Risa Lindsay - Investor Relations Matthew Molchan - President and Chief Executive Officer Jeffry Keyes - Chief Financial Officer.

Andrew D'Silva - B. Riley & Co. LLC Larry Haimovitch - HMTC Mitra Ramgopal - Sidoti & Company, LLC.

Greetings and welcome to Digirad Corporation Third Quarter 2017 Results Conference Call. At this time, all participants are in a listen-only-mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I’d now like to turn the call over to Risa Lindsay.

Please go ahead..

Thank you, Rob, 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 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 but are not limited to, 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 2017 second 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, and thank you, Risa. Good morning, everyone and thank you all for joining us today for our third quarter 2017 results conference call.

As we mentioned in our press release today, our service businesses had a good third quarter, with Diagnostic Services posting a year-over-year revenue increase, and Mobile Healthcare performing within our expectations based on the operational changes we made earlier this year and leadership operations and by adding additional resources to our provisional sales efforts.

The Mobile Healthcare is still performing lower than last year they're building a pipeline of deals back up and executing much better than earlier this year. We believe the business remains on track with the ability to grow as we move into next year.

Our product businesses which include Diagnostic Imaging and Medical Device Sales and Services continue to be impacted by slower capital spending which we attribute in part to the uncertainty around the Affordable Care Act.

Now we have seen this slower capital spend we believe that the backlog of potential deals we continue to build and when things ease up we should be in a good position to capitalize on those sales.

Since revise bill related to the Affordable Care Act has now failed twice we are optimistic that there might be easing on this topic we might see some higher capital sales soon.

As we announced on October 4, Philips Healthcare informed us on September 28 that they would be canceling their consolidated agreement with us, with an effective date of December 31, 2017. This cancellation was unexpected, but as I will explain this is only a small part of our overall business.

The activity related to Philips is contained within our MDSS business segment.

To be clear our relationship with Philips include the following general components; number one, products sales where we earned a commission from sales of certain Philips branded products within the Upper Midwest region of the U.S.; number two, installation revenue from the same products sold in the region; number three, warranty revenues from certain products sold in the region; and finally, revenues from post-warranty service contracts sold in the region.

As a result with Philips cancellation, after December 31, 2017 we will no longer have revenues from product sales, installation or warranty revenues. These accounted for approximately $3 million or 31% of the MDSS business segment revenue through September 2017.

However, we will continue to generate revenue from MDSS post-warranty service contracts past December 31, 2017 as we own and manage those contracts.

This change does open up opportunity to us allowing us to operate our MDSS service business in territories, customer classes, and modalities that were not allowed under the current agreement with Philips. Pursuing these expanded opportunities after December 31, 2017 will definitely be a new endeavor and it will bring new challenges.

So we are carefully evaluating our general approach and ability to expand based on this. We are considering all strategic options, but as of now, we plan to continue to run this business with our existing resources including servicing our current book of long-term contracts.

In addition, we have implemented enhanced sales resources to start selling into territory and in adjacent territories once our agreement terminates.

Based on the general underperformance of the products component of the MDSS business so far in 2017, the install warranty and products sales have not contributed much to the bottom line this year both for the third quarter and for the year-to-date periods, but did have a larger contribution in 2016.

We have quantified this information in the tables in our earning release today. We'll have to make certain operational changes related to this business going away, but we do not expect the equivalent revenues and cost related activities to continue into 2018.

As you can imagine, Jeff and I received a lot of calls and questions related to the impact on our business, capital allocation, and board strategy with a notice from Philips. Overall, the MDSS component impacted by this notice is a small part of our business.

We have been asked what our plan is to replace its revenue and contribution to the bottom line, but lot’s of the Philips contract is always been a risk to our business and this risk included this potential impact. With a lot of this business, it's clear that it will impact our bottom line and then long-term despite the 2017 performance.

Based on the timing, we don't have an immediate replacement to this revenue or contribution, but what I can say is that we continue to have a very robust service and product sales businesses at Digirad will continue to effectively and efficiently run these businesses.

As we move forward, our core businesses will continue to generate revenue, profit, cash flow, and grow into the future and like always, we will continue look for opportunities that will contribute to our bottom line and enhance shareholder value.

Based on the recent events and our stock price, we've also considered and evaluated our capital allocation. Original authorization of $12 million, we currently have available approximately $6.3 million under our board approved share buyback program.

We will continue to consider all options, but currently we believe that our dividend is the best way of returning value to our shareholders in the long-term and we do not have any plans of adjusting or stopping our dividend.

Based on our current view with the updated forecast we released today in current vision of 2018, we expect the business to continue to generate plenty of free cash flow to fund business needs, service our credit facility, and pay our ongoing dividend.

In the meantime, we'll continue to focus on our three tier growth strategy for the Company, which are acquisitions. Our goal is to acquire companies that fit within our business model of providing healthcare solutions on as needed, when needed, and where needed basis in a very financially disappointing manner.

Number two, adding new services to our portfolio that we can provide through our current distribution channels, and finally number three, organic growth within our existing portfolio of services and channels. Now I'd like to 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 will make references to both GAAP results as well as adjusted results. The adjusted results are non-GAAP and do not include non-recurring charges.

I will also make references to adjusted EBITDA, which is a non-GAAP measure that further excludes depreciation, amortization, interest, taxes and stock-based compensation. Finally, I will make reference to free cash flow, which is a non-GAAP measure taking operating cash flow and subtracting cash pay for capital expenditures.

We believe the presentation of these non-GAAP measures along with our GAAP financial statements in reconciliation 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 today.

Now I will give a brief summary of the quarter's activity. Total revenue for the third quarter of 2017 was $28.6 million compared to $31.1 million for the same period last year. Our overall gross profit percentage in the third quarter of 2017 was 23.3% compared to 26.7% in last year's third quarter.

In Diagnostic Services, revenue and gross profit percentage for the third quarter was $12.2 million and 21.2% compared to $12.1 million and 20.5% in last year's third quarter.

Our Mobile Healthcare business produce revenues in gross margin in the third quarter of 2017 of $10.5 million with the gross profit percentage of 13.8% compared to $11.8 million and 19% for the same period in the prior year.

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 2017 compared to the prior year from both new business and higher volume from existing customers with some offset on lower average price per day.

For Mobile Healthcare, the year-over-year revenue change was primarily result of lower provisional business, which we are addressing with the changes in management operations and sales that Matt discussed earlier.

In our Diagnostic Imaging business, revenue and gross profit percentages for the third quarter of 2017 was $3 million and 44.3% compared to $2.7 million and 43.5% in the prior year third quarter.

MDSS had revenue and gross profit percentage of $2.9 million and 44.1% in the third quarter of 2017, compared to $4.6 million and 52.9% for the same period in the prior year. In our Diagnostic Imaging business, the higher overall revenue and gross margin was impacted by the volume and mix of camera sold.

But overall the third quarter of 2017 was slightly lower than our expectations. We believe due in part to uncertainty around the Affordable Care Act. In MDSS, the change in revenue and gross profit percentage was mainly attributable to the timing and type of capital equipment sales with our partnership with Philips.

Though we are continuing our sales efforts for Philips branded products in the fourth quarter, we believe that are affected this maybe impacted based on the Philips terminations announcement.

Due to the terminations notice from Philips, we were required to conduct an impairment analysis for MDSS business unit as well as evaluate the carrying value by deferred tax assets related to our net operating losses.

Based on this analysis, we recorded $2.6 million goodwill impairment to the MDSS business unit in the third quarter and also recorded $6.4 million reserve to our deferred tax asset. The impact of these adjustments was eliminated from our adjusted net income and adjusted EBITDA for the quarter and year-to-date periods.

Moving on to the bottom line results for the third quarter, adjusted net income was $1.5 million or $0.07 adjusted earnings per share compared to adjust to net income of $1 million or $0.05 adjusted earnings per share in the third quarter of last year.

Adjusted EBITDA was $3 million for the third quarter of 2017 compared to $3.6 million in the third quarter of last year. As of September 30, 2017, the outstanding balance under credit facility was $18.5 million and overall net debt position including all cash and cash equivalents was $17.4 million.

On a go forward basis, we intend to sweep all available excess cash on a daily basis to minimize our overall interest expense. In addition at September 30, we were in compliance with all our bank covenants.

Further, we have discussed the impact of the Philips cancellation on our overall business with Comerica, our banking partner and the result of the conversation there were no concerns. We will obviously work closely with our partners at Comerica as we move forward. And finally today, we announced our regular quarterly cash given in $5.5 per share.

The dividend will be paid on November 30 to shareholders of record as of November 20. Now I'd like to turn the call over to the operator for questions..

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from the line of Andrew D'Silva with B. Riley. Please proceed with your question..

Good morning, guys. Thanks for taking my call. Just a couple, primarily going to be focusing on the Philips contract more than anything else. I was just first of all curious if you could maybe elaborate on some of the timing issues that happened there.

Initially I thought they had to give you 180-day warning before they drop coverage or drop the relationship.

And then I was also interested in out of that $3 million in sales that you mentioned that they generated through that contract do you think that aren’t going to be there any more, but how much of that hit the gross profit line?.

Hey Andy, this is Jeff. Good morning. So regarding the timing of the contract terminations, we had agreed with Philips to do a 90-day cancellation.

The timing of the cancellation at year end just made a lot of sense and ultimately that was the best move for both companies, so we obviously thought that that was the best move from an employee communication financial cutoff, so that's where we cut the contract off..

But there weren’t any covenants that were changed during 2017 where it went from 180 days down to 90 days as far as the mandatory timeline for the cutoffs there was nothing that changed?.

We had previously agreed with Philips to have a 90-day terminations period, so that's what did change..

So was there any sort of like footnote because I didn’t see anything about that anywhere..

At the end of the day, Andy, they gave us the termination notice, we work with them, and we agreed to cut it off at December 31 regardless of that period of time that was noticed. We felt that December 31 cutoff was the best time to cut the contract off, so that's what we concluded.

So regarding your gross profit question, I mean we did put information in the financial tables in the back of the earnings release.

So on a year-to-date basis for that product revenue; we gave $3 million that was the impact of the product sales commissions and install or warranty and the cost of revenue impact of that was about $1.1 million, $1.2 million, so the gross margin impact was roughly $1.9 million. Those details are in the back of our earnings release..

Okay. I did not see that, but I will look more closely.

And then as far as the part of the business that's remaining which is the post-warranty business, could you explain what the typical cycle works for just say an installation of equipment, how long it takes before it's off warranty goes on a post-warranty, and then how long equipment typically states post-warranty before they upgrade to new equipment, so that kind of give us a timeline of when we think things out in post-warranty might fall off?.

Yes. Andy, this is Matt.

Typically warranty will be one-year in duration and then typically the customer will go ahead and sign up a post-warranty contracts four to five years – and then they would typically renew that for potentially another three years, seven to eight years is about the time frame for this type of equipment before change out or upgrade or what not is what we're seeing on average for the different types of equipment that we would have on service warranty..

So should we assume that roughly one eighth of the business that is Philips related post-warranty should just start to fall off every year as we go forward?.

Not necessarily because we could continue to re-sign those customers up and provide post-warranty support service to them. We would be at that point – at that point be an independent sales service organization and as an independent service organization, we would provide a new post-warranty service contracts to those customers..

Okay. Got it.

And so what is Philips typical strategy in regions where they're not using a third-party for sales and like now that in the Upper Midwest they're going to be taking over a lot of their own sales and warranty because of this change with you guys typically what are they do for proposed warranty today utilize outside companies or do they discontinued to provide post-warranty services, but just not covered under their typical warranty?.

So typically outside of the relationship that they had with Digirad. They would provide their own internal service organization that would provide post-warranty support. One of those customers could choose to use another independent service organization in that area. They could go with a manufacturer or with a different service provider.

But they besides all regions, the entire country is covered by internal Philips resources providing post-warranty support contracts. With this change, now they will have the entire country covered with internal resources to provide post-warranty support to those customers using Philips equipment..

Okay. And this last question as far as the Mobile Healthcare side of the business.

Did any of the issues that happened in the beginning of the year and end of last year have any impact in your opinion on the Philips relationship maybe to change management or anything like that?.

No, they had no impact it all..

Okay. All right. Great. Thank you very much. Good luck going forward..

Thank you, Andy..

Thank you. Our next question is from the line of Larry Haimovitch with HMTC. Please go with your question..

Good morning, gentlemen..

Good morning, Larry..

So looking at the table you provided roughly $4 million of revenue for the nine months for Philips my math, my high powered math is so that's about $5.3 million on an annual basis that you now will not have going forward? Is that – have am I thinking about that correctly?.

Well, just to be clear Larry, I think you're looking at 2016 versus 2017..

Oh! Okay. It’s even less..

Yes, so it’s $3 million year-to-date 2017 which the majority of that’s product sales and commissions and there is a small install warranty. I mean clearly from in a go forward bases I mean this is a product sales business.

So it's just going to depend each year on theoretically how well we sold products on the forward impacts, but that's why we've given the reverse impact for close to see..

Okay.

So the $3 million business for new nine months or $4 million annualized will not be going forward into 2018?.

That correct..

Well, that even mystifies me more, because I thought it was even more then $4 million annualized that was thinking it was more like $6 or $7.

So that mystifies me even more your stock just has gotten absolutely destroyed after you made that announcement and I'm sitting here in amazement at people trashing your stock with what amounts to what $4 million on call yourself $110 million business roughly just to pick a around number.

That works out to be less than 4% and your stocks down 50% or whatever? Any explanation..

We certainly had a lot of calls there could have been a little confusion on the information of exactly when component of the business that was impacted I mean that's obviously why we're giving these details today..

Yes..

Certainly addressed a lot of calls over the last many weeks that we were waiting for the call today to provide the details in our earnings release and you guys are asking all the right questions on capital allocation I think there might have been concern that the dividend was not going to continue on but we absolutely plan to keep the dividend stable as we move forward.

So markets don't always work exactly dynamically with your result so we're a little surprised to Larry..

Jeff and Matt in retrospect do you think you might have positioned this news development in a different way, your 8-K that rather than press release that there wasn't a lot of information now the impact is even smaller than any of us spot.

So I think the stock acted badly in a time of great uncertainty when, oh my god maybe they lost 30%, 40% of their business, without people understanding that it's relatively unimportant. That's not zero, but it's relatively unimportant to you..

Well I think that there was – obviously the timing was not perfect. We realized with this notice written on the end of September, we realized that we had to – we had a call coming and we had to formulate all of the information and to be able to present it in such a way, could we have guided out sooner in retrospect we probably could have.

But we felt we want to do a thorough job, so that when we meet today with all the information we can deliver clearly the impact on the business on a go forward basis..

Okay.

Is there any other contract like Philips that you have any risk of losing? I don't think, so but I'm just checking to see there's anything else in the portfolio that you could find out some day, a vendor has – customer has terminated you and separate from all that the mobile contracts, which you have, something on the order of Philips is what I’m asking?.

Yes, there's nothing in particular, but I want to be careful, Larry. Read our risk factors in our 10-Qs and 10-K..

Sure..

We got larger customers that are out there. There's a variety of things that can impact our business, but there was no manufactures wrapper relationship like with Philips that's out there per share..

Okay, and then just to be sure I understood your comments during the prepared remarks, the Board considered a buyback, but the Board felt that keeping the dividend was the highest priority?.

That is correct..

Okay, great. Thanks guys. I'll jump back in queue..

Thank you..

Our next question comes from the line of [indiscernible]. Please proceed with your question..

Hi, thanks for taking my question.

Just a question about share buybacks, it’s like an opportunistic time to do some buybacks, could we possibly see some going forward and how does the Board feel in general about share buybacks versus dividends?.

Well, I'll say this, we do have a share buyback plan in place absolutely and we did that for a reason. But right now after careful consideration, we do feel like the dividend is the best use of our capital allocation.

So that we certainly consider it as I mentioned before, but we are sticking to the use of the dividend as a way to return shareholder value at this point..

All right, that was my only question. Thanks and I hope you enjoy your weekend..

All right. Thank you, Michael..

Our next question is from the line of Mitra Ramgopal with Sidoti & Company. Please proceed with your question..

Yes, good morning. Matt, first just a couple questions relating to the DMS acquisition, if you had to go back and as you look at mobile and medical equipment, was it a case where you're actually more attracted to mobile business.

But you had to kind of take the medical equipment as part of the package or that was a business you like to the standalone?.

Well, certainly it was one company that we purchased they had these two components. And as we look at that acquisition, we still continue look at the acquisition.

We feel this good acquisition and it’s an acquisition that had two components of service component and a products component, much like Digirad has a service component and a products component. So we look at it as one business.

We understood the risk with the Philips relationship, but we still felt like it was a – not a huge risk especially from the standpoint that we understood that if Philips did cancel, what we were still left with a service post want to support service business that we feel has value and we thought that was something to the risk was very small and if Philips did just continue the sales relationship.

So plus we also were able to get a very robust, Mobile Healthcare business along with that acquisitions. So certainly we feel really good about the acquisition. We continue to feel good despite this latest Philips cancellation..

Thanks. And I know you said you're evaluating options for the segment, but it seems like you are committed to looking to expand it geographically adding personal et cetera, if you can maybe pick up some incremental revenue that might not have been available before being tied to Philips..

That's correct. We're continuing to look at all avenues for sure and right now at this point we are committed to creating an independent service organization and going out and competing for new business and to continue to maintain the current contracts and provide service under those contracts.

So there's a lot of work, a lot of effort that will go into that. Going from a manufacturer who wrap into an independent service provider does require a lot of time, effort and resource and we are currently right in the middle of all of that at this point as we look to transition January 1..

Thanks. I was just wondering if you could comment generally in terms of what you're seeing regarding hospital volumes, obviously there is a lot of uncertainty out there in terms of ACA et cetera.

I don't know if you're seeing it having any impact on your business yet?.

Certainly is on the product business for sure, we are in the middle of it, especially as it relates to our clientele, our clientele are normally smaller type organizations and they seem to be feeling this impact fishy rural type hospitals that we work with or feeling the impact of the uncertainty of whether or not they will have funding on a go forward basis.

So certainly this is something that has impacted our product sales and that's what we’re seeing this impact generally. And we're hopeful though that we're in a period now where it seems like that period of unrest has left and we're assuming and we’re hoping that the next quarters will bode well for our product business.

I do want to make one comment you know obviously there's a lot of unrest in our product portion of our MDSS business segment those employees know that they contract with Philips ending December 31. We were counting on a good fourth quarter based on the pipeline of deals within the MDSS sales segment.

Obviously based on our revised forecasting guidance we feel like there will this disruption will cause issue and having the ability to close some of those deals outside the general uncertainty that the ACA brings about. So our forecast definitely reflects all of this..

Okay thanks. That's very helpful.

And Jeff is a quick question regarding the goodwill impairment is that pretty much behind you or do you anticipate any further write-down as we look into 4Q and even beyond?.

Well, I mean the process is based on looking at the for business and projecting our future value relating it back to the good well. So I mean if we feel like we've made a reasonable estimate and that impairment amounts. So I don't necessarily expect anything going forward.

So it's our best estimate of where we're at, I mean anything can happen for sure Mitra, but I think we're at the right number now..

Okay. Thanks again for taking the questions. End of Q&A.

Thank you. At this time, I'll turn the floor back to management for closing remarks..

Thanks. As always we appreciate all our shareholders and your continued feedback and support. We remain very excited about our business in Digirad’s future..

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