Greetings, ladies and gentlemen, and welcome to the Digirad Corporation Third Quarter 2020 Results Conference Call.

As a reminder, 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 and 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 these -- those reports and speak only as of the date of this call. The company undertakes no obligation to update these forward-looking statements.

In the earnings release today and in its comments, management makes references to both GAAP results as well as adjusted results. The adjusted results are non-GAAP and do not include nonrecurring charges. Also, adjusted EBITDA, which is a non-GAAP measure that further excludes depreciation, amortization, interest, taxes and stock-based compensation.

Finally, free cash flow, which is a non-GAAP measure, taking operating cash flow and subtracting cash paid for capital expenditures. Management believes the presentation of these non-GAAP measures, along with GAAP financial statements and reconciliations, provide a more thorough analysis of ongoing financial performance.

Investors can find a reconciliation of results on a GAAP versus non-GAAP basis in the earnings release. If you did not receive a copy of the press release and would like one, please contact Digirad at (858) 726-1600 after the call or its Investor Relations representative, Lena Cati of The Equity Group at (212) 836-9611.

Also this call is being broadcasted 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. It is now my pleasure to introduce Jeff Eberwein, Chairman of Digirad..

Thank you, operator. Good morning, and thank you all for joining us today for our third quarter 2020 results conference call. On the call with me today are Matt Molchan, our CEO; and David Noble, our Chief Operating and Chief Financial Officer. Our Q3 2020 operating and financial results continue to be impacted by the slowdown due to COVID-19.

Although doctor offices and hospitals started to return to normal operations in Q3, activity levels remained below normal in the quarter, causing our Healthcare division's revenue and gross profit to be lower than the prior year quarter.

Our Diagnostic Services business has begun to rebound, but our diagnostic imaging business has seen a slowdown in camera sales due to purchase delays related to capital funding decisions driven by the pandemic.

Our Building & Construction division has significant momentum as shown by Q3 revenue, increasing 70% versus the prior -- the previous quarter. KBS Builders, Inc., KBS, our modular building manufacturing business focused on the Northeast, increased production at its South Paris Maine plant in Q3 due to recently won commercial projects.

In addition, KBS recently reopened an ancillary building at its previously idle Oxford, Maine plant to manufacture wall panels for the New England market, creating a new business line for KBS. Because of the strong demand outlook for KBS, we're studying ways to increase our production capacity and are excited about the outlook for this business.

We continue to execute on our HoldCo growth strategy and value enhancement initiatives to maximize stockholder value. Our HoldCo structure allows division CEOs to focus on operations and organic growth, while HoldCo management focuses on corporate strategy and capital allocation.

In addition to looking for attractive bolt-on acquisitions for our existing operating businesses, we're also looking to create new business divisions in the future through the disciplined acquisition of businesses complementary to our HoldCo structure.

In addition, we recently announced the sale of DMS Health, which will substantially improve our balance sheet and better position us to fund high-return internal growth investments and pursue acquisitions. With that, I'll turn it over to our Healthcare CEO, Matt Molchan. Matt, please go ahead..

Thanks, Jeff. Revenue from our Healthcare division in Q3 2020 fell by 14.9% to $21.8 million over the same period in the prior year. This was due to a slowdown associated with the COVID-19 pandemic.

Although many doctor offices have reopened and many hospitals have started to, once again, perform nonemergency procedures, overall activity remains below pre-COVID-19 levels.

And as a result, gross profit for the Q3 2020 reporting period decreased by 24% over the same period last year due to these lower activity levels that led to lower overall revenue and lower overall volume in the quarter.

In Diagnostic Services, revenue and gross margin percentage for the third quarter of 2020 was $10.7 million and 19.4% compared to $11.7 million and 18.5% in last year's third quarter.

The decrease in Diagnostic Services revenue compared to the prior year was primarily due to a decrease in testing days and scans resulting from the impact of the COVID-19 pandemic. The increase in Diagnostic Services gross margin percentage was due to lower health care expenses and improved labor efficiency during the Q3 2020 reporting period.

In addition, we want to point out that the non-GAAP adjusted EBITDA for Diagnostic Services increased from $1.674 million to $1.736 million in the quarter compared to last year's third quarter. This is mainly attributed to a tight control of our operating expenses during the 2020 quarter.

Our Mobile Healthcare business produced revenue and gross margin in the third quarter of $9 million and 12.8%, respectively, compared to $10.6 million and 13.6%, respectively, for the same period in the prior year.

The quarter-over-quarter revenue and gross profit decreases in the Mobile Healthcare business was primarily due to a slowdown in overall volume due to the COVID-19 pandemic and the associated public health measures that our customers have put in place.

In our Diagnostic Imaging business, revenue and gross margin for the third quarter of 2020 was $2 million and 19.5%, respectively, compared to $3.4 million and 35%, respectively, in the prior year third quarter.

The decrease in Diagnostic Imaging revenue and gross margin was due to the slowdown of camera sales associated with the capital funding delays and uncertainty because of the COVID-19 pandemic. Now I'm going to turn the call over to Dave Noble, our CEO and our CFO, who will provide additional financial highlights for the third quarter.

Dave, please go ahead..

Thanks, Matt, and good morning. Third quarter 2020 Building & Construction division revenue and gross margin were $8.5 million and 14.7%, respectively, compared to $2.7 million and 17.5% in the prior year third quarter.

Much of this increase in revenue was due to our ownership of the business for the full third quarter this year compared to just 20 days in the same period last year.

However, we did experience a significant increase in KBS activity levels, as Jeff mentioned, and $2.2 million of the third quarter revenue, or almost 25%, came from 2 recently won commercial projects in the Boston area. For Q3 2020, SG&A increased by 12.5% company-wide compared to Q3 2019.

Again, this was due to the reporting of a full quarter of Building & Construction expenses in the 3 months ended September 30, 2020, compared to just the 20 days of expenses that were recognized in the same period last year as the acquisition closed on September 10, 2019.

Moving on to company-wide bottom line results for the third quarter of 2020, we had a net loss from continuing operations of $1.8 million compared to a net loss from continuing operations of $1.5 million in the same period in 2019.

Non-GAAP adjusted net loss from continuing operations in the third quarter of 2020 was $0.9 million or $0.19 a share compared to an adjusted net income of $14,000 or $0.01 of share in the third quarter of last year.

As a reminder, in Q2, we completed a public offering through the issuance of 2.45 million shares of common stock, which includes the exercise of the over-allotment option, raising $5.5 million before fees and expenses.

Concurrently, we issued warrants to purchase up to an additional 1,112,500 shares, and some of these warrants have already been exercised. Therefore, per share amounts for the Q3 2020 period reflect a new share count of 4.8 million.

Non-GAAP adjusted EBITDA decreased to $1.1 million for the third quarter of 2020 compared to $2.0 million in the third quarter last year, and this was driven by the decrease in revenue and gross profit resulting from the COVID-19 pandemic.

For the third quarter of 2020, we registered an operating cash outflow of $1.9 million and a free cash outflow of $2.2 million compared to an operating cash flow -- outflow of $1.1 million and a free cash inflow of $365,000 in the third quarter of last year.

The main driver of this outflow was a onetime injection of cash into working capital at KBS to support higher production levels as that business grows steadily.

As of September 30, 2020, the outstanding balance on our credit facilities was $23.3 million, and this includes $6.6 million in PPP funds, which we fully anticipate will be completely forgiven in the coming months. Our overall net debt position, including around $4 million in cash and cash equivalents, was $18.9 million at the end of the quarter.

In addition to obtaining forgiveness on the $6.6 million of PPP loans in the coming months, we will also use some of the proceeds from the sale of our DMS business to further pay down debt in early January. Now I'd like to turn the call over to the operator for any questions.

Operator?.

[Operator Instructions] And our first question is from Theodore O'Neill with Litchfield Hills..

Jeff, I asked about this on the last call about whether you're seeing any lumber prices going up. And I ask this again because where I live, here, we're still seeing construction activity that's like we've never seen before. So I'm wondering if you could comment on that.

And also, now that you've opened up the Oxford, Maine plant, can you talk about capacity utilization? And were you -- and if you're at 100% or headed there? Give us some characterization on that..

Jeff, I asked about this on the last call about whether you're seeing any lumber prices going up. And I ask this again because where I live, here, we're still seeing construction activity that's like we've never seen before. So I'm wondering if you could comment on that.

And also, now that you've opened up the Oxford, Maine plant, can you talk about capacity utilization? And were you -- and if you're at 100% or headed there? Give us some characterization on that..

Sure. So lumber prices, as most people know, it can be very volatile.

And we had an incredible spike this year where I was just looking at it earlier day, I think the year started at around $400 in the futures market and got down to $250 in the depths of the COVID sell-off and then went above $1,000 towards the end of the summer and has more recently settled into the $500, $600 range.

So it is hard to manage a business and have smooth profits when there's so much volatility in the input. And I think I mentioned last time that with the proceeds of the equity offering, we did pre-buy quite a bit of materials for the large commercial construction projects that we had won.

We didn't buy 100% of the materials that we needed for the whole rest of the year, and we are increasing prices. So I guess, in short, what we've seen is that lumber prices have settled back down to a more reasonable range, and we have been increasing prices.

So margins improve with a lag has been our experience in prior periods where you have such a big spike in input prices. And then on our capacity utilization, I guess there are several ways to look at it.

Our South Paris plant right now is pretty fully utilized and the Oxford plant has several buildings on it, and we opened up an ancillary building to produce wall panels.

And we are studying ways to be able to increase our output, and we have a goal of being able to go from 10 boxes a week, which is 500 boxes a year, to -- first step would be to get to 15 boxes a week and then as our backlog and sales pipeline continue to grow, we'd, ultimately, like to go to 20 plus.

But we're studying various ways to increase that capacity, and it could be expanding the South Paris plant or it could be fully reopening the Oxford plant or both of those things..

And our next question is from Tate Sullivan with Maxim Group..

If I can just tail on that lumber question as well, too. For the gross profit margin in Building & Construction, understanding the 15% gross profit margin in 3Q '20 was indicated by lumber.

But can you talk about -- I mean, consistent lumber prices and sales price visibility, where you would like that gross profit margin to be longer term, please?.

Yes, above 20% certainly. And we think we'll get there in a normal lumber price environment. I think we'd get there fairly quickly..

Okay. Great. And then post the DMS sale as well, and I think it has a higher capital required business. But could you decline overhead expenses as well in $5.6 million in the quarter for overhead expenses.

Is that a run rate? Or did that include some expenses that we should not model going forward?.

Yes, Dave, do you want to start with that?.

Yes. I have to look at that number. I don't know what number you're pulling from. But to answer the first question, we will be cutting some of our overhead expenses with the sale of that business. There'll be Day 1, some expenses that actually go with that business. And then some of the remaining expenses will cut in ensuing months.

We will be reducing a couple of headcount in some of the corporate areas. But there'll be significant savings on overhead along with the sale of that business..

Okay. And you've commented on cameras, camera decisions from hospitals getting too late.

Can you just remind us -- I mean, a rough average price of each camera sale?.

Yes. Yes, this was Dave, but I'll turn that over to Matt..

Yes. So our ASP across the different varieties of cameras that we sell is around the 225 to 235, $225,000 to $235,000..

And then my last one to, post the DMS sale, to Jeff, if I may.

I mean -- and with the PPP forgiveness, how much cash will you like to hold on to have more flexibility for acquisitions or you pay down debt and use debt capacity? Or can you just talk about that strategy going forward?.

Sure. The sale of DMS will substantially improve our liquidity and financial flexibility to pursue acquisitions. So on Day 1, we will pay down a lot of debt, but the vision -- and we'll have more cash than debt after that transaction closes and so we'll be in a net cash position.

But that will give us more firepower and more credibility to pursue acquisitions because we'll be able to close on things and not have to raise any capital or have any funding contingency when we're talking to potential acquisition candidates.

And we're looking at, as we've talked about before, bolt-on acquisitions for the Building & Construction business and also bolt-ons for the Healthcare business. And then we'll also start to look at potential new legs to the stool.

But we've been very internally focused for the last 12 to 18 months, just executing the merger and improving the operations in the Building & Construction side, improving sales, and that is well underway.

We certainly have more work to do, and we see a lot more upside just from our organic initiatives, but that asset sale, closing the sale of DMS is really going to be a game changer for us in terms of our ability to start to be outward looking and look for other ways to grow the company..

Our next question is from Jeff Kobylarz with Diamond Bridge Capital..

Just wanted to drill down a little bit more into the gross margin in the Building segment. So the gross margin in the second quarter was 21%, and the third quarter was below 15%.

So was that all lumber? Or were there other issues that drove the gross margin down?.

You want to take that?.

Yes. I would just say, I'll turn this over to Dave, but the 2 quick bullet points are input prices rose massively in a short period of time and although we are increasing prices, it just takes a while to pass that along. Ultimately, it does get passed along, but that takes a while.

And then another thing is that we significantly increased our workforce, particularly at KBS. And it just takes a while to get the efficiencies and have a super-efficient, well-oiled production line..

And I would just say, just to add a little more color. I mean when you think about the different businesses within Building & Construction, the modular business, we price projects with a gross margin target, but that presupposes a certain utilization of the plant.

And we achieved that level of utilization in the third quarter, so we're achieving those margins. In other words, we might quote something at a 20%, 25% gross margin, but that assumes the plant is operating at 8 to 10 units a week. So if we're operating in half that, obviously, we're not going to hit that margin.

But I will say we are hitting the margins that we're targeting for the third quarter as activities really expanded in that plant. The other piece of the business out in the Midwest, we have 2 parts to that business.

We have a retail business where we can actually raise prices on the retail product multiple times a week, if we have to, to maintain those margins, and we do, do that. But then we also have a wall panel business out there where you might quote a project in June and produce it in November.

And so if material skyrocket, as they did this past year, then that project is not going to be terribly profitable. We do attempt to have a fixed shelf life for those quotes, and we try to pass on some of that increase, but suffice it to say, there are some projects that we're not making money on in the last few months in that business.

Having said that, lumber prices have come down quite a bit since mid-September, and we're buying lumber for some of the projects that were -- that we've won and that are in our backlog, and those projects will restore target gross margins to where we want them to be..

Yes, I would just say -- this is Jeff. The strongest thing I'd say about that is we see continued strong revenue growth in that segment, and we see gross margins above 20%..

Okay. Great. Yes, I just was curious also if you can comment about the pipeline, it sounds like you're looking to expand.

So is there any big picture number? You've quoted $50 million in the past of a pipeline of orders you're evaluating, bidding on? Any comment you can make on top data?.

That pipeline has remained pretty static, but we're producing at a pretty good rate. So we're definitely refilling that pipeline. And I think -- we have a number of large projects in that pipeline that we think we will close.

Our weighted pipeline, and that is, if we weight it according to the probability that we think -- that each salesperson associates with their various leads is about $15 million. And that number has been creeping up.

So I think that we're seeing -- we're starting to see some acceleration anecdotally on the KBS side, we're getting looks at projects that, 6 months ago, we would never get a look at. And so I -- we feel that we're sort of on the cusp of bringing that business to the next level. And we're executing on the 2 large projects that we announced in June.

One of them is completely built, the other one, we're in the midst of Phase II, and we've just won a Phase III as we put out in our press releases. So we're very optimistic about that pipeline and the growth in that pipeline..

And one thing I would -- this is Jeff, I would just add to that, that we think is very, very positive. When we first started talking about those projects, and we -- the very first time we mentioned having a sales pipeline of $50 million, it included those commercial projects. So the one in Natick, Massachusetts was $6.7 million.

The other one, the veterans housing one was around $2 million. So you add that together, and that's almost $9 million of projects. And so once we win something, it actually disappears from our backlog because it goes into production.

And if we've replaced that with new projects that we're bidding on and the weighted average, so probability to adjusting for it, our pipeline hasn't declined, which is a pretty strong statement, given that we took $9 million out and is being produced and replaced it.

So all that said another way, I mean, the factory is sold out for the rest of this year and is getting pretty fully sold out for Q1. We still have some slots left, and we're starting to book things for April production.

And our experience with this business, over several years, we haven't seen that before because Q1, typically, is the slowest period of the year by far, given that our manufacturing operations are in Maine, and there's virtually -- there's very little residential construction in the Northeast in Q1..

Okay. So yes, I was going to ask that question, too, about seasonality, just so we can understand what to expect as far as the seasonality in the New England area.

So are you saying that there won't be a seasonal decline from the third quarter run rate?.

Not near, if there is, it's not nearly like previous years..

And the commercial -- getting into the commercial space has really helped us with that seasonality. For example, we won -- we put this in a press release, a third phase to the Tachi [ph] project in Natick, Massachusetts. That third phase will be produced during the month of January.

So that's a typically slow month, as Jeff says, on the residential side. We pretty much filled every production slot with boxes that are going to that project in Natick for that month..

Okay. All right. And as far as the EBITDA margin in the Building segment, it dropped down to 2% in this third quarter because of the volatility you said of the inputs. And the second quarter EBITDA margin was 14% on the lower -- on just $5 million of revenue.

Is there any kind of big picture range of EBITDA you can share with us that we could expect?.

Well, there's probably some timing elements to that, but we think, on an annualized basis, if we can keep between 20% and 25% gross margins, our EBITDA margin should be 10% plus..

Yes. 10% to 15%, I think, is a good range. And yes, it'll be volatile quarter-to-quarter, depending on raw material prices and just the mix, the product mix of what we happen to be producing in that particular quarter. And as you pointed out, there is some seasonality.

But over time, we think it's a business that should do in the 10% to 15% range in terms of EBITDA margin..

[Operator Instructions] And our next question is from Al Hill [ph], a private investor..

Today, after the sale of DMS, what is the book value per share of the company? I can't find any data on that..

We don't have that exact number in our financial statements. So I'm just looking at our balance sheet right now. So at the end of September, our book value was $19.1 million, and we had about $4.7 million of shares outstanding. And at the end of the year, we'll still have the DMS business because the target is to close it in January.

But I would just say the selling price is above book value. So it will be accretive to book value per share when we sell that business..

Okay.

And we'll have that in January?.

Well, we'll complete the sale in January. I'm not sure exactly what we'll publish in terms of financials. The latest you would see that is on our Q1 financials, you'll see what the new book value is post the sale of that business..

So just today, I'm just doing some rough math in my head.

So that's basically somewhere near $4 to $5 a share common stock book value as of today?.

That's right..

[Operator Instructions] And we have reached the end of our question-and-answer session. And I'll now turn the call over to Jeff Eberwein for closing remarks..

Well, thanks, again, operator. And I'd just like to note that Dave, Matt and I are always available to take your calls and discuss any questions you might have. So please don't hesitate to contact us. We're going to continue to share our story with existing and potential investors in the coming weeks and months.

We're very excited about our future and very excited to tell our story. We're scheduled to present at two conferences next week, one is the Craig-Hallum Conference on November 17, and the second one is the Benchmark Conference on November 18.

As always, we appreciate all of our stockholders and your continued feedback and support So thank you very much for your time today..

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation..