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(Registrant’s Telephone Number, Including Area Code)
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.0001 per share
DRAD
NASDAQ Global Market
Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share
DRADP
NASDAQ
Global Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required
to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
o
Non-accelerated
filer
x
Smaller reporting company
x
Emerging growth company
o
If an emerging growth company, indicate by check mark if the
registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes No x
Important Information Regarding Forward-Looking Statements
Portions of this Quarterly Report on Form 10-Q (including information incorporated by reference) include “forward-looking statements” based on our current beliefs, expectations, and projections regarding our business strategies, market potential, future financial performance, industry, and other matters.
This includes, in particular, “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q, as well as other portions of this Quarterly Report on Form 10-Q. The words “believe,”“expect,”“anticipate,”“project,”“could,”“would,” and similar expressions, among others, generally identify “forward-looking statements,” which speak only as of the date the statements were made. The matters discussed in these forward-looking statements are subject to risks, uncertainties, and other factors that could cause our actual results to differ materially from those projected, anticipated, or implied in the forward-looking statements. The most significant of these risks, uncertainties, and other factors are described in “Item 1A — Risk Factors” of this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December
31, 2018 filed with the U.S. Securities and Exchange Commission on March 1, 2019. Except to the limited extent required by applicable law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
4
PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL
STATEMENTS
5
DIGIRAD CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
Investments
in and receivables from related parties
—
275
Other assets
851
406
Total
assets
$
91,361
$
50,594
Liabilities,
Mezzanine Equity and Stockholders’ Equity
Current liabilities:
Accounts payable
$
9,480
$
5,206
Accrued
compensation
4,101
3,862
Accrued warranty
342
197
Deferred
revenue
1,756
1,687
Short-term debt
3,988
—
Operating
lease liabilities
1,790
—
Other current liabilities
4,708
2,265
Total
current liabilities
26,165
13,217
Long-term debt
17,217
9,500
Long-term
payable from related parties
1,925
—
Deferred tax liabilities
121
121
Operating
lease liabilities, net of current portion
3,356
—
Other liabilities
1,749
1,956
Total
liabilities
50,533
24,794
Commitments and contingencies (Note 10)
Preferred
stock, $0.0001 par value: 10,000,000 shares authorized: 10% Series A Cumulative Redeemable preferred stock, 8,000,000 shares liquidation preference ($10.00 per share), 1,915,637 shares issued or outstanding at September 30, 2019
19,156
—
Stockholders’
equity:
Common stock, $0.0001 par value: 30,000,000 shares authorized; 2,048,743 and 2,024,979 shares issued and outstanding (net of treasury shares) at September 30, 2019 and December 31, 2018, respectively
See
accompanying notes to consolidated financial statements.
12
DIGIRAD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
Basis of Presentation
The unaudited condensed consolidated financial statements included in this Form 10-Q have been prepared in accordance with the U.S. Securities and Exchange Commission (the “SEC”) instructions for
Quarterly Reports on Form 10-Q. Accordingly, the condensed consolidated financial statements are unaudited and do not contain all the information required by U.S. generally accepted accounting principles (“GAAP”) to be included in a full set of financial statements. The unaudited condensed consolidated balance sheet at December 31, 2018 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for a complete set of financial statements. The audited consolidated financial statements for our fiscal year ended December 31, 2018, filed with the SEC on Form 10-K on March 1, 2019, include
a summary of our significant accounting policies and should be read in conjunction with this Form 10-Q. In the opinion of management, all material adjustments necessary to present fairly the results of operations, cash flows, and balance sheets for such periods have been included in this Form 10-Q. All such adjustments are of a normal recurring nature. The results of operations for interim periods are not necessarily indicative of the results of operations for the entire year.
Discontinued Operations
On February 1, 2018, Digirad Corporation (the “Company” or “Digirad”) completed the sale of its customer contracts relating to the Medical Device Sales and Service (“MDSS”) post-warranty service business to Philips North America
LLC (“Philips”) pursuant to an Asset Purchase Agreement, dated as of December 22, 2017 for $8.0 million. For all periods presented in our condensed consolidated statements of operations, all sales, costs, expenses, and income taxes attributable to MDSS, except as related to the impact of the decrease in the federal statutory tax rate (see Note 11 Income Taxes), have been aggregated under the caption “earnings from discontinued operations, net of income taxes.” Cash flows used in or provided by MDSS operations as part of discontinued operations are disclosed in Note 2 Discontinued Operations, within the notes to our unaudited condensed consolidated financial statements. Unless otherwise noted, amounts and disclosures throughout these notes to condensed consolidated financial
statements relate to our continuing operations.
Sale of Telerhythmics, LLC
On October 31, 2018, the Company entered into a membership interest purchase agreement (the “Telerhythmics Purchase Agreement”) with G Medical Innovations USA, Inc. (“G Medical”), pursuant to which we sold all the outstanding membership interests in Telerhythmics (“Telerhythmics”) to G Medical. The total consideration related to the Telerhythmics Purchase Agreement was $1.95 million in cash, which was paid at the closing on October 31, 2018. In connection with the transaction, the
Company agreed to make partial monthly rent payments aggregating $0.2 million through January 2021. The Telerhythmics Purchase Agreement includes customary representations, warranties, covenants, and indemnification obligations of the parties, including a non-competition covenant by the Company. The gain on the sale of Telerhythmics, LLC was approximately $19 thousand.
Reverse Stock Split
On May 31, 2019, the Company filed a Certificate of Amendment to its Restated Certificate of Incorporation
(the “Amendment”) in order to effect a reverse stock split of the issued and outstanding shares of its common stock at a ratio of 1-for-10 (the “Reverse Stock Split”) and to reduce of the number of authorized shares of common stock to 30 million shares authorized (the “Share Reduction”). The Reverse Stock Split was implemented for the purpose of regaining compliance with the minimum bid price requirement for continued listing of the Company’s common stock on the Nasdaq Global Market.
The Reverse Stock Split and the Share Reduction became effective on June 4, 2019, at which time (a) every ten shares of the
Company’s issued and outstanding common stock were automatically combined into one issued and outstanding share of common stock and (b) the number of authorized shares of common stock under the Company’s Restated Certificate of Incorporation, as amended, was automatically reduced to 30 million shares authorized. No fractional shares were issued in connection with the Reverse Stock Split. Instead, the Company issued one full share of the post-Reverse Stock Split common stock to any stockholder who would have been entitled to receive a fractional share as a result of the Reverse Stock Split. The Amendment did not affect the par value of the
Company’s common stock. The Company’s common stock began trading on a split-adjusted basis on June 5, 2019.
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The Amendment, effecting the Reverse Stock Split and the Share Reduction, was approved by the stockholders of the Company at the Company’s 2019 Annual Meeting of Stockholders held on May 1, 2019. In connection with approving the Reverse Stock Split, the
Company’s stockholders granted authority to the Company’s board of directors to determine, at its discretion, a ratio within the range of 1-for-5 to 1-for-10, at which to effectuate the Reverse Stock Split. The Reverse Stock Split was approved by the Company’s board of directors on March 8, 2019, and the ratio of 1-for-10 was approved by the Company’s board of directors on May 15, 2019.
The terms of equity awards under the Company’s incentive plans, including the per share exercise price
of options and the number of shares issuable under outstanding awards, were converted on the effective date of the Reverse Stock Split in proportion to the reverse split ratio (subject to adjustment for fractional interests). In addition, the total number of shares of common stock that may be the subject of future grants under the Company’s incentive plans were adjusted and proportionately decreased as a result of the Reverse Stock Split.
All authorized, issued, and outstanding stock and per share amounts contained in the accompanying condensed consolidated financial statements have been adjusted to reflect the 1-for-10 Reverse Stock Split for all prior periods presented. The Reverse Stock Split was effective June 4, 2019.
ATRM Merger
On
September 10, 2019, Digirad completed its acquisition of ATRM Holdings, Inc. (“ATRM”) pursuant to an Agreement and Plan of Merger, dated as of July 3, 2019 (the “ATRM Merger Agreement”), among Digirad, Digirad Acquisition Corporation, a Minnesota corporation and wholly-owned subsidiary of Digirad (“Merger Sub”), and ATRM. Under the terms of the ATRM Merger Agreement, Merger Sub merged with and into ATRM, with ATRM surviving as a wholly owned subsidiary of Digirad (the “ATRM Merger” or the “ATRM Acquisition”).
At the effective time of the ATRM Merger, (i) each share of ATRM common stock was converted into the right to receive three one-hundredths (0.03) of a share
of 10.0% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share, of the Company (“Company Preferred Stock”) and (ii) each share of ATRM 10.00% Series B Cumulative Preferred Stock, par value $0.001 per share (“ATRM Preferred Stock”), converted into the right to receive two and one-half (2.5) shares of Company Preferred Stock, for an approximate aggregate total of 1.6 million shares of Company Preferred Stock. No fractional shares of Company Preferred Stock were issued to any ATRM shareholder in the ATRM Merger. Each ATRM shareholder who would otherwise have been entitled to receive
a fraction of a share of Company common stock in the ATRM Merger received one whole share of Company Preferred Stock. See Note 5 Merger, within the notes to our unaudited condensed consolidated financial statements for further detail.
Mezzanine Equity
Pursuant to the Certificate of Designations, Rights and Preferences of 10% Series A Cumulative Perpetual Preferred Stock of Digirad Corporation (the “Certificate of Designations”), upon a Change of Control Triggering Event, as defined in the Certificate of Designations, holders of the Company Preferred Stock may require the Company to redeem the
Company Preferred Stock at a price of $10.00 per share, plus any accumulated and unpaid dividends (a “Change of Control Redemption”). As this redemption feature of the shares is not solely within the control of Digirad, the equity of Digirad does not qualify as permanent equity and has been classified as mezzanine or temporary equity. Accordingly, the Company recognizes Company Preferred Stock as mezzanine equity in the condensed consolidated financial statements. Company Preferred Stock is not redeemable and it was not probable that the Company Preferred Stock would become redeemable as of September 30, 2019.
In addition to a Change of Control Redemption,
the Certificate of Designations also provides that the Company may redeem (at its option, in whole or in part) the Company Preferred Stock following the fifth anniversary of issuance of the Company Preferred Stock, at a cash redemption price of $10.00 per share, plus any accumulated and unpaid dividends.
Use of Estimates
Preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. By their nature,
estimates are subject to an inherent degree of uncertainty. Actual results could differ from management’s estimates.
Leases
Lessee Accounting
We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, operating lease liabilities, and operating lease liabilities, net of current portion in our condensed consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our condensed consolidated balance sheets.
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ROU assets represent our right to use an underlying asset
for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. We use the implicit discount rate when readily determinable; however, as most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease valuation may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
The
Company elected to not separate lease and non-lease components of its operating leases in which it is the lessee and lessor. Additionally, The Company elected not to recognize right-of use assets and leases liabilities that arise from short-term leases of twelve months or less.
Lessor Accounting
We determine lease classification at the commencement date. Leases not classified as sales-type or direct financing leases are classified as operating leases. The primary accounting criteria we use for lease classification are (a) review to determine if the lease transfers ownership of the underlying asset to the lessee by the end of the lease term, (b) review to determine if the lease grants the lessee a purchase option that the lessee is reasonably certain to exercise, (c) determine, using a seventy-five percent
or more threshold, if the lease term is for a major part of the remaining economic life of the underlying asset (however, we do not use this classification criterion when the lease commencement date falls within the last 25 percent of the total economic life of the underlying asset) and (d) determine, using a ninety percent or more threshold, if the present value of the sum of the lease payments and any residual value guarantees equal or exceeds substantially all of the fair value of the underlying asset. We do not lease equipment of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. Each of the Company’s leases is classified as an operating lease.
The Company elected the operating lease practical
expedient for its leases to not separate non-lease components of regular maintenance services from associated lease components. This practical expedient is available when both of the following are met: (i) the timing and pattern of transfer of the non-lease components and associated lease component are the same and (ii) the lease component, if accounted for separately, would be classified as an operating lease.
Property taxes paid by the lessor that are reimbursed by the lessee are considered to be lessor costs of owning the asset, and are recorded gross with revenue included in other non-interest income and expense recorded in operating expenses.
The Company selected a lessor accounting policy election to exclude from revenue and expenses sales taxes and other similar taxes assessed by a governmental
authority on lease revenue-producing transactions and collected by the lessor from a lessee.
Operating lease equipment is carried at cost less accumulated depreciation. Operating lease equipment is depreciated to its estimated residual value using the straight-line method over the lease term or estimated useful life of the asset.
Rental revenue on operating leases is recognized on a straight-line basis over the lease term unless collectability is not probable. In these cases rental revenue is recognized as payments are received.
Recently Adopted Accounting Standards
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which amended the existing accounting standards for the accounting for leases. Most significant among the changes in the standard is the recognition of ROU assets
and lease liabilities by lessees for those leases classified as operating leases under current U.S. GAAP. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The Company adopted ASC 842 beginning January 1, 2019, using the modified-retrospective method, which will result in a cumulative effect adjustment to accumulated deficit at the beginning of 2019, rather than adjustments to the comparative prior periods presented in the financial statements. In connection with the adoption, the Company has elected to utilize the package of practical expedients, including: (1) not reassess the lease classification for any expired
or existing leases, (2) not reassess the treatment of initial direct costs as they related to existing leases, and (3) not reassess whether expired or existing contracts are or contain leases. Upon adoption, the Company recorded right-of-use assets and lease liabilities on its condensed consolidated balance sheet of $3.8 million and $3.9 million, respectively, primarily related to real estate and vehicle leases. See Note 7 Leases, within the notes to our unaudited condensed consolidated financial statements .
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use
Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The Company early adopted ASU 2018-15 beginning January 1, 2019, and applied the guidance prospectively to the implementation costs incurred in its NetSuite ERP implementation. As of September 30,
2019, the Company has capitalized $0.2 million of implementation costs.
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Note 2. Discontinued Operations
On February 1, 2018, the Company completed the sale of its customer contracts relating to our MDSS post-warranty
service business to Philips pursuant to an Asset Purchase Agreement, dated as of December 22, 2017, for $8.0 million. The total cash proceeds were adjusted for deferred revenue liabilities assigned to Philips at the closing date, as well as $0.5 million of proceeds held in escrow, subject to claims for breaches of general representation and warranties, which was recorded in other current assets at the date of sale. All claims were settled as of December 31, 2018. Prior to the sale of the customer contracts, we received notification from Philips on September 28, 2017,
that our distribution agreement to sell Philips imaging systems on a commission basis would be terminated, effective December 31, 2017. As a result, our product sales activities within our MDSS reportable segment were also discontinued effective in the first quarter of 2018.
For the nine months ended September 30, 2019, Digirad recognized a $350 thousand gain for the remaining settlement of the warranty claims in regards to equipment sold to Phillips.
The Company deemed the disposition of our MDSS reportable segment in
the first quarter of 2018 to represent a strategic shift that will have a major effect on our operations and financial results, in accordance with the provisions of FASB authoritative guidance on the presentation of financial statements, we have classified the results of our MDSS segment as discontinued operations in our condensed consolidated statement of operations for all periods presented.
The Company has allocated a portion of interest expense to discontinued operations since the proceeds received from the sale were required to be used to pay down outstanding borrowings under our previous revolving credit facility with Comerica Bank, a Texas banking association (“Comerica Bank”) under that certain Revolving Credit Agreement, dated June 21, 2017, by and between the
Company and Comerica Bank (the “Comerica Credit Agreement”). The allocation was based on the ratio of proceeds received in the sale to total borrowings for the period. In addition, certain general and administrative costs related to corporate and shared service functions previously allocated to the MDSS reportable segment are not included in discontinued operations.
The following table presents financial results of the MDSS business (in thousands):
Healthcare Product and
Product-Related Revenues and Services Revenue
Healthcare Product and product-related revenue are generated from the sale of gamma cameras and post-warranty maintenance service contracts within our Diagnostic Imaging reportable segment.
Healthcare Imaging services revenue are generated from providing diagnostic imaging services to customers within our Diagnostic Services and Mobile Healthcare reportable segments. Services revenue also includes lease income generated from interim rentals of imaging systems to our customers.
Revenue Recognition
Revenue is recognized when a customer obtains control of promised goods or services. The
Company records the amount of revenue that reflects the consideration that it expects to receive in exchange for those goods or services. The Company applies the following five-step model in order to determine this amount: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the
Company satisfies each performance obligation. Taxes collected from customers, which are subsequently remitted to governmental authorities, are excluded from revenue.
The majority of our contracts have a single performance obligation as we provide a series of distinct services that are substantially the same and are transferred with the same pattern to the customer. For contracts with multiple performance obligations, we allocate the total transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. We use an observable price to determine the stand-alone selling
price for separate performance obligations or when an observable price is not available, we use a cost plus margin approach.
Our products are generally not sold with a right of return and the Company does not provide significant credits or incentives, which may be required for as variable consideration when estimating the amount of revenue to be recognized.
Disaggregation of Revenue
The following tables present our revenues for the three and nine months ended September 30, 2019 and 2018, disaggregated by major source (in thousands):
(1)
Reflects twenty days of the Building and Construction segment activities from September 10th through September 30th.
18
Nature of Goods and Services
Mobile Imaging
Within our Diagnostic Services and Mobile Healthcare reportable segments, our sales are derived from providing services and materials to our customers, primarily physician practices and hospitals, that allow them to perform diagnostic imaging services at their site. We typically bundle our services in providing staffing, our imaging systems, licensing, radiopharmaceuticals, and supplies depending on our customers’ needs. Our contracts
with customers are typically entered into annually and are billed on a fixed rate per-day or per-scan basis, depending on terms of the contract. For the majority of these contracts, the Company has the right to invoice the customer in an amount that directly corresponds with the value to the customer of the Company’s performance to date. The Company uses the practical expedient to recognize revenue corresponding with amounts we have the right to invoice for services performed.
Camera
Within
our Diagnostic Imaging segment, camera revenues are generated from the sale of internally developed solid-state gamma camera imaging systems. We recognize revenue upon transfer of control to the customer, which is generally upon delivery and acceptance. We also provide installation services and training on cameras we sell, primarily in the United States. Installation and initial training is generally performed shortly after delivery. The Company recognizes revenues for installation and training over time as the customer receives and consumes benefits provided as the Company performs the installation services.
Our sale of imaging systems includes a one-year warranty that we account for as an assurance-type warranty.
The expected costs associated with our standard warranties and field service actions continue to be recognized as expense when cameras are sold. Maintenance service contracts sold beyond the term of our standard warranties are accounted for as a service-type warranty and revenue is deferred and recognized ratably over the period of the obligation.
Camera Support
Within our Diagnostic Imaging segment, camera support revenue is derived from the sale of separately-priced extended maintenance contracts to camera owners, training, and the sale of parts to customers that do not have an extended warranty. Our separately priced service contracts
range from 12 to 48 months. Service contracts are usually billed at the beginning of the contract period or at periodic intervals (e.g., monthly or quarterly) and revenue is recognized ratably over the term of the agreement.
Services and training revenues are recognized in the period the services and training are performed. Revenue for sales of parts are recognized when the parts are delivered to the customer and control is transferred.
Lease Income
Within our Mobile Healthcare segment, we also generate income from interim rentals of our imaging systems to customers
that are in the midst of new construction or refurbishing their current facilities. Rental contracts are structured as either a weekly or monthly payment arrangement and are accounted for as operating leases.
Within our Building and Construction segment, KBS subleased the manufacturing building located in Waterford, Maine to North Country Steel Inc., a Maine corporation with an initial 5 year term rental agreement, commenced on September 6, 2019. The rental agreement is structured with a monthly payment arrangement and is accounted for as operating lease.
Building and Construction
Within the building and construction segment, ATRM, through its wholly-owned
subsidiaries KBS Builders, Inc. (“KBS”), EdgeBuilder, Inc. (“EdgeBuilder”), and Glenbrook Building Supply, Inc. (“Glenbrook” and together with EdgeBuilder, “EBGL”), services residential and commercial construction projects by manufacturing modular housing units and other products and supplies general contractors with building materials. KBS manufactures modular buildings for both single-family residential homes and larger, commercial building projects. EdgeBuilder manufactures structural wall panels, permanent wood foundation systems and other engineered wood products, and GlenBrook is a retail supplier of lumber and other building supplies.
Real Estate and Investments
Within our real estate and investment division, Star Real Estate Holdings USA, Inc. (“SRE”),
generates income from the lease of commercial properties and equipment, and Lone Star Value Management, LLC (“LSVM”), a Connecticut based exempt reporting advisor, provides services that include investment advisory services, and the servicing of pooled investment vehicles.
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Deferred Revenues
We record deferred revenues when cash payments are received or due in advance of our performance, including amounts that are refundable. We have determined our contracts do not include a significant financing component. The majority of our deferred revenue relates to payments received
on camera support post-warranty service contracts, which are billed at the beginning of the annual contract period or at periodic intervals (e.g., monthly or quarterly).
Changes in the deferred revenues for nine months ended September 30, 2019, is as follows (in thousands):
Included in the balances above as of September 30, 2019 and December 31, 2018 is non-current deferred revenue included in other liabilities of $0 thousand and $26 thousand, respectively.
The
Company has elected to use the practical expedient under ASC 606 to exclude disclosures of unsatisfied remaining performance obligations for (i) contracts having an original expected length of one year or less or (ii) contracts for which the practical expedient has been applied to recognize revenue at the amount for which it has a right to invoice.
We recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year.
The Company applies a practical expedient to expense costs as incurred for costs to obtain a contract when the amortization period would have been one year or less. These costs mainly include the Company’s internal sales commissions; under the terms of these programs these are generally earned and the costs are recognized at the time the revenue is recognized.
Note 4. Basic and Diluted Net Income (Loss) Per Share
For the three and nine months ended September 30, 2019
and 2018, basic net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted net income per common share is calculated to give effect to all dilutive securities, if applicable, using the treasury stock method. In periods for which there is a net loss, diluted loss per common share is equal to basic loss per common share, since the effect of including any common stock equivalents would be antidilutive.
The following table sets forth the reconciliation of shares used to compute basic and diluted net (loss) income per share for the periods indicated (in thousands):
Weighted-average
shares outstanding—basic and diluted
2,046
2,018
2,038
2,013
(Loss)
income per common share—basic and diluted
Continuing operations
$
(0.74
)
$
(0.59
)
$
(2.27
)
$
(1.45
)
Discontinued
operations
$
—
$
(0.12
)
$
0.13
$
2.61
Net
(loss) income per common share—basic and diluted
$
(0.74
)
$
(0.71
)
$
(2.14
)
$
1.16
The
computation of diluted earnings per share excludes stock options and stock units that are anti-dilutive. The following common stock equivalents were anti-dilutive (in thousands):
On September 10, 2019 (the “ATRM Acquisition Date”), Digirad completed its acquisition of ATRM pursuant to the ATRM Merger Agreement under which Merger Sub (a wholly owned subsidiary of Digirad) merged with and into ATRM, with ATRM surviving as a wholly owned subsidiary of Digirad. As a result of the ATRM Merger, ATRM’s operations have been included in our consolidated financial statements since the ATRM Acquisition Date.
ATRM, through its wholly-owned subsidiaries, KBS, Glenbrook, and EdgeBuilder, services residential and commercial construction projects by manufacturing modular housing units, structural wall panels, permanent wood foundation systems, and other engineered wood products
and supplies general contractors with building materials. LSVM, which was a wholly owned subsidiary of ATRM on the ATRM Acquisition Date, is a Connecticut based exempt reporting advisor that was acquired by the Company in the ATRM Acquisition.
At the effective time of the ATRM Merger, (i) each share of ATRM common stock was converted into the right to receive three one-hundredths (0.03) of a share of 10.0% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share, of the Company (Company Preferred Stock) and (ii) each share of ATRM 10.00% Series B Cumulative
Preferred Stock, par value $0.001 per share (ATRM Preferred Stock), converted into the right to receive two and one-half (2.5) shares of Company Preferred Stock, for an approximate aggregate total of 1.6 million shares of Company Preferred Stock. No fractional shares of Company Preferred Stock were issued to any ATRM shareholder in the ATRM Merger. Each ATRM shareholder who would otherwise have been entitled to receive a fraction of a share of Company common stock in the ATRM Merger received one whole share of Company Preferred Stock.
The acquisition-date fair value of the consideration transferred in connection with the ATRM Merger approximately $17.5 million, which consisted of the following (in thousands):
Digirad
Series A Cumulative Perpetual Preferred Stock (1,615,637 shares)
$
16,156
Settlement of pre-existing note receivable between DRAD and ATRM
296
Fair value of pre-existing joint venture settlement between DRAD and ATRM
1,000
Estimated
purchase price
$
17,452
The fair value of the preferred shares issued was determined based on the product of (a) $10.00 (the stated liquidation preference per share of Company Preferred Stock), and (b) 1,615,637 (the number of shares of Company Preferred Stock were issued and exchanged in the ATRM Merger).
The following table summarizes the preliminary fair values of the assets acquired and liabilities assumed at the ATRM Acquisition Date. The
Company has not yet finalized the accounting for the ATRM Acquisition (in thousands):
Cash and cash equivalents
$
—
Accounts receivable, net
2,831
Inventory,
net
1,609
Other current assets
481
Property and equipment, net
840
Operating Lease Right-of-use assets, net
495
Accounts
payable and other accrued liabilities
(10,851
)
Debt and notes payable
(5,144
)
Lease liability
(499
)
Net assets acquired (liabilities assumed)
(10,238
)
Goodwill
8,230
Intangibles
19,460
Estimated purchase price
$
17,452
The $19.5
million of identified intangible assets was allocated as follows (in thousands):
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Fair Value
Useful Life
(years)
Trade
Names
$
5,540
15
Customer Relationships - Modular Buildings
7,820
10
Customer Relationships - Wood Products
5,670
10
Backlog
430
1
Fair
value of identified intangible assets
$
19,460
Goodwill and intangibles of $8.2 million and $19.5 million, respectively, were not yet assigned to the segments. The goodwill recognized is attributable primarily to expected synergies and the assembled workforce of ATRM. As of September 30, 2019, there were no changes in the recognized amounts of goodwill resulting from the
acquisition of ATRM.
The Company recognized $2.1 million of acquisition related costs including legal, accounting that were expensed in the current period. These costs are included in the condensed consolidated statement of operations in the line item entitled “Merger and finance costs.”
The amounts of revenue and earnings of ATRM included in the Company’s condensed consolidated statement of operations from the ATRM Acquisition Date to the period ending September 30, 2019 are as follows (in thousands):
Revenue
$
2,737
Net
loss
$
(178
)
The following table presents supplemental cash flow information of the merger (in thousands):
Issuance of Digirad Series A Cumulative Perpetual Preferred Stock (1,615,637 shares)
$
16,156
$
—
Settlement
of pre-existing note receivable between DRAD and ATRM
$
296
$
—
Fair value of pre-existing joint venture settlement between DRAD and ATRM
$
1,000
$
—
The
following represents the pro forma condensed consolidated statement of operations as if ATRM had been included in the consolidated results of the Company for the three and nine months ending September 30, 2019 and 2018 (in thousands):
These
amounts have been calculated after applying the Company’s accounting policies and adjusting the results of ATRM to reflect the additional depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant, and equipment and intangible assets had been applied on January 1, 2018, together with the consequential tax effects.
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Note 6. Supplementary Balance Sheet Information
The components of inventories are as follows (in thousands):
In April 2019, Digirad purchased three manufacturing facilities, including land, in Maine that manufacture modular buildings (two of which were purchased from KBS Builders, Inc., a wholly-owned subsidiary of ATRM (“KBS”)) for $5.2
million and leased those three properties to KBS. KBS subleased the manufacturing building located in Waterford, Maine to North Country Steel Inc., a Maine corporation with an initial 5 year term rental agreement, commenced on September 6, 2019. The rental agreement is structured with a monthly payment arrangement and is accounted for as operating lease. Refer to lease income discussed in Note 3. Revenue.
Note 7. Leases
Lessee
We have operating and finance leases for corporate offices, vehicles, and certain equipment. Our leases have remaining lease terms of 1
year to 5 years, some of which include options to extend the leases and some of which include options to terminate the leases within 1 year. Operating leases are included separately in the condensed consolidated balance sheets and finance lease assets are included in property and equipment with the related liabilities included in other current liabilities and other liabilities in the condensed consolidated balance sheets.
The components of lease expense are as follows (in thousands):
We are committed to making future cash payments on non-cancelable operating leases and finance leases (including interest). The future minimum lease payments
due under both non-cancelable operating leases and finance leases having initial or remaining lease terms in excess of one year as of September 30, 2019 were as follows (in thousands):
Assets and Liabilities
Measured at Fair Value on a Recurring Basis
The following table presents information about our financial assets that are measured at fair value on a recurring basis, and indicates the fair value hierarchy of the valuation techniques we utilize to determine such fair value at September 30, 2019 and December 31, 2018 (in thousands).
The
investment in equity securities consists of common stock of publicly traded companies. The Company occasionally enters into lumber derivative contracts in order to protect its gross profit margins from fluctuations caused by volatility in lumber prices. At September 30, 2019, the Company had a net long (buying) position of 1,870,000 board feet under seventeen lumber derivatives contracts and had a short position of 1,650,000 board feet under
fifteen lumber derivative contracts.
The level 1 and 2 securities and derivative contracts are included in other assets on the Company’s condensed consolidated balance sheet. The fair values are based on the closing prices observed on September 30, 2019. During the nine months ended September 30, 2019the
Company recorded in the condensed consolidated statement of operations an unrealized gain of $29 thousand and immaterial unrealized losses. During the year ended December 31, 2018, the Company recorded unrealized gains of $43 thousand and unrealized losses of $105 thousand.
We did not reclassify any investments between levels in the fair value hierarchy during the nine months ended September 30, 2019.
The fair values of the
Company’s revolving credit facility approximate carrying value due to the variable rate nature of these borrowings.
Note 9. Debt
A summary of the Company’s debts is as follows (in thousands):
On March 29, 2019, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) by and among certain subsidiaries of the Company, as borrowers (collectively, the “Borrowers”); the Company, as guarantor; and Sterling National Bank, a national banking association, as lender (“SNB”).
The Loan Agreement is a five-year credit facility maturing in March 2024, with a maximum credit amount of $20.0
million for both revolving loans and outstanding letter of credit obligations (the “SNB Credit Facility”). Under the SNB Credit Facility, Borrowers can request the issuance of letters of credit in an aggregate amount not to exceed $0.5 million at any one time outstanding. As of September 30, 2019, the Company had $0.1 million of letters of credit outstanding and had additional borrowing capacity of $2.8 million.
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At
the Borrowers’ option, the SNB Credit Facility will bear interest at either (i) a Floating LIBOR Rate, as defined in the Loan Agreement, plus a margin of 2.50% per annum; or (ii) a Fixed LIBOR Rate, as defined in the Loan Agreement, plus a margin of 2.25% per annum.
The Company used a portion of the financing made available under the SNB Credit Facility to refinance and terminate, effective as of March 29, 2019, its previous credit facility under the Comerica Credit Agreement.
The Loan Agreement includes certain representations, warranties of Borrowers, as well as events of default and certain affirmative and negative covenants by the Borrowers that are customary
for loan agreements of this type. These covenants include restrictions on borrowings, investments and dispositions by Borrowers, as well as limitations on the Borrowers’ ability to make certain distributions. Upon the occurrence and during the continuation of an event of default under the Loan Agreement, SNB may, among other things, declare the loans and all other obligations under the Loan Agreement immediately due and payable and increase the interest rate at which loans and obligations under the Loan Agreement bear interest. The SNB Credit Facility is secured by a first-priority security interest in substantially all of the assets of the Company and the Borrowers and a pledge of all shares of the Borrowers.
On March 29, 2019, in connection with the
Company’s entry into the SNB Loan Agreement, Mr. Eberwein, the Chairman of the Company’s board of directors, entered into Limited Guaranty Agreement (the “Limited Guaranty”) with SNB pursuant to which he guaranteed to SNB the prompt performance of all the Borrowers’ obligations to SNB under the SNB Loan Agreement, including the full payment of all indebtedness owing by Borrowers to SNB under or in connection with the Loan Agreement and related SNB Credit Facility documents. Mr. Eberwein’s obligations under the Limited Guaranty are limited in the aggregate to the amount of (a) $1.5 million, plus (b) reasonable costs and expenses of SNB incurred in connection with the Limited Guaranty. Mr. Eberwein’s obligations under the Limited Guaranty terminate upon the
Company and Borrowers achieving certain milestones set forth therein.
In connection with the SNB Credit Facility, in the nine months ended September 30, 2019, the Company recognized a $0.2 million loss on extinguishment due to the write off of unamortized deferred financing costs associated with the Comerica Credit Agreement.
As of September 30,
2019, ATRM had outstanding revolving lines of credit of approximately $4.0 million. Our debt through ATRM primarily included (i) $1.3 million principal outstanding on KBS’s $4.0 million revolving credit facility under a Loan and Security Agreement, dated February 23, 2016, (as amended, the “KBS Loan Agreement”), with Gerber Finance Inc. (“Gerber Finance”) and (ii) $2.6 million principal outstanding on EBGL’s $3.0 million revolving credit facility under a Revolving Credit Loan Agreement, dated June 30, 2017 (as amended, the “Premier Loan Agreement”) with Premier Bank (“Premier”), net of an
immaterial amount of unamortized financing fees. As of September 30, 2019, ATRM is at the maximum borrowing capacity under both revolving lines of credit, based on the inventory and accounts receivable on that day which fluctuates weekly.
See Note 13, Related Party Transactions, for information regarding certain ATRM promissory notes that are outstanding.
KBS Loan Agreement
The KBS Loan Agreement provides KBS with a revolving line of credit with borrowing availability of up to $4.0 million. Availability under the line of credit is based on a formula tied to KBS’s eligible accounts receivable, inventory and other collateral. The KBS Loan Agreement
was scheduled to expire on February 22, 2018, but, under the terms of the agreement, was extended automatically for an additional one-year period ending on February 22, 2019, and in 2019 the KBS Loan Agreement was again extended automatically for an additional one-year period ending on February 22, 2020. The KBS Loan Agreement may extend again automatically for an additional one-year period unless a party provides prior written notice of termination. Upon the final expiration of the term of the KBS Loan Agreement, the outstanding principal balance is payable in full. Borrowings bear interest at the prime rate plus 2.75%, with interest payable
monthly. The KBS Loan Agreement also provides for certain fees payable to Gerber Finance during its term, including a 1.5% annual facilities fee and a 0.10% monthly collateral monitoring fee. KBS’s obligations under the KBS Loan Agreement are secured by all of its assets and are guaranteed by ATRM. Unsecured promissory notes issued by KBS and ATRM are subordinate to KBS’s obligations under the KBS Loan Agreement. The KBS Loan Agreement contains representations, warranties, affirmative and negative covenants, defined events of default and other provisions customary for financings of this type. Financial covenants require that KBS maintain a maximum leverage ratio (as defined in the KBS Loan Agreement) and KBS not incur a net annual post-tax loss in any fiscal year during the term of the KBS Loan Agreement. At September 30,
2019, approximately $1.3 million was outstanding under the KBS Loan Agreement.
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The parties to the KBS Loan Agreement have amended the KBS Loan Agreement to provide for increased availability under the KBS Loan Agreement to KBS under certain circumstances, including for new equipment additions, and certain other changes, as well as a waiver of certain covenants.
As of December 31, 2018 and 2017, KBS was not in compliance with the financial covenants requiring no net annual post-tax loss for KBS
or the minimum leverage ratio covenant as of these test dates. Additionally, KBS was not in compliance with the requirement to deliver the Company's fiscal year-end financial statements reviewed by an independent certified accounting firm acceptable to Gerber Finance within 105 days from the fiscal year ended December 31, 2017. The occurrence of any event of default under the KBS Loan Agreement may result in KBS’s obligations under the KBS Loan Agreement becoming immediately due and payable. In April 2019 and June 2019, we obtained a waiver from Gerber Finance for these events. In addition obtaining a waiver for these covenants, the Company and Gerber Finance agreed to eliminate the minimum leverage ratio
covenant for fiscal years after 2018.
On September 10, 2019, the parties of the KBS Loan Agreement entered into a Consent and Acknowledgment Agreement and Twelfth Amendment to Loan Agreement (the “Twelfth Amendment”), by and among Gerber Finance, KBS, ATRM and the Company, pursuant to which the Company agreed to guarantee amounts borrowed by certain ATRM’s subsidiaries from Gerber Finance. The Twelfth Amendment requires the Company to serve as an additional guarantor with the existing
guarantor, ATRM, with respect to the payment, performance and discharge of each and every obligation of payment and performance by the borrowing subsidiaries with respect to the loans made by Gerber Finance to them. The Twelfth Amendment also provides that upon payment in full of the EGBL Obligations (as defined therein), the amount of the Cash Collateral (as defined therein) will be reduced to $300,000. Additionally, ATRM has on deposit $200,000 in a collateral account maintained with Gerber Finance to secure the loans under the KBS Loan Agreement.
EBGL Line of Credit
On June 30,
2017, EBGL entered into the Premier Loan Agreement with Premier providing EBGL with a working capital line of credit of up to $3.0 million. The Premier Loan Agreement replaced the prior revolving credit facility under a loan and security agreement with Gerber Finance (the “EBGL Loan Agreement”), which was terminated on the same date and all obligations of EBGL and ATRM in favor of Gerber Finance in connection with the EBGL Loan Agreement were extinguished.
Availability under the Premier Loan Agreement is based on a formula tied to EBGL’s eligible accounts receivable, inventory and equipment, and borrowings bear interest at the prime rate plus 1.50%, with interest payable monthly and the outstanding principal balance payable upon expiration of the term of the Premier Loan Agreement.
The Premier Loan Agreement also provides for certain fees payable to Premier during its term. The initial term of the Premier Loan Agreement was scheduled to expire on June 30, 2018, but was extended by Premier until February 1, 2019, and in July 2019, it was extended further by Premier until October 1, 2019. On October 1, 2019, it was extended until November 1, 2019; and on November 1, 2019, was extended until January 1, 2020. The Premier Loan Agreement may be further extended from time to time at our request, subject to approval by Premier. EBGL’s obligations under the Premier Loan Agreement are secured by all of their inventory,
equipment, accounts and other intangibles, fixtures and all proceeds of the foregoing.
As of December 31, 2018 and 2017, EBGL was not in compliance with the following covenants under the Premier Loan Agreement: (i) requirement to maintain a Debt Service Coverage Ratio for the calendar year of at least 1.0; and (ii) a requirement to deliver the Company's fiscal year-end audited financial statements within 120 days of the end of each calendar year. The occurrence of any event of default under the Premier Loan Agreement may result in EBGL’s obligations under the Premier Loan Agreement becoming immediately due
and payable. In April, October and November 2019, we obtained a waiver from Premier for these events through October 1, 2019 and further January 1, 2020 (the current maturity date of the Premier Loan Agreement).
The Premier Loan Agreement contains representations, warranties, affirmative and negative covenants, events of default and other provisions customary for financings of this type. The occurrence of any event of default under the Premier Loan Agreement may result in the obligations of EBGL becoming immediately due and payable.
As a condition to close and to then later extend the term of the Premier Loan Agreement, ATRM and Mr. Eberwein executed a guaranty in favor of Premier, which
has, through the multiple extensions described above, been extended through January 1, 2020, under which ATRM and Mr. Eberwein have absolutely and unconditionally guaranteed all of EBGL’s obligations under the Premier Loan Agreement.
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Note 10. Commitments and Contingencies
In the normal course of business, we have been, and will likely continue to be, subject to other litigation or administrative proceedings incidental to our business, such as claims related to customer disputes, employment practices, wage and hour disputes, product liability,
professional liability, commercial disputes, licensure restrictions or denials, and warranty or patent infringement. Responding to litigation or administrative proceedings, regardless of whether they have merit, can be expensive and disruptive to normal business operations. We are not able to predict the timing or outcome of these matters.
Note 11. Income Taxes
We provide for income taxes under the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the financial statements. We provide a valuation allowance for deferred tax assets if it is more likely than not that these items will expire before we are able to realize their
benefit. We calculate the valuation allowance in accordance with the authoritative guidance relating to income taxes, which requires an assessment of both positive and negative evidence regarding the realizability of these deferred tax assets, when measuring the need for a valuation allowance. Significant judgment is required in determining any valuation allowance against deferred tax assets. As of December 31, 2017, as a result of a three-year cumulative loss and recent events, such as the unanticipated termination of the Philips distribution agreement and its effect on our forecasted income, we concluded that a full valuation allowance was necessary to offset our deferred tax assets. We continue to record a full valuation allowance against our deferred tax assets and intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal.
During
the quarter ended September 30, 2019, the Company acquired ATRM by way of a merger between ATRM and a newly formed wholly owned subsidiary of the Company, with ATRM surviving the merger as wholly owned subsidiary of the Company. As a result of the ATRM Merger, the Company will absorb the tax attributes of ATRM. The Company is still evaluating the impact of the ATRM Acquisition to the Company’s tax accounts. To the extent
that the write up of acquired intangibles in the acquisition exceed the value of ATRM’s tax attributes after considering Internal Revenue Code section 382 ownership change rule impacts to those acquired tax attributes, the Company would need to record a deferred tax liability and tax expense associated with the ATRM Acquisition. The tax disclosures below do not contemplate the implications of any potential deferred tax liability or related expense associated with the ATRM Acquisition, as the Company currently doesn’t have enough information to finalize any conclusions with respect to the tax accounting for the ATRM Acquisition. The Company is currently performing analysis to evaluate the value of acquired tax attributes
and is in process of working on the tax accounting for the ATRM Acquisition.
Intraperiod tax allocation rules require us to allocate our provision for income taxes between continuing operations and other categories of comprehensive income, such as discontinued operations. In periods in which we have a year-to-date pre-tax loss from continuing operations and pre-tax income in other categories of comprehensive income, such as discontinued operations, we must consider that income in determining the amount of tax benefit that results from a loss in continuing operations and that shall be allocated to continuing operations.
As a result of the intraperiod tax allocation rules, for the nine months ended September 30, 2019, the
Company recorded an income tax benefit of $0.2 million and an income tax expense of $0.1 million within continuing operations and discontinued operations, respectively. For the nine months ended September 30, 2018, the Company recorded an income tax benefit of $0.9 million and $0.9 million of income tax expense within continuing operations and discontinued operations, respectively.
As of September 30, 2019, we had unrecognized
tax benefits of approximately $3.6 million related to uncertain tax positions. Included in the unrecognized tax benefits were $3.2 million of tax benefits that, if recognized, would reduce our annual effective tax rate, subject to the valuation allowance.
We file income tax returns in the U.S. and in various state jurisdictions with varying statutes of limitations. We are no longer subject to income tax examination by tax authorities for years prior to 2014; however, our net operating loss carryforwards and research credit carryforwards arising prior to that year are subject to adjustment. Our policy is to recognize interest expense and penalties related to income tax matters as a component of income tax expense.
27
Note
12. Segments
Our reporting segments have been determined based on the nature of the products and services offered to customers or the nature of their function in the organization. We evaluate performance based on the gross profit and operating income (loss). The Company does not identify or allocate its assets by operating segments.
Subsequent
to the ATRM Merger, the Company formed a building and construction segment through ATRM that services residential and commercial construction projects by manufacturing modular housing units, structural wall panels, permanent wood foundation systems, and other engineered wood products, and supplies general contractors with building materials. The Company also formed real estate and investments segment through SRE and LSVM to manage real estate assets and investments.
28
Note
13. Related Party Transactions
Perma-Fix
Mr. John Climaco currently serves as a Director of the Company and a member of the Corporate Governance and Strategic Advisory committees of the Board. Until July 11, 2017, Mr. Climaco also served as a Director of Perma-Fix Environmental Services, Inc. (NASDAQ: PESI). Further, from June 2, 2015 until July 11, 2017, Mr. Climaco served as the Executive Vice President of Perma-Fix Medical S.A., a majority-owned Polish subsidiary of Perma-Fix Environmental Services, Inc. On July 27, 2015, we entered into a Stock Subscription Agreement (the “Subscription Agreement”)
and Tc-99m Supplier Agreement (the “Supply Agreement”) with Perma-Fix Medical. Under the terms of the Subscription Agreement, we invested $1.0 million USD in exchange for 71,429 shares of Perma-Fix Medical. Pursuant to the Supply Agreement, should Perma-Fix Medical successfully complete development of the new Tc-99m resin, Perma-Fix Medical will supply us or our preferred nuclear pharmacy supplier with Tc-99m at a preferred rate and we will purchase agreed upon quantities of such Tc-99m for our nuclear imaging operations, either directly or in conjunction with our preferred nuclear pharmacy supplier. In addition, in connection with the Subscription Agreement, the Company’s President and CEO was appointed to the Supervisory Board of Perma-Fix Medical. The investment in Perma-Fix is included
in other assets in the condensed consolidated balance sheets.
Limited Guaranty
On March 29, 2019, in connection with the Company’s entry into the Loan Agreement, Mr. Eberwein, the Chairman of the Company’s board of directors, entered into Limited Guaranty Agreement (the “Limited Guaranty”) with SNB pursuant to which he guaranteed to SNB the prompt performance of all the Borrowers’ obligations to SNB under the Loan Agreement, including the full payment of all indebtedness owing by Borrowers to SNB under or in connection with the Loan Agreement and related SNB Credit Facility documents. Mr. Eberwein’s obligations under the Limited Guaranty are limited in the
aggregate to the amount of (a) $1.5 million, plus (b) reasonable costs and expenses of SNB incurred in connection with the Limited Guaranty. Mr. Eberwein’s obligations under the Limited Guaranty terminate upon the Company and Borrowers achieving certain milestones set forth therein.
ATRM
Jeffrey E. Eberwein, the Chairman of our board of directors is also the Chief Executive Officer of Lone Star Value Management, LLC (“LSVM”), which is the investment manager of Lone Star Value Investors, LP (“LSVI”) and Lone Star Value Co-Invest I, LP (“LSV Co-Invest I”). Mr. Eberwein is also the sole manager of Lone Star Value Investors GP, LLC (“LSV GP”), the general partner of LSVI and Co-Invest I, and is the sole owner of LSV Co-Invest I.
LSVM was a wholly owned subsidiary of ATRM on the ATRM Acquisition Date (see Acquisition of LSVM). Prior to the closing of the ATRM Merger, Mr. Eberwein was also Chairman of the board of directors of ATRM.
Prior to the closing of the ATRM Merger, Mr. Eberwein and his affiliates owned approximately 4.3% of the outstanding Digirad common stock and 17.4% of the outstanding ATRM common stock. In addition, LSVI owned 222,577 shares of ATRM’s 10.0% Series B Cumulative Preferred Stock (the “ATRM Preferred Stock”) and another 374,562 shares of ATRM Preferred Stock were owned directly by LSV Co-Invest I. Through these relationships and other relationships with affiliated entities, Mr. Eberwein may
be deemed the beneficial owner of the securities owned by LSVI and LSV Co-Invest I. Mr. Eberwein disclaimed beneficial ownership of ATRM Preferred Stock, except to the extent of his pecuniary interest therein. At the effective time of the ATRM Merger, (i) each share of ATRM common stock converted into the right to receive three one-hundredths (0.03) of a share of Company Preferred Stock and (ii) each share of ATRM Preferred Stock converted into the right to receive two and one-half (2.5) shares of Company Preferred Stock.
As of September 30, 2019, Mr. Eberwein owned approximately 4.3% of the outstanding Digirad common stock. In addition, as of September 30, 2019, Mr. Eberwein owned 1,196,926
share of Company Preferred Stock, and LSVI owned 300,000 shares of Company Preferred Stock. Mr. Eberwein as the CEO of LSVM, which is the investment advisor of LSVI, and as the sole manager of LSV GP, which is the general partner of LSVI Mr. Eberwein may be deemed the beneficial owner of the securities held by LSVI. Mr. Eberwein disclaims beneficial ownership of Company Preferred Stock, except to the extent of his pecuniary interest therein.
Private Placement
Immediately prior to the closing of the ATRM Merger, Digirad issued 300,000 shares of Company Preferred Stock in a private placement (the “Private Placement”) to LSVI for a price of $10 per share for total proceeds to the
Company of $3 million. The Private Placement was made pursuant to the terms of a Stock Purchase Agreement, dated as of September 10, 2019 (the “SPA”). The Company Preferred Stock sold in the Private Placement have not been registered under the Securities Act of 1933, as amended (the “Act”), and may not be resold absent registration under, or exemption from registration under, the Act.
29
At the closing of the Private Placement, the Company and LSVI entered into a Registration Rights
Agreement, dated as of September 10, 2019 (the “Registration Rights Agreement”), pursuant to which Digirad agreed to file a registration statement with the SEC, covering the resale of the shares of Company Preferred Stock issued in the Private Placement, if and upon the written request of the Private Placement investors at any time on or before September 10, 2021. Digirad is obligated to maintain the effectiveness of the registration statement from its effective date until the later of (a) the date on which all registrable shares covered by the registration statement have been sold, or may be sold without volume or manner of sale restrictions under Rule 144 or (b) the second anniversary of the closing date. Digirad agreed to use commercially reasonable efforts to have the
registration statement declared effective by the SEC as soon as possible following the filing thereof.
In addition, prior to the effective time of the ATRM Merger, the Company entered into a put option purchase agreement with Mr. Eberwein, pursuant to which the Company has the right to require Mr. Eberwein to acquire up to 100,000 shares of Company Preferred Stock at a price of $10 per share for aggregate proceeds of up to $1,000,000 at any time, in the Company’s discretion, during the 12 months following the effective time of the ATRM Merger
(the “Issuance Option”).
ATRM Notes Payable
ATRM, a wholly owned subsidiary of the Company as a result of the ATRM Merger, has the following related party promissory notes outstanding:
(i) unsecured promissory note (principal amount of $0.6 million payable to LSV Co-Invest I), with interest payable semi-annually at a rate of 10.0% per annum (LSV Co-Invest I may elect to receive interest in-kind at a rate of 12.0% per annum), with any unpaid principal and interest due on January 12, 2020 (the “January Note”);
(ii)
unsecured promissory note (principal amount of $1.02 million payable to LSV Co-Invest I), with interest payable semi-annually at a rate of 10.0% per annum (LSV Co-Invest I may elect to receive interest in-kind at a rate of 12.0% per annum), with any unpaid principal and interest due on June 1, 2020 (the “June Note”); and
(iii) unsecured promissory note (principal amount of $0.3 million payable to LSVM), with interest payable annually at a rate of 10.0% per annum (LSVM may elect to receive any interest payment entirely in-kind at a rate of 12.0% per annum), with any unpaid principal and interest due
on November 30, 2020 (the “LSVM Note”).
LSVM and LSV Co-Invest I on July 17, 2019, waived any right to accelerate payment with respect to the ATRM Merger under the LSVM Note, the January Note, and the June Note. On November 13, 2019, LSV Co-Invest I extended the maturity date of the January Note from January 12, 2020, to the earlier of (i) October 1, 2020 and (ii) the date when the January Note is no longer subject to a certain Subordinate Agreement dated January 12, 2018, as amended, in favor of Gerber Finance. On November 13, 2019 LSV Co-Invest I also extended the maturity
date of the June Note from June 1, 2020, to the earlier of (i) October 1, 2020 and (ii) the date when the January Note is no longer subject to a certain Subordinate Agreement dated June 1, 2018, as amended, in favor of Gerber Finance.
Subordination Agreement
LSVM and LSV Co-Invest I are party to subordination agreements with ATRM and Gerber Finance pursuant to which LSVM and LSV Co-Invest I agreed to subordinate the obligations of ATRM under their unsecured promissory notes to the obligations of the borrowers to Gerber Finance. Additionally, as a condition to the Premier Loan Agreement, Mr. Eberwein entered into a guaranty in favor of
Premier Bank, absolutely and unconditionally guaranteeing all of the borrowers’ obligations.
Acquisition of LSVM
On April 1, 2019, ATRM entered into a Membership Interest Purchase Agreement (the “LSVM Purchase Agreement”) with LSVM and Mr. Eberwein. Pursuant to the terms of the LSVM Purchase Agreement, Mr. Eberwein sold all of the issued and outstanding membership interests of LSVM to ATRM (the “LSVM Acquisition”) for a purchase price of $100.00, subject to a working capital adjustment provision. The LSVM Acquisition closed simultaneously with the execution and delivery of the LSVM Purchase Agreement, and was deemed effective as of January
1, 2019 for accounting purposes, as a result of which LSVM became a wholly-owned subsidiary of ATRM. Pursuant to the LSVM Purchase Agreement, the current assets as well as the $0.3 million promissory note issued by ATRM and current liabilities existing prior to January 1, 2019 remain with Mr. Eberwein. Cash contributions made by Mr. Eberwein subsequent to the ATRM Acquisition also exist as a payment due to Mr. Eberwein by ATRM. The LSVM Purchase Agreement contains representations, warranties, covenants and indemnification provisions customary for transactions of this type. LSVM was acquired by the Company as part of the ATRM Acquisition.
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Financial
Assistance
On May 1, 2019, the special committee of the Company’s board of directors (the “Special Committee”) approved financial assistance by the Company to ATRM, in the form of advances or cash payments on behalf of ATRM, in order assist ATRM in becoming current with its financial statements and filings with the SEC. Under the terms of this approval, the Company was authorized to advance or spend up to an aggregate maximum amount of $0.4 million, with subsequent increments of $0.01 million subject to further approval by a designated
member of the Special Committee. On July 30, 2019, the Special Committee increased the amount of financial assistance that the Company is authorized to provide to $0.8 million. The Company entered into an agreement with ATRM pursuant to which ATRM agreed to repay all such financial assistance if the ATRM Acquisition did not close.
As of September 30, 2019 and upon the completion of the ATRM Merger, the Company has made cash payments on behalf of ATRM of approximately $0.7
million.
Joint Venture
On December 14, 2018, Digirad and ATRM, entered into a joint venture and formed Star Procurement, LLC (“Star Procurement”), with Digirad and ATRM each holding a 50% interest. The purpose of the joint venture is to provide the service of purchasing and selling building materials and related goods to KBS with which Star Procurement entered into a Services Agreement on January 2, 2019. In accordance with the terms of the Star Procurement Limited Liability Company Agreement, Digirad made a $1.0 million capital contribution to the joint venture, which was made in January 2019.
As of September 30,
2019, and upon the completion of the ATRM Merger, the investment in Star Procurement was included as purchase consideration as an increase in paid in capital within the condensed consolidated balance sheets.
Note Receivable
On December 14, 2018, the Company received an unsecured promissory note from ATRM in the principal amount of $0.3 million (the “ATRM Note”) in exchange for a loan to ATRM in the same amount. The ATRM Note bears interest at 10% per annum for the first 12 months of its term, and at 12% per annum for the remaining 12 months. All unpaid principal and interest is
due on December 14, 2020. ATRM may prepay the note at any time after a specified amount of advance notice to the Company. The ATRM Note provides for customary events of default, the occurrence of any of which may result in the principal and unpaid interest then outstanding becoming immediately due and payable. The ATRM Note was included in other assets in the condensed consolidated balance sheets.
As of September 30, 2019, and upon the completion of the ATRM Merger, the note receivable was included as purchase consideration as an increase in paid in capital within the condensed consolidated balance sheets.
Acquisitions
and Leases of Maine Facilities
Through its SRE subsidiary the Company purchased from KBS, a wholly-owned subsidiary of ATRM, two plants in Maine that manufacture modular buildings and leased these properties back to KBS, as further described below.
Waterford
On April 3, 2019, 947 Waterford Road, LLC (“947 Waterford”), a wholly-owned subsidiary of SRE, entered into a Purchase and Sale Agreement (the “Waterford Purchase Agreement”) with KBS pursuant to which 947 Waterford closed on the purchase of certain real property and related improvements (including buildings) located in Waterford, Maine (the “Waterford Facility”) from KBS, and acquired the Waterford Facility. The purchase price of
the Waterford Facility was $1.0 million, subject to adjustment for taxes and other charges and assessments.
KBS subleased the manufacturing building located in Waterford, Maine to North Country Steel Inc., a Maine corporation with an initial 5 year term rental agreement, commenced on September 6, 2019. The rental agreement is structured with a monthly payment arrangement and is accounted for as operating lease.
Paris
On April 3, 2019, 300 Park Street, LLC (“300 Park”), a wholly-owned subsidiary of SRE, entered into a Purchase and Sale Agreement (the “Park Purchase Agreement”) with KBS, pursuant to which 300 Park closed on the purchase
of certain real property and related improvements and personal property (including buildings, machinery and equipment) located in Paris, Maine (the “Park Facility”) from KBS, and acquired the Park Facility. The purchase price of the Park Facility was $2.9 million, subject to adjustment for taxes and other charges and assessments.
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Lease of Maine Facilities
On April 3, 2019, KBS entered into a separate lease agreement with each of 947 Waterford (the “Waterford Lease”) and 300 Park (the “Park Lease”). The Waterford Lease has an initial term of 120 months,
which is subject to extension. The base rental payments associated with the initial term under the Waterford Lease are estimated to be between $1.2 million and $1.3 million in the aggregate. The Park Lease has an initial term of 120 months, which is subject to extension. The base rental payments associated with the initial term under the Park Lease are estimated to be between $3.3 million and $3.6 million in the aggregate. ATRM has unconditionally guaranteed the performance of all obligations under the Waterford Lease and Park Lease to be performed by KBS under each lease, including, without limitation, the payment of all required rent.
On March 27, 2019, 56
Mechanic Falls Road, LLC (“56 Mechanic”), a wholly-owned subsidiary of SRE, purchased from a third party certain property and equipment located in Oxford, Maine (the “Oxford Facility”). The transaction closed on April 25, 2019. The purchase price of the Oxford Facility was $1.2 million, subject to adjustment for taxes and other charges and assessments. On April 3rd and 18th of 2019, KBS signed a lease and an amendment, respectively, with 56 Mechanic (the “Oxford Lease”), which became effective upon the closing of the transaction. The initial term under the Oxford Lease will commence upon delivery of the Oxford Facility to KBS. The Oxford Lease has an initial term of 120 months, which is subject to extension. The base rental payments associated with the initial term under the Oxford Lease are estimated to be
between $1.4 million and $1.5 million in the aggregate. ATRM has unconditionally guaranteed the performance of all obligations under the Oxford Lease to be performed by KBS, including, without limitation, the payment of all required rent.
As of September 30, 2019 and upon the completion of the ATRM Merger, the sale-leaseback arrangement is consolidated in the condensed consolidated balance sheets.
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Note 14.
Redeemable Preferred Stock
Holders of shares of the Company Preferred Stock will be entitled to receive, when, as and if, authorized by the Company’s board of directors (or a duly authorized committee of Digirad board of directors) and declared by the Company out of funds legally available for the payment of dividends, preferential cumulative cash dividends at the rate of 10.0% per annum of the liquidation preference of $10.00 per share. Dividends will be payable quarterly, in arrears, on the last calendar day of March, June, September and December (each a “dividend payment date”)
to holders of record at the close of business on the first day of each payment month. As of September 30, 2019, the Company’s board has not declared the dividend.
Note 15. Subsequent Events
None.
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ITEM 2.
MANAGEMENT’S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This management’s discussion and analysis of financial condition and results of operations (“MD&A”), contains forward-looking statements that involve risks and uncertainties. Please see “Important Information Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks, and assumptions that may cause our actual results to differ materially from those discussed in the forward-looking statements. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q, and the audited consolidated financial statements and related notes thereto for the fiscal year ended December 31, 2018,
which were included in our Form 10-K, filed with the SEC on March 1, 2019.
The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods.
Overview
On September 10, 2018, we announced that our board of directors approved the conversion of Digirad into a diversified holding company (the “HoldCo Conversion”) and the potential acquisition of ATRM Holdings, Inc. (ATRM) as an initial “kick-off” transaction. On September 10, 2019, Digirad completed the ATRM Acquisition and thereby converted into a diversified holding company. Digirad, as a diversified holding
company, has three divisions:
•
Healthcare (Digirad Health): designs, manufactures, and distributes diagnostic medical imaging products. Digirad Health operates in three businesses: Diagnostic Services, Mobile Healthcare, and Diagnostic Imaging. The Diagnostic Services business offers imaging and monitoring services to healthcare providers as an alternative to purchasing the equipment or outsourcing the job. The Mobile Healthcare business provides contract diagnostic imaging, including computerized tomography (“CT”), magnetic resonance imaging (“MRI”), positron emission tomography (“PET”), PET/CT, and nuclear medicine and healthcare expertise through
a convenient mobile service. The Diagnostic Imaging business develops, sells, and maintains solid-state gamma cameras.
•
Building and Construction (ATRM): services residential and commercial construction projects by manufacturing modular housing units, structural wall panels, permanent wood foundation systems, and other engineered wood products, and supplies general contractors with building materials
•
Real Estate and Investments: manages real estate assets (currently three manufacturing plants in Maine) and investments.
Healthcare
(Digirad Health) delivers convenient, effective, and efficient healthcare solutions on an as needed, when needed, and where needed basis. Digirad’s diverse portfolio of mobile healthcare solutions and diagnostic imaging equipment and services provides hospitals, physician practices, and imaging centers throughout the United States access to technology and services necessary to provide patient care in the rapidly changing healthcare environment.
ATRM manufactures modular housing units for commercial and residential applications. ATRM operates in two businesses: (i) modular building manufacturing and (ii) structural wall panel and wood foundation manufacturing, including building supply retail operations. The modular building manufacturing business is operated by KBS, the structural wall panel and wood foundation manufacturing segment is operated by EdgeBuilder, and the retail building supplies are sold through Glenbrook. KBS,
EdgeBuilder and Glenbrook are wholly-owned subsidiaries of ATRM.
Real Estate & Investments generates income from the lease of commercial properties and equipment through Star Real Estate Holdings USA, Inc. (SRE), and provides services that include investment advisory services and the servicing of pooled investment vehicles through Lone Star Value Management, LLC (LSVM), a Connecticut based exempt reporting advisor. LSVM, which was a wholly owned subsidiary of ATRM on the ATRM Acquisition Date, was acquired by the Company in the ATRM Acquisition.
In February of 2018, we completed the sale of our customer contracts relating
to our MDSS post-warranty service business to Philips. On October 31, 2018, we sold our Telerhythmics business to G Medical Innovations USA, Inc., for $1.95 million cash.
On December 14, 2018, Digirad and ATRM, entered into a joint venture and formed Star Procurement, with Digirad and ATRM each holding a 50% interest. The purpose of the joint venture is to provide the service of purchasing and selling building materials and related goods to KBS with which Star Procurement entered into a Services Agreement on January 2, 2019. In accordance with the terms of the Star Procurement Limited Liability Company Agreement, Digirad made a $1.0 million capital contribution to the joint venture, which was made in January 2019. This entity was
subsequently consolidated within the condensed consolidated financial statements upon completion of the ATRM merger.
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On September 10, 2019 (the ATRM Acquisition Date), Digirad completed its acquisition of ATRM pursuant to the results of ATRM Merger Agreement under which Merger Sub (a wholly owned subsidiary of Digirad) merged with and into ATRM, with ATRM surviving as a wholly owned subsidiary of Digirad. As a result of the ATRM Merger, ATRM’s operations have been included in our consolidated financial statements since the ATRM Acquisition Date. Digirad’s aim with this acquisition is to continue to grow its business into an integrated healthcare services company while simultaneously converting into a diversified
holding company through the acquisition of businesses that meet Digirad’s internally developed financially disciplined approach for acquisitions. The Company expects to achieve significant synergies and cost reductions by eliminating redundant processes and facilities.
As part of the HoldCo Conversion, Digirad formed a real estate and investments division under a newly formed subsidiary named Star Real Estate Holdings USA, Inc. (“SRE”) for the purposes of holding significant real estate assets that Digirad acquires. In April 2019, as an initial transaction to create Digirad’s real estate division under SRE and launch that aspect of the HoldCo Conversion, Digirad funded the initial purchase of three manufacturing facilities in Maine that manufacture modular buildings and leased those three properties. The funding of the assets acquisition
was primarily through the revolver loan under our SNB Credit Facility. Digirad expects SRE to be substantially self-funded over time by raising its own capital in the form of commercial mortgages on the properties it owns or by raising other forms of external capital.
Strategy
Our main strategic focus is to continue to grow our business into an integrated healthcare services company while simultaneously converting into a diversified holding company through the acquisition of businesses that meet our internally developed financially disciplined approach for acquisitions. Within the healthcare industry, we believe that there are many opportunities to provide outsourced and mobile healthcare services and solutions in the current healthcare environment. We believe that our strategy within the healthcare industry will be accomplished by:
•
Focused
organic growth from our core businesses.
•
Introducing of new service offerings through our existing businesses or through acquisitions; and
•
Acquiring complementary companies.
Discontinued Operations
On February 1, 2018, the Company completed the sale of its customer contracts
relating to our MDSS post-warranty service business to Philips pursuant to an Asset Purchase Agreement, dated as of December 22, 2017 for $8.0 million. The Company deemed the disposition of our MDSS reportable segment in the first quarter of 2018 to represent a strategic shift that will have a major effect on our operations and financial results. In accordance with the provisions of FASB authoritative guidance on the presentation of financial statements, we have classified the results of our MDSS segment as discontinued operations in our condensed consolidated statement of operations for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations were reclassified as held for sale in Digirad’s consolidated balance sheet.
Business Segments
As
of September 30, 2019, our business is organized into five reportable segments:
•Diagnostic Services
•Mobile Healthcare
•Diagnostic Imaging
•Building and Construction
•Real Estate and Investments
Diagnostic Services. Through Diagnostic Services, we offer a convenient and economically efficient imaging and monitoring services program as an alternative to purchasing equipment or outsourcing the procedures to another physician or imaging center. For physicians
who wish to perform nuclear imaging, echocardiography, vascular or general ultrasound tests, we provide imaging systems, qualified personnel, radiopharmaceuticals, licensing services, and the logistics required to perform imaging in their own offices, and thereby the ability to bill Medicare, Medicaid, or one of the third-party healthcare insurers directly for those services, which are primarily cardiac in nature. We provide imaging services primarily to cardiologists, internal medicine physicians, and family practice doctors who typically enter annual contracts for a set number of days ranging from once per month to five times per week.
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Mobile Healthcare.
Through Mobile Healthcare, we provide contract diagnostic imaging, including computerized tomography (“CT”), magnetic resonance imaging (“MRI”), positron emission tomography (“PET”), PET/CT, and nuclear medicine and healthcare expertise to hospitals, integrated delivery networks (“IDNs”), and federal institutions on a long-term contract basis, as well as provisional (short-term) services to institutions that are in transition. These services are provided primarily when there is a cost, ease, and efficiency component of providing the services directly rather than owning and operating the related services and equipment directly by our customers.
Diagnostic Imaging. Through
Diagnostic Imaging, we sell our internally developed solid-state gamma cameras, imaging systems and camera maintenance contracts. Our imaging systems include nuclear cardiac imaging systems, as well as general purpose nuclear imaging systems. We sell our imaging systems to physician offices and hospitals primarily in the United States, although we have sold a small number of imaging systems internationally.
Building and Construction. ATRM through its wholly-owned subsidiaries KBS, Glenbrook and EdgeBuilder, services residential and commercial construction projects by manufacturing modular housing units, structural wall panels, permanent wood foundation systems, and other engineered
wood products, and supplies general contractors with building materials. KBS is a Maine-based manufacturer that started business in 2001 as a manufacturer of modular homes. The KBS competitive strategy is to offer top quality products for both commercial and residential buildings with a focus on customization to suit the project requirements, provide value with our engineering and design expertise, and meet the timeframe needed by the customer. Glenbrook is a retail supplier of lumber, windows, doors, cabinets, drywall, roofing, decking and other building materials and conducts its operations in Oakdale, Minnesota. EdgeBuilder is a manufacturer of structural wall panels, permanent wood foundation systems and other engineered wood products and conducts its operations in Prescott, Wisconsin. The Glenbrook competitive strategy is to provide top-quality building materials and unmatched service and attention to detail to building professionals, as well as homeowners. In addition,
Glenbrook provides highly personalized service, knowledgeable salespeople and attention to detail that the larger, big-box chain home stores do not provide. The EdgeBuilder competitive strategy is to offer a superior product unique to the project’s requirements, provide value with our engineering and design expertise, and meet the timeframe needed by the customer, while staying cost-competitive. EdgeBuilder’s production strategy is to utilize automation and the most efficient methods of manufacturing and high-quality materials in all of its projects.
Real Estate and Investments. As part of the HoldCo Conversion, Digirad formed a real estate division under a newly formed subsidiary named Star Real Estate Holdings USA, Inc. (“SRE”) for the purposes of holding significant real estate assets that Digirad acquires. As an initial transaction to create Digirad’s real estate division under SRE and launch
that aspect of the HoldCo Conversion, in April 2019, Digirad funded the initial purchase of three manufacturing facilities in Maine that manufacture modular buildings and leased those three properties. The funding of the assets acquisition was primarily through the revolver loan under our SNB Credit Facility. Digirad expects SRE to be substantially self-funded over time by raising its own capital in the form of commercial mortgages on the properties it owns or by raising other forms of external capital. Lone Star Value Management, LLC (LSVM), which was a wholly owned subsidiary of ATRM on the ATRM Acquisition Date, is a Connecticut based exempt reporting advisor that was acquired by the Company in the ATRM Acquisition. LSVM provides services that include investment advisory services and the servicing of pooled investment vehicles. The
Company expects to use LSVM to make strategic investments in future potential acquisition targets for the Company.
Our Market
The target market for our healthcare division is comprised of cardiologists, internal medicine physicians, family practice physicians, hospitals, IDNs, and federal institutions in the United States that perform or could perform a diagnostic imaging procedure, have a need for cardiac event monitoring, or have interest in purchasing a diagnostic imaging product. During the year ended December 31, 2018, through Diagnostic Services and Mobile Healthcare, we provided imaging services to 992 physicians, physician groups, hospitals, IDNs and federal institutions. Our Diagnostic Services and Mobile Healthcare businesses currently
operate in approximately 40 states. In the past, our market has been negatively affected by lower reimbursements from the Center for Medicare and Medicaid Services (“CMS”) and third-party insurance providers for the codes under which our customers bill for our services, although reimbursements have stabilized in the last several years. We have addressed, and will continue to address, these market pressures by modifying our Diagnostic Services and Mobile Healthcare business models, and by assisting our healthcare customers in complying with new regulations and requirements.
The target market for our building and construction division includes residential home builders, general contractors, owners/developers of commercial buildings, and individual retail customers.
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Trends
and Drivers
The market for diagnostic services and products is highly competitive. Our healthcare division, which is focused primarily on the private practice and hospital sectors, continues to face uncertainty in the demand for diagnostic services and imaging equipment, which we believe is due in part to the impact of the Deficit Reduction Act on the reimbursement environment and the 2010 Healthcare Reform laws, as well as general uncertainty in overall healthcare and legislative changes in healthcare, such as the Affordable Care Act. These challenges have impacted, and will likely continue to impact, our operations. We believe that the principal competitive factors in our market include budget availability for our capital equipment, qualifications for reimbursement, pricing, ease-of-use, reliability, and mobility.
Diagnostic Services. In providing Diagnostic
Services imaging services, we compete against many smaller local and regional nuclear and ultrasound providers that may have lower operating costs. The fixed-installation operators often utilize older, used equipment, and the mobile operators may use older Digirad single-head cameras or newer dual-head cameras. We are the only mobile provider with our own exclusive source of triple-head mobile systems. Some competing operators place new or used cameras into physician offices and then provide the staffing, supplies, and other support as an alternative to a Diagnostic Services service contract. In addition, we compete against imaging centers that install fixed nuclear gamma cameras and make them available to referring physicians in their geographic vicinity. In these cases, the physician sends their patients to the imaging center.
Diagnostic
Imaging. In selling our imaging systems, we compete against several large medical device manufacturers who offer a full line of imaging cameras for each diagnostic imaging technology, including x-ray, MRI, CT, ultrasound, nuclear medicine, or SPECT/CT and PET/CT hybrid imagers. The existing nuclear imaging systems sold by these competitors have been in use for a longer period of time than our internally developed nuclear gamma cameras, and are more widely recognized and used by physicians and hospitals; however, they are generally not solid-state, light-weight, as flexible, or portable. Additionally, certain medical device companies have developed a version of solid-state gamma cameras that may directly compete with our product offerings. Many of the larger multi-modality competitors enjoy significant competitive advantages over us, including greater brand recognition, greater financial and technical resources, established relationships with healthcare
professionals, broader distribution networks, more resources for product development and marketing and sales, and the ability to bundle products to offer discounts.
Mobile Healthcare. The market for selling, servicing, and operating diagnostic imaging services, and imaging systems is highly competitive. In addition to direct competition from other providers of services similar to those offered by us, we compete with freestanding imaging centers and healthcare providers that have their own diagnostic imaging systems, as well as with equipment manufacturers that sell imaging equipment directly to healthcare providers for permanent installation. Some of the direct competitors, which provide contract MRI and PET/CT services, have access to greater financial resources than we do. In addition, some of our customers are
capable of providing the same services we provide to their patients directly, subject only to their decision to acquire a high-cost diagnostic imaging system, assume the financial and technology risk, and employ the necessary technologists, rather than obtain equipment and services from us. We may also experience greater competition in states that currently have certificate of need laws if such laws were repealed, thereby reducing barriers to entry and competition in those states. We also compete against other similar providers in quality of services, quality of imaging systems, relationships with healthcare providers, knowledge and service quality of technologists, price, availability, and reliability.
Building and Construction. The target market for our building and construction division includes residential home builders, general contractors, owners/developers of commercial buildings, and individual
retail customers.
Real Estate and Investments. As part of the HoldCo Conversion, Digirad formed a real estate division under a newly formed subsidiary named Star Real Estate Holdings USA, Inc. (“SRE”) for the purposes of holding significant real estate assets that Digirad acquires. As an initial transaction to create Digirad’s real estate division under SRE and launch that aspect of the HoldCo Conversion, in April 2019, Digirad funded the initial purchase of three manufacturing facilities in Maine that manufacture modular buildings and leased those three properties. The funding of the assets acquisition was primarily through the revolver loan under our SNB Credit Facility. Digirad expects SRE to be substantially self-funded over time by raising its own capital in the form of commercial mortgages on the properties it owns or by raising other forms
of external capital. As part of the investment arm of the Company, LSVM, a Connecticut based exempt reporting advisor may make strategic investments in future potential acquisition targets for the Company or in pursuit of other strategic relationships. LSVM currently also provides investment advisory services and manages assets of related and unrelated parties to the Company through pooled investment vehicles.
Acquisition of ATRM Holdings, Inc.
On September 10, 2018, we announced the potential acquisition of ATRM pursuant to a non-binding letter of intent with ATRM. On July
3, 2019, we announced that we had entered into an Agreement and Plan of Merger (the ATRM Merger Agreement) by and among the Company, Digirad Acquisition Corporation, a newly formed Minnesota corporation and wholly-owned subsidiary of the Company (Merger Sub), and ATRM. On September 10, 2019 (the ATRM Acquisition Date), Digirad completed its acquisition of ATRM pursuant to the ATRM Merger Agreement under which Merger Sub merged with and into ATRM, with ATRM surviving
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as
a wholly-owned subsidiary of Digirad. As a result of the ATRM Merger, ATRM’s operations have been included in our consolidated financial statements since the ATRM Acquisition Date.
At the effective time of the ATRM Merger, (i) each share of ATRM common stock was converted into the right to receive three one-hundredths (0.03) of a share of 10.0% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share, of the Company (Company Preferred Stock) and (ii) each share of ATRM 10.00% Series B Cumulative Preferred Stock, par value $0.001 per share (ATRM Preferred Stock) converted into the right to receive two and one-half (2.5) shares of Company Preferred Stock, for an approximate aggregate total of 1.6 million shares of Company Preferred Stock. No fractional shares of Company Preferred Stock were issued to any ATRM shareholder in
the ATRM Merger. Each ATRM shareholder who would otherwise have been entitled to receive a fraction of a share of Company common stock in the ATRM Merger received one whole share of Company Preferred Stock. Upon the effectiveness of the ATRM Merger, each share of ATRM Common Stock and each share of ATRM Preferred Stock issued and outstanding were no longer be outstanding and automatically were canceled and retired and ceased to exist. ATRM held a special meeting of its shareholders at which the holders of ATRM Common Stock and ATRM Preferred Stock, voting as separate classes, approved the ATRM Merger Agreement and the transactions contemplated thereby, including the ATRM Merger.
As a result of the ATRM Merger, ATRM’s operations have been included in the consolidated financial statements since the ATRM Acquisition Date. ATRM, through its wholly-owned subsidiaries,
KBS, Glenbrook, and EdgeBuilder, manufactures modular buildings for commercial and residential applications, and manufactures structural wall panels, permanent wood foundation systems, and other engineered wood products for use in construction of residential and commercial buildings. As of the ATRM Acquisition Date, ATRM wholly owned LSVM, a Connecticut based exempt reporting advisor located in Greenwich, CT. Digirad’s aim with this acquisition is to continue to grow its business into an integrated healthcare services company while simultaneously converting into a diversified holding company through the acquisition of businesses that meet Digirad’s internally developed financially disciplined approach for acquisitions. The Company expects to achieve significant synergies and cost reductions by eliminating redundant processes and facilities.
Critical
Accounting Policies and Estimates
In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our revenue and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet. We believe that the estimates, assumptions, and judgments involved in the accounting policies described in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates.
The
decrease in Diagnostic Services revenue compared to the prior year quarter was primarily due to the sale of our Telerhythmics business in October 2018, resulting in a loss of revenues of $0.9 million.
The increase in Mobile Healthcare revenue compared to the prior year quarter was primarily due to an increase in rental revenue of $0.2m in sublease and owned assets. The utilization of our interim rentals can vary in each period based on customers that are in the midst of new construction or refurbishing their current facilities.
The increase in Diagnostic Imaging revenue was due to more advanced camera sales compared to prior year quarter.
Building and Construction
Building
and construction revenue is summarized as follows (in thousands):
The
increase in real estate and investments revenue was revenue generated by the LSVM and intercompany lease revenue from SRE subsequent to the ATRM Merger. The SRE lease revenue was eliminated through intercompany consolidation in the condensed consolidated financial statements.
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Gross Profit
Healthcare Gross Profit
Healthcare gross profit and gross margin by segments is summarized as follows (in thousands):
The
decrease in Diagnostic Services gross margin percentage was mainly due to higher corresponding increase in costs of goods sold than revenue due to higher radiopharmaceutical material costs, and higher salaries and benefits due to greater number of days ran, studies performed.
The increase in Mobile Healthcare gross margin percentage was primarily due to a favorable mix of services provided, and $0.5 million lower of equipment maintenance costs.
The increase in Diagnostic Imaging gross margin percentage was primarily due to more advanced cameras sold compared to the prior year quarter.
Real Estate and Investments
Real Estate and Investments gross profit and margin is summarized as follows (in thousands):
The Real Estate and Investments gross profit relates to depreciation expense and the write-off of some of the assets included with the three manufacturing facilities acquired in April 2019.
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Operating
Expenses
Operating expenses are summarized as follows (in thousands):
Three Months Ended September 30,
Percent
of Revenues
2019
2018
Change
2019
2018
Dollars
Percent
Selling,
general and administrative expenses
$
4,948
$
4,785
$
163
3.4
%
17.5
%
18.6
%
Amortization
of intangible assets
399
356
43
12.1
%
1.4
%
1.4
%
Merger
and financing
1,058
—
1,058
100.0
%
3.7
%
—
%
Total
operating expenses
$
6,405
$
5,141
$
1,264
24.6
%
22.6
%
20.0
%
The
increase in selling, general and administrative expenses expenses was primarily due to $0.5 million expenses from the Building and Construction Division and offset by $0.3 million in savings from lower salaries and benefits resulting from lower headcount, as well as reduced costs for contracted outside services particularly in the information technology (IT) and human resources (HR) areas from the Healthcare division.
The increase in amortization of intangible assets was due to the ATRM Merger by approximately $0.1 million and offset by the sale of our Telerhythmics business in October 2018. Prior to the sale of Telerhythmics, the Company had recognized an approximately $0.5 million impairment on Telerhythmics related goodwill.
Merger and financing costs for three months ended
September 30, 2019, is predominantly comprised of one-time costs related to the acquisition of ATRM, including an increase of $1.1 million in ATRM related expenses.
Total Other Expense
Total other expense is summarized as follows (in thousands):
Interest expense, net, for the three months ended September 30, 2019 and 2018 is predominantly comprised of cash interest costs and related amortization of deferred
issuance costs on our debt.
The loss on building relates to the sale of buildings and land in Fargo, North Dakota.
Income Tax Expense
For the three months ended September 30, 2019, the Company recorded an income tax benefit of $2.0 thousand within continuing operations. See Note 11 Income Taxes, within the notes to our unaudited condensed consolidated financial statements for further information related to the Company’s income taxes.
Income
from Discontinued Operations
See Note 2 Discontinued Operations, within the notes to our unaudited condensed consolidated financial statements for information regarding discontinued operations.
The
decrease in Diagnostic Services revenue compared to the prior year was primarily due to the sale of our Telerhythmics business in October 2018, resulting in a loss of revenues of $3.1 million.
The decrease in Mobile Healthcare revenue compared to the prior year quarter was primarily due to an increase in cancellations resulting in a decrease of $1.4 million, and lower owned rental revenue of $0.8 million due to lower utilization and fewer assets in the mobile healthcare fleet, partially offset by higher sublease rentals of $0.5 million and higher accessories sales. The utilization of our interim rentals can vary in each period based on customers that are in the midst of new construction or refurbishing their current facilities.
The increase in Diagnostic Imaging revenue was due to an increase
in number of cameras sold compared to prior year period.
Building and Construction
Building and construction revenue is summarized as follows (in thousands):
The
increase in real estate and investments revenue was revenue generated by the LSVM and intercompany lease revenue from SRE subsequent to the ATRM Merger. The SRE lease revenue was eliminated through intercompany consolidation in the condensed consolidated financial statements.
Gross Profit
Healthcare Gross Profit
Services gross profit and gross margin by segment is summarized as follows (in thousands):
The
increase in Diagnostic Services gross margin percentage was mainly due to the sale of our Telerhythmics business in October 2018, which typically had narrow or negative gross margins.
The increase in Mobile Healthcare gross margin percentage was primarily due to an unfavorable mix of services provided, as well as higher equipment and vehicle leasing costs of compared to the prior year period.
The decrease in Diagnostic Imaging gross margin percentage was primarily due to lower revenue, higher cost of goods sold due in part to merit increases in salaries, and higher material variance costs from scrapped equipment.
Real Estate and Investments
Real Estate and Investments gross profit and margin is summarized as follows (in thousands):
The Real Estate and investments gross profit relates to depreciation expense and the write-off of some of the assets included with the three manufacturing facilities acquired in April 2019.
43
Operating
Expenses
Operating expenses are summarized as follows (in thousands):
Nine Months Ended September 30,
Percent
of Revenues
2019
2018
Change
2019
2018
Dollars
Percent
Selling,
general and administrative expenses
$
14,648
$
15,627
$
(979
)
(6.3
)%
18.8
%
20.0
%
Amortization
of intangible assets
965
1,069
(104
)
(9.7
)%
1.2
%
1.4
%
Merger
and financing
2,058
—
2,058
100.0
%
2.6
%
—
%
Goodwill
impairment
—
476
(476
)
(100.0
)%
—
%
0.6
%
Total
operating expenses
$
17,671
$
17,172
$
499
2.9
%
22.6
%
22.0
%
The
decrease in selling, general and administrative expenses was primarily due to $1.5 million in savings from lower salaries and benefits resulting from lower headcount following the sale of our Telerhythmics business in October 2018, as well as reduced costs for contracted outside services particularly in IT and HR areas as a result of steps we took to streamline our internal operations and offset by $0.5 million ATRM selling, general and administrative expenses.
The decrease in amortization of intangible assets was due to the sale of our Telerhythmics business in October 2018. and offset by $0.1 million amortization of intangible assets from ATRM.
Merger and financing costs for nine months ended September
30, 2019, is predominantly comprised of one-time costs related to the acquisition of ATRM, including an increase of $2.1 million in ATRM related expenses and a write-off of capitalized costs related to the Preferred Offering described below under “Liquidity and Capital Resources” in this MD&A.
Total Other Expense
Total other expense is summarized as follows (in thousands):
Other
expense, net for nine months ended September 30, 2019, is predominantly comprised of one-time costs related to the ATRM Merger.
Interest expense, net, for the nine months ended September 30, 2019 and 2018 is predominantly comprised of cash interest costs and related amortization of deferred issuance costs on our debt.
The loss on building relates to the completion of the sale of buildings and land in Fargo, North Dakota.
Loss on extinguishment of debt is related to the write-off of unamortized deferred financing costs related to the termination of the Comerica
Credit Agreement on March 29, 2019. See Note 9, Debt, within the notes to our unaudited condensed consolidated financial statements for further information.
Income Tax Expense
For the nine months ended September 30, 2019, the Company recorded an income tax benefit of $0.2 million within continuing operations. During the nine months ended September 30, 2018, an income tax benefit of $0.9 million was recorded in continuing operations
in accordance with the intraperiod allocation rules as a result of income generated from the gain on the sale of one of our business segments recorded in discontinued operations. See Note 11, Income Taxes, within the notes to our unaudited condensed consolidated financial statements for further information related to the Company’s income taxes.
Income from Discontinued Operations
See Note 2, Discontinued Operations, within the notes to our unaudited condensed consolidated financial statements for information regarding discontinued operations.
44
Liquidity
and Capital Resources
Overview
We used cash of $0.8 million from operations during the nine months ended September 30, 2019. Cash flows from operations primarily represents net loss (adjusted for depreciation, amortization, and other non-cash items), as well as the net effect of changes in working capital. Cash flows from investing activities primarily represent our investment in capital equipment required to maintain and grow our business, as well as acquisitions and dispositions. Cash flows from financing activities primarily represent net proceeds from borrowings and receipt of cash related to the exercise of stock options, offset by outflows related to dividend payments and repayments of long-term
borrowings.
Our principal sources of liquidity are our existing cash and cash equivalents, cash generated from operations, and availability on our revolving line of credit from our Sterling Credit Agreement. As of September 30, 2019, we had $1.5 million of cash and cash equivalents, as well as $2.8 million available under our revolving line of credit.
The Company has filed a registration statement on Form S-1, as amended on Form S-1/A, with the SEC for a potential offering (the “Preferred Offering”) of nonconvertible Series A Cumulative Term Preferred Stock (the “Series A Preferred Stock”) on March
12, 2019 and April 9, 2019, respectively. However, the Company will not proceed with its proposed offering of nonconvertible preferred stock on substantially the terms described in the registration statement.
We require capital principally for capital expenditures, acquisition activity, dividend payments, and to finance accounts receivable and inventory. Our working capital requirements vary from period to period depending on inventory requirements, the timing of deliveries, and the payment cycles of our customers. Our capital expenditures consist primarily of medical imaging and diagnostic devices utilized in the provision of our services, as well as vehicles and information technology hardware and software. Based upon our current level of expenditures, we believe our current working capital,
together with cash flows from operating activities, will be more than adequate to meet our anticipated cash requirements for at least the next 12 months.
Cash Flows
The following table shows cash flow information for the nine months ended September 30, 2019 and 2018 (in thousands):
Net cash (used in) provided by operating activities
$
(765
)
$
2,218
Net
cash (used in) provided by investing activities
$
(5,726
)
$
6,691
Net cash provided by (used in) financing activities
$
6,362
$
(9,898
)
Operating
Activities
The decrease in cash compared to the prior year period was primarily due to lower net income adjusted with the spending of the one-time merger and financing costs for non-cash items as a result of higher accounts receivable and lower accounts payable.
Investing Activities
The decrease in investing activities cash flow compared to the prior year period was primarily attributable to $6.8 million of proceeds received from the sale of our MDSS service contract business to Philips during the prior year and $5.2 million investment in the acquisition of three Maine properties.
Financing Activities
The
increase in cash flows from financing activities is primarily due to net borrowings of approximately $7.6 million compared to net principal repayments in the prior year quarter of $5.9 million as we used proceeds from the Sterling National Bank credit facility to finance the purchase of three Maine properties.
Sterling Credit Facility
On March 29, 2019, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) by and among certain subsidiaries of the Company,
as borrowers (collectively, the “Borrowers”); the Company, as guarantor; and Sterling National Bank, a national banking association, as lender (“SNB”).
The Loan Agreement is a five-year credit facility maturing in March 2024, with a maximum credit amount of $20.0 million for both revolving loans and outstanding letter of credit obligations (the “SNB Credit Facility”). Under the SNB Credit Facility, Borrowers can request the issuance of letters of credit in an aggregate amount not to exceed $0.5 million at any one time outstanding.
45
At
the Borrowers’ option, the SNB Credit Facility will bear interest at either (i) a Floating LIBOR Rate, as defined in the Loan Agreement, plus a margin of 2.50% per annum; or (ii) a Fixed LIBOR Rate, as defined in the Loan Agreement, plus a margin of 2.25% per annum.
The Company used a portion of the financing made available under the SNB Credit Facility to refinance and terminate, effective as of March 29, 2019, its previous credit facility under the Comerica Credit Agreement.
The Loan Agreement includes certain representations, warranties of Borrowers, as well as events of default and certain affirmative and negative covenants by the Borrowers that are customary
for loan agreements of this type. These covenants include restrictions on borrowings, investments and dispositions by Borrowers, as well as limitations on the Borrowers’ ability to make certain distributions. Upon the occurrence and during the continuation of an event of default under the Loan Agreement, SNB may, among other things, declare the loans and all other obligations under the Loan Agreement immediately due and payable and increase the interest rate at which loans and obligations under the Loan Agreement bear interest. The SNB Credit Facility is secured by a first-priority security interest in substantially all of the assets of the Company and the Borrowers and a pledge of all shares of the Borrowers.
In connection with the SNB Credit Facility, in the nine months ended September
30, 2019the Company recognized a $0.2 million loss on extinguishment due to the write off of unamortized deferred financing costs associated with the Comerica Credit Agreement.
As of September 30, 2019, ATRM had outstanding revolving lines of credit of approximately $ 4.0 million.
Our notes payable through ATRM primarily included (i) $1.3 million principal outstanding on KBS’s $4.0 million revolving credit facility under a Loan and Security Agreement, dated February 23, 2016, (as amended, the “KBS Loan Agreement”), with Gerber Finance Inc. (“Gerber Finance”) and (ii) $2.6 million principal outstanding on EBGL’s $3.0 million revolving credit facility under a Revolving Credit Loan Agreement, dated June 30, 2017 (as amended, the “Premier Loan Agreement”) with Premier Bank (“Premier”), net of an immaterial amount of unamortized financing fees. As of September 30, 2019, ATRM is at the maximum borrowing capacity under both revolving lines
of credit. See Note 9 Debt, within the notes to our unaudited condensed consolidated financial statements for further detail, including with regard to term extensions under the Premier Loan Agreement and guarantees by ATRM and Mr. Eberwein.
In addition, the Company has certain ATRM promissory notes outstanding as more fully described in Note 13, Related Party Transactions, within the notes to our unaudited condensed consolidated financial statements.
Off-Balance Sheet Arrangements
On September 10, 2019, the parties to the KBS Loan Agreement entered a Consent and Acknowledgment Agreement and Twelfth Amendment to
Loan Agreement, by and among Gerber Finance, KBS, ATRM and the Company, pursuant to which the Company agreed to guarantee amounts borrowed by certain of ATRM’s subsidiaries from Gerber. The Twelfth Amendment requires the Company to serve as an additional guarantor with the existing guarantor, ATRM, with respect to the payment, performance and discharge of each and every obligation of payment and performance by the borrowing subsidiaries with respect to the loans made by Gerber to them. See Note 9, Debt,
within the notes to our unaudited condensed consolidated financial statements for further detail.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We
maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934 (the “Exchange Act”) reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
46
As
required by Rules 13a-15(e) and 15d-15(e) of the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2019.
The Company closed the acquisition of ATRM on September 10, 2019, and ATRM’s total assets and revenues constituted 38.0% and
3.5%, respectively, of the Company’s consolidated total assets and revenues as shown on our consolidated financial statements as of and for the nine-months ended September 30, 2019. As disclosed in ATRM’s Annual Report on Form 10-K filed with the SEC on June 26, 2019, ATRM’s chief executive officer and chief financial officer concluded that ATRM’s disclosure controls and procedures and ATRM’s internal control over financial reporting were not effective as of December 31, 2018 due to material weaknesses in ATRM’s internal control over financial reporting based on 1) an insufficient number of personnel with an appropriate level of GAAP knowledge and experience to create the proper environment for effective internal control over financial
reporting, 2) oversight processes and procedures that guide individuals in applying in internal control over financial reporting were not adequate in preventing or detecting material accounting errors, and 3) ATRM did not utilize a perpetual inventory system for tracking inventory at KBS. As the ATRM Acquisition occurred in the third quarter of fiscal 2019, we excluded the internal control over financial reporting of ATRM from the scope of our assessment of the effectiveness of the Company’s disclosure controls and procedures. This exclusion is in accordance with the general guidance issued by the Staff of the Securities and Exchange Commission that an assessment of a recently-acquired business may be omitted from our scope in the year of acquisition, if specified conditions are satisfied.
Our disclosure controls and procedures are designed
to provide reasonable assurance of achieving their objectives as specified above. Management does not expect, however, that our disclosure controls and procedures will prevent or detect all errors and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.
Changes in Internal Control over Financial Reporting
Except as described below, there has been no change in our internal control over financial reporting identified in connection with the evaluation
required by paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
On September 10, 2019, we completed the acquisition of ATRM. We are in the process of integrating the operations of ATRM into our overall internal control over financial reporting process.
47
PART II. OTHER INFORMATION
ITEM
1.
LEGAL PROCEEDINGS
See Note 10 Commitments and Contingencies, within the notes to our unaudited condensed consolidated financial statements for a summary of legal proceedings.
ITEM 1A.
RISK FACTORS
In evaluating us and our common stock, we urge you to carefully consider the risks and other information in this Quarterly Report on Form 10-Q, as well as the risk factors disclosed in Item 1A to Part I of our Annual Report on Form 10-K for the fiscal year ended
December 31, 2018, which we filed with the SEC on March 1, 2019, and in our registration statement on Form S-4 filed with SEC on July 19, 2019, as amended on August 7, 2019, in connection with the ATRM Merger. Except as noted below, the risks and uncertainties described in “Item 1A - Risk Factors” of our Annual Report on Form 10-K have not materially changed. Any of the risks discussed in this Quarterly Report on Form 10-Q or any of the risks disclosed in Item 1A to Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, as well as additional risks and
uncertainties not currently known to us or that we currently deem immaterial, could materially and adversely affect our results of operations or financial condition.
Risks Related to our Businesses
Our HoldCo Conversion and related acquisitions or investments could involve unknown risks that could harm our business and adversely affect our financial condition.
We are in the process of becoming a diversified holding company with interests in a variety of industries and market sectors. The real estate acquisitions that we have made under our SRE real estate division and the pending and future acquisitions that we consummate will involve unknown risks, some of which will be particular to the industry in which the acquisition target operates. Although we intend to conduct extensive business, financial, and legal due diligence in connection
with the evaluation of all our acquisition and investment opportunities, there can be no assurance our due diligence investigations will identify every matter that could have a material adverse effect on us. We may be unable to adequately address the financial, legal, and operational risks raised by such acquisitions or investments, especially if we are unfamiliar with the industry in which we invest. The realization of any unknown risks could prevent or limit us from realizing the projected benefits of the acquisitions or investments, which could adversely affect our financial condition and liquidity. In addition, our financial condition, results of operations and the ability to service our debt will be subject to the specific risks applicable to any company we acquire or in which we invest.
We are subject to particular risks associated with real estate ownership, which could result in unanticipated losses or expenses.
Following
our recent acquisition of real estate, our business is subject to many risks that are associated with the ownership of real estate. For example, if our tenants do not renew their leases or default on their leases, we may be unable to re-lease the facilities at favorable rental rates. Other risks that are associated with real estate acquisition and ownership include, without limitation, the following:
•
general liability, property and casualty losses, some of which may be uninsured;
•
the inability to purchase or sell our assets rapidly
to respond to changing economic conditions, due to the illiquid nature of real estate and the real estate market;
•
leases which are not renewed or are renewed at lower rental amounts at expiration;
•
the default by a tenant or guarantor under any lease;
•
costs relating to maintenance and repair
of our facilities and the need to make expenditures due to changes in governmental regulations, including the Americans with Disabilities Act;
•
environmental hazards created by prior owners or occupants, existing tenants, mortgagors or other persons for which we may be liable;
•
acts of God affecting our properties; and
•
acts
of terrorism affecting our properties.
48
We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could materially harm our business.
We rely on information technology and systems, including the Internet, commercially available software, and other applications, to process, transmit, store, and safeguard information and to manage or support a variety of our business processes, including financial transactions and maintenance of records, which may include personal identifying information and other valuable or confidential information. If we experience material failures, inadequacies, or interruptions or security
failures of our information technology, we could incur material costs and losses. Further, third-party vendors could experience similar events with respect to their information technology and systems that impact the products and services they provide to us or to our customers. We rely on commercially available systems, software, tools, and monitoring, as well as other applications and internal procedures and personnel, to provide security for processing, transmitting, storing, and safeguarding confidential information such as personally identifiable information related to our employees and others, information regarding financial accounts, and information regarding customers and vendors. We take various actions, and we incur significant costs, to maintain and protect the operation and security of our information technology and systems, including the data maintained in those systems. However, it is possible that these measures will not prevent the systems’ improper functioning
or a compromise in security, such as in the event of a cyberattack or the improper disclosure of information. Security breaches, computer viruses, attacks by hackers, online fraud schemes, and similar breaches can create significant system disruptions, shutdowns, fraudulent transfer of assets, or unauthorized disclosure of confidential information. For example, in April 2019, we became aware that we had been a victim of criminal fraud commonly referred to as “business email compromise fraud.” The incident involved the impersonation of an officer of the Company and improper access to his email, resulting in the transfer by the Company of funds to a third-party account.
Despite any defensive measures we take to manage threats to our business, our risk
and exposure to these matters remain heightened because of, among other things, the evolving nature of such threats in light of advances in computer capabilities, new discoveries in the field of cryptography, new and sophisticated methods used by criminals including phishing, social engineering, or other illicit acts, or other events or developments that we may be unable to anticipate or fail to adequately mitigate. Any failure to maintain the security, proper function and availability of our information technology and systems, or certain third-party vendors’ failure to similarly protect their information technology and systems that are relevant to our operations, or to safeguard our business processes, assets, and information could result in financial losses, interrupt our operations, damage our reputation, cause us to be in default of material contracts, and subject us to liability
claims or regulatory penalties, any of which could materially and adversely affect us.
We may not be able to achieve the anticipated synergies and benefits from business acquisitions.
Part of our business strategy is to acquire businesses that we believe can complement or expand our current business activities, both financially and strategically. On September 10, 2019, Digirad acquired ATRM and its subsidiaries, including KBS, EdgeBuilder and Glenbrook with these synergistic benefits in mind. Previously, Digirad acquired PRHC and its subsidiaries, (including DMS Heath) on January 1, 2016; MD Office on March
5, 2015,; and Telerhythmics on March 13, 2014, which Digirad subsequently sold on October 31, 2018. Acquisitions involve many complexities, including, but not limited to, risks associated with the acquired business’ past activities, loss of customers, regulatory changes that are not anticipated, difficulties in integrating personnel and human resource programs, integrating ERP systems and other infrastructures, general underperformance of the business under Digirad control versus the prior owners, unanticipated expenses and liabilities, and the impact on its internal controls of compliance with the regulatory requirements under the Sarbanes-Oxley Act of 2002. There is no guarantee that its acquisitions will increase the profitability and cash flow of Digirad, and its efforts could cause unforeseen complexities and additional cash outflows, including financial losses.
As a result, the realization of anticipated synergies or benefits from acquisitions may be delayed or substantially reduced, and could potentially result in the impairment of its investment in these businesses.
There can be no assurances that we will be successful as a diversified holding company.
Part of Digirad’s strategy is to become a diversified holding company through the acquisition of businesses that, Digirad believes, will realize a material benefit from being part of a larger holding company structure, both financially and strategically. There can be no assurances that Digirad will find suitable acquisition targets that will enable Digirad to successfully realize its conversion into a diversified holding company, and even if such targets are identified, there can be no assurances that Digirad can negotiate and complete such acquisitions on attractive terms.
If
Digirad is unable to make successful acquisitions, its ability to grow its business could be adversely affected and its conversion to a diversified holding company structure may not succeeds. If Digirad succeed in making suitable acquisitions, Digirad may not be able to obtain the expected profitability or other benefits in the short or long term from such acquisitions.
49
Acquisitions, including the ATRM Acquisition, involve many complexities, including, but not limited to, risks associated with the acquired business’ past activities, loss of customers, regulatory changes that are not anticipated, difficulties in integrating personnel and human resource programs, integrating ERP systems and other infrastructures under Company control, unanticipated expenses
and liabilities, and the impact on its internal controls of compliance with the regulatory requirements under the Sarbanes- Oxley Act of 2002. There is no guarantee that its acquisitions will increase the profitability and cash flow of Digirad, and its efforts could cause unforeseen complexities and additional cash outflows, including financial losses. As a result, the realization of anticipated benefits from acquisitions may be delayed or substantially reduced. In addition, its leadership team’s attention may also be diverted by any historical or potential acquisitions.
The Company is dependent on its senior management team and other key employees.
The Company’s success
depends, to a significant extent, on its senior management team and other key employees and the ability of other personnel or new hires to effectively replace key employees who may retire or resign. Failure to retain its leadership team and attract and retain new leadership and other important personnel could lead to ineffective management and operations, which could materially and adversely affect its business and operating results.
The cyclical and seasonal nature of the housing industry causes ATRM’s revenues and operating results to fluctuate, and
ATRM expects this cyclicality and seasonality to continue in the future.
The housing industry is highly cyclical and seasonal. It is influenced by many national and regional factors, including
the availability of financing for home buyers and developers, consumer confidence, interest rates, demographic and employment trends, income levels, housing demand, general economic conditions (including inflation and recessions), and the availability of suitable home sites. As a result of the foregoing factors, ATRM’s revenues and operating results have been volatile, and ATRM expects this volatility to continue in the future. Unfavorable changes in any of the above factors or other issues that may arise
could have an adverse effect on ATRM’s revenue and earnings.
Although modular and wall panel construction in its factories eliminates many of the weather-related challenges encountered with site-built construction, ATRM’s operations can still be impacted by weather and other seasonal factors. Weather can cause delays in site preparation,
including delays in building the foundation for a commercial project or residential home, access to building sites and customer delays in setting modular homes or wall panels due to weather conditions and temperature. Additionally, sales demand, especially for residential homes, generally weakens in the winter months, particularly in the northeast and upper Midwest regions of the United States. As a result, both KBS and EBGL experience some seasonality. At KBS, the third quarter typically is the strongest demand period and the first quarter typically is the lowest demand period during the year. Although EBGL experiences some seasonality, it is less pronounced than KBS. EBGL’s fluctuations in business are impacted more by the timing of its large wall panel projects. At EBGL, the first quarter typically is the strongest demand period and the third quarter typically is the lowest demand period during the year.
ATRM’s operating
results could be adversely affected by changes in the cost and availability of raw materials.
Prices and availability of raw materials used to manufacture its products can change significantly due to fluctuations in supply and demand. Additionally, availability of the raw materials used to manufacture its products may be limited at times resulting in higher prices and/or the need to find alternative suppliers. Both KBS’s and EBGL’s major material components are dimensional lumber and wood sheet products, which include plywood and oriented strand board. Lumber costs are subject to market fluctuations. Furthermore, the cost of raw materials may also be influenced by transportation costs. It is not certain that any price increases can be passed on to its customers without affecting demand or that limited availability of materials will not impact its production capabilities. The state of the financial and housing markets may also
impact its suppliers and affect the availability or pricing of materials. ATRM’s inability to raise the price of its products in response to increases in prices of raw materials or to maintain a proper supply of raw materials could have an adverse effect on its revenue and earnings.
ATRM has material weaknesses in its internal control over financial reporting and concluded that its disclosure controls and procedures and internal control over financial reporting were not effective as of December 31, 2018.
Prior to the closing of the ATRM Merger, ATRM’s chief executive officer and chief financial officer concluded that its disclosure controls and procedures and its internal control over financial reporting were not effective as of December 31, 2018 due to material weaknesses in its internal
control over financial reporting related to inadequate accounting processes and internal control procedures. The Company’s failure to successfully remediate these material weaknesses could cause the Company to fail to meet its reporting obligations and to produce timely and reliable financial information. Additionally, such failure could cause investors to lose confidence in the Company’s public disclosures, which could have a negative impact on its stock price.
ATRM has a few customers that account for a significant portion of its revenues, and the loss of these customers, or decrease in their demand for its products, could have a material adverse effect on its results.
50
ATRM
relies on a limited number of customers for a substantial percentage of its net sales and accounts receivable. A reduction, delay, or cancellation of orders from some of these significant customers, or the loss of some of these customers, would likely have an adverse impact on its operating results.
If KBS is unable to maintain or establish its relationships with independent dealers and contractors who sell its homes, KBS revenue could decline.
KBS sells residential homes through a network of independent dealers and contractors. As is common in the modular home industry, KBS’s independent dealers may also sell homes produced by competing manufacturers and can cancel their relationships with KBS on short notice. In addition, these dealers may not remain financially solvent, as they are subject to industry, economic, demographic and seasonal trends similar to those faced by KBS. If
KBS is not able to maintain good relationships with its dealers and contractors or establish relationships with new solvent dealers or contractors, KBS’s revenue could decline.
Due to the nature of ATRM’s business, many of its expenses are fixed costs and if there are decreases in demand for its products, it may adversely affect its operating results.
Many of its expenses, particularly those relating to properties, capital equipment, and certain manufacturing overhead items, are fixed in the short term. Reduced demand for its products causes its fixed production costs to be allocated across reduced production volumes, which adversely affects its gross margins and profitability.
Certain actions taken in connection with reducing operating costs may have a negative impact on ATRM’s business.
In
the event of a housing downturn and a decline in its revenues, ATRM may implement cost reduction actions such as temporary factory shutdowns, workforce reductions, pay freezes and reductions, and reductions in other expenditures. In doing so, ATRM will attempt to maintain the necessary infrastructures to allow ATRM to take full advantage of subsequent improvements in market conditions. However, there can be no assurance that reductions ATRM may make in personnel and expenditure levels and the loss of the capabilities of personnel ATRM has terminated or may terminate will not inhibit ATRM in the timely ramp up of production in response to improving market conditions.
Due to the nature of the work the Company and its subsidiaries perform, the
Company may be subject to significant liability claims and disputes.
The Company and its wholly owned subsidiaries engage in services that can result in substantial injury or damages that may expose the Company to legal proceedings, investigations and disputes. For example, in the ordinary course of its business, the Company may be involved in legal disputes regarding personal injury and wrongful death claims, employee or labor disputes, professional liability claims, and general commercial disputes, as well as other claims. LSVM as an exempt reporting advisor may also be subject
to legal proceedings and investigations with the SEC or other regulatory bodies and may have disputes related to its fiduciary duties to the funds or instruments LSVM manages. An unfavorable legal ruling against the Company or its subsidiaries could result in substantial monetary damages. Although the Company has adopted a range of insurance, risk management, safety, and risk avoidance programs designed to reduce potential liabilities, there can be no assurance that such programs will protect the Company fully from all risks and liabilities. If the
Company sustains liabilities that exceed its insurance coverage or for which the Company is not insured, it could have a material adverse impact on its results of operations and financial condition.
ATRM’s costs of doing business could increase as a result of changes in, expanded enforcement of, or adoption of new federal, state or local laws and regulations.
ATRM is subject to various federal, state and local laws and regulations that govern numerous aspects of its business. In recent years, a number of new laws and regulations have been adopted, and there has been expanded enforcement of certain existing laws and regulations by federal, state and local agencies. These laws and regulations, and related interpretations and enforcement activity, may change as a result of a variety of factors,
including political, economic or social events. Changes in, expanded enforcement of, or adoption of new federal, state or local laws and regulations governing minimum wage or living wage requirements; the classification of exempt and non-exempt employees; the distinction between employees and contractors; other wage, labor or workplace regulations; healthcare; data protection and cybersecurity; the sale and pricing of some of its products; transportation; logistics; supply chain transparency; taxes; unclaimed property; energy costs and consumption; or environmental matters could increase its costs of doing business or impact its operations.
Risks Related to our Indebtedness
On March 29, 2019, we entered into the SNB Loan Agreement, with Sterling National Bank, a national banking association. The SNB Loan Agreement is a five-year revolving
credit facility (maturing in March 2024), which, as amended, has a maximum credit amount of $20 million. We used a portion of the financing made available under the SNB Loan Agreement to refinance and terminate, effective as of March 29, 2019, our previous credit facility under the Comerica Credit Agreement.
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Our indebtedness could restrict our operations and make us more vulnerable to adverse economic conditions.
Our indebtedness could have important consequences for us and our stockholders. For example, the SNB Loan Agreement requires a balloon payment at the termination of the facility in March 2024, which may require us to dedicate a substantial portion of our
cash flow from operations to this future payment if we feel we cannot be successful in our ability to refinance in the future, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, and acquisitions, and for other general corporate purposes. In addition, our indebtedness could:
•
increase our vulnerability to adverse economic and competitive pressures in our industry;
•
place us at a competitive disadvantage compared to our competitors that have less debt;
•
limit
our flexibility in planning for, or reacting to, changes in our business and our industry; and
•
limit our ability to borrow additional funds on terms that are acceptable to us or at all.
The SNB Loan Agreement governing our indebtedness contains restrictive covenants that will restrict our operating flexibility and require that we maintain specified financial ratios. If we cannot comply with these covenants, we may be in default under the SNB Loan Agreement.
The SNB Loan Agreement governing our indebtedness contains restrictions and limitations on our ability to engage in activities that may be in our long-term best interests. The SNB Loan
Agreement contains affirmative and negative covenants that limit and restrict, among other things, our ability to:
•
incur additional debt;
•
sell assets;
•
incur liens or other encumbrances;
•
make
certain restricted payments and investments;
•
acquire other businesses; and
•
merge or consolidate.
The SNB Loan Agreement limits our ability to pay dividends and to redeem our equity securities if such dividend or redemption would result in our non-compliance with the financial covenants in the SNB Loan Agreement, there is insufficient borrowing availability under the SNB Loan Agreement, or if there is a default or event of default under the SNB Loan Agreement
that has occurred and is continuing. The Company may, therefore be required to reduce or eliminate its dividends, if any, including on the Series A Preferred Stock (if any outstanding), and/or may be unable to redeem shares of the Series A Preferred Stock (if any outstanding) until compliance with such financial covenants can be met.
The SNB Loan Agreement contains a fixed charge coverage ratio covenant and a leverage ratio covenant. Going forward, we may not have the ability to meet these and other covenants under the SNB Loan Agreement depending on a number of factors including, without limitation, the performance of our business, capital allocation decisions made by the Company, or events beyond our control.
Our
failure to comply with our covenants and other obligations under the SNB Loan Agreement may result in an event of default thereunder. A default, if not cured or waived, may permit acceleration of our indebtedness. If our indebtedness is accelerated, we cannot be certain that we will have sufficient funds available to pay the accelerated indebtedness (together with accrued interest and fees), or that we will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all. This could have serious consequences to our financial condition, operating results, and business, and could cause us to become insolvent or enter bankruptcy proceedings, and stockholders may lose all or a portion of their investment because of the priority of the claims of our creditors on our assets.
Substantially all of our assets have been pledged to SNB as security for our indebtedness under the SNB Loan Agreement.
Pursuant
to the SNB Loan Agreement, the SNB Loan Agreement is secured by a first-priority security interest in substantially all of the assets of the Company and its subsidiaries and a pledge of all shares and equity interests of the Company’s subsidiaries. Upon the occurrence and during the continuation of an event of default under the SNB Loan Agreement, SNB may, among other things, declare the loans and all other obligations under the SNB Loan Agreement immediately due and payable and increase the interest rate at which loans and obligations under the SNB Loan Agreement bear interest. The exercise by SNB of remedies provided under
the SNB Loan Agreement in the event of a default thereunder may have a material adverse effect on the liquidity, financial condition and results of operations of the Company and could cause the Company to become bankrupt or insolvent. In the event of any bankruptcy, liquidation, dissolution, reorganization, or similar proceeding against us, the assets that are pledged as collateral securing any unpaid amounts under the SNB Loan Agreement must first be used to pay such amounts, as well as any other obligation secured by the pledged assets, in full, before making any distributions to our stockholders. In the event of any of the foregoing, our stockholders could lose all or a part of their investment.
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If
we are unable to generate or borrow sufficient cash to make payments on our indebtedness, our financial condition would be materially harmed, our business could fail, and stockholders may lose all of their investment.
Our ability to make scheduled payments on or to refinance our obligations will depend on our financial and operating performance, which will be affected by economic, financial, competitive, business, and other factors, some of which are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations to service our indebtedness or to fund our other liquidity needs. If we are unable to meet our debt obligations or fund our other liquidity needs, we may need to restructure or refinance all or a portion of our indebtedness on or before maturity or sell certain of our assets. We cannot assure you that we will be able to restructure or refinance any of our indebtedness on
commercially reasonable terms, if at all, which could cause us to default on our debt obligations and impair our liquidity. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations.
Increases in interest rates could adversely affect our results from operations and financial condition.
The SNB Loan Agreement allows the Company to elect for amounts borrowed under the SNB Loan Agreement to be subject to a floating interest rate which may change with market interest rates. An increase in prevailing interest rates would have an effect on the interest rates charged on our variable rate debt, which rise and fall upon changes in interest rates. If prevailing interest rates or other
factors result in higher interest rates, the increased interest expense would adversely affect our cash flow and our ability to service our indebtedness.
The Gerber Finance loan agreements contain certain covenants that restrict ATRM’s ability to engage in certain transactions and may impair its ability to respond to changing business and economic conditions.
ATRM’s loan agreements with Gerber Finance contain certain affirmative and negative covenants, including a financial covenant requiring ATRM to not incur a net annual post-tax loss for the fiscal year ending December 31, 2019 and a minimum level of net income for each fiscal year thereafter. These covenants also include restrictions on its abilities to take certain actions without the consent of Gerber Finance, and may limit its ability to respond to changing business and economic
conditions. These restrictions include, among other things, limitations on the ability of the borrowers to take the following actions: merge, consolidate, acquire or invest in another company; incur additional debt; enter into transactions with affiliates; engage in other businesses; sell, transfer or otherwise dispose of assets; and make certain payments, including dividends or distributions to Digirad.
ATRM’s inability to comply with the financial covenants under its loan agreements with Gerber Finance and Premier Bank could have a material adverse effect on its financial condition.
As of December 31, 2018, KBS was not in compliance with the financial covenants under the KBS Loan Agreement requiring no net annual post-tax loss for KBS or the minimum leverage ratio covenant as of these test dates. Additionally, KBS was not in compliance
with the requirement to deliver ATRM’s fiscal year-end financial statements reviewed by an independent certified accounting firm acceptable to Gerber Finance within 105 days from the fiscal year ended December 31, 2017. The occurrence of any event of default under the KBS Loan Agreement may result in KBS’s obligations under the KBS Loan Agreement becoming immediately due and payable. In April 2019, ATRM obtained a waiver from Gerber Finance for these events. In addition, ATRM and Gerber Finance agreed to eliminate the minimum leverage ratio covenant for years after 2018.
As of December 31, 2018, EBGL was not in compliance with the following covenants under the Premier Loan Agreement:(i) a requirement to maintain a Debt Service Coverage Ratio for the calendar year of at least 1.0; and (ii) a requirement to deliver ATRM’s fiscal
year-end audited financial statements within 120 days of the end of each calendar year. The occurrence of any event of default under the Premier Loan Agreement may result in EBGL’s obligations under the Premier Loan Agreement becoming immediately due and payable. In April 2019, ATRM obtained a waiver from Premier Bank for these events through January 1, 2020.
If ATRM fails to comply with any financial covenants under its loan agreements with Gerber Finance or Premier Bank going forward, the applicable lender(s) may demand the repayment of the credit facilities amount outstanding and any unpaid interest thereon.
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The ability of Digirad to use net operating loss carryforwards
to offset future taxable income for U.S. income tax purposes may be limited.
As of December 31, 2018, Digirad had federal NOLs of approximately $83.7 million and state NOLs of approximately $26.7 million. Significant changes that impact Digirad in the 2017 Tax Cut and Jobs Act (the “TCJA”) include a limitation on the utilization of NOLs arising after December 31, 2017 to 80% of taxable income with an indefinite carryforward. The TCJA also reduced the corporate income tax rate to 21%, from a prior rate of 35%, which may cause a reduction in the economic benefit of its NOLs and other deferred tax assets available to us. In addition, at the state level, there may be periods during which the use of NOLs is suspended or otherwise limited, which could accelerate or permanently increase state taxes owed. Further, the ability
of Digirad to use NOLs to offset future taxable income will depend on the amount of taxable income Digirad generates in future periods and whether Digirad becomes subject to annual limitations on the amount of taxable income that may be offset by its NOLs.
Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), imposes an annual limitation on the amount of taxable income that may be offset by a corporation’s NOLs if the corporation experiences an “ownership change” as defined in Section 382 of the Code. An ownership change occurs when the corporation’s “5-percent shareholders” (as defined in Section 382 of the Code) collectively increase their ownership in the corporation by more than 50 percentage points (by value) over a rolling three-year period. Additionally, various states have similar limitations on the use of state NOLs following an ownership change. As of December 31,
2018, ATRM had federal net operating loss carryforwards (“NOLs”) of approximately $104.7 million and state NOLs of approximately $23.3 million. The completion of the ATRM Merger will result in an ownership change under Section 382 with respect to ATRM.
The ATRM Merger should not result in an ownership change with respect to Digirad’s NOLs because Digirad believes that the Company Preferred Stock issued to ATRM shareholders in the ATRM Merger should be treated as “plain vanilla” or “pure preferred stock” within the meaning of Section 1504(a)(4) of the Code and would, therefore, be excluded for the purposes of determining whether an ownership change under Section 382 has occurred. However, if the Company Preferred Stock issued in the
ATRM Merger is not considered “plain vanilla” or “pure preferred stock” within the meaning of Section 1504(a)(4) of the Code, the Company Preferred Stock will be treated as “stock” for purposes of Section 382 of the Code. In such event, an ownership change under Section 382 will likely occur with respect to Digirad’s NOLs.
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
This certification is being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. § 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated
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by
reference into any filing of Digirad Corporation, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
