Star Equity Holdings, Inc. (STRR) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Digirad Corporation 2012 Third Quarter and Nine Months Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Matt Clawson of Allen & Caron. Please go ahead.

Thank you very much, Douglas. And thank you, all, for joining us this morning. If you did not receive a copy of today’s press release and would like one, please contact our office at (949) 474-4300 after the call and we'll be happy to send you one. Also this call is being broadcast live over the web and may be accessed at Digirad’s website at www.digirad.com. Shortly after the call, a replay will also be available on the company’s website. I'd like to remind everyone that certain statements made during this conference call including the question-and-answer period are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. These forward-looking statements include statements about the company’s revenues, costs and expenses, margin, 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 or uncertainties include but are not limited to the business and economic condition, 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, and 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 Todd Clyde, President and CEO; and Jeffry Keyes, Chief Financial Officer. They will discuss the 2012 third quarter and 9 months results, update us on the company's financial strategies 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 Todd Clyde. Good morning, Todd.

Thank you, Matt. And I appreciate everyone joining us today on our Third Quarter 2012 Conference Call. I'd like to start today by introducing 2 of the leading members of our new senior management team. Along with our newly constituted Board of Directors, these are the people who will be helping me lead Digirad to a new era of growth and expansion and toward our goal of sustained profitability. Our new Chief Financial Officer, Jeffry Keyes, joined us in September. Jeff came to us from Sapphire Energy, a developer of alternative energy systems, and before that, Advanced BioHealing and CareFusion. Jeff is fitting in well with our team and shares our values, including keeping Digirad lean and agile and, at the same time, being extremely careful with our cash so we can make the kind of important moves we are currently considering that will deliver value directly to shareholders and prosperity to this company. Jeff will make a few specific comments later about our financial results. Second, our other important new leader here is Sarah Hanssen. Sarah joined our team last January as our Senior Vice President of Strategic Marketing and Business Development. We think enough of Sarah's work in her short time here that we've folded the management of our sales organization and the product business into her duties. Sarah came to us from Amylin Pharmaceuticals and, before that, Roche Diagnostics. She has more than 15 years of experience in driving growth through commercial operations, strategic marketing, business integration, operations and business development. Again, we are considering a variety of important options going forward and Sarah is playing an important role in this process. Sarah not only has brought experience with partnerships but also has experience repositioning commercial operations, including building the right sales foundation. Sarah has jumped into this new role with both feet, and we are already seeing results as bookings in the fourth quarter have increased. I will temper my enthusiasm a bit on the bookings as it will take more than one quarter to build the competency we need to have success in our product business, but we are on the right track. Quite frankly, our product sales have been hitting -- have not been hitting the mark despite our excellent product portfolio. I say this in context of a challenging market that has shrunk dramatically in recent years. We can and must do better. Sarah's new role will help drive this effort. The good news is we continue to generate a lot of interest in our core solid-state cameras, both our ergo and cardiac cameras. We also expect the fourth quarter to be better than the third. As I touched on earlier, some of the activities we are actively exploring are a variety of new ways to drive growth in our product business through R&D and new sales leadership and continue to generate cash in our DIS business and, if possible, expand its top line. Of course, we are also looking at strategic activities that makes sense and can be accretive for our DIS business. One of our main goals in the meantime continues to be to manage our cash and spend prudently so we maintain cash as an asset and are poised to act when circumstances are right for the long-term prospects of Digirad. Before I turn the call over to Jeff to discuss the finances, I think most of you know that our management team and our strategic committee at the board level have been looking at a variety of viable strategic alternatives. I know that there are some frustration among our shareholder base that this process is taking too long, but I can tell you all that we are very close to making some final decisions. We are vetting these options and taking advantage of the new ideas and perspectives from these new members. I believe this is a good process for our stakeholders. As you have noted, 2 of our brand new board members have been buying sizable amounts of our stock personally. Furthermore, under our stock repurchase program, we have purchased an incremental $1 million worth of our own stock over the past 9 months. I believe that demonstrates that, while we are going through this process, our team has a lot of confidence in what we are doing today and in our future, enough confidence that board members are investing their own money into what we are doing, as well as we are returning. We have now returned a few million dollars of cash to our shareholders through our stock buyback program. Now I'd like to turn the call over to Jeff to briefly discuss some of the numbers.

Thanks, Todd. As a means of transition from Todd's discussion of company stock, I'd like to provide a little bit more detail on our stock repurchase program. During the third quarter, we spent approximately $400,000 buying back our own stock as part of the program and, as Todd mentioned, a total of $1 million of purchases year-to-date. Furthermore, during the third quarter, we've decided to add another $2 million to our stock repurchase program. Adding to the program allows the board the flexibility to repurchase our shares if and when we believe the opportunity is right to provide value to our shareholders. We will keep you posted on these developments as we go forward. That said, we currently have more than $27 million in cash and investments on hand, which I believe leaves us in a sound position to act quickly on any strategic alternatives that makes sense. Todd and I both believe that a prudent management of operation and expenses is imperative right now, with so many options at stake in the near future. Overall, revenues for the quarter were down modestly to $11.8 million compared to $13.4 million in the third quarter of 2011. Revenues for our Digirad Imaging Solutions or DIS business were $8.9 million. While the DIS business did generate cash in the quarter, the top line was impacted by a lower-than-normal number of service days in the summer months. I'd like to note that our DIS business in the Northeast has been negatively affected by the horrible storm that hit it --- hit the region a few days ago. Of course, our thoughts and prayers go out to those individuals who have experienced loss in that region. The total impact in our fourth quarter results is yet to be determined, but we have already lost the last 3 days and expect to lose some more as we move forward. Revenues on the product side, what we call our camera business, were $3 million. We do see positive momentum going into the fourth quarter as camera bookings have improved over the third quarter. For the year-to-date, total revenues were $37.5 million, down from the $41.9 million for the same period a year ago. DIS revenue was down slightly to $27.5 million, but product revenue was down to $10 million, off from the $13 million from a year ago. Due to the decrease in revenues, our gross margins in the third quarter were also negatively impacted, coming in at $3.1 million or 26.5% of revenue compared to the $4.2 million or 30.9% of revenue in the prior year. Our expenses remained in check as an increase in R&D was offset in savings in marketing and G&A for the period. That investment in R&D was associated with some ongoing programs to determine the feasibility of using our camera technology more broadly for specialized imaging applications. Again as I mentioned, cash and investments totaled more than $27 million and approximately $400,000 of that cash was used buying back our stock during the quarter, bringing our total purchases up to $1 million for the year. We also used approximately $400,000 in cash on a year-to-date basis in legal and administrative costs associated with our shareholder negotiations that were completed during our second quarter. Needless to say, we do not anticipate endless cash burn here. And in fact, we're finding ways to conserve expense and cash until we are more comfortable that we are returning to revenue growth. Before we open the call for questions, I wanted to say I look forward to getting know -- getting to know many of you in the coming weeks and months as we respond to your questions and have meetings with many of you in person. I personally see the opportunity at Digirad to be an exceptional one and welcome your contact as we layout our plans, execute and build value. Now, operator, I think we can take some questions.

[Operator Instructions] Our first course -- first question, I'm sorry, is from the line of Paul Nouri with Noble Equity Funds.

You mentioned that you want to keep cash on hand for acquisitions. Does it make more sense to make acquisitions on the service side, or to purchase new technologies?

Yes, that's a good question. I mean, first of all, to be clear, we're considering a number of different alternatives. Certainly, if you looked at the DIS business, which is the services side, I think you could see a pretty easy story of it. If you could do a very financially disciplined acquisition, that could be tucked into some of the areas that we operate the business today and have a very rapid return even with the somewhat volatile market, you could do an acquisition like that, that would be very positive on the business and, like I said, bring a rapid return. So if we were to do anything on that side, it would be probably under those types of views. On the technology side, it would have to be something that was significant in terms of driving us into a growth market that was -- that really took advantage of some competency that we had as well. That would be a little bit further out, probably, in some thinking, if we were to do something like that. So those are just alternatives that are under consideration.

And you spent some money this quarter buying back shares. Is that something you see going forward? Or you are going to wait until you come to a conclusion about the strategic alternatives?

Yes, I think that's a great question. So total -- in total, since we put the plan in place, we've repurchased 2 million shares. We purchased about 1 million of that in this year. The other 1 million was almost all in 2009, a little bit of trickling in the other 2 years after that. That is something that we're weighing currently. So we may not be quite as active on the repurchase over the next quarter here as we're really narrowing down on that strategic view.

Our next question is from the line of Adam Peck from Heartland Funds.

I'm going to ask my obligatory: How many cameras were sold and how many ergos were sold?

There were 4 -- 5 cameras that were shipped in total in the quarter and 1 of those was an ergo. The camera business -- and I kind of alluded to this in the natural comments, but I made a decision to put Sarah Hanssen over the commercialization responsibilities of that business. Armando Jackson is no longer with Digirad. Sarah's doing a very good job. There is definitely some rebuilding that has to happen. But we've had very strong bookings in the fourth quarter so far. Those bookings in the fourth quarter are kind of interesting, they're coming both out of the cardiac as well as the hospital side of the business. And I know that there has been some -- a little bit -- I'd say a little bit of an increases in buying by some of the cardiology groups as these cameras just continue to get much older. I wouldn't say that you're going to see this massive hockey stick where all of a sudden a mass amount of practices are buying, but it's good to see some of that improvement. The ASPs on those cameras are much lower than what historical levels would have been, but there definitely seems to be some level of an appetite. I think that the first blush view is that these cameras that we have are very good. We're not probably positioning them quite as well as we can. That's our fault. The reason I bring that up, Adam, is that's something that can be solved and remedied. So we're working very diligently to do that. And we believe that we can have more success with the ergo. Everyone who has that camera is having tremendous experiences with it. We've recently sold a camera to a group who had done a -- kind of a try-to-buy with the system and they used it in a lot of parts of the hospital and had a fantastic experience. So when people get their hands on it, that experience continues to be really positive.

Was the ergo sold in the third quarter to an existing customer, or a new customer?

New customer.

Okay. And as far as the bookings, are ergos the -- a larger percent of bookings than they are of historical sales as a percent of total cameras sold?

No. I would say that it's still a blend, right? So in total, we'll have a larger -- we'll have a decent share of ergos in the entire year versus just the, I guess, in relationship to the total cardiac line but it'll still be roughly -- I don't know the exact number, I kind of call it half and half in the year as a whole. So what we also see is that the, X.ACT camera, although has had limited success in the past, there is a little bit of opportunity to start to sell that more aggressively based on us positioning it more correctly. And we started to do that already and we're in some good discussions. The challenge and just [ph] to temper that a little is -- the hospitals sales cycle is much longer. So even if you're selling in the outpatient area of a hospital, it's still going through a hospital sales cycle. So that will take a little bit of time to come around.

Is it possible if you could throw what the bookings number was?

I don't -- here's -- well, I've been talking a little bit about kind of where the trajectory is in the fourth quarter as much as where it is in the third quarter. I'm not sure of the total number that we booked in the third quarter, I think it was maybe 6 cameras, something like that, okay? But it has been more favorable in the fourth quarter.

All right. So did you say you lost 3 days in the Northeast already, from Sandy?

Yes, yes.

And what percent of your hubs would have been affected?

You're probably looking at about 25%. If I think of it on a revenue basis, those areas represent about 25% of the overarching business. Some of those will come back online faster than others, right? I mean, obviously, New Jersey was hit hard. We don't do business in New York in DIS, so that area isn't hit but the -- and then you have -- some modest loss would have kind of hit in the Midwest. But the good news is we didn't lose any equipment, none of our facilities were impacted. So we'll come back online fast. It's just a matter of also the responsive element of the physicians coming back online and getting back into the routine process of their practices. We always get a little bit nervous too in terms of when people are dealing with natural disasters. And now they have other issues that they're dealing with, what does that represent in terms of going out and getting routine health care done. And just their monetary situation shifts a little bit. But so we won't know all that for a little bit, but they'll definitely be some impact but probably not dramatic.

Okay. So your enthusiasm for the fourth quarter is more geared towards product versus DIS, and DIS could be weaker just because of loss days?

Yes, I mean, DIS is kind of charting along. The challenge that we've been trying to grapple with is how do you stem the modest slide. So if you look at DIS, right, the revenue was down around 4% last year over the previous year, and it's been kind of declining a bit. And those ASP pressures continue to be in play. But the business itself has been more stable. We've been able to generate the cash, but we don't want that business to continue to slide. So like the earlier caller was asking this question around acquisition, and do any of those things makes sense. Well, they certainly would make sense in terms of adding density and scale back in so that you can maintain that cash and broaden the cash, right? That would be the view. But if you did anything like that, you'd have to do it in a pretty acute financial view of how an acquisition would be done. And the question is, can you actually get a willing seller at those levels, right? That's always a kind of a challenge, right? So it is an interesting idea and it would be certainly part of the strategic alternatives that would be considered.

All right. Well, just as one of your longer-standing shareholders, our two-cents would be -- you've been in a very difficult environment, especially with where reimbursements have been going and hospital CapEx spending since the financial crisis. But we get a little uneasy when you start talking about M&A when you're currently not earning your cost of capital. So if you're thinking about acquisitions, we would hope that we could first straighten out the current business -- get both product and DIS earning their cost of capital, then we'd be much more comfortable with acquisitions.

Yes, yes. No, I think it's a fair comment, Adam, and I appreciate that and also appreciate that we're approaching anything that we're looking at with a real eye towards the shareholder view. Obviously, we're trying to increase the value and we're in a bit of a tight box in terms of how to think through that with where these businesses are and how stable or how unstable they've kind of been in the past. And so we would only do something that really makes a lot of sense. So that's the intention. And there would be a -- like I said, a real strong eye to financial discipline if you did something like that.

Okay. And can you say with 100% confidence that shareholders will learn the strategic direction of the company by the next quarter?

I think we are pushing really hard to be able to do that. I can't tell you with 100% certainty, but I think that we have been having very spirited debate about what is absolutely the right thing to do. And we appreciate that we need to get back with an answer and that there's some fatigue in terms of the length of time that we've spent in doing that. So we are pushing hard to try to do that.

Okay. I'll leave you a little wiggle room, maybe 99%?

Oh, you're so kind.

And the last time you spoke about the strategic direction, you did bring up that you're looking at partnerships to unlock value. Are those discussions ongoing?

They are ongoing, yes.

Our next question is from the line of Ross Taylor with Somerset Capital Management.

I'd like to second the concern about putting the M&A cart before the operating horse. I think that it would make it a lot easier and make us as investors a lot more comfortable if we saw the business had been able to get to where it can operate at a break-even or better level both earnings-wise as well as cash flow-wise before we go off and spend a lot of cash in the hope that we find an acquisition that maybe makes things better.

Yes, I know. I appreciate that, Ross. And I don't want to leave anyone with an impression that we have said we're going to go out and spend $10 million or $20 million on acquisitions, right? There isn't that type of commitment at this point at all. So we understand that. And my comment would probably be more in towards a tuck-in type scenario. And what I was talking about is, if you look at the profile of the business, how do you shore it up, get some growth and expand the cash generation of the operating business itself. And that's kind of what we're -- what we've been talking about. No question that we continue to work diligently to make the operational foundation of the business stronger. And some parts of the business are easier to do that with than others. I'd say that DIS is fairly stable in terms of all the foundation. The challenge is just the overarching market pressures that continue to allow the ASPs to slide downward so that's something that you fight against constantly. The product side, if you look at where those cameras sales have been over the last kind of 3 years, is we've been stuck in this bottom trough level where you're upside-down against your capacity level of a facility, right? So we have to get those numbers up, and that's one of the reasons why I made that change with Sarah.

And it sounded like, from some of your earlier comments, that strategic activity was really effectively another way of saying acquisition. And that made me, I think, a little bit nervous and I'm sure it made some -- a few other holders nervous as well...

Yes, when we think, Ross, about strategic alternatives for this business, it's everything from driving the technology into a new sector within health care that's high-growth, high-margin, high-expansion opportunity to how do you expand new services into DIS business, can you do acquisitions, do you sell the business, do you divest pieces of the business, right? Do you divest the entire business, right? All those pieces are in play and under heavy consideration in trying to find the correct risk-reward in terms of that value and even the correct expectation of shareholders in terms of where and how you could liquidate these businesses, if that is an alternative and is that the most effective path versus whatever the counter-alternatives might be, so -- and then looking at all that within the risk-reward element, right? So it's been a very robust interactive view and there are no -- there are no sacred cows in the process in trying to determine what is right.

Okay, that sounds good. Back on order flow this quarter. Well, therefore, since you had 6 orders last quarter, I take it that you've had more than 6 orders this quarter, from your statements?

We're pleased with what we're doing so far.

Okay. Lastly, when you guys make your decision and make your announcement on those strategic alternatives, process and where it's going to be taking us, I would recommend that you hold a conference call to allow us to both get a better understanding of it, interact with you on it and ask any questions that we might have directly, as opposed to having us calling in separately to try to pick things apart.

I would wholeheartedly agree with that, right? So if we do that intra-call, if you will, we would -- we'll schedule a call. If it happens to be at an earnings call period, we'd do it then, but yes.

Okay. And congratulations on seeing your directors -- your 2 new directors, particularly so aggressive in the market. I think that's a great sign and should give shareholders a really strong vote of confidence that these guys are putting a fair amount of their own money behind their belief that this stock is worth substantially more than its trading at today.

Yes. And I think the other comment I would make, my view from the board, is you have a group of very engaged gentlemen who really want to do the right thing to increase the value of the stock, right, period. And there's tremendous discussions about that and there is seldom a discussion that the perspective of the shareholder is not at the table, if you will.

Well that's great. That's really great to see. Thank you very much. Good luck.

Thanks, Ross.

Our next question is from the line of Tyson Bauer with KC Capital.

A couple of quick questions kind of relating -- or following some of the previous gentlemen. On the product side of the business, it's always been a battle to get to scale where we want it to be to really support some more growth activities there. And that's been a difficult road to go down. With the bookings and a little bit relative improved outlook, are we still kind of stuck with conditions that we're still uncertain whether that will support the kind of scale that is required? Or are we still in the environment where achieving that scale independently is still -- has its bumps in the roads?

Well, let's see, I'm not sure I -- If I don't answer your question well...

[indiscernible] can you achieve what you're hoping to independently on the product side?

Independently, yes. I think my -- where my concerns lie, is exactly what you highlighted, right? In terms of the scale. I think we have a very good product portfolio. I think that there are elements in the market in terms of dollar allocation and pressures that hospitals have and physician practices have that represent the lion's share of the issues that we face and have been very hard to kind of fight our way through. I -- as an example, Adam Peck was talking earlier about the ergo and we can get pretty good excitement on the ergo in a number of settings and those will go forward in a budget cycle. And then the hospital, because they've been stretching out, not buying equipment, and they're trying to forget where they go next, they end up allocating the budget dollars to a SPECT-CT camera, for example, okay? And so the camera then goes back in the budget cycle for the following year. Sometimes, that may go on for multiple cycles. Other times, we've been able to get it to bump in the following cycle. But when you play that out in your mind, that could be a 2-year cycle to get that camera in the door and sold, and it didn't have anything to do with the need and desire for the camera. Now I guess you could say it didn't have trumping value proposition over a SPECT CT, but it's -- we understand it wouldn't necessarily do that. So that's what concerns me quite a bit in terms of, can we drive enough scale to get back to the levels that we were at when I first took over and we did 85 cameras in the product business in 2008, I mean, that -- the profile, the profitability profile, the growth profile was just dramatically different than it has been today. And so -- but then when you balance and you say, "Okay, can you do it with someone else?" those are the alternatives that we're looking at. But I would say that the -- a potential buyer for that business, for example, or even maybe a partner on that side, if you stay in these traditional product lines, there's not a lot there, right? It's fairly anemic. Siemens, GE and Philips are spending their efforts and money on these much larger devices. They're kind of letting their cardiac lines just run their course and fall out. GE is probably the exception to that. So the ability to kind of find that effective partner that could scale it out is a little bit different. What I do believe in, Tyson, is that, that business unit can do better than it has been doing, okay, with more crisp, succinct execution. And that falls on us to make that happen. And -- but we don't want to run a business that's going to continue to just generate losses year over year over year, right? So we're grappling with all that, right? And the idea is how do you come out of this with a very clear, successful path that balances risk and reward with the shareholder? If it was really easy and there was this clear cut view, then we would have announced that already, right? There are some clear views, but they have larger risk elements associated with them. So those are the things that we're working through. Perhaps that was a little more than you were looking for. But we are considering what you described, but I just -- I -- my experience in the interactions we've had is the -- there aren't 20 groups lining up to do what you described.

The natural perception is it's hard to find anyone that would have an interest in both the service and the product, so they're somewhat independent of each other as [indiscernible] of the company -- do we make -- or is it the thought process, in your opinion, that we either go down one path or another, but it's going to be awfully difficult to maintain the current path with the product and service sides separated?

Yes, that's a great question. I think that there is value in both businesses. There is certainly value, if you're going to stay in the public arena, to have scale. And so if you shed one of those elements, you need to be doing that and then driving quickly into how to make the other one larger and more scaled-out would be my view. But I think I'll hold off in giving you a firm view in response until we understand and commit to exactly what we're doing strategically. If you look down the road -- and I'll go down far enough that you won't be able to really hold me accountable, if I look down 10 years, yes, I would look at separating those business elements and driving a strong service business down one path and driving a strong product business down another. But when is it the right time to create that break point? That's a different question.

Is being a public entity as you go through your strategic process, is that being viewed as a positive asset on some of these alternatives that you can offer, different alternatives here?

Yes, yes. I think, under some alternatives, that's exactly correct. And I think, under others, it would probably behoove the business to be private. So those are things that you kind of grapple with as well, right, just in terms of what you're trying to accomplish. But there's also a view that, if an investor is private or if an investor is public, they're still looking for a good return with a managed level of risk and so how do you kind of make that happen and effectuate the [indiscernible] Value creation.

At this time, there are no further questions in queue. I'd like to turn the call back over for closing remarks.

Thank you, everyone. We appreciate you being on the call today. I also appreciate the level of questions and giving us a chance to provide some insight. Obviously, we are trying to be very prudent in what we are considering going forward. And I continue to remind you of my statement earlier that we've gone through a lot of change in terms of at our board level, we've put a number of new folks into the management team. We have a lot of energy even despite all of the challenges that the business faces. The management team is incredibly committed to try to make a difference and drive real value, and certainly, that is the absolute case with the board. We look forward to updating you soon on our strategic view and vision for the future of the business. Thanks again for joining us today.

And ladies and gentlemen, that does conclude our conference for today. We'd like to thank you for your participation. And you may now disconnect.