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Executives

Matthew Clawson – Allen & Caron

Matt Molchan – President and Chief Executive Officer

Jeffry R. Keyes – Chief Financial Officer

Analysts

Paul Thomas Nouri – Noble Equity Funds

Digirad Corporation (DRAD) Q2 2013 Earnings Call August 1, 2013 11:00 AM ET

Operator

Good day, ladies and gentlemen and thank you for standing by, and welcome to the Digirad Corporation 2013 Second Quarter and Six-month Results Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions and instructions will be given at that time (Operator Instructions)

I would now like to turn the conference over to Mr. Matt Clawson of Allen & Caron. Go ahead sir.

Matthew Clawson

Thank you, Jill, and thank you all very much for joining us this morning. If you didn't receive a copy of today's release and would like one, please contact our office at (949) 474-4300 after the call, and we'll be happy to get you on. 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, operation, portable imaging services, product division, financial results, estimated market share 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 this morning’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 2013 second 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.

Matt Molchan

Good morning. Thanks, Matt, and thanks to everyone for joining us today on our second quarter 2013 results conference call. For those of you that might be joining us for the first time, my name is Matt Molchan, and I took over the CEO role at Digirad in July. Prior to that, I was the President of the company, and prior to that, I was responsible for running the company’s DIS division.

Before I discuss the second quarter, let me briefly touch on an additional announcement we made this morning. Yesterday, we closed on an agreement to sell technology for surgical imaging system we call Trapper to Novadaq Technologies. Trapper is a research and development initiative consisting of an imaging device in probe for use in surgical oncology. Based on our recent strategic shift, this technology was a non-core asset, which led to our decision to sell it at this time.

As part of the agreement, we received $2 million and up to $1 million in deferred contingent payments based on meeting specific regulatory and commercial milestones, and the potential for product royalties for a period of five years. Though a non-core asset for Digirad, Novadaq is well suited to develop this technology for the future. We believe this is a great outcome for both companies.

Now to summarize our results, we had a very solid quarter. Our first four quarter under the new operational and strategic framework we installed earlier this year. Results of the quarter were right in line with our internal expectations and show that the basic platform of our business is sound and the impacts of our restructuring are starting to be seen. We had year-over-year revenue increases on both Diagnostic Imaging and DIS sides of our business, which as those that you know that, that follow us regularly this hasn’t been the norm recently. From a commercial standpoint, we believe we are operating very well.

Overall, our current near-term goal is to make Digirad a leaner, more nimble, ultimately, stronger company, with a focus on generating income and cash flow as well as creating shareholder value. It’s obviously very early in the process of installing our new strategic framework, but I think we’re off to a great start in building a foundation for success going forward.

Let me recap briefly how we got here. Digirad has historically been a two-sided business. The Diagnostic Imaging side that is focused on selling advanced nuclear imaging cameras and the Digirad Imaging Solutions side or DIS, which is focused on providing in-office cardiology imaging services on an as needed, when needed and where needed basis. After months of market research and now assisting consultations with our Board of Directors, we concluded on a strategy to focus and concentrate our efforts on an outsourced services solutions of DIS.

As we believe that this is the best opportunity for income cash flow generation and growth in the current healthcare environment. To be clear, we are still selling our Diagnostic Imaging cameras in the marketplace and maximizing the value of the excellent customer service and maintenance on that side of the business. But we will do it in a more cost aligned basis that will produce higher margins on that side of the business as we selectively sell those cameras. Ultimately, we believe DIS is inherently the more scalable business offering greater growth and expansion opportunities going forward.

This quarter, we went all steam ahead on our new strategy. Revenues were up on the Diagnostic Imaging product side, partly because we sold a number of ergo cameras, but based on our new strategy, we’re also focused on right sizing our cost structures and eliminating cash burn, which means eliminating many of the resource and development and sales and marketing costs associated with our Diagnostic Imaging business.

Jeff will go into the financials in more detail in a few moments, but you should note that our cost cutting has been effective and is beginning to show up in our bottom line. On that note, if you look closely at the financials, you will see that minus the non-recurring costs we incurred restructuring the business, we basically broke even this quarter.

Furthermore, as most of you know, we are involved in a series of proxy challenges with an activist shareholder. Their initial proxy content was unsuccessful as shareholders voted to retain the current Board. However, following the Annual Shareholder Meeting, a desisting group filed a lawsuit as consumed financial and personnel resources. We hope the matter is resolved shortly and the resources can be fully focused on generating value for our shareholders.

Back to the bottom line, if you eliminate those costs associated with the proxy content and the litigation, which were over $500,000 for the quarter, it becomes a straight forward analysis to show that we can become profitable in the very near future and an ongoing basis.

Our strategy to grow the DIS side of the business continues to be A, we’re going to identify organic growth opportunities via new and expanded services that we can utilize in our robust network of customers; and B, identify and pursue a number of financially disciplined tuck-in acquisitions in key DIS regions. We want to expand our regional networks and infrastructure we already have in place and build on that business.

With DIS, our biggest job everyday is utilization. Maximizing the structure and workforce that we have put in place, but building up the networks in each region we can accomplish that and grow, as well as ultimately increase our margins and profitability. We believe the opportunities are there.

With that, I’d like to turn the call over to Jeff for more detail on our financials. Jeff?

Jeffry R. Keyes

Thanks, Matt, and good morning, everyone. In the release today and in my prepared comments, I will make references to both GAAP result as well as adjusted results, for which the adjusted results do not include non-recurring charges associated with the restructuring. Adjusted results are considered a non-GAAP financial measure.

As Matt mentioned, since there were still material restructuring activities going on during the quarter, we did see significant restructuring charges during Q2. While we will continue to see restructuring activities and lingering charges throughout the year, the biggest hits expense-wise occurred in Q1 and Q2 of this year. having said that, we anticipate the company will move into profitability from normal business operations, notwithstanding restructuring charges in the second half of 2013 and from that point moving forward. In addition, as Matt mentioned, we had restructuring charges that were approximately $600,000 relating to all the activities during the second quarter.

Now for a brief summary of the quarter’s activity, total revenue for the second quarter 2013 was $12.9 million, compared to $12.7 million for the same period in the prior year. DIS revenue for the second quarter of 2013 was $9.5 million, compared to $9.4 million in the same period of the prior year. Diagnostic Imaging revenue, which includes our camera sales and customer service business for the second quarter of 2013, was $3.4 million, compared to $3.3 million for the same period in the prior year.

Gross profit for the second quarter of 2013 was $3.8 million, or 29.4% of revenue, compared to $3.7 million, or 29.0% of revenue in the prior year quarter. Operating expenses for the 2013 second quarter were $4.4 million. Total adjusted operating expenses, which backed out the non-recurring restructuring expenses was $3.8 million.

Net loss for the second quarter of 2013 was $616,000, or a loss of $0.03 per share, compared to a net loss of $891,000, or $0.05 per share in the same period of the prior year. However, adjusted net loss for the second quarter of 2013 was just $6,000, essentially break-even as Matt indicated.

Remember too, our adjusted numbers only reflect the removal of the non-recurring restructuring charges. They do not reflect any adjustment or the removal of the over $500,000 spent during the quarter related to our proxy contest and subsequent litigation.

Cash and cash equivalents and available-for-sale securities totaled $22.2 million as of June 30, 2013. Cash and cash equivalents and available-for-sale securities totaled $27.2 million as of December 31, 2012. This reduction period-over-period is mainly a result of utilizing cash for our stock buyback program as well as utilized for our restructuring activities.

During the quarter, we purchased approximately $1.25 million common shares under our $12 million stock repurchase program at an average price of approximately $2.41 per share.

Needless to say, we continue to believe that our share price is an outstanding value and as such, we have purchased a significant amount of shares. At June 30, 2013, we had approximately $6.9 million remaining under our $12.2 million repurchase program.

Total revenue for the first six months of 2013 was $24.4 million, compared to $25.7 million for the prior year period. DIS revenue for the first six months of 2013 was $18.4 million, compared to $18.7 million for the prior year. Diagnostic Imaging product revenue for the first six months of 2013 was $6 million, compared to $7 million for the same period last year.

Gross profits for the first six months of 2013 increased to $6.6 million or 27.1% of revenue, compared to $7.4 million or 28.6% of revenue for the prior year. Overall, we did experience some pricing pressures in the first quarter of 2013 in our DIS business, which is reflected in our six months results. However, we believe the majority of this small decrease in revenue year-over-year is related to this traction of implementing our restructuring plan during the first quarter.

Gross margin was down slightly year-over-year for the six months ended, primarily related to an inventory adjustment stated in our first quarter 2013 along with the impact of a one-time workers’ comp credit experienced in 2012.

Our net loss for the first six months of 2013 was approximately $3 million, a loss of $0.16 per share. This is compared to a net loss of $2.2 million or $0.11 per share for the same period last year. On an adjusted basis, our net loss for the first six months of 2013 was $1.4 million or $0.07 per share, and reflect the elimination of our proxy contest and litigation charges of over $500,000 as well as inventory adjustments taken in the first quarter as part of our new strategy.

To reiterate some of the items that Matt mentioned, we are well on our way to completing our restructuring plan and moving forward with creating and returning shareholder value. We clearly have made improvements this quarter, breaking even on an adjusted basis, and would have been even further ahead, if we had not been involved in this proxy litigation. Though we made significant improvements on our cost reductions in implementing our restructuring plan, our second quarter results still do not reflect go-forward run rate. we expect our cost savings will continue as we move forward with the Q3 and Q4 emerging as a more of the quarterly run rate on the cost side of the business. We will emerge from this restructuring creating net income and generating cash flow. Now I’d like to turn the call over to Matt for some closing remarks. Matt?

Matt Molchan

Thanks, Jeff. Again, despite some ongoing distractions, we are executing our strategic plan just as we said we would. We are making the restructuring changes we need to be profitable, aggressively at pursuing acquisitions and executing our growth plan. While on the near-term, we’ll be shaking off some restructuring costs and dealing with what remains at the proxy activity. We now believe we are well on our way to making Digirad a solid value and growth story. As we emerge into the third quarter and second half of the year, we are building a much more solid and prosperous Digirad and now more than at any other time in the recent past, we believe our future looks bright and then those of you who are or will be involved with shareholders, will ultimately benefit from the changes and execution going on today.

Thank you. And now, I’d like to turn the call back over to the operator for any questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And our first question comes from the line of Paul Nouri with Noble Equity Funds. Go ahead, please.

Paul Thomas Nouri – Noble Equity Funds

The Trapper technology that you sold, is it at all close to commercialization, and is that at least three or five years of?

Matt Molchan

Well, it was definitely from our standpoint, it would have been that way. I mean, part of the value that Novadaq saw in the technology was that they would able to commercialize it quicker than we would ever, if we ever could commercialize that product. Based on our new strategy, that technology was definitely non-core and we found an opportunity with Novadaq to sell to them. and there, we’re much better suited to commercialize that surgery based product, which we currently have no products, services or any type of business in surgery in hospital today.

Paul Thomas Nouri – Noble Equity Funds

And what kind of a royalty you’re going to be getting on it like mid single-digit?

Matt Molchan

Jeff, answer that one.

Jeffry R. Keyes

Yeah. so we haven’t publicly disclosed the royalty rate on the agreement. so it probably won’t get into those numbers. I can’t say that from a go-forward standpoint, as far as Novadaq is concerned, they’re taking the rents from here. so the commercialization and timeline of those events will be all in our quarter to end. There is still some more work to do and we don’t know what type of clinical trials and initiatives that they are going to take the product through, but ultimately the agreement allowed us to again, develop this non-core asset and the $2 million upfront we have opportunities to earn our milestones about to $1 million. And then after that, if Novadaq is able to commercialize it and get the product into the market, we would enjoy some royalties for a period of five years after that.

Paul Thomas Nouri – Noble Equity Funds

And were you committing any at all significant resources to this within your product division like is it going to improve your gross margin on that side or had you kind of left that alone for a little while?

Matt Molchan

As far as resources that were committed to that, the majority of those resources that had worked on various R&D initiatives were part of the resources that were reorganized in our restructuring efforts. So as result of disposing of this non-core asset, you’re not going to see any difference in our restructuring plan or cost savings going forward, because the folks in activities that were associated with this had already been incorporated within our restructuring plan.

Paul Thomas Nouri – Noble Equity Funds

Like the R&D level has dropped pretty significantly, is this a sustainable area for it to be in like $200,000?

Matt Molchan

Well, we feel like we’ve got some great technology. We’ve got technology that works in the current healthcare market and into the future. We’ve always felt that our cameras are very unique in terms of the mobility and the convenience that they offer and obviously that’s the cornerstone of our DIS business, the use of those mobile cameras. So at this point, we felt like it was a hire versus rent type of decision. We needed to make this company profitable, we needed to create shareholder value and drive cash flow, and at this point, with our technology being at the level that it’s at, which is very favorable to the market, we felt now was the time to really divest into our R&D efforts and really concentrate on our current products and services.

Paul Thomas Nouri – Noble Equity Funds

Okay, and the DIS gross margin as you had talked about came in a bit. What can we expect for that going forward like around what it is now 24 or kind of go up a little bit, so it’s 26.

Matt Molchan

Well. Obviously, that is a constant piece of our business to better utilize the equipment there we have out in the field. And so, we feel like based on some of the hits, what effects our gross margin, part of it is obviously, our pricing and our ability to manage our resources. So we’ve initiated a number of different internal plans to improve our gross margins, but at this point, we are not at a point where we can kind of give guidance on that piece. But I will tell you that we are making improvements on our utilization, reimbursement has stabilized and so we feel like the price pressures and what not that we’ve experienced in the past years are not present in our current market. So, we intend to continue to move forward and look for improvements in that area in DIS.

Paul Thomas Nouri – Noble Equity Funds

Okay. And the final question for now. Concerning the proxy contest, as you know, some of the costs, I guess are legal costs, can you talk about how much of this is going to be recurring over the next few quarters and whether the major shareholder who is leading the efforts, do you think is going to continue this into next year for another proxy contest next year?

Matt Molchan

I think, it’s hard to predict any of the outcome of any type of litigation, of course, we believe that our side of the concept is solid and we will have significant concerns going through this litigation. On a cost perspective, again, going forward, we can’t predict on, if definite, a shareholder will come back and continue to engage Digirad. Our hope is that we can settle this matter and put it behind this and move forward. So it’s hard to predict from the cost perspective. I can’t say that we expect after Q2 to have the majority of the cost reimbursed from an insurance perspective. So there might be some costs that will not be reimbursed, but we expect the majority of the legal litigation costs to subside.

Paul Thomas Nouri – Noble Equity Funds

Okay, thanks.

Matt Molchan

Thank you.

Operator

(Operator Instructions) And it appears there are no further questions. so I will turn the call back to Mr. Molchan for any closing remarks.

Matt Molchan

Thank you very much and thank you all for attending our call. Like we said previously, we felt we had a very strong quarter, but this is a foundation, this is a building block for our future. We’re very excited about the strategic path that we are on. We feel that we are in a market that it is definitely favorable to the products and services that we offer, and we’re looking forward to a great second half of the year and beyond. So once again, thank you and look forward to talking to you all in the next quarter. Take care.

Operator

Ladies and gentlemen, this concludes the Digirad Corporation 2013 second quarter and six-month results conference call. Thank you for your participation. You may now disconnect.

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