Digirad's (DRAD) CEO Matt Molchan on Q1 2016 Results - Earnings Call Transcript

| About: Digirad Corporation (DRAD)

Digirad Corporation (NASDAQ:DRAD)

Q1 2016 Earnings Conference Call

April 29, 2016 11:00 AM ET

Executives

Risa Lindsay - Investor Relations

Matt Molchan - President, Chief Executive Officer and Director

Jeffry Keyes - Chief Financial Officer and Corporate Secretary

Analysts

Larry Haimovitch - HMTC

Juan Molta - B. Riley & Company

Operator

Greetings and welcome to Digirad Corporation First Quarter 2016 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Risa Lindsay. Thank you, Ms. Lindsay. You may begin.

Risa Lindsay

Thank you, Chris. 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’d 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 statements about the company’s revenues, costs and expenses, margin, operations, financial results, restructuring efforts, 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 2016 first 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.

Matt Molchan

Good morning, Risa. Thank you. Good morning, everyone, and thank you all for joining us today for our first quarter 2016 results conference call. It’s great to be talking with you all today at the close of another excellent quarter for Digirad. This quarter is the first quarter reporting results that include our recent acquisition of DMS Health, which transacted on January 1.

Our revenues for the first quarter were $31.2 million, a year-over-year increase of 125%. And our adjusted EBITDA for the first quarter was $3.7 million, a year-over-year increase of 345%. Obviously, the DMS Health acquisition has elevated Digirad to the next level in terms of revenue, size, scale and geographical coverage.

As a reminder, DMS Health is an integrated healthcare services company that is headquartered in Fargo, North Dakota, that operates in two primary business segments: mobile healthcare, which includes mobile, fixed-site and provisional diagnostic imaging and mobile healthcare solutions throughout the United States, with their biggest concentration of customers in the Upper Midwest; and medical equipment sales and service, selling and servicing primarily Philips medical equipment through their exclusive relationship with Philips Healthcare.

We remain very excited about the incorporation of DMS Health operations and employees into Digirad and we are progressing very well with our operational integration plan.

Now, for a quick business-by-business update. Our Diagnostic Services business, which includes our in-office mobile diagnostic imaging activities, Digirad Imaging Solutions or DIS and our cardiac monitoring business, Telerhythmics, continue to perform very well. DIS performed well year-over-year benefiting from high volume from existing customers, as well as volume from new customers.

Overall, our Diagnostic Services revenue increased 14% year over year in the first quarter from the favorable volume I mentioned, as well as the impact of a full quarter of revenue from the MD Office Solutions acquisition that was completed in March of 2015. Still, as we have mentioned in the past, we are seeing challenges with some competition and with the overall market in general at DIS.

But we are continuing to deploy other value-added services and pricing structures into these markets that we believe over the long-term will address these challenges and allow us to continue to grow organically as we move forward. I can say we are seeing some near-term positive results from these initiatives.

Our Diagnostic Imaging business performed well during the quarter, increasing its year-over-year revenue by 9% and ending the quarter with a good pipeline of business and forward outlook. As we move forward, we’ll continue to put effort in international markets as well as aligning ourselves with larger purchasing opportunities by being part of high-quality buying organizations.

In addition, we are conducting small enhancements to certain cameras in our product line to allow them to gain higher reach in the marketplace. These initiatives are being deployed over several quarters and will take some time before they gain full traction. Therefore, in the meantime, we’ll continue to manufacture and sell our existing high-quality nuclear imaging cameras in our current markets.

Our Mobile Healthcare business performed very well for the first quarter under Digirad ownership. And I’m very excited with the management team that is running that business for Digirad. As a reminder, Mobile Healthcare provides mobile healthcare solutions to small and regional size hospitals throughout the United States. Mobile Healthcare currently offers MRI, CT, PET/CT and other mobile diagnostic solutions and has ability to provide a variety of other mobile healthcare solutions over time to leverage its relationships, infrastructure and logistical backbone.

As we move forward, we’re going to be exploring some of these other mobile healthcare solutions and believe some might be able to be integrated within the business over time, providing potential new revenue streams.

Our medical sales and services business, also new to Digirad from the DMS Health acquisition, performed well in the first quarter. They have an existing - they have an exciting pipeline of future product sales. Also as a reminder, our medical sales and service business has an exclusive relationship with Philips Healthcare to provide product sales, installation, warranty and product support within a specific geographical area in the upper Midwest region of the United States. They primarily sell imaging systems, patient monitoring systems, and provide support to imaging systems within that same general region.

We generate revenues from commissions from these product sales and also generate revenue by directly servicing Philips products in the region. The acquisition of DMS Health is certainly a transformational event for Digirad. As we remain grounded in our legacy and the new businesses we have today, we also set our sights on our future, as we continually work to grow, add value and transform our company into an even more diverse healthcare solutions company.

This dovetails into our overall corporate strategy at Digirad, which is to focus on three main areas for growth.

Area number one, acquisitions, our goal is to acquire companies that fit within our business model of providing healthcare solutions on as needed, when needed, and where needed basis in a very financially disciplined manner; area number two, adding new services to our portfolio that we can provide through our current distribution channels; And area number three, organic growth within our existing portfolio of services and channels.

Though most of our current efforts are spent running our businesses in integrating DMS Health, Jeff and I continue to spend time, looking at possible acquisitions. Right now, we are primarily spending our time on potential deals, where owners are motivated and they are looking for potential transaction relatively soon.

However, as we stated before, the timing and size of these deals vary and we’ll only get involved in deals that we believe we can secure at the right financial metrics and add overall value to our company.

Now, I’d like to turn the call over to Jeff, to give other comments and a more detailed financial update for the quarter and year. Jeff?

Jeffry Keyes

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 such as those that are associated with acquisition integration and purchase intangible asset amortization.

In addition, I will make references to adjusted EBITDA, which also is a non-GAAP measure that further excludes depreciation, amortization, interest, taxes and stock-based compensation. We believe the presentation of these non-GAAP measures along with our GAAP financial statements and reconciliations provide a more thorough analysis of our ongoing financial performance. You can find the reconciliations of our results on a GAAP versus non-GAAP basis in the earnings release today.

As we have previously discussed, we closed on DMS Health on January 1, 2016 and the results of DMS operations are included in our results for the entire quarter.

Now, for a brief financial summary of this quarter’s activity, total revenues for the first quarter 2016 was $31.2 million compared to $13.8 million for the same period last year., but the largest impact being the inclusion of the DMS Health business units, mobile health care and medical equipment sales and services in our results.

Revenue for these new business segments contributed a total of $15.6 million to our overall revenue for the quarter. Revenues for Diagnostic Services were $12 million compared to $10.6 million for the first quarter of last year. And revenues for Diagnostic Imaging were $3.6 million compared to $3.3 million in the first quarter of last year.

Our overall gross profit percentage in the first quarter of 2016 was 29.1% compared to 26.4% in last year’s first quarter. In Diagnostic Services, the gross profit percentage for the first quarter was 21.2% compared to 19.5% in last year’s first quarter. And in our Diagnostic Imaging business, the gross profit percentage was 47.9% compared to 48.5% in the prior year’s first quarter.

Overall, the revenue increase and gross profit percentage increase in our Diagnostic Services business was possibly impacted by higher volume of service days ran in the first quarter of 2016 compared to the prior year, both from new business activity as well as less cancellations in 2016 versus the prior year.

In Diagnostic Imaging, our overall revenue and gross margin was impacted by the timing and mix of cameras sold as well as higher releases of prior reserved inventory in Q1 of 2015 versus Q1 of 2016. Now, I’ll make some comments on our new business segments Mobile Healthcare and Medical Equipment Sales and Services.

In the first quarter of 2016 Mobile Healthcare produced revenue of $12 million and a gross profit percentage of 24.6%. While Medical Equipment Sales and Services had revenues of $3.6 million and a gross profit percentage of 51.8%. Moving forward, we generally expect the gross profit percentages for these business segments to be in line with these in the first quarter. So Medical Equipment Sales and Services can vary somewhat depending on the timing of product sales and related commission revenues related to our exclusive Philips relationship.

As a reminder, we do experience some seasonality in our businesses. And notwithstanding other factors, the fourth and the first quarters are our slower quarters in the year, but the second and third quarters being our higher revenue quarters.

Further, we also expect this seasonality trend to be consistent with the inclusion of DMS Health business units as we move forward. The Mobile Healthcare business experiences most of the same seasonality concepts as Diagnostic Services. Medical Equipment Sales and Services business experiences the same timing concept based on timing of equipment sold similar to Diagnostic Imaging.

Notwithstanding acquisitions, we expect this trend to continue as we move forward. During the first quarter, we also incurred closing and integration cost related to DMS Health of $1.5 million. We expect to incur approximately another $500,000 of remaining integration costs over the remaining portion of 2016.

Moving on to the bottom-line results for the first quarter, adjusted net income was $1.3 million or $0.07 per diluted share, compared to $0.3 million or $0.02 per diluted share in the first quarter of last year. Adjusted EBITDA was $3.7 million in the first quarter of 2016, an increase from the $0.8 million in last year’s first quarter.

One noteworthy impact for the quarter was included in our financial results, but adjusted from our adjusted results was the impact of the release of previously reserved deferred tax assets associated with our net operating loss carried forward. As we have discussed previously, we have over $90 million of federal NOLs as of December 31, 2015 that can be utilized to offset taxable income as we move forward. However, based on our prior history of losses these benefits were previously all reserved prior to the third quarter of 2015.

In the third quarter of 2015, we conducted a detailed analysis of our deferred tax reserves and determined it was appropriate to release approximately 50% of these reserves, which resulted in recognition of approximately $18.2 million of deferred tax benefits during that quarter.

During the first quarter of 2016 we conducted a similar but updated analysis based on the closing of DMS Health and inclusion of their operations into ours, which resulted in further releases that generated $12.5 million of income tax benefit during the quarter. As of now, the vast majority of our previously reserved deferred tax benefits have been released.

We only have our remaining $5.6 million of gross reserved benefits of the original $95 million we had reported over the last couple of years. As we expect to generate taxable income in 2016, we will see some more releases related to our taxable income in 2016 which will likely result in very low effective tax rate for 2016 of around 6%.

As we move into 2017, we expect our effective tax rate to be in the 38% to 40% range, as we have released all of our expected tax benefits related to NOL. One important thing to remember in context are our effective tax rate moving around between 2016 and 2017 is this, we expect our cash tax rate as we move forward into foreseeable future to be around 6%, no matter what our effective tax rate is.

Today, we also reaffirmed our 2016 financial guidance, which is to produce revenues of between $125 million and $130 million and adjusted EBITDA of $17 million to $18 million. In addition, based on including our purchase accounting associated with DMS Health acquisition, we expect to have adjusted diluted earnings per share of between $0.30 and $0.35 per share.

As you know, we also closed on a credit facility with Wells Fargo in January 1, 2016 to help fund the acquisition of DMS Health. This credit facility has three components: a line of credit that has a borrowing base of up to $12.5 million and bears interest of LIBOR plus 2%; a tranche A, as a borrowing base of $20 million and bears interest at LIBOR plus 2.5% and amortizes over seven years; and a tranche B, that has a borrowing base of $7 5 million and bears interest at LIBOR plus 5% and amortizes over three years.

At March 31, 2016, our weighted average interest rate on our credit facility was 3.41% and the total principal balance outstanding was $32 million. Our net debt position left all cash, cash equivalents, available sale of securities and restricted cash was $18.4 million. Moving forward, we expect to utilize most of our excess available cash to be applied against our credit facility to help reduce overall interest expense.

And finally, we announced today our regular quarterly cash dividend of $0.05 per share that will be paid on May 27 to shareholders of record on May 30.

Now, I would like to turn the call over to the operator to take questions.

Question-and-Answer Session

Operator

Thank you, everyone. At this time, ladies and gentlemen, we will be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Larry Haimovitch from HMTC. Please proceed with your question.

Larry Haimovitch

Good morning, gentlemen, and congrats on another good quarter.

Matt Molchan

Thanks. Good morning, Larry.

Jeffry Keyes

Hi, Larry.

Larry Haimovitch

Hey, Matt. Once again, this is the third or fourth quarter. I think you’ve mentioned the word competition and how you’re dealing with it. I keep wondering about, if you could provide little more color on that, since you proactively bring up the competitive aspect of the business.

Matt Molchan

Really, it’s just a fundamental aspect that we’re running into in certain of our markets, where we do have small mom-and-pop competitors that are competing on price. And as that occurs that does - obviously, as we’ve spoken about in previous quarters that still has a downward effect on the DMS operating performance - the DIS operating performance.

So we just want to point that out. Although we have been - as I also stated, we’ve been working on new initiatives that have been combating that type of price pressure and we are seeing some small benefits from these new programs.

And I think as we see increases as we saw in DIS in the first quarter, so we saw some organic growth less the acquisition over 5%. So we are starting to see some benefit from those initiatives to combat that. But it’s still in certain areas that we are running into some of these mom-and-pops, and we are experiencing some price pressure.

Larry Haimovitch

Great, a follow-up question, Matt, it sounds like overall the acquisition has gone very, very well, and it’s as expected. Were there any issues or disappointments, as you started integrating the two companies that you might want to share with us?

Matt Molchan

We have not experienced any disappointments at all. Very excited about the company, very excited about the people and the relationships they have with their customers. It has definitely - now, lot of work, integrating, mainly the operational aspects of the back-office, the HR, the IT, the finance departments. But for in general, we have not had any surprises to this point and it has gone very smoothly.

Larry Haimovitch

Great. Thank you, Matt.

Matt Molchan

Thank you, Larry.

Operator

Ladies and gentlemen, our next question comes from the line of Juan Molta from B. Riley & Company. Please proceed with your question.

Jeffry Keyes

Hi, Juan.

Matt Molchan

Juan?

Operator

Mr. Molta, your line is live.

Juan Molta

Yes. Sorry, I had on mute, sorry, sorry. Good morning, guys.

Matt Molchan

Good morning, Juan.

Juan Molta

Hi, how are you? First question is on the 2016 guidance. Do you see like - given this quarter’s results and the strength you had this quarter was above our estimate you could have potentially increased that guidance on. I was wondering if you’re just being conservative for the balance of the year. Is there something in particular that you are seeing the may marginally reduce results in the nine months?

Jeffry Keyes

No, Juan. There’s nothing in particular, but at the same time we just acquired a company that essentially doubled the size of Digirad. And we’re coming out for the first quarter. So there’s seasonality and activity within the businesses. As we mentioned we don’t have concerns or any thoughts on the full year that would cause us deep concern as we go forward.

But in time, we think the guidance range that we provided is appropriate. And, obviously, each quarter we’ll take a look at it and we’ll update everyone as needed. But right now, we think the full year guidance range is appropriate based on, how we are seeing the year coming together.

Juan Molta

Okay, very good. And regarding a couple of questions on product sales, the product sales was about 20% stronger than we had forecasted. Was that due mainly to DMS or is that the core nuclear imaging product there?

Matt Molchan

[Multiple Speakers] I don’t have in front of me the - your estimate on how you calculate that. But we have two separate divisions now that are selling product, our traditional diagnostic imaging business, which was up about 9% over last year quarter-over-quarter, and then our medical equipment sales and services business, which obviously as I said performed well in the first quarter.

But maybe - and I apologize, I don’t have year forecast right directly in front of me. So I am not sure, if which one have had - where you forecasted on those sales. But both divisions are performing very well, both have very strong backlogs and we’re very excited about their performance in 2016.

Juan Molta

Okay, very good. Then the next question is on product margins, which is almost 50%, you already mentioned, you expect that level of margins for the balance of the year. And I was wondering about the previously marked-down inventory that you had going through the cost of goods sold line. Is that not going to be an issue here going forward that may reduce product margins?

Jeffry Keyes

So let me just clarify a little bit between the businesses, obviously, diagnostic imaging for product sales, we manufacture and sell those products. So the actual product cost is part of the margin and then for medical equipment sales and services, we generate revenues based on a commission off a product that is sold via Philips.

We’re not actually running the cost of the product through COGS and the ultimate margin. So, having said that, your other question was about inventory releases, there was a minor amount of inventory releases within margin in the first quarter of 2016 for diagnostic imaging. But we do not expect any more of that. And it was definitely less than it was in the first quarter of 2015.

That actually took margin down year over year comparatively for that one concept one. But we don’t expect any more margin benefit going through for the course for inventory releases, just normal inventory activity. So, yes, we are aware of that and we would expect margins to be in the same general level as a combined product and equipment sales business across the new DMS business unit in the - our Digirad diagnostic imaging business units.

Juan Molta

Okay, very good. Regarding pricing in the services side, have you seen any change now that we’re working with the 2016 reimbursements off of Medicare, have you seen benefits or just has it been neutral?

Matt Molchan

I mean, overall, I would say, it’s been neutral. I mean, certain sections of our business did benefit actually from some increases, but it’s a very small portion of our business. So for the most part, in general, it’s been very neutral.

Juan Molta

Okay. And you mentioned in your - I was going to ask about future acquisitions, but most of your efforts right now are going to be spent on integrating DMS from running the business as it is. So we shouldn’t expect too much in terms of acquisitions in the next 12 months that are meaningful or maybe a little more color there?

Matt Molchan

Well, obviously, we’re definitely going to be opportunistic. In terms of deals that would come across our table that with the right financial metrics will make sense for Digirad. So we’ll continue to have our eye opened on that. But you’re correct. For the most part we are concentrating on integrating this business. And as those opportunities come up, we will obviously address them, and buy the proper resources to execute them if we feel like they will be beneficial to Digirad.

Juan Molta

Okay, very good. That’s all I have. Thank you very much guys.

Matt Molchan

All right.

Jeffry Keyes

All right. Thank you, Juan.

Operator

[Operator Instructions] There are no further questions at this time. I would like to turn the call back over to management for any closing remarks.

Matt Molchan

Thanks, Chris. As always, we appreciate all our shareholders and your continued feedback and support. We are very excited about our business model and our future. And we believe that there are many more good things to come. Jeff and I look forward to discussing our results and business update with you next quarter for our second quarter results. Thank you.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. We thank you for your time and participation. You may disconnect your lines at this time. And have a wonderful rest of your day.

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