserves and the ability to potentially release some of those reserves. So that's what we did and based on that and quantitative and qualitative analysis we released the reserves to our best estimate of future profitability of the business.

Now, this analysis was only allowed to be conducted as of a 9/30 close date based on business activities as of the date. It has nothing to do with DMS Health and the future potential profitability it could bring to the business.

However, when we close on DMS Health, it will require us to reanalyze the deferred tax asset reserve position, and it could result in further releases but we'll have to get to -- we'll have to cross that bridge when we get to that point. .

So when we look at the accounting entries, the bookkeeping entries for this, debit what and credit what? What are the 2 entities we get? So I'm trying to understand where this affects your balance sheet and or income statement. .

Sure. So debit assets, primarily long-term assets, deferred tax assets, which are presented in our financials and credit income tax expense, which is essentially a benefit in income tax. And it is noncash, Larry. There's no expectation of cash from this situation.

It is an accounting adjustment and why we adjusted out of our adjusted earnings and adjusted EBITDA. .

And as you say, Jeff, it sounds like when you get DMS closed, it would be very likely you would have to reassess it because now you're a much more profitable business than you were before DMS. .

The rules are very specific, I'm only allowed to consider what's kind of under the Digirad umbrella as of 9/30. Anything else that happens going forward could impact our ability -- could impact our profitability and would require us to reassess where we're yet at. So the answer is yes. .

I've got a couple of other questions, but let me jump back in the queue, and I'll pop back in. .

Our next question comes from the line of Juan Molta of B. Riley & Co. .

I wanted to ask a little bit more on DMS as we progress to the closing of this acquisition.

What are the largest and most important integration hurdles that you need to overcome? And where do you stand with those, aside from just this the sheer size that's the merger of equals, but anything else that you can comment on?.

Obviously, with any acquisition you're going have integration -- significant integration related to the scale and scope of this particular acquisition. So we're -- from day 1, we're going to be engaged.

We're actually going to be engaging a integration consultant because we feel like this is a -- in past acquisitions, we felt like it was something that the team could handle, this one is a lot bigger, and we want to make sure that we have all our bases covered.

So we are certainly going to be working with their team, they'll be working with our teams to really bring these 2 companies -- really, as you mentioned, 2 companies that are really of equal size come together. But we have looked at this, and we have diligenced this acquisition very thoroughly.

We are not anticipating any huge hurdles that are -- that we have not already anticipated. So we expect to bring our -- bring the teams together. We've already had very good initial meetings, and we're very excited about the prospects of this acquisition as we move forward.

But I'll ask Jeff, if there is any thoughts that you would have to answer Juan's question further. .

Sure. I'd just kind of reiterate in our prepared comments, Juan, the fact that the near-term goals are to integrate back-office activities.

And probably, the near-term hurdles and effort is just going to -- having a company that's efficient from its day-to-day activities on how it addresses HR and IT and finance functions, because DMS Health is anticipated to be run as a complete separate business unit.

But there's all those general compliance activities that the company needs to have under one umbrella; HR, IT, finance functions and process flows under one umbrella. It's all about making sure that we're all marching to the same tune and we're pretty efficient on how we run our business operations, but that's essentially it.

Beyond the fact that we're equal-sized companies for the large part, and we got to work through all the concepts associated with that, including culture and getting everyone marching to the same tune. And we don't anticipate any major concerns in those areas as Matt mentioned. .

Okay, perfect. I'll ask a second question, and we've talked about this a little before, not on live, but -- with DMS you're going to have a publicly traded comp that's more like that business relative to core Digirad where it was a little bit harder to find a comp.

And there's this pending acquisition or pending majority transaction with the comp with Alliance. Do have any comments as to that? And we're looking at your stock maybe trading a little bit below what we think a fair value would be given the estimates that you have given.

Any comments as to how the stock has reacted to this transaction, how that may be affected? If you have any color or any thoughts you have on the transaction, how that may be affecting you.

How you are different from them, et cetera?.

I think, Juan, that we don't really have huge comments on how the stock price is trading relative to the acquisition or pro forma results. I think the market's the market. And I think as time moves on, and we start reporting DMS results, we'll settle into a normal pattern.

But I don't think we have a big comment on where the stock price is trading relative to the pro forma results. I think there's too many market variables that can be in play there. And certainly, first and foremost is we got to close on DMS and start reporting results, and then we'll see how things turn out. .

I'd also, say, it's not an exact comp either. I mean the -- portions of DMS, as we've mentioned, DMS is made up of 3 divisions, if you will, right? They have the mobile imaging division, which is very similar with the large trucks for MRI, head CT and what not, that you might find at an Alliance.

But they also have a significant services business, a post-warranty -- warranty and post-warranty support business, very similar to our camera support business within our Diagnostic Imaging business, where they're working with -- exclusively with Philips equipment, as that provider of service.

And they also, have an equipment sales business much like our diagnostic imaging camera sales business in terms of that they're selling product into the business. Those are areas that kind of separate the DMS Health from an Alliance.

And really fit nicely rather into our Digirad business, where we have a mobile imaging side of the business, we -- in our DIS business. We have a camera support business, post-warranty support within our Diagnostic Imaging and a product sales piece within our Diagnostic Imaging as well.

So we feel it's a perfect marriage between these 2 companies, Digirad and DMS Health. And even though we might have some similar businesses to a company like Alliance, we're not perfectly aligned with Alliance. .

Our next question comes from the line of Larry Haimovitch of HMTC. .

Matt, a follow-up question for you. When you look at the quarter, obviously, every quarter has some good things that happen and maybe at couple disappointments. Wanted to get your puts and takes on how you looked at the quarter. Where you thought you did better than you hoped for and maybe where you didn't quite meet your expectations.

Obviously, the quarter was solid, but just curious about within the business itself, how you view the various parts. .

Thank you, Larry. I would say that, I agree, it was a solid quarter across the board. I would say that I'm most pleased with what we're seeing out of our Diagnostic Imaging business, the turnaround of that business, the pipeline of deals that we're seeing in front of us. The performance has really been outstanding and ahead of our expectations.

I would also comment that our 2 acquisitions -- most recent acquisitions, MD Office and Telerhythmics, are performing very well, performing above expectations from that standpoint, which is great, fitting in line with how we looked at this business, in terms of how we would grow it and how we would take advantage of some of these acquisitions that we were able to make and -- so we feel very really good about that.

I would say if there was some below the line activity in the quarter, it would be within our core DIS business. One of our absolute goals is to see core organic growth out of that business, both on the top line and then obviously what it's producing at the bottom line.

And we took a little -- not a huge step back, but we've taken some hits as you can see in our margin. Although, we are seeing some top line revenue minor growth there, we're also combating, as Jeff pointed out, some competitive pressures in certain areas of the country. And that has kind of halted some of the progress that we're seeing.

Some of the good news is we're seeing a lot more companies in health care systems and physician offices and whatnot who might not have looked at Digirad in the past, but our assortment and arrangement of services that we're providing, not only through our core products, but adding Telerhythmics and whatnot, we're getting access and we're getting looks from companies and health care systems that might not have known who Digirad was or what we might offer.

So future definitely looks bright from that standpoint. I think some of those setbacks that we experienced this quarter are very minor and do not reflect where we feel we can take the DIS business into the future. So overall, like I said, it's been a great quarter, and hopefully that kind of gives you some further color, Larry, on my thoughts. .

One other quick question to follow-up on that. There was some comment made in the prepared remarks about pricing pressures.

Is this the pricing pressure you were feeling from some of the small players that are maybe struggling a little bit, maybe a little bit more desperate, and the only way they see to build business and take share from you or others is to cut prices?.

That's correct. That's how we're looking, and that's what we're experiencing in certain of our areas. And that does have an effect on our overall margins because we are seeing that. But once again, that is part of our growth strategy, right, is to look at some of these smaller competitors throughout the regions that we are operating in.

As those that are very familiar with our DIS business realize, our profitability really requires a dense area that we can run our vans within, and the more we can gain within that area, either through acquisition or through organic growth, the more profitable that area will be.

So we're certainly looking at a number of these opportunities that we're currently competing with. So that's certainly one of the reasons. .

Our next question comes from the line of Eric Gomberg from Dane Capital Management. .

So wondering over the past couple of quarters, I guess, the organic growth has been fairly modest. Kind of backing out MD Office and lapping year-over-year, it seems that this is a very strong organic growth quarter.

I was wondering if you think it's kind of more a timing issue of some of the deals or if you are kind of now firing on all cylinders with Telerhythmics, and if you're just feeling greater strength in the market, notwithstanding pricing pressure. .

Definitely, we saw some -- like I mentioned, with Telerhythmics, the business definitely -- we are starting to see some of the rewards, right, from our investment into that business. It's taken us some time to get our hands around the business and really to be able to tell our story to customers.

So we were able to capitalize on opportunities within our distribution channel that allowed us to present Telerhythmics in such a way over the past 6 months that now we're starting to reap some of those benefits. So, yes, I think that would be a major portion of some of the year-over-year growth that we're seeing in Telerhythmics.

But we are seeing, like I said, we are seeing volume. I mean I can tell you this, within our DIS business we're running more days than we ran the year before, we are scanning more patients than we scanned the year before. The offset for that are some of these pricing pressures that we are experiencing.

But the Telerhythmics business definitely was a big contributor to that growth you're seeing. .

Great. And just one other question, it sounds like the deal pipeline is very robust, and again, I know the focus is on the DMS Health integration.

But just wondering from a lending perspective or bank support perspective, could you even consider another the deal of the size of DMS Health?.

Eric, this is Jeff. On our banking arrangement, of course, it's not closed, but we do have carveouts for acquisitions if we -- of modest size to be able to complete those while still engaged in the facility.

Of course, if we were to look at anything of significant size, would have to talk to the bank and get approval and possibly adjust our arrangement. But the short answer is yes.

For the smaller tuck-in ones, we have room within our facility and covenants to be able to accomplish those if they meet certain metrics, all of which would be metrics that we would expect to achieve if we were to even move forward on a potential acquisition.

So I don't think the credit facility that we're going to get into is going to be a gating item on us being able to complete an acquisition. .

But sizable transformative acquisitions like DMS are still on the table prospectively?.

It was the right fit, right time, right concept for sure, however, from a credit facility standpoint, that would certainly cause us to go back and talk through that with the bank. .

At this time, there are no further questions in the audio portion of this conference. With that, being said, I would like to turn the conference to the management for closing remarks. .

Thank you, Jim. Thank you to all of our stockholders and other interested parties who joined us this morning. We appreciate your interest in Digirad. Jeff and I look forward to discussing our results and business update with you next quarter for our fourth quarter and full year results. Thank you, have a good day. .

This concludes the teleconference. Thank you for your participation. You may disconnect your lines at this time..