Marisa Lindsay - Matthew G. Molchan - Chief Executive Officer, President and Director Jeffry R. Keyes - Chief Financial Officer and Corporate Secretary.

Larry Haimovitch - Haimovitch Medical Technology Consultants Carlo Cannell Keith Hinton - Sidoti & Company, Inc. William John Nasgovitz - Heartland Advisors, Inc..

Greetings, and welcome to the Digirad 2014 Third Quarter and 9-Month Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Risa Lindsay of Digirad Corporation. Thank you. You may begin..

Thank you, Jessie, and thank you, all, very much for joining us this morning. If you didn't receive a copy of our release and would like one, please contact our office at (858) 726-1600 after the call, and we'd be happy to get you one. Also, this call is being broadcast live over the web and may be accessed at Digirad's website at www.digirad.com.

Shortly after the call, a replay will also be available on the company's website. I'd 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 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. For more information about the risks and uncertainties is available at the company's -- 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 the yesterday's press release.

The information discussed on this morning's conference call should be used in conjunction with the consolidated statements and notes 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 2014 third quarter 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..

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 an as-needed, when-needed and where-needed basis; area number two, adding new services to our portfolio that we can provide to our current distribution channels; and finally, area number three, organic growth within our existing portfolio of services and channels.

We continue to review a variety of potential acquisitions, looking for the right opportunities that fit both operationally and financially for Digirad and its shareholders.

As we've said before, when we find ones that fit our goal of providing health care services on an as-needed, when-needed and where-needed basis and fit to the strict financial metrics that we have established, we will move forward. Before I turn the call over to Jeff, I'd like to note 2 other important items covered in our press release yesterday.

First, we reaffirmed our 2014 financial guidance at the top end of the ranges we previously provided during our second quarter release, and Jeff will go into more detail shortly. Second, as you probably saw over the past few days, we've issued open letters to PDI, Inc., a provider of health care services.

The letters express our clear interest in acquiring all the outstanding shares of PDI via a merger. As you know, Digirad takes pride in providing health care services on an as-needed, where-need and when-needed basis, and we feel that PDI fits within the strategy.

We've always been clear that we have been looking for acquisitions that can add services to our new -- to our portfolio of services will be a good value to our shareholders, be accretive to earnings per share and be accretive the overall cash flow. We believe that an acquisition of PDI at the right price will meet all of these criteria.

From what we can tell, based on publicly available information, we believe we can offer significant synergies, including eliminating duplicative cost of running a public company, back-office G&A as well as introduce our overall leaner operating style.

This is why we'd like to immediately begin deeper conversations with PDI to determine what further savings and synergies can be derived from a combination of the 2 businesses. However, as this is an ongoing process, we're limited on this call in terms of how much detail we can disclose.

But you should expect us to have more to say about this opportunity in the future. With that, I'd like to now turn the call over to Jeff.

Jeff? Jeff?.

Thanks, Matt. Good morning, everyone. In the earnings release 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'll make references to adjusted EBITDA, which is also a non-GAAP measure that further excludes stock-based compensation. We feel 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 reconciliations of our GAAP versus non-GAAP results in our earnings release. I'll start with a brief summary of the quarter's activity. As Matt noted, total revenue for the third quarter of 2014 was $13.9 million compared to $12.4 million for the same period last year.

Revenues for Diagnostic Services, which include our recent Telerhythmics acquisition, were $10.8 million compared to $9.5 million for the third quarter of last year. Diagnostic Imaging revenue was $3.1 million for the third quarter of 2014 compared to $2.9 million in the third quarter last year.

Our overall gross profit percentage in the third quarter of 2014 was 31.8%, up from 30.8% in last year's third quarter. In Diagnostic Services, the gross profit percentage for the third quarter of 2014 was 25.5% compared to 27.1% in last year's third quarter.

In the Diagnostic Imaging business, the gross margin percentage in 2014 third quarter was 54% compared to 42.6% in the prior year third quarter. Overall, the gross profit percentage in Diagnostic Services businesses was impacted by planned integration efforts of our Telerhythmics business.

In Diagnostic Imaging, we enjoyed year-over-year margin expansion based on reduced manufacturing costs, plus the benefit of some previously reserved inventory being released. At the end of September, cash and cash equivalents and available-for-sale securities totaled $21.8 million, an increase of about $400,000 from our June 30 balance.

During the quarter, the business produced a good amount of cash for which we returned some of that cash to our shareholders and also invested in our business. We continue to have plenty of cash to deploy our strategic plan and make strategic acquisitions in a financially disciplined manner, as well as fund our regular quarterly dividend.

Moving on to bottom line results for the third quarter. Adjusted net income was $1.2 million or $0.06 per diluted share compared to an adjusted income of $1.1 million or $0.06 per diluted share in the prior year quarter.

Our year-over-year results reflected our recent investment in additional sales and marketing efforts in both businesses as we continue to drive efforts for growth in the future as well as our integration plan for Telerhythmics.

Adjusted EBITDA, another GAAP measure -- another non-GAAP measure we utilized to monitor performance, so to $1.7 million for the third quarter 2014 compared to an adjusted EBITDA of $1.5 million for the same prior -- same period in the prior year.

As we released yesterday and Matt mentioned earlier, we are reaffirming our 2014 financial guidance at the top end of our previously announced ranges. Overall, in 2014, revenue will be right around $55 million, non-GAAP adjusted diluted earnings per share will be around $0.15 per share and non-GAAP adjusted EBITDA will be around $5 million.

The company's non-GAAP financial guidance for adjusted diluting earnings per share excludes restructuring charges, acquired intangible asset amortization and related tax impacts and further, in the case of EBITDA stock-based compensation expense.

Finally, we announced yesterday our regular quarterly cash dividend of $0.05 per share payable November 24 to shareholders of record of November 12. Now I'll turn the call back over to Matt.

Matt?.

Thanks, Jeff. I'd like to close by saying we believe we continue to be on the right track for growth, and we are excited about our future, particularly as we move forward into 2015, which we expect to be a record year for profit.

We continue to believe that the trends in the health care market are moving toward our business models, which we -- which accentuates efficiency and value-added services. Our mission to provide health care services and technology on an as-needed, when-needed and where-needed basis has never been more timely or more well received in the marketplace.

Now I'd like to turn the call over to the operator for questions..

[Operator Instructions] Our first question is coming from the line of Larry Haimovitch with HMTC..

I'm very new to the story, although I had a history following Digirad for some time, relatively new to owning the stock. My question is this.

Regarding PDI, I realized you may not be able to say a lot about the current situation because of legal reasons, et cetera, recognizing that you guys have done a tremendous job since you got involved with Digirad and you changed the whole company in such a positive way, it's very impressive, I just wonder, when you think about acquiring PDI, it's several times the size of Digirad, does that give you any pause for concern? Does the management team have the bandwidth to take on an acquisition of a company of such a large size relative to your size?.

Well, thank you. First off, thank you, Larry, for your comments and, obviously, for being in our stock. But to answer your question, we looked at this opportunity. We looked at the skill set of -- that we have on our management team. We feel that we have the skill set on our team to handle and to run a company of a much larger size.

That's why we are actively looking for acquisition opportunities.

We feel that given our top line and our organization that we have put together, very confident that we can move forward, not only with the continued success of our current Digirad business, but additionally, with some strategic opportunities that we see with the combination of Digirad and PDI..

How do you propose to finance this acquisition if, in fact, you were able to get PDI to the table? Have you given any indication at all about that? Or it's not appropriate to discuss at this point..

We've announced that we'd likely fund this transaction with a combination of stock and cash. But once we've had a chance to talk to the management team, obviously, we'll have a more precise information on what that split would look like..

And then finally, have you proposed a purchase price yet? I don't know if I've seen an actual purchase price that you propose yet for this acquisition..

No, we have not..

Our next question is coming from the line of Carlo Cannell with Cannell Capital..

Can you tell me what do you estimate the run rate of Telerhythmics might be if it was running on all cylinders? Effective maxed out utilization of the existing infrastructure, call it, 95% or whatever is relevant.

What do you think that this business could do?.

Well, first off, thank you, Carlo. We're very excited about the opportunity of Telerhythmics.

We feel that from a synergistic standpoint, from a strategic standpoint, we have many opportunities given that the majority of our traditional Digirad customer base is cardiologists and the very fact that, on average, 95% of all cardiologists in the United States outsource their event monitoring service to companies such as Telerhythmics.

So we're very excited about the opportunity there. But we -- as we've publicly stated, as part of this acquisition and as we continue to integrate Telerhythmics into Digirad and we look at the cross-selling opportunities, as we think through and as we talk to our physician customers about the potentials, we're still very excited.

But we're still guiding towards the EBITDA numbers that we talked about that will begin in the second year of our acquisitions as we talked about our expectations for Telerhythmics on the EBITDA side and -- is around $500,000 in EBITDA.

Jeff, can you confirm that for me?.

What year? You're talking about next year?.

Correct..

Okay.

and that's without any entering any new markets, correct?.

It would be -- that is a correct -- that's a correct statement..

Okay.

And the total consideration, can you remind me, for Telerhythmics?.

I'm sorry.

Jeff, can you go ahead and just make sure that I made the right number there? Was it $500,000 or $750,000?.

Yes, no problem. Let's define the time periods because we kind of went from time periods that were a little bit different than calendar time periods. So we acquired Telerhythmics kind of late mid-March 2013. We've stated publicly that -- in the first year, that we can produce EBITDA around the $350,000 mark.

And so as you move into year 2, which would be March, April, year 2 going into the second year, so 2015 into 2016, that would be around the $800,000 mark. So Matt was kind of combining those 2 numbers as kind of expectations as you merge into that around the $500,000 mark.

So as you look at Telerhythmics and what we paid, we paid around $3.4 million in cash for the business. There is an earn-out opportunity for the owners that we achieve certain EBITDA metrics as we move forward by 3 years..

Okay. What I really want is to know what you could produce in 2017, I'm sure you would like to know the answer to that question as well, but I'll let that rest for now. Second question, what do you think your cost of debt would be right now? I know that debt has not been on your mind for some time.

But if you were going to go to a lender, what do you think the cost would be? What do you think the coupon would be?.

Jeff, why don't you take that one?.

So I think it's probably too early to say. I mean, I -- there's definitely preferential rates going on in the market right now, but I think it's fundamentally going to come down to Digirad and our financial strength.

I mean, I personally think, based on the last couple of years of our operating activity, that we could get some reasonably favorable rates, but I think it's kind of too early to say on that.

And then just kind of reaching out a little further, if you're anticipating something like this relative to a larger acquisition, I guess we would just have to see how we would go through and fund that. For example, the PDI acquisition, we proposed publicly that it would be a split between stock and cash.

We don't necessarily think that we would need that for that transaction. But having said that, if we were to go after for debt, I think we would get reasonably favorable rates compared to market right now..

And is there unanimity? Is there consensus in the board that issuing stock at this price is the best interest of shareholders? I mean, I don't know why you would issue stock if you could borrow at -- I'm just guessing you could borrow at 3% to 4%..

I mean, at this point, Carlo, there -- it's still preliminary in terms of financing of a larger acquisition, that we still have a long way to go..

Right, yes. Well, be that as it may, I applaud the acquisition you made, the Telerhythmics acquisition. It's too early probably to tell whether that was a triple, but it sounds like it's certainly a single or double. And I applaud the board's letter to PDI. Good luck to you. Good luck to us..

Thank you very much, Carlo..

The next question is coming from the line of Keith Hinton with Sidoti & Company..

I have a couple questions here, so I'll just jump right in. This one, Jeff could probably handle. But the gross margin in the Imaging segment obviously jumped up quite a bit. I'm curious as to whether we think of that as more of a one-off from some inventory burn-off or if that's a sign of things to come in the segment..

Jeff, why don't you go ahead and speak to that?.

Sure. So I mean, certainly, the year-over-year difference there, Keith, a decent portion of that has to do with inventory that's being released that was previously reserved. But outside of that, we actually are seeing margin expansion on our Diagnostic Imaging business as we move forward. And this all relates to a couple key things.

The first item is the fact that we just -- we've outsourced the manufacturing process, the majority of the manufacturing process for our cameras. And that's starting to kind of flow through our operations as we've sold through a good chunk of our older inventory, and so we're starting to see some of that price savings come through in our margin.

And then second, the infrastructure that we had in Poway, California, in the old facility, certainly burned down some of the manufacturing costs. And as you guys know, that we've restructured and moved out that facility into a smaller facility, and so we're starting to see some of those cost-savings flow through as well.

So 54%, I would say that's probably a little high expectation as we move forward. But higher than 42.6% that we had in the prior year? Absolutely. I think we're trending higher just based on the cost savings.

So we're going to keep marching forward and look for those cost savings, and you should see it come through in our margin for Diagnostic Imaging..

Okay. The -- that sort of leads me into my next question here. The guidance for the fourth quarter comes out to about 8% year-over-year growth in the revenue if you're looking at the top -- or at the top of the guidance. But the top of the guidance, in terms of adjusted EPS, is only looking for about $0.01.

I'm curious as to whether there's some kind of big margin contraction that we're expecting there. I'm just a little curious about why we're not seeing that revenue gain translating to the bottom line in terms of the guidance..

Well, let me comment first. Jeff, you can add on. But obviously, our hope and our goal is to beat guidance and even beat the higher end of our guidance. And -- but having said that, the fourth quarter, as we look at our business, it is a business of seasonality.

It is a business of -- when holidays hit and our mobile vans are unable to go out to certain locations in November and December, we traditionally experience our fourth quarter to be not as successful as our second and third quarter. That's just part of the seasonality of our business.

But having said that though, we -- so we have to take that into account as we look at our projections. But before I let Jeff add on anything, I also say this is really our second time issuing guidance.

We want to make sure that we are -- we positively hit or exceed what we're putting out there on a first time basis, and that also is a factor in where we are.

But we do have to kind of, I guess, conservatively say that the fourth quarter, though, is, because of holidays and whatnot, we anticipate that to be not as successful as our second and third quarter.

Jeff, you want to add anything to that?.

No, I think that basically sums it up. Beyond the fact that, Keith, I look at the high end -- when I say the high end of the range, high end could be slightly below the top end of the range, at the top end of the range or slightly above the top end of the range. That's kind of how I look at the high end of the range..

Okay. The last question I had and we've obviously discussed this a little bit on the call so far. But in terms of PDI, Inc., I'm curious as to whether you can speak at all to what it is that attracted you to the particular company and what synergies you're looking to leverage.

Because I sort of compare that one to the Telerhythmics acquisition and the Telerhythmics acquisition, there was clear customer synergies in terms of your looking to take new products through the same channels.

But PDI, Inc., I'm just curious as to what sort of synergies it is that you're looking at that makes you think that kind of acquisition could be accretive..

Well, clearly, the combination of 2 public companies and the synergies that you can gain from some savings there is one thing. But in terms of the strategic synergies, they're in health care services business. They are dealing with physicians across a wide variety of specialties. Some of those are areas that we're very interested in.

They're also interested in diagnostics, which is another area that we are obviously, involved in as well. So we look at it that there is a strategic fit.

It might not be as, I guess, intuitive to see as the Telerhythmics combination was, but we certainly, from our management viewpoint, feel that there's plenty of synergistic opportunities that we can take advantage of with a health care services business such as PDI..

[Operator Instructions] Our next question is coming from the line of Bill Nasgovitz with Heartland Funds..

Say, on this PDI situation, boy, turnarounds are tough for anybody and you might be very good at it and you have proven that, however, taking on debt on top of a turnaround, I think, is doubly difficult. I, for one, as long-term shareholders in DRAD here, I would -- I'm surprised that you are even thinking about this.

But I, for one, would love to see you remain focused on your core competencies and stay away from the debt markets, plus don't dilute us at this level..

Okay. Thank you, Bill..

It appears we have no other questions at this time. I would now like to turn the floor back over to management for any additional concluding comments..

Thank you very much. Before we close today's conference call, I want to thank all of the stockholders and other interested parties who joined us this morning and express our appreciation for your continued interest and support. Jeff and I look forward to speaking with you again when we report our year-end results.

Operator, that concludes today's conference call. Thank you..

Ladies and gentlemen, we thank you for your participation, and you may disconnect your lines at this time..