Landauer's (LDR) CEO Bill Saxelby on Q3 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Landauer, Inc. (LDR)

Landauer, Inc. (NYSE:LDR)

Q3 2014 Earnings Conference Call

August 5, 2014 10:00 a.m. ET

Executives

Bill Saxelby – President and Chief Executive Officer

Mark Zorko – Interim Chief Financial Officer

Jeffrey Volz – Treasurer & Vice President-Financial Planning

Analysts

Rob Mason – Robert W. Baird

Steve O’Neil – Hilliard Lyons

Mitra Ramgopal- Sidoti & Company

Operator

Good day and welcome to the Landauer’s Third Quarter Earnings Conference Call. Today’s conference is being recorded.

At this time I would like to turn the conference over to Mark Zorko, Interim Chief Financial Officer. Please go ahead, sir.

Mark Zorko

Thank you, Tracy. Good morning everyone. I’m pleased to welcome you to our 2014 third quarter earnings conference call. As the operator mentioned, with me on the call is Bill Saxelby, the Company’s President and Chief Executive Officer.

By now you’ve had the opportunity to review the press release we issued yesterday following the markets close. The release has been posted on the company’s website at landauer.com under the Investors tab. In addition, you will find posted our quarterly results slide deck that highlights key activities and accomplishments related to the quarter. During this call today, Bill and I will reference these slides. Our objective this morning is to provide additional clarity and then move to the question-and-answer portion of the call to address specific questions you may have.

Before turning the call over to Bill, I need to remind everyone of the Safe Harbor provisions contained in our press release, which also governs this conference call and that certain statements made today are not historical and may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Please refer to the Safe Harbor statements contained within the press release as well as the information contained in the company’s annual Form 10-K report and other reports we filed with the SEC.

At this time I’ll turn the call over to Bill Saxelby, the CEO. Bill?

Bill Saxelby

Thank you, Mark. Good morning everyone, and thank you for joining us for our 2014 third quarter earnings call. As reported yesterday, revenues for Q2 2014 were $34.8 million, with a net loss of $36.6 million, and adjusted EBITDA that was $7.4 million. There are three items that affected the Q3 results that I’ll address upfront in my remarks this morning and then Mark will provide additional detail on the quarter during the financial review portion of the call.

As Mark said, I’m going to refer to the fiscal 2014 third quarter results PowerPoint presentation throughout my remarks this morning and I’ll review five topics this morning. First, an overview of Q3 results. Second, we’d like to reaffirm our 2014 guidance after the effect of the Q3 charges. Third, an update on military funding, which is a very positive development. Fourth, review business segment highlights for the quarter. And then fifth, reaffirm that there’s no change to the company’s dividend policy.

The first topic will be to address Q3 results. If you’d please turn to page 19 of the PowerPoint, you’ll see a walk-across slide that begins with Q3 results as reported for revenue net income and adjusted EBITDA. The first column to the right of Q3 as reported results shows the effect of the IZI goodwill and intangible asset impairments. The next column to the right shows the charge for acquisition and reorganization expenses for severance expenses that will allow us to continue to decrease our cost structure. And the next column shows the reduction of non-cash stock-based compensation. The last column shows an adjusted Q3 year-to-date performance of $112 million in revenue, $8.2 million in net income and $28.9 million in adjusted EBITDA. Burk will discuss this in more detail during his remarks.

The second topic is that we are reaffirming our full year guidance range for revenue, net income and adjusted EBITDA after adjusting for the charges just referenced. If you turn to Page 18 of the PowerPoint, you’ll see the starting point at the far left hand side of the page which begins with the adjusted Q3 year to date results from Page 19, and then shows the full year guidance. Here is a summary explanation of the five major drivers in Q4 that will take us from Q3 year to date adjusted performance to the full year guidance range. First, one is the Military Revenue we are forecasting now that the orders we anticipated have been received. The second is a large InLight international order. The third is the anticipated run rate of the core Radiation Measurement segment. The fourth is a strong quarter for Medical Physics Commissioning projects. And then in addition to Imaging Revenue that is a result of new systems agreement signed and the fifth are Restructuring Savings.

Michael will address the Q3 adjusted results as a building block to reaffirming guidance after the effect of the charges in addition to the items just mentioned. Topic number three is the positive progress made with military funding in the third quarter. Please turn to Page 10 of the PowerPoint deck. This is a review of the military opportunity for the business which shows the growth over the last couple of years from $0 million to $8 million in FY 2013, and the $50 million to $150 million potential in the FY 2015 through 2017 timeframe. The 2015 through 2017 potential is a combination of the $50 million to $60 million that the army needs to fully implement the Radwatch program beyond any orders we have received to date, and the $100 million potential represented by the Navy RFP that we have discussed throughout the year.

We actually received $15.6 million in military orders in Q3. $1.1 million was for our standard InLight products, and $14.5 million was for the Radwatch System. We chose to highlight the $14.5 million in the press release, given the importance of this order to our FY 2014 performance and to show that the army has continued to prioritize the Radwatch System to replace existing field radiation detection systems post the issues with sequestration that we began to see at the end of FY 2013. I'd also add that this $14.5 million is the largest order that we’ve received to date from the army for the Radwatch System. The $14.5 million represents the full revenue value that is split with our military partner Aquila. Landauer’s portion of this revenue was approximately $6.4 million.

In FY 2014, we made a decision to manage revenue and profits with our military partner differently. Landauer sees less revenue with no change in operating income. The military in total will generate $4.5 million for Landauer in FY 2014. We continue to be in active discussions with multiple congressional offices, both House and Senate with the military Radwatch Program management team, with several army and National Guard operating units who are interested in their troops having the latest radiation safety technology system and the Army G-8 Funding organization. We’re pursuing the yearend reprogramming dollars in the last two months of FY 2014 which with additional funding for the Radwatch program in FY 2015 and we are also in discussions relative to funding for the 2015 through 2017 timeframe.

The final update concerning the military is the navy RFP process. As you know from previous calls, in March of FY 2013 we responded to a request for proposal from the Navy that has a value of $100 million. We now understand that the timeline to hear a response to that RFP will now be in the fall of this calendar year. We do not know if the timeline is accurate or how successful it will be in the outcome of that RFP, but we did want to supply our most current understanding of where this opportunity is at from a decision timeline perspective.

The fourth topic is to review the key updates of each of the three business segments. And first, I’ll address the radiation measurement segment and overview three areas of progress relative to our strategy for that segment in the quarter. If you please turn to page nine of the PowerPoint under the category of competitive growth, the military funding update that I just discussed was the biggest highlight in the quarter for the rad measurement segment.

The second highlight in the quarter is that we introduced our next generation wireless solid state dosimetry offering which we have now branded as verified at the Health Physic summer meeting this last July, last month and we’ve received very positive feedback. This was a soft launch of the new product and the promotional material for that product can be seen on page 11 of the PowerPoint. The new platform builds on our military Radwatch system investment and experience and will allow Landauer to offer the dosimetry system that will transmit radiation dos information via an electronic wireless platform. This platform will eliminate the manual processes and logistics-intensive badge delivery system that the industry works with today.

Now if you would turn to page 10 in the PowerPoint, you’ll see that we’ve updated the R&D expense for the verified development in 2014. The project spending is now forecasted to be $2.6 million versus the $3 million discussed on the Q2 call. We’ve also updated the cost reduction opportunity we’ll have with this project. As we refine the business case, we believe that the cost reduction opportunity will be in the range of $5 million to $10 million versus the $1 million to $5 million that we’ve discussed on the Q2 call. And we expect these cost reductions to begin in FY2016. There will also be a revenue and gross profit opportunity in addition to the cost reductions I just described. And in future calls we’ll discuss the adoption rate and how that will affect the current dosimetry platform revenue from a cannibalization rate along with the pricing premium we expect to gain with the new platform.

The final point I’d like to emphasize as I did on the Q2 earnings call is that the sensor development is not yet completed and the cost reductions as well as the revenue opportunities are predicated on the successful completion of that sensor development. However, we felt confident enough in our ability to successfully complete the sensor development that we introduced the products with a soft launch last month.

The third highlight for the radiation measurement segment in the quarter was the decision to have our sales organization for radiation measurement, begin to sell medical physics imaging services, in addition to the traditional occupational dosimetry and informatics services beginning in the fourth quarter of 2014. You’ll recall that on the Q1 and Q2 earnings call this year, we discussed our commitment to reenergizing our revenue growth in this segment. The radiation measurement sales team selling medical physics imaging services is a solid example of focusing on organic growth. The occupational dosimetry business and the medical physics imaging services have synergy as both typically fall under the responsibility of the director of radiology in a hospital. By having our sales team be able to offer occupational dosimetry and imaging services, we are leveraging the medical physics acquisition and we are becoming a larger consultative solution provider for the director of radiology.

We are also maximizing our sales people’s time on a hospital sales call where they now have more to sell to the same call point. This maximizes the radiation measurement sales investment we made in FY2013 when we doubled the size of our sales team and it keeps the medical physics segment from having to invest in its own stand-alone sales structure. The structure also makes sense to our group purchasing and, IDN Independent Delivery Network customers as they contract for both occupational dosimetry and imaging under the same contract group typically.

We’ve been discussing the new TJC, The Joint Commission imaging accreditation requirements which are highlighted in the appendix of the PowerPoint on pages 23 and 24. This new accreditation requirement is doubling the spend on imaging regulatory compliance for radiology departments in hospitals. We will be focusing our sales people to sell our Medical Physics services in the geographies where we have Medical Physics infrastructure that we can leverage our medical physics people investment and improve medical physics margins to be a better utilization of those investments. You will hear about a substantial increase in the investment in imaging Medical Physicist as a result of new agreement that we’ve signed and as a result of the new TJC accreditation requirements when I discuss medical physics in just a minute.

Also, and very importantly, we’ve identified approximately $2 million in dosimetry services business that’s with our competition today. We will use this combined offering to target that high margin radiation measurement revenue in addition to increasing medical physics revenue.

Next, I will discuss the medical physics segment and the substantial progress that’s been made relative to the enterprise-wide Radiation Safety Solution. If you would turn to page 9 and refer to the competitive growth column on page 9 for Medical Physics, first we’ll review progress made in terms of new contracts closed. Of the 4 contracts that were valued at $10 million that we have discussed on previous earnings call this year, we’ve actually signed two contracts that are valued at $3.7 million. We have an LOI for one system that is valued at $4 million and we are in current negotiations with 2 other systems that are valued at approximately $750,000. Of the four systems that we’ve highlighted in Q1, we were unsuccessful in one of the four systems. They made a decision to work with a local vendor who happened to have very strong ties to the CEO of that system.

Very importantly, we wanted to point out that we now have 8 major IDNs, Independent Delivery Networks under contract with Medical Physics that represents 77 individual hospitals. Our current revenue with these 8 IDNs is $12 million and our total potential if we had all of these IDNs imaging as well as therapy business, would be an additional $18 million for a total potential of $30 million. Now what we’re learning from these systems sales is that it’s easier to convert imaging business primarily because the business is currently handled by outside consultants and more importantly, because the new TJC requirements for imaging are driving the need for standardization across the system.

Next, if you turn to page 22 of the deck you’ll see that the second update for Medical Physics is to review the new TJC accreditation which takes effect in July of FY 2015 and how customers are responding to this new set of requirements. We are seeing on average that a hospital has to spend approximately an additional one times their current spend for imaging accreditations to be in compliance with the new joint commissioning or the new joint commission accreditation requirement. A hospital that is historically spending say $10 million for imaging services will have to spent between $18,000 to $20,000 going forward to be compliant. We’re seeing customers aggressively beginning to put plans in place to meet these new requirements that take effect in July of 2015.

When we sign a new system-wide agreement, the customer typically will focus on ensuring that their imaging procedures and protocols are in place system-wide before they will focus on Radiation Oncology, Medical Physics or what we refer to as 5herapy. This means that the total potential revenue in the system will roll out in a step fashion beginning with imaging.

In an effort to take full advantage of Directors of Radiology needing to be compliant with the New TJC requirements, if you turn to Page 13 of the deck, we wanted you to see the promotional material they we’ll be using at the upcoming AHRA meeting which is actually next week. The AHRA stands for the Association for Medical Imaging Management and this show was attended by 1,000 imaging leaders and is considered the major trade show for this group annually. You can see from the brochure that our focus is on the comprehensive consultative solution that we can offer as customers plan for this new accreditation requirement. Landauer will be a major corporate sponsor at this AHRA meeting, which as I said is being held next week in Washington DC.

The third update for Medical Physics is our progress against our national geographic service footprint. Based on the contracts that we have signed in 2014, we now have a presence in all major geographies in the U.S; New York State, New England, the Mid-Atlantic States, the Southeast, The South, the Midwest and the West Coast. Our number of Physicists and dosimetrists has grown from 140 at the beginning of 2014 to what will be 156 by the end of Q4. These physicists were added to support the new agreements that I referenced earlier. We’ve accomplished a significant milestone in terms of creating the first National Medical Physics practice group, and we’re beginning to see that local Medical Physics organizations are seeing their growth in our approach. And as I mentioned earlier, we now have eight major IDNs under contract that represents 77 individual hospitals across the U.S.

The fourth Medical Physics update was the decision to have the Rad measurement salesforce sell Medical Physics imaging services. Not to be redundant, but as I just discussed a few minutes ago when I talked about the Rad measurement segment, this selling organization now selling imaging services leverages our sales productivity with the radiology call point. It takes advantage of the New TJC accreditation requirements and really differentiates Landauer who can help customers solve this new accreditation need. It focuses on opportunities that will allow for targeting competitive dosimetry business by combining the spend-involved services, and the opportunity to combine occupational dosimetry with imaging to increase our consultative importance with Directors of Radiology is an important next step in our Medical Physics strategy.

Finally, I'd like to discuss the Medical Products segment. And if you turn to Page 14 of the deck, we’re obviously very disappointed with the performance of the Medical Products investment and the charge that we had to take this quarter. In the modelling exercises we did before acquiring this business, we modelled pricing pressure over the first three years of ownership. But what we’ve seen in terms of actual pricing declines in the core Spherz business was significantly below what we had modelled, and the pricing decline has happened in a much shorter period of time than we had modelled. Faced with this dynamic, we took action as quickly as possible to change the management team and address the short-term issues of stabilizing the business while building a new product development pipeline.

I continue to be very pleased with the direction and focus that Greg Groenke, our segment President is giving Medical Products. We now have the right team in place and strategy to generate growth and profitability in this segment. We’re focused on transitioning the business to a medical device business. And as you can see by the slide, we have two new product offerings that are going through the FDA 5 10-K products approval process this fiscal year with the expectation that they will be ready for commercial introduction in Q4 of FY 2014 and Q1 of 2015. We’re also involved in OEM partnering discussions relative to these new products. I will continue to keep you updated on progress going forward.

My final topic is to communicate that our dividend policy remains unchanged in 2014. Page 20 reviews our Q2 dividend payout and we have no plan to change the dividend level which will be $2.20 a share for the year.

So in conclusion, we’ve made significant progress against our key strategic initiatives in the quarter. We believe that the market opportunities we discussed provide Landauer with attractive prospects to grow and expand our business. And we believe that the commitment to our shareholders’ best interest, the strength of our product offerings and our position as a market leader in global Dosimetry services, Medical Physics services and medical products will continue to drive growth and development of Landauer role to the long term.

And with that, I’d like to turn the call over to Mark, for our review of our financials.

Mark Zorko

Thank you, Bill. Consolidated revenues for the quarter were $34.8 million, a decrease of $1.8 million from the prior year period or approximately 5%. Radiation measurement revenues were $24.2 million, a decrease of 8% or $2.2 million from the prior year third quarter of $26.4 million. The decrease was due primarily to lower Radwatch revenues of $1.3 million driven by the timing of military orders. In addition, the company recorded a revenue reduction adjustment of $1.4 million to better reflect our Dosimetry badge service revenue and the timing of revenue recognized for a long term contract.

Medical Physic revenues for the third quarter increased 3.8% to $8.2 million due to a modest increase in imaging revenue. Medical products revenues for the third quarter were $2.4 million and essentially unchanged from the prior year. Gross margins were 48.3% for the third quarter compared with 50.9% in the prior year quarter. The decrease in the gross margin was due to the reduced revenues of our radiation measurement products in part as a result of the $1.4 million adjustment previously mentioned.

SG&A expenses for the third quarter of 2014 and 2013 were $13.8 million and $12.6 million respectively. For the third quarter of 2014, total SG&A expenses increased due to bad debt expense of $0.7 million and professional fees of $0.5 million.

Let me spend a minute on our impairment charge. During the third quarter, it became apparent that anticipated revenue and profitability trends in our medical products business were not being achieved to the extent forecast. Early budget reviews also indicated future sales growth and margins may be less than expected. We updated the forecast based on the most recent financial results and our best estimates for future operations. The updated forecast reflects slower growth in revenues and lower margins for the business due to anticipated continuing pricing pressures from certain competitors. While we have included the forecast of new product sales, the volume level only results in a modest year over year sales increase.

We recorded a $62.2 million pretax charge for this quarter for the impairment of goodwill and intangible assets. The impairment charge during this period is non-cash in nature and does not affect the company’s current liquidity or debt covenant compliance. This charge is in addition to the $22.7 million impairment charge taken last year. I should point out that in spite of the challenges, the business is cash flow positive and investing in new product development.

The operating loss for the third quarter of 2014 was $60.8 million compared with an operating loss of -- $50.8 million compared with an operating loss of $16.8 million for the third quarter of 2013.

Operating income adjusted for the impairment charge and the $1.6 million of reorganization cost was $3 million. Prior year operating income adjusted for the $22.7 million impairment charge was $5.9 million. Radiation measurement operating income for the third quarter of 2014 decreased to $6.3 million or 27.6% from $8.7 million from the comparable prior year period. The decrease in operating income was due to a$1.4 million decrease in gross margin resulting from the decrease in revenues as well as a $1.1 million increase in SG&A expenses due to higher bad debt and consultant fees.

Medical Physics operating income was $0.4 million compared to $1 million in the third quarter of 2013. The decrease in operating income was related to increased staffing expenses of $0.7 million to support additional contracts in the imaging division and to support continued advancement of the segment’s system sell initiative.

Medical products operating loss for the third quarter was $62.4 million compared to an operating loss of $22.6 million in the third quarter of last year. The decrease in operating income was due primarily to the goodwill and intangible charges previously discussed.

Our equity income from unconsolidated joint ventures was lower by $200,000 compared to the prior year due to a loss from our joint venture with Aquila related to delays in military orders.

The effective tax rate for the third quarter of 2014 and 2013 was 40.8% and 21.6% respectively. The increase in the effective tax rate was driven by the effect of certain permanent items having a greater impact on our rate due to a lower level of book income. Our outlook for the full year effective tax rate is now 42% to 45%.

The net loss for the third quarter was $36.6 million or $3.86 per diluted share compared to a net loss of $13.8 million or $1.46 per diluted share in the same period last year. The decrease in net income was due to the impairment charge partially offset by a larger tax benefit. Including the impairment charge, the adjusted net loss was $0.7 million compared to an adjusted net income of $4.8 million in the prior year period. The resulting adjusted diluted earnings per share for the third quarter was a loss of $0.07 per share compared to a profit of $0.51 a share in the same period last year.

Turning to cash flow metrics, a reconciliation net income to EBITDA is included in the financial tables. Adjusted EBITDA for the third quarter was $7.4 million compared with $11.1 million for the prior year third quarter. The decrease was due primarily to reduced gross margin of $1.8 million, an increase in bad debt expense of $0.7 million, outside services of $0.5 million along with the decrease in equity income of our joint venture of $0.2 million due to the timing of military orders.

The net cash provided by operating activities, less capital expenditures and adjusted for reorganization cost or what we call free cash flow for the nine months of 2014 was $25.2 million compared with $11.8 million for the first nine months of 2013 due to an increase in receivable collections, other working capital improvements, and reduced capital expenditure. The third quarter of 2014 was a positive $7.3 million of free cash flow.

Quarter end the company gets $36.7 million of unused availability under its current $175 million credit facility, which provides adequate liquidity to meet our current and anticipated obligations. Our cash balances and liquidity remain adequate to grow the business with additional capital investment to meet ongoing debt service and continued dividend cash to shareholders.

I’ll conclude my remarks by confirming our 2014 full year guidance as noted in the press release. Our revenue forecast for the year is in a range of $150 million to $260 million. Based upon the assumptions above and excluding the effect of impairment and reorganization charges, we evaluated the impact of changes during the third quarter, reviewed our run rate from normalized operations and added the impact of improvements and shipment increases expected in the fourth quarter. This process got us comfortable with guidance for adjusted net income in the range of $16 million to $18 million, and adjusted EBITDA in the range of $44 million to $46 million.

Tracy, this concludes our opening remarks. So at this point, please open the lines for the question-and-answer session. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Rob Mason from Robert Baird.

Rob Mason – Robert W. Baird

Good morning. A number of questions. I guess first I just wanted to clarify the guidance, in particular net income. So the $16 million to $18 million number doesn’t change, but it was – my sense previously when we were guiding to that number, that was a GAAP number. Now we’re referencing an adjusted number which I understand excludes the goodwill impairment. What else does the adjusted number exclude for the full year net income?

Mark Zorko

It’s the impairment number as well as the acquisition on the reorganization cost that we reflected in the closer of $1.6 million. One other small item relates to an-add back for non-cash stock based compensation.

Rob Mason – Robert W. Baird

Okay. Previously we were taking out FAS 123?

Mark Zorko

Hey Rob?

Rob Mason – Robert W. Baird

Yes.

Mark Zorko

Hold on just one – this is Jeff Volz.

Jeff Volz

This is Jeff. The non-cash stock is not included in that calculation of the $17 million. It's just the restructuring, a little bit of acquisition and the impairment.

Rob Mason – Robert W. Baird

Okay. Mark, what was the intangible amortization annually associated with the piece that you wrote off?

Mark Zorko

It was approximately $2 million.

Rob Mason – Robert W. Baird

$2 million annually associated with that $15 million or so?

Mark Zorko

Like $2.4 million.

Rob Mason – Robert W. Baird

Okay. Bill, on the Radwatch orders, and what your expectations are for 4Q, I was a little bit confused. I thought you said that Radwatch revenue for this year would be $4.5 million. And then guidance contemplates maybe $3 million to $4 million in the fourth quarter. But I show those tracking at a higher level year to date closer to $2.7 million. So I was trying reconcile the $4.5 million that you spoke to versus where we’re already stand year to date.

Bill Saxelby

Yeah. The way – Think about it this way. Probably some of the confusion, Rob is just around how we started to explain funding that we had received at different points each quarter. So think of it as we had an additional – we had an initial – and I’ll look for Jeff to make sure this is correct, we have three different categories of numbers that basically equal to the $4.5 million. You’ve got $1.5 million that are revenues associated with non-Radwatch sales to the military this year. And then the delta approximately $3 million is going to be associated with Radwatch. So we wanted to try to explain and I'm glad you asked the question, Rob. We’re trying to explain that -- that’s why I reference that we actually had $15.6 million in total orders in the quarter, $14.5 million of which was Radwatch. Then going back to what will the military in total be from a forecast perspective for the full year, both Radwatch and non-Radwatch revenue, that’s the $4.5 million.

Rob Mason – Robert W. Baird

Okay. And your visibility on the remaining piece of the $14.5 million order that you received, your visibility on that shipping is over what time frame?

Bill Saxelby

Primarily over the time frame of 2015.

Rob Mason – Robert W. Baird

Okay. And -- but we still --

Bill Saxelby

And Remember that you have that -- you have the revenue split so the $14.5 million equates to -- that $14.5 million is basically split between our JV partner and ourselves. $6.4 million of that is the Landauer P&L and then we also obviously have the operating and net income effect to the Landauer P&L and then we also have an equity income portion of this that’s associated with the JV with Aquila. And one last thing, Rob and for all who are tracking this, we made a change in terms of revenue, but not operating income in terms of how we split both revenue and operating income. So, the same amount of operating income will be to our P&L as we have had previously. But we will -- that’s the reason for the delta between 14.5 and 6.4, Meaning 6.4 is what we’ll see. The delta is the -- is what our JV partner will see.

Rob Mason – Robert W. Baird

Yeah, understood. And on the verified product can you touch on what you think the -- still the investment is in dollars CapEx or operating expense I’m not sure where we stand with respect to the $2.6 million in R&D, how much of that is in the rear view mirror and forthcoming. But could you just discuss as we go through the fourth quarter and into next year to the extent you can, how much investment and cost is needed to get that product to market?

Bill Saxelby

I think Rob, the best way for us and I’ll look to my guys here to explain that right now is that just to frame this, the $2.6 million is expense that we’re going to have this fiscal year. And previously we had said it was going to be $3 million. So, we just updated that. It will about $400,000 less than what we talked about in Q2. That will be the expense for this year. We are working through total CapEx requirements. From an expense standpoint, I’ll look to Jeff, approximately $2 million in expenses for next year.

Jeff Volz

Yeah, but you don’t get next year. Some of the initial design work that was done this year makes the R&D number larger.

Bill Saxelby

Yeah. So assume if we’re at $2.6 million this year, we’ll have an expense of approximately $2 million next year and then there will be a capital component that will be tied to software developments and then we’ll also after then flesh out what the requirements are going to be for the device, the cost of the device itself. We are really not prepared right now to go through that conversation, Rob. We should have a better visibility on that though when we get to the Q4 call.

Rob Mason – Robert W. Baird

Or just directionally, do you see your CapEx in ‘15 materially different than it has trended this year?

Bill Saxelby

Yes. It’s probably going to go up in the range of about $3 million, $3 million to $4 million for the verified product. And I’m looking at both Jeff and Mark. Correct me, I think those numbers are right.

Rob Mason – Robert W. Baird

Okay. Maybe I’ll jump back in the queue for now.

Operator.

We’ll go next to Steve O’Neil from Hilliard Lyons.

Steve O’Neil – Hilliard Lyons

Good morning. Just wanted to -- I think this has been largely covered but you may have to run through it again. To hit the lower level of your guidance range, you’re going to need to have a quarter that’s above maybe above $0.60 a share or somewhere on that range. Am I correct -- is that a correct assumption on my part first of all?

Bill Saxelby

Yes. We have like a number of positive developments that are planned to materialize in the fourth quarter that will get us into that range, Steve.

Steve O’Neil – Hilliard Lyons

Okay. And then of course now you’ve talked about the lower expenses related to verify, but where is that coming -- where is that coming out of versus what you thought originally?

Jeff Volz

There’s a few things, Steve. This is Jeff. Obviously there are some very large military and InLight sales that are above what we had expected in Q4. Not so much above the year. It’s more of timing coming into Q4 versus what we expected some of that to be in 3. There is a ramp up in the Medical Physics business both due to discrete commissioning activities and also a ramp of the system sale opportunities that we have signed. And now we’ll begin to recognize revenue there as the restructuring and other cost increases. And that’s going to be you primary drivers to get us to the -- into that guidance range.

Steve O’Neil – Hilliard Lyons

Okay. In terms of the -- looking at the $2.6 million in spending for the next generation dosimetry platform, down from $3 million that you mentioned. How are you getting $400,000 out of there without hurting development of that product?

Jeff Volz

The primary thinking, Steve, as went into the year and we were actually looking at the, what I’ll call the real science side of it, there was an expectation that we would go a couple of different routes on sensor development. And the success rate on the primary sensor has been successful that we have opted not to spend money on alternate routes.

Steve O’Neil – Hilliard Lyons

And then finally and I’m not sure how you answer this, but -- actually let me back up one second. With your equity as low as it is now, are you close to being in violation of any debt covenant?

Mark Zorko

No. We are still in a comfortable position with our debt covenants based on our current performance as well as our forecast. We did an amendment to our covenants a month ago to provide a little bit of additional head room with our debt service coverage.

Steve O’Neil – Hilliard Lyons

Okay. So then the final question would be what’s your commitment to the dividend after fiscal 2014? And that may be something you can’t answer, but I’d like to hear anything you might be able to say about that.

Bill Saxelby

Steve, this is Bill. You are right. I can’t make that comment prior to the fourth quarter, but it’s the intention of the management team and the board to continue to positively support the dividend. And I think our past practice should be considered by yourself and others when they think about the go forward. I would say is maybe the best way to answer that.

Steve O’Neil – Hilliard Lyons

Okay. Thanks for even trying to answer it. I know it was a difficult question. Thank you very much.

Operator

(Operator Instructions) We’ll go next to Mitra Ramgopal from Sidoti.

Mitra Ramgopal- Sidoti & Company

Good morning. First I had a question on the Medical product segment. I know you mentioned you expect some new products to be approved and based on the slide number 14, I think as we look out 2015, 2017 you are anticipating opportunities anywhere from $10 million to $30 million. And I was just wondering how that played into what you talked about earlier regarding the decision to write down or take the impairment etc., as you looked at that business and the opportunities.

Mark Zorko

Mitra, thanks for your question. The write down is in response to looking not only at the modest impact of new product development and the revenue from those products, but also takes into account the pricing pressure that we’ve been under for our existing products, our primary existing product line which has been much more aggressive than what was previously anticipated. So the combination of those two items brought down our forecast quite substantially from what it had previously been which led to the impairment charge.

Mitra Ramgopal- Sidoti & Company

So in the absence of bringing on new products, it seems like the base business is being hurt significantly in terms of pricing pressures?

Bill Saxelby

Yeah. Mitra, this is Bill. I would – my comment would be in my, let’s call it 35 or 36 years, I have not seen – be careful how I – not be careful how I choose my words, but I've not seen this level of pricing pressure in a compressed timeframe like we have here. And that’s no excuse. It's a reality. And I would make a comment that there is a high level of frustration from my personal perspective because I'm responsible for the decision ultimately to get involved in the business. And very unfortunately, we just – what we had seen versus what we had modelled, even though we thought we had been appropriately conservative in our pricing assumptions, the reality has just been different, and we’ve had to deal with that. So, the answer is I think you’re absolutely correct. Absent other products, the impairment represents the current state of that business under those circumstances.

We have been -- on that go-forward discussion, we’ve been appropriately conservative about these new products. However, on Page 14 that you referenced, those numbers that get us to the range that you see are very well thought out in our procedure base around opportunities that we see for these devices that were under development now. The challenges of working through channel, how we approach, how we price, those are all things that we’re working through. And I think our approach given especially some of the issues that we’ve had was to post the appropriate assessment of the business today, then update as we go forward what we think the – let’s call it the growth and the profit opportunities are going to be. So, let me stop there. Does that help in terms of the question?

Mitra Ramgopal- Sidoti & Company

Yeah. Definitely. Thanks for the color on it. And on a different note, if you look at clearly the last two years, including fiscal ’14 with one quarter to go, we’ve seen two years of earnings declines. I know you’re not providing guidance for fiscal ’15, but how comfortable are you that this should probably be the bottom for you and you’re pretty confident that as we look ahead, we should see much improved numbers?

Bill Saxelby

Yeah. The answer I would say, Mitra is confidence and good relative to what I think will be a reasonable approach over the next two to three years going forward. And the reason we put the strategic initiatives in the decks that we did, starting on Page 10 for the core business, the Radiation Measurement business, which really highlights the military as well as what we think the opportunity is to improve the operating income of the business from a cost reduction perspective. Those are both very substantial and we’re feeling much better candidly about the military. Hopefully, this $14.5 million order that came through, which -- our first order as a reminder to some was $12.5 million. So this is substantially larger than anything that we’ve received previously.

I'm confident that the Army is going to work through as a funding process to get to the remaining $50 million to $60 million. That maybe obviously is a wild card at this point for us, meaning we just don’t know what's going to be decided if at this point, although it does look like they’re going to get to a decision in the fall. The numbers that we’re talking about in dosimetry is simply executing on the new technology with existing clients. So you can see that we’ve not put anything in here from a revenue perspective, although we do anticipate that we’ll work through both a cannibalization of Luxel and we’ll have some pricing premium opportunities with the new product, but that’s not yet contemplated here. And then the one last thing – the third thing I would say for Rad Measurement is we are seeing an expanded interest in a system wide approach to managing radiation safety and security systems. And I’ll just leave you with this point because I don’t want to go into this in much detail, but we’ll flesh this out in more detail as we go through Q4 into next year.

Nuclear power has a very sophisticated way that they track everything radiation-oriented within a nuclear power facility. Medical has a very significant need for the same. Hospitals have a need for the same. And as systems consolidate, that need is becoming more evident. That’s not listed on these sheets, but I would name that as probably the third item that we think about that could be a fairly substantial annuity growth opportunity for Rad measurement. In terms of Medical Physics, this Joint Commission requirement that’s highlighted on page 13, we will see -- without going through any kind of a guidance discussion, we are going to see between a $5 million to $10 million increase in the medical Physics business next year based on what we are seeing at it relates to imaging.

They’re going to see a nice improvement in terms of their operating income. And we really do believe that the combination of the Rad measurement sales organization and the Medical Physics Imaging services under the radiology umbrella if you will it’s going give us a differentiating opportunity. So the two businesses have an opportunity to leverage each other which is something we always hope for when you put these businesses together.

And finally we are starting to finally see something concrete come out as it relates to patient dose. We’ve talked about this for a number of years but until the Joint Commission came out, we couldn’t really point to a specific that said this was going to change customer behavior. We have done an in depth amount of work to understand that hospitals, not standalone imaging centers, but hospitals that have imaging are going to have to spend about the same amount that they have spent annually, they’ll have to spend in addition to meet their requirements so my example of the $10 million, excuse me a $10,000 expense at a hospital grows to somewhere around $18,000 to $20,000 simply to be compliant. A big focus of what we are going to do at this AHRA meeting in DC will be focused on that. And now that we are building up the platform for a national Medical Physics practice group, I think this is where we are going to really start to see traction with that business.

The last piece is the Medical Products business and I think especially because of the challenges that we’ve had, we tried to be appropriately conservative here. We will quickly know whether or not these new devices really give us an opportunity which we think they do. But it’s going be a concept we’ll have to work thorough. So step back and to ask – the confidence is really in summary military verify with a longer term opportunity at a system wide, let’s call it radiation safety integration opportunity. That’s Rad measurement. Medical Physics will be driven over the next two to three years with fully implementing these joint commission requirements. And then by the way when we are in a facility for imaging, that’s a natural lead for us to then start talking about therapy as an opportunity in terms of radiation oncology and the management of Medical Physics there. And then finally hopefully we have seen the bottom of this situation with medical products and these new products. So when we get to talking about guidance without getting into that conversation now, we are feeling confident that we are going to be able to say that we are going to start to see this is moving let’s call it in the right direction.

Operator

We’ll go next to Rob Mason from Robert W Baird.

Rob Mason - Robert W Baird

Bill, I wanted to circle back to the verified platform. We stepped up the potential savings cost reduction potential from $1 million to $5 million. Now it’s $5 million to $10 million. Could you just delineate the source of that and where the confidence comes from around that? And also just to clarify, does that in anyway contemplate the -- or embed the elimination of R&D associated with developing that platform?

Bill Saxelby

Rob, let me go first of all to the facts are that we have about $23 million to $24 million that supports the logistics associated with badge management for the company. The $5 million to $10 million range comes from I think some very good work around what we think the opportunity is to take cost out of the system. I stepped up to $5 million to $10 million primarily because a couple of things, one is we are better refining the business model now for the program. We put a significant amount of effort into looking at the operating expenses and as well as manufacturing overhead etc. And we are feeling much more confident about that number. The number of approximately $23 million to $24 million is a real number. So we understand that is the potential to be able to look at reductions against that.

The other thing is obviously because of the challenges associated with having to discuss the different variable this quarter, I just thought it was important to be able to be let’s say more specific about what we really think the verified cost opportunity can be. It’s a fairly wide range I understand. We were trying to be extremely conservative in the beginning, but we were also -- as Jeff pointed out, we were also left confident of where we stood with sensor development back in the Q1 timeframe or even early Q2 than we do today. And I still want to qualify that we still have work to do, but as Jeff pointed out with Steve’s question, we feel much better about that.

I think you should think about that reduction opportunity as realistic and then as we get into the beginning of 2015, especially the first say six months into 2015, I think we’ll be able to better hone in on what that number really is going to be from a reduction stand point. But if you think the 23 is your total opportunity, then I think our range of $5 million to $10 million is appropriate. Relative to the funding, the majority of the R&D funding will be finished within the first six months of 2015. And what I mean by that is sensor development will be completed here probably in the first quarter of 2015 the way things look right now, so the first quarter of our 2015.

Wee then have to go through the various Nav Lab accreditation requirements that are, that happen every -- so every three months this business gets an opportunity to introduce a new product or Nav Lab accreditation which we have to have before we can take the product to market. We consider Nav Lab accreditation a part of the technology of R&D expenses. That’s why you’ll see less expense next year, but not a dramatic decrease because we still have development and then we still have the regulatory hurdles that we have to go through. I think your second question dealt with how are we going to fund this appropriately. And given what we think the operating income opportunity is, this is clearly the company’s number one priority.

And so the other component of this obviously is going to be beyond expense, is going to be the capital for software. We’ve got the requirements of software development already completed so meaning it’s not like we are going to start a requirements process and how are we going to develop the software. That’s been a significant part of the work that was done this year. We still have to code though and we can’t begin our coding process until we actually finish the sensor. So I'll stop there and then say we still can’t answer the last part of your question earlier, and maybe now which is we do know that we’re going to have capital for software. That’s the number I gave you. Let’s call it $3 million to $3.5 million next year. And then we’ll have the device investment that we’ll need to make. But there will also be revenue and profits to help offset that capital expense and then we’re – then we’re going to have cost reduction opportunities probably more in the 2017 time frame is when we’ll fully realize operating expense because the plan is to introduce these products at the end of 2015. And we won’t really see full cost out until we’re able to transition the Luxel product line. So we’ll see the real – we’ll see the benefits begin in 2016 and then in a much more significant way in 2017.

Rob Mason – Robert W. Baird

Understood. Just to clarify, though, the R&D that we’ll take into 2015 associated with the $2 million or so, we’re not counting that in the cost savings this five to ten, are we? Eventually I would think the $2 million goes lower?

Bill Saxelby

No. The answer is we’re not. Correct.

Rob Mason – Robert W. Baird

Okay. And then just lastly, how should we think about this step up in Med Physics with the new contracts that you’ve signed, I guess the $3.7 million? Will those ramp us in some kind of linear fashion? It wasn’t all that obvious in the quarter that we absorbed that linear, at least this first $2.6 million contract?

Bill Saxelby

Yeah. I think you can think of it as we’re going to be approximately $32 million to $33 million at the end of this year and we’ll be in the range of $40 million next year. That kind of takes into account your linear ramp.

Rob Mason – Robert W. Baird

Okay. And we’ve added the labor to be able to supply these contracts? That was reflected in the step up to $700,000 I guess in cost in the quarter?

Bill Saxelby

Yeah. Correct. Now there is one other component of the $700,000. To be completely transparent, you’ve got about 300 of that that’s actually – let’s call it physicist staffing that was in the quarter. There was about $400,000 that when we went to the segment reporting, we took some corporate expense both in terms of things like senior management, two individuals who had been splitting time with Rad Measurement and Medical Physics, moved them – dedicated them to Medical Physics. We also had things like insurance 401-K, and a couple of other ancillary items that fell into what I would call a corporate allocation that is now in the run rate of the business. So the 700 splits between what I will call 400 allocations, 300 staffing. But it wasn’t substantial staffing requirement. And what has to happen Rob is that in the case of one system in particular without naming the specific system, I'm looking at Mike Kennedy who’s in the room, who runs the business that 23 locations for that – 23 hospitals for that group, so 24.

So we have to basically have physicists in place either through acquisition or through organic growth. So what we’ve chosen to do here is we’ve chosen to go with organic growth and we’ve hired those individuals. It's the total of about seven to eight individuals that will be dedicated to that one system. That’s about $1.1 million worth of imaging business. So they go in upfront. So there is about – there is close to about a two month lag from the time we hire until we recognize revenue. And the last part of that is we have a process we go through to access each one of their facilities.

When we hire the individual, we do the system – we do the facility assessments within the system. Then we make recommendations. Then we begin to build revenues. So that’s why you’re going to see the ramp from – let’s call it approximately $32 million to $33 million to $40 million. And we’ve seen the expense now as we’ll see – we’ll start to see as Jeff mentioned, we’ll start to see the imaging revenue begin to – Still will be fairly modest but will probably be in the range of about $300,000 to $400,000 in the fourth quarter which is the beginning of that ramp process.

Rob Mason – Robert W. Baird

Okay. That’s great. Thanks for that clarity.

Operator

We now have no further questions at this time. I'd like to turn the call back over to you Mr. Zorko .

Mark Zorko

Thank you for taking the time this morning to participate in our call. If there’s any further questions, we can handle those offline. At this time we’ll close the call and again, thank you for your participation.

Operator

This now concludes today’s conference. We thank you for your participation.

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