Star Equity Holdings, Inc. (STRR) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by and welcome to the Digirad Corporation 2012 Fourth Quarter and Year End Results Conference call. [Operator Instructions] This call is being recorded today, Thursday, February 28, 2013. I would now like to turn the call over to Mr. Matt Clawson, of Allen & Caron. Go ahead, sir.

Thank you, Jo, and thank everyone this morning for joining us on the call. If you didn't receive a copy of today's release and would like one, feel free to contact our office at (949) 474-4300. I will be happy to get 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, business and economic conditions, technological change, industry trends, changes in the company’s market and competition. More information about 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 CEO, Todd Clyde. Joining Todd this morning on the call are Jeff Keyes, Digirad's CFO; Jeff Eberwein, Chairman of Digirad's board; and Matt Molchan, President of the DIS division and incoming President of Digirad. Todd and Jeff will discuss the 2012 fourth quarter, and year end preliminary results, update us on the company's new 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 Todd Clyde. Good morning, Todd.

Thanks, Matt and I appreciate everyone joining us today for our fourth quarter and full year 2012 conference call. I'm very pleased to begin by saying we had a good fourth quarter, which we all see as a positive sign for a much more interesting 2013. Our Digirad Imaging Solutions business, that we call DIS, was solid, even though the results in our Northeastern hubs took a slight hit in October due to the impact of Hurricane Sandy. Our camera business had an improved quarter but continues to be challenged with operational inefficiencies. As much of you know, for more than a year, we have been in the midst of a strategic analysis of how to position the company and its businesses for maximum value to the markets we serve and a critical importance to our shareholders. Over the past 3 years or more, the markets we play in, namely the hospital nuclear camera sales market, in-office nuclear camera sales market and in-office imaging services markets, have experienced a great deal of volatility in terms of reimbursement, healthcare reform, poor economic trends and insurance and regulatory changes. These resulted in our having to carefully consider the most effective manner to improve our businesses and drive value to our shareholders. We conducted an in-depth market research to look at many possible strategic directions, including partnerships, acquisitions divestitures and new product development and new services. We have also considered the views of our shareholders, including reconstituting our board by adding 4 new board members at the end of April and early May of 2012, all who came at the recommendation of our largest shareholders. We believed it was important to allow the new board the appropriate amount of time to digest and consider all of the strategic options for the business. Based on this effort and the counsel from our new board, we have decided to focus strategically on growing and expanding the footprint and cash flow from our DIS services business and also the positive cash that we receive out of our service and maintenance business, which is linked to our diagnostic imaging business, or what we have historically referred to as our product business. Of course, we will continue to sell our solid-state cameras into the marketplace, we will simply be restructuring the imaging camera part of the diagnostics imaging business to no longer burn cash in this business. Our main focus with this strategy is to maximize cash flow from operations and return value directly to our shareholders. After this restructuring, we believe we will be able to drive annualized free cash flow in the range of approximately $3 million, to $4 million. In tandem, we will launch a more aggressive stock repurchase program, which the board has voted to increase from its existing $2 million in current availability to $5 million available for repurchase, in order to return value directly to our shareholders. Finally, we will thoughtfully pursue new opportunities to increase our DIS service, increase the asset utilization of that business and of course, with a total focus of increasing the cash flow by executing on financially disciplined acquisitions that align to our DIS business. When we identify assets that can have a benefit to revenues are accretive almost immediately and have a relatively risk short payback period, those are the ones we would act on. We are not looking to make huge investments. I repeat, we will not make a really large acquisition that will take years to pay off. Again, this strategy is about maximizing and expanding cash flow and giving the business the return, as well as the returns for the shareholders. Following that model, we recently identified and acquired a leading provider of imaging service businesses in the Southeast. The acquisition provides us a strong presence in another key southern region, takes advantage of nearby operational leadership and infrastructure and generate favorable operating margins of EBITDA. That acquisition was made for approximately 2.5x cash flow, with a cash cost of $475,000. We will seek and continue to make smart investments that could add, scale and maintain solid cash flow. Finally, we are making some key management changes in line with the new strategic direction of the business. Matt Molchan, who has successfully served as the President of our DIS business for more than 1 year, is being promoted to President of Digirad. Matt joined us when we acquired Ultrascan, the Southeast's largest mobile ultrasound business in May of 2007. Matt was -- has been CFO at Ultrascan previously and he also held other executive positions at Somera, Inc. and Equifax. Matt is here today and available as needed during the Q&A part of this call. I will be working side-by-side with Matt making -- during the restructuring process and I will continue to be CEO of Digirad during the 6-month transition period, after which time, Matt will become Digirad President and CEO and I will step down from that role. Keeping the current executive structure in place, after the restructuring, would result in a top-heavy organization and our principal goal is to create a lean company. I have a lot of confidence in Matt and he will do a tremendous job in the role as he has done running the DIS business. In order to reduce costs further, we also plan on relocating the Digirad corporate headquarters to Atlanta, where Matt is based, from our current San Diego base, pending a complete examination of the cost of relocation. In addition to the change, we're elevating Virgil Lott to the position of President of our Diagnostic Imaging business, which will likely -- which will continue here in San Diego. Jeff Keyes will continue to lead our finance and accounting team as our CFO, also here in San Diego. Now, I'll turn the call over to Jeff Keyes, who will go through our financials. Then, I will make a few comments before we open it up for a Q&A session. Jeff?

Thanks, Todd. As we noted in the release this morning, the company is currently undergoing an analysis with our auditors to determine if the results of our restructuring efforts will create any impairment on the assets as of December 31, 2012, as well as an estimate of the restructuring charges to be recorded in the first quarter of 2013. As such, all 2012 financial information today is released and I will summarize its preliminary and subject to change based on the conclusion of that analysis. Because of the preliminary status of this report, I will keep my comments shorter than normal. Preliminary total revenue for the fourth quarter of 2012 was $13 million, up almost 10% from the $11.9 million from the same period in the prior year and up sequentially from $11.8 million in the third quarter of 2012. Preliminary DIS revenue in the fourth quarter of 2012 was $8.5 million, compared to $9 million in the same period the prior year and $8.9 million in the prior sequential quarter. Preliminary diagnostic imaging revenue for the fourth quarter of 2012 was $4.5 million compared to $2.9 million for the same period in the prior year and $3 million in the prior quarter. Preliminary gross profit for the fourth quarter of 2012 was $3.8 million or 29.1% of revenue, compared to $3.1 million or 26% of revenue in the same period the prior year and $3.1 million or 26.4% of revenue in the prior quarter. Preliminary net loss for the fourth quarter of 2012 was $0.3 million or $0.01 per share, compared to a net loss of $2.8 million or $0.15 loss per share in the same period as the prior year and a net loss of $0.9 million or $0.05 loss per share in the prior quarter. Most importantly, cash and cash equivalents and available sales of securities at the end of December 31, 2012, was $27.2 million or $1.42 per share, which is the same balance that we had at the end of our third quarter and includes the cash paid for our acquisition. For the full year, preliminary total revenue for the year ended was $50.5 million compared to $53.7 million for the prior year. DIS revenue for 2012 was $36.1 million compared to $37.8 million for the prior year. And diagnostic imaging revenue for 2012 was $14.4 million, compared to $16 million in the prior year. Gross profit was $14.3 million or 28% of revenue, compared to $14.8 million or 27.5% of revenue for the prior year. Preliminary net loss for the year ended December 31, 2012, was $3.3 million or $0.17 loss per share, compared to a net loss of $3.3 million or $0.18 loss per share in the prior year. In total for the year, the company purchased approximately $1 million dollars of Digirad common stock under our repurchase program and as we mentioned earlier, that repurchase program is going to be increased from a $2 million availability to $5 million of availability. Again, as I mentioned earlier, we're going through this analysis to determine if the results of restructuring will create an impairment at our December 31, 2012 preliminary results, an estimated restructuring charge for Q1 2013. As a company and a management team, we have a high sense of urgency on getting all our cost cutting measures implemented and completed, as well as setting up the business for success in the future. Now I'll hand the call back to Todd for some additional comments.

Thanks, Jeff. Those of you who have followed us closely know that over the past quarters, we have reconstituted our board, streamlined that board and have promoted Jeff Eberwein to Chairman of our board. Jeff has a wealth of Wall Street experience and a focus on creating shareholder value. All of us on the board have spent these past months immersed in evolving the strategic direction for Digirad. Ultimately, our strategic decisions were based on the fact that we have a strong business structure here at Digirad, but one that needs to generate greater cash flow and build shareholder value. In addition, consideration was given to the shareholder base and the fact that many of our largest shareholders have a value -- a strong value orientation. Alternative strategies to that plan that we have laid out typically would've required a higher investment and therefore, with the time and cash requirement, greater risk factors. The culmination of those metrics became the basis for the ultimate decision we made. I can speak for the executive team and the board when I say that the process resulted in the solution that makes sense for our shareholders and we are very happy to have a resolution and to begin working towards progress on our new path. Digirad is a great brand in the marketplace and is a well-run organization with a great deal of value that is still to be unlocked. We're all very excited about the prospects that are in front of us. With that, let me turn the call open to questions.

[Operator Instructions] And our first question comes from the line of Paul Nouri with Noble Equity Fund.

For the quarter, the revenues came in pretty nicely and the cost structure was good, but I was a little surprised that the equipment revenue bumped up or the service revenue was a little lower than I expected. If we look at the equipment revenue, can we expect that it’s going to be at a lower run rate next year? Or can we use that $4.5 million number going into 2013.

We did see a strong quarter in the fourth quarter in equipment sales. I mean certainly, the overall year is still at a level where we have operational inefficiencies, but this was definitely the best quarter that we've had during the year. We've had a number of deals that we've worked in the pipeline for a long time that have started to come through. In terms of your question about, is that really a run rate level? I still think that there's volatility in the marketplace. It's a little bit hard to absolutely say and plus, we're going to have an emphasis on generating cash kind of as the first priority for the business, so we want to make sure that the transactions that we enter into are kind of oriented towards that vein. In terms of your comment around the DIS services revenue, we did experience a little bit of slowdown in October based on the impact of Hurricane Sandy, but it is common for our business to have a little bit of slowdown around the holiday season, as doctors and also their patients take time off. So in that -- sometimes, that could be a little more acute, sometimes it's not. We also can sometimes have weather elements either in the fourth quarter or in the first quarter that can create some issues. For example, this quarter when some big storms went through the Northeast, we lost a few days of business. So those things happen.

Is there anything to suggest that the service revenue aside from tuck-in acquisitions can start increasing again next year?

Yes. That's a good question. We have obviously not given guidance specifically on our revenue and our numbers. The business, as I indicated in my prepared remarks, really has had a lot of challenges in the marketplace with regulatory changes, the healthcare reform and all of that. We've seen that begin to stabilize as the healthcare reform and the implementation of healthcare reform has become more, I guess, kind of, it starts to become implemented and people start to understand it a little bit better, but I don't want to leave you with this impression that all the volatility gets completely removed. So whether we can absolutely drive strong growth off of the base business, I can't say that, but what we do believe we can do is generate cash and look at ways, if you were to do some tuck-in acquisitions, to kind of expand the top line through that process.

Okay. And then turning over to capital allocation for 1 minute. You expanded the buyback to around $5 million, you have $27 million on the balance sheet and you're expected to cut off free cash flow. You're not going to do any large acquisitions. So I think the expectation should be that there's going to be at least $20 million on the balance sheet for the foreseeable future. Is that just a number that gives the company operational flexibility? Or is there a thought as to something else that can be done with that additional money, like, I don't know, an extended buyback, or a one-time dividend or something?

Yes, all those things have been under consideration and I can tell you that our Board of Directors is laser-focused on ways to provide a return to our shareholders. That's why we talked about expanding that, growing the cash in the business and then taking that cash and returning it to the shareholder via a buyback. In terms of the cash balance, you're correct. What we would like to do is get through the restructuring process and get the business kind of stabilized coming out of that restructuring and then that gives us a chance at the board level to kind of look at that and reassess what is really the most effective strategy from there. So we're not saying absolutely yes and we're not saying absolutely no. We want to be measured and thoughtful in our process.

And our next question comes from the line of Ed Schwartz [ph] with Schwartz Investments [ph].

I just wanted to look at your thought process with the buyback increase of $3 million versus giving that $3 million back to shareholders in the dividend, what's the difference in terms of shareholder value that shareholders could expect?

I guess, I'm trying to think, I mean let me make a comment and then make sure -- if I'm not answering your question effectively, please ask it again. But certainly when I think about putting cash directly into the hands of shareholders, that's a good thing to do and something to be considered, but it also ends up being kind of a one-time click and then you don't have the cash and the value is not reflected longer, if you buy back shares, then you're essentially taking shares off the table and increasing the ownership percentage of the respective shareholders around the table and allowing that value to continue. That would be my kind of general comment.

And I think the formula for buying back shares is a certain percentage of your average daily volume or something like -- I could be wrong but I think I'm in the right range there, where -- how long do you think it will take to make this buyback effective? I mean to fully buyback the shares.

Yes, you are correct that historically, we have done the buybacks via an 10b-18 plan. There are obviously other mechanisms to buy at a more rapid rate. We have to wait until the window opens, which it opens kind of 3 days after this call, in order to put a plan in place and extend that forward. So the board has not made the final decision on that specific implementation, but I believe we're leaning towards putting an 10b-18 plan in place again.

And one other quick question. You mentioned you don't give guidance, I understand there may be some impairment charges in the first quarter, and some restructuring charges. Putting those aside, when do you think you'll be profitable on a quarterly basis?

Our intention is to obviously come out of this year with that run rate viewpoint, okay, when you look at the financials. Why I'm slightly cautious is we've established the plan, we've made a specific decision at the board level. We have very recently notified top management of this change and therefore, we have the high-level plans in place and in process, but there's lots of details to work through. So we're going to focus and get the restructuring done as fast as we possibly can and do it really with a high level of urgency, but in terms of saying, "Hey, we're going to absolutely come out really, really strong in the third quarter or in the second quarter." It's a little early for me to say, but we'll certainly try -- we'll try to give you insight as we're progressing in this plan. Again, the key is reduce the cost structure, reorganize the business effectively, get the cash coming in and then really be thoughtful as we move forward and the idea is that you're -- on an annual basis, you're expanding that shareholder value.

And our next question comes from the line of Ross Taylor with Somerset Capital.

It's nice to see the strategic plan being laid out to us as clearly as this. Quick question, size of the NOLs, how big are they?

So the federal -- total federal number's around 95. Jeff, the California's, $26 million?

It's right in the $30 million range.

I can tell you that the federal -- all of those are intact today. You start having some that fall off. I want to say starting in either 2016 or 2018, kind of roughly in that range. So that's an asset that we talk a lot about with the board in terms of how do you monetize this asset and our goal here as you think about this strategy that's been laid out, Ross, is all right, generate the cash, obviously you're going to be generating profit in that experience and that profit should be ostensibly tax-free for quite some time.

I would agree and looking at -- you're talking about $3 million to $4 million in savings coming out of the imaging business. You're moving the corporate headquarters, I assume that, that's going to generate a savings of some measurable amount. Do you have an idea on what size that is?

Yes, we don't yet, and we're frantically trying to pull all of that together. If we had a decent range, we would have put it in the release, but we appreciate that we have some great businesses here and we're going to take advantage of their strength. Certainly with a primary focus of the strategy being on the DIS services business, we just felt that running that out in Atlanta made a heck lot of sense. Matt's been doing a great job and frankly, we also had to cut costs and so we just couldn't keep kind of the same executive over infrastructure in place. So we will get that information out. We certainly have requirements to do that and Jeff is analyzing with his team even a potential impairment on the balance sheet at 12/31, based on this as he said in his prepared remarks.

And I would assume that any acquisitions you make will be both cash flow positive and earnings positive?

Absolutely. I mean we're, again, laser-focused on cash generation so anything that we do, we're looking for rapid payback and we're looking for expansion of the cash that the operation generates. Those will be kind of my 2 simple statements and then, you would take that cash, and you'd have-- you would take that cash and return it to the shareholder through a buyback and then you'd have some cash to look at a -- another acquisition. But don't expect us to say, "Yes, we're going to do 5 acquisitions in a year, right?" That's not what we're trying to do here, because we are not trying to have urgency for acquisition. We're having urgency for cash growth, okay. So we'll be judicious in anything that we do.

Well, I'm one of those value-oriented investors who was very pleased with the steps. Looking at -- you're also talking about buying back about 10% plus of the outstanding shares and so when I'm looking at this, I come up with the idea that on a cash basis pretty much any earnings, operating earnings, should flow to the bottom line because of your significant tax loss carried forward. So it's not hard for me to see you guys earning somewhere between $0.15 and $0.25 on the run rate, as we move to the end of this year on an annual run rate, is my math wrong?

I probably prefer not to comment on your math, but your hypothesis, I agree with, right. Your hypothesis is aligned with what we're trying to do strategically.

And so looking at a situation, where I'd see you at the end of the year possibly looking at $0.20, $0.25 in earnings with a $20-plus million in cash sitting on the balance sheet. It strikes me as buying back stock is an incredibly leveraged play on the future of this company and that we would strongly support buyback at this point over something such as a dividend, because I think even here at current prices $2.25, $2.30 the stock is significantly undervalued we would think by perhaps, an order of 100% or more. But we encourage the buyback.

Thank you for that input and I know you've given us input in the past, Ross, and I've appreciated your thoughtfulness to any of the ideas that you've had historically and thanks for your level of engagement and also your ownership.

And I won't say goodbye to you and congratulations yet, because I think we'll get you for at least 1 or 2 more calls.

And our next question comes from the line of Shai Dardashti with DCM.

I'd like to actually run through 3 questions about restructuring. The first question is, what assumptions are being baked in to the $3 million to $4 million free cash flow number in terms of revenue ranges and operating margin ranges?

I would tell you that you can see that we are focused very much on the cash flow, so I'm not going to necessarily talk about the revenue level. What I've told you was that the DIS business we're trying to expand, we continue to work on that and the ability -- like 1 of the earlier callers said if you could really grow the top line in a way that the market was receptive and do it where you could generate cash, sure, we would absolutely do that, it's just that market's been incredibly volatile. We see it stabilizing in terms of that, but it still had some shrink. I mean if you look over the last 2 years, the DIS revenue by year has shrunk. So I think you can look at those things as kind of -- some of the viewpoints of the trend line, but we're definitely looking to reduce cost and we're looking to therefore, expand the operating returns of the business and the cash flow. I appreciate that's probably a little more general that you would like, but that's probably the best I can answer at this time.

Okay, and then in terms of the reducing the cost structure process, could you comment on what the cash charges might be versus non-cash charges? At a high-level, what would -- just trying to get some clarity.

This is Jeff Keyes. I would say that we're still going through that analysis, as we mentioned. Again, we may have an impairment on our 12/31/12 balance sheet and we also have to analyze what our Q1 impairment will be. There definitely will be an impairment in Q1. It's the process of going through that analysis that will take time. You can appreciate there's a lot of finance and accounting rules that go into that and we have to work through that with our auditors. From an impairment of a non-cash basis versus a cash basis, you'll see most of the cash and non-cash impairment flow through likely in Q1, but there will be ongoing components of this restructuring, whether it's deemed impairment or not, I would call a non-recurring activity, as we move forward towards the end of the year, because there'll be certain concepts such as severance arrangements and other activities that will have a cash flow out -- cash outflow from the company that will happen at the time of that event. So, again, probably a little bit more general comment but you'll see if I estimate most of the impairment-type charges come through in Q1 with some lingering impact over the next couple of quarters.

And then last question, could you comment who the peers are for the DIS service segment, please?

That's a tough one because there are not specific companies that are absolute peers. Companies like RadNet, Alliance Imaging, Insight Imaging, those are possible peers and then there are lots of companies that have -- do a similar type of business, but they're really smaller-type organizations that are kind of these regional players, right, which are the types of groups that we would look to possibly partner with, or possibly acquire, or something like that on a go-forward basis. So there's very few in the realm of the public domain. I think you could look at healthcare service businesses as a type of comp.

And our next question is from the line of Adam Peck with Heartland Funds.

First off, congratulations, Matt, and good luck. Second, Todd, I know you'll be here for a while longer, but in case I'm not on a call going forward that's on a public forum, I just want to thank you for your contribution to the company, which I certainly understand is the tough decisions that went into the new strategic direction but applaud both management and the board for making the proposed changes. And Todd, I want to wish the best of luck in your future endeavors.

Thanks a lot, I definitely appreciate that and we appreciate your support and involvement with the business and we're looking forward to increasing the return that you and your fund and other shareholders will receive in the future.

We certainly look forward to it. When you reference the $3 million to $4 million in free cash flow, is it fair to assume that the vast majority of that would be coming from improvements in the imaging business?

I would almost think of it in a couple of ways, right? We definitely generate cash in our DIS business. We're going to look for ways to expand that. Certainly our customer service element of our diagnostic imaging business generates a very nice margin and a very nice return. So we're going to expand that, but definitely, we're going to reduce some of the cost that have been in that diagnostic imaging business, that's true.

Okay, do you have the EBIT for both segments in the fourth quarter?

Don't have the number immediately handy, but we did provide the quarterly information in the press release. We can do a follow-up on that. And again, we have our information presented on a preliminary basis. So I think you should see an update come out as we complete that impairment analysis and we can provide some updated EBIT information as well.

And Jeff, we would expect to file the 10-K roughly in the next few weeks.

Yes, I would expect that we would file our 10-K, which would have the updated financial information, within about the next week, 1.5 week.

And that's where you have the segment reporting.

And we have a follow-up question from the line of Paul Nouri with Noble Equity Funds.

The $3 million or $4 million free cash flow number, is that a 2014 goal?

Yes, I would look at the free cash flow range that we provided in the release as an annualized go-forward goal. Obviously, we're going to have to get through the restructuring charges and the activity in 2013, so I wouldn't necessarily expect that number to materialize in 2013. But on a go-forward basis, on a rolling basis, that's the range that we expect to see.

And currently, is most of the R&D associated with the product business?

Yes.

And so -- I think you're doing a pretty good product business, even though it's been a tough business, you have new products, and -- so you're going through a cost restructuring now. How are you going to balance having a good product and hopefully, growing product business with cutting cost at the same time? I feel that is a pretty big challenge.

Yes, you're right. It is always a challenge and we have to be sensitive to the market size and how we can best take advantage of that. I mean certainly, some of the strategic alternatives that we looked at would've required a significant investment in the new product development and then would've taken us, as an example, into different call points as well. Those are things that were certainly considered. If I answer your question specifically, we are going to -- we're going to have to balance that because we do have some very unique technology in the marketplace. We believe that we'll be able to take advantage of that technology for quite some time based on what we can have. So we will reduce our spend in that area.

And there are no further questions at this time. So I will turn it back to management for any closing remarks.

Thank you very much. We appreciate everyone's involvement today on the call. We appreciate everyone's patience as we work through the strategic direction of the business. I'd like to thank the Board of Directors and the management team for their rigorous effort in doing that. We're very excited to get the business moving in the direction of the strategic plan that we have outlined. We know that there is a tremendous amount of work to do for us to get that accomplished. We're very confident in what we can do. I'd also like to personally congratulate Matt Molchan for his promotion and for Virgil Lott's promotion. I think that you're going to see that we're going to have a strong team going forward. And we're looking forward to untapping that value and we'll keep you posted on the upcoming calls. Thanks, again, everyone, have a good rest of your day.

Ladies and gentlemen, this does conclude the Digirad Corporation 2012 Fourth Quarter and Year End Results Conference Call. Thank you for your participation, you may now disconnect.