Star Equity Holdings Inc (STRR) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Digirad Corporation Third Quarter 2017 Results Conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the call over to Rica Lindsey. 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 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, 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 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, and thank you, Rica. 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 in leadership operations and by adding additional resources to our provisional sales efforts.

Though mobile healthcare is still performing lower than last year, they are building their pipeline of deals back up and are 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. Though we have seen this slower capital spend, we believe that the backlog of potential deals will continue to build, and when things ease up, we should be in a good position to capitalize on those sales. Since a revised bill related to the Affordable Care Act has now failed twice, we are optimistic that there might be an easing on this topic, and we might see some higher capital sales soon.

As we announced on October 4th, Philips Healthcare informed us on September 28th 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 was 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, product 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 of the Philips cancellation, after December 31, 2017, we will no longer have revenues from product sales, installation, or warranty revenue. 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 businesses 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 in the 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 product sales have not contributed much to the bottom line this year, both for the third quarter or 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 costs related to these 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 forward strategy with the 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 this revenue and contribution to the bottom line. The loss of the Philips contract has always been a risk to our business, and this risk included this potential impact. With the loss of this business, it is clear that it will impact our bottom line in the long-term despite the 2017 performance.

Based on the timing, we don't have an immediate replacement of 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. We 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'll continue to look for opportunities that will contribute to our bottom line and enhance shareholder value.

Based on the recent events and our stock price, we have also considered and evaluated our capital allocation. Of our original authorization of $12 million, we currently have available approximately $6.3 million under our Board-approved share buyback program. We'll 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've released today and 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-tiered 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 an as-needed, when-needed, and where-needed basis in a very financially disciplined 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 and 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 paid for capital expenditures. We believe the presentation of these non-GAAP measures, along with our GAAP financial statements and 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 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 produced revenues and gross margin in the third quarter of 2017 of $10.5 million, with a 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 a result of lower provisional business, which we are addressing with the changes in management and operations 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 cameras sold, but overall, the third quarter 2017 was slightly lower than our expectations, we believe due in part to uncertainty around the Affordable Care Act. At MDSS, the change in revenue and gross profit percentage is 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 our effectiveness may be impacted based on the Philips termination announcement.

Due to the termination notice from Philips, we were required to conduct an impairment analysis for our MDSS business unit, as well as evaluate the carrying value of our deferred tax assets related to our net operating losses. Based on this analysis, we recorded a $2.6 million goodwill impairment to the MDSS business unit in the third quarter, and also recorded a $6.4 million reserve to our deferred tax assets. 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 adjusted 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 on our 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 30th, 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 dividend of $0.055 per share. The dividend will be paid on November 30th to shareholders of record as of November 20th.

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

Thank you. (Operator Instructions). Andrew D'Silva with B. Riley.

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 dropped coverage, or dropped 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 or the things that aren't going to be there anymore, about how much of that hit the gross profit line?

This is Jeff. So regarding the timing of the contract termination, 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 cutoff? There's nothing that changed?

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

So was there any sort of footnote? Because I didn't see anything about that anywhere.

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

So regarding your gross profit question, we did put information in the financial tables in the back of the earnings release. So on a year-to-date basis, for the product revenue, we gave $3 million. That was the impact of the product sales commissions and install and 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. And those details are in the back of our earnings release.

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 off-warranty goes on a post-warranty, then how long equipment typically stays post-warranty before they upgrade to new equipment? So that kind of give us a timeline of when we think things on post-warranty might fall off.

This is Matt. Typically, a warranty will be one year in duration, and then, typically, a customer will go ahead and sign up a post-warranty contract four to five years in length, and then they would typically renew that for potentially another three years. Seven to eight years is about the timeframe for this type of equipment before change-out or upgrade, or whatnot, 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 at that point be an independent service organization, and as an independent service organization, we would provide new post-warranty service contracts to those customers.

What is Philips' typical strategy in regions where they're not using a third party for sales? So now 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 do they do for post-warranty? Do they utilize outside companies, or do they just continue to provide post-warranty services, but it's 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, or those customers could choose to use another independent service organization in that area. They could go with the manufacturer or with a different service provider. But besides our region, the entire country is covered by internal Philips resources providing those 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.

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 the change in management or anything like that?

No. They had no impact at all.

Larry Haimovitch with HMTC.

Looking at the table you provided, roughly $4 million of revenue for the nine months for Philips, my high-powered math here says that's about $5.3 million on an annual basis that you now will not have, going forward. Am I thinking about that correctly?

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

Oh, okay. It's even less, then. It's even less.

Yes. So it's $3 million year-to-date 2017, which the majority of that is product sales and commissions, and there is a small install and warranty. Clearly, from a go-forward basis, 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 impact, but that's why we've given the reverse impact for folks to see.

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

That's correct.

Well, that even mystifies me more, because I thought it was even more than $4 million annualized. I was thinking it was more like $6 million or $7 million. 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 a $110 business, roughly, just to pick a round number. That works out to be less than 4%, and your stock's down 50%, or whatever. Any explanation?

We've certainly had a lot of calls. There could have been a little confusion on the information of exactly what component of the business that was impacted. That's obviously why we're giving these details today. Certainly addressed a lot of calls over the last many weeks, but we were waiting for the call today to provide the details in our earnings release.

You guys are asking all the right questions on capital allocation, and 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 results, so we're a little surprised, too, Larry.

Jeff and Matt, in retrospect, do you think you might have positioned this news development in a different way? You 8-Kd it rather than press-released it. There wasn't a lot of information. Now the impact is even smaller than any of us thought, 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 here without people understanding that it's relatively unimportant. It's not zero, but it's relatively unimportant to you.

Obviously the timing was not perfect. We realized, with this notice right on the end of September, we realized that we had a call coming up. We had to formulate all of the information and be able to present it in such a way. Could we have got it out sooner? In retrospect, we probably could have, but we felt we wanted to do a thorough job so that, when we meet today, we'll have all the information, and we can deliver clearly the impact on the business on a go-forward basis.

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

There's nothing in particular, but I want to be careful, Larry. Read our risk factors in our 10-Qs and 10-Ks. We got larger customers that are out there. There's a variety of things that can impact our business, but there was no manufacturer's rep relationship like with Philips that's out there, for sure.

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.

[Michael Kotarinas] with [Solagreen] Capital.

It seems 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, say, dividends?

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 we certainly considered 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.

Mitra Ramgopal with Sidoti & Company.

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 were actually more attracted to the mobile business, but you had to take the medical equipment as part of the package, or that was a business you liked as a standalone?

Certainly it was one company that we purchased, and it had these two components. And as we looked at that acquisition, and we still continue to look at the acquisition, we feel it was a good acquisition. It was an acquisition that had two components, a service component and a products component, much like Digirad has a service component and a products component.

So we looked at it as one business. We understood the risk with the Philips relationship, but we still felt like it was not a huge risk, especially from the standpoint that we understood that, if Philips did cancel, we were still left with a post-warranty support service business that we feel has value, and we thought that that was something, that the risk was very small if Philips did discontinue the sales relationship. And plus, we also were able to get a very robust mobile healthcare business along with that acquisition. So certainly we feel really good about the acquisition. We continue to feel good despite this latest Philips cancellation.

And I know you said you're evaluating all options for the segment, but it seems like you're committed to looking to expand it geographically, adding personnel, et cetera, and see 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 current contracts. So there's a lot of work, lot of effort that will go into that. Going from a manufacturer's rep 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 1st.

I was just wondering if you could comment generally in terms of what you're seeing regarding hospital volumes. Obviously there's a lot of uncertainty out there in terms of ACA, et cetera. I don't know if you're seeing it having an impact on your business yet.

It 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, especially rural-type hospitals that we work with, are feeling the impact and 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 where 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.

Now, I do want to make one comment. Obviously there's a lot of unrest in our product portion of our MDSS business segment. Those employees know that the contract with Philips is ending December 31st. We were counting on a good fourth quarter based on the pipeline of deals within the MDSS sales segment. Obviously, based on our revised forecast and guidance, we feel like this disruption will cause issue in us on having the ability to close some of those deals outside of the general uncertainty that the ACA brings about. So our forecast definitely reflects all of this.

Regarding the goodwill impairment, is that pretty much behind you, or do you anticipate any further write-downs as we look into 4Q, and even beyond?

The process is based on looking at the forward business and projecting out future value and relating it back to the goodwill. So we feel like we've made a reasonable estimate in that impairment amount, so I don't necessarily expect anything, going forward. So it's our best estimate of where we're at. Anything can happen for sure, Mitra, but I think we're at the right number now.

Thank you. At this time, I will 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 and Digirad's future.

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