Digirad Corporation
DIGIRAD CORP (Form: 10-Q, Received: 11/03/2017 16:27:37)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549  
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE TRANSITION PERIOD FROM              TO             
Commission file number: 001-35947
A1A12.JPG
Digirad Corporation
(Exact name of registrant as specified in its charter)
Delaware
 
33-0145723
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
 
1048 Industrial Court, Suwanee, GA
 
30024
(Address of Principal Executive Offices)
 
(Zip Code)
(858) 726-1600
(Registrant’s Telephone Number, Including Area Code)
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   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes   x     No   ¨
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
x
 
 
 
 
Non-accelerated filer
¨   (Do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
 
 
 
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. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨  Yes No  x
As of November 1, 2017 the registrant had 20,052,984 shares of Common Stock ($0.0001 par value) outstanding.




DIGIRAD CORPORATION
TABLE OF CONTENTS
 
IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
EXHIBIT 10.1
 
EXHIBIT 10.2
 
EXHIBIT 31.1
 
EXHIBIT 31.2
 
EXHIBIT 32.1
 
EXHIBIT 32.2
 
EXHIBIT 101.INS XBRL Instance Document
 
EXHIBIT 101.SCH XBRL Taxonomy Extension Schema Document
 
EXHIBIT 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
 
EXHIBIT 101.LAB XBRL Taxonomy Extension Label Linkbase Document
 
EXHIBIT 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
 
EXHIBIT 101.DEF XBRL Taxonomy Extension Definition Linkbase Document
 


2



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, 2016 filed with the Securities and Exchange Commission on February 28, 2017. 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.

3



PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
DIGIRAD CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
  (in thousands, except per share data)
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Services
$
22,667

 
$
23,825

 
$
69,080

 
$
72,496

Product and product-related
5,888

 
7,261

 
18,341

 
21,837

Total revenues
28,555

 
31,086

 
87,421

 
94,333

 
 
 
 
 
 
 
 
Cost of revenues:
 
 
 
 
 
 
 
Services
18,629

 
19,110

 
56,034

 
56,795

Product and product-related
3,286

 
3,675

 
10,607

 
10,407

Total cost of revenues
21,915

 
22,785

 
66,641

 
67,202

 
 
 
 
 
 
 
 
Gross profit
6,640

 
8,301

 
20,780

 
27,131

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Marketing and sales
1,992

 
2,426

 
6,661

 
7,888

General and administrative
3,878

 
4,608

 
14,919

 
15,900

Amortization of intangible assets
578

 
578

 
1,734

 
1,735

Goodwill impairment
2,580

 

 
2,580

 

Total operating expenses
9,028

 
7,612

 
25,894

 
25,523

 
 
 
 
 
 
 
 
(Loss) income from operations
(2,388
)
 
689

 
(5,114
)
 
1,608

 
 
 
 
 
 
 
 
Other expense:
 
 
 
 
 
 
 
Other expense, net
(237
)
 
(428
)
 
(237
)
 
(414
)
Interest expense, net
(224
)
 
(342
)
 
(842
)
 
(1,092
)
Loss on extinguishment of debt

 

 
(709
)
 

Total other expense
(461
)
 
(770
)
 
(1,788
)
 
(1,506
)
 
 
 
 
 
 
 
 
(Loss) income before income taxes
(2,849
)
 
(81
)
 
(6,902
)
 
102

Income tax (expense) benefit
(6,050
)
 
(202
)
 
(6,845
)
 
12,222

Net (loss) income
$
(8,899
)
 
$
(283
)
 
$
(13,747
)
 
$
12,324

 
 
 
 
 
 
 
 
Net (loss) income per share:
 
 
 
 
 
 
 
Basic
$
(0.44
)
 
$
(0.01
)
 
$
(0.69
)
 
$
0.63

Diluted
$
(0.44
)
 
$
(0.01
)
 
$
(0.69
)
 
$
0.62

 
 
 
 
 
 
 
 
Dividends declared per common share
$
0.055

 
$
0.05

 
$
0.155

 
$
0.15

 
 
 
 
 
 
 
 
Net (loss) income
$
(8,899
)
 
$
(283
)
 
$
(13,747
)
 
$
12,324

Other comprehensive income:
 
 
 
 
 
 
 
Unrealized gain on marketable securities

 

 

 
10

Reclassification of other-than-temporary losses on available-for-sale securities included in net (loss) income
83

 
263

 
52

 
230

Total other comprehensive income
83

 
263

 
52

 
240

Comprehensive (loss) income
$
(8,816
)
 
$
(20
)
 
$
(13,695
)
 
$
12,564

See accompanying notes to the unaudited condensed consolidated financial statements.

4



DIGIRAD CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)  
(in thousands, except share data)
September 30,
2017
 
December 31,
2016
Assets

 

Current assets:
 
 
 
Cash and cash equivalents
$
1,103

 
$
2,203

Securities available-for-sale
79

 
917

Accounts receivable, net
14,002

 
14,503

Inventories, net
5,903

 
5,987

Restricted cash
359

 
1,376

Other current assets
1,874

 
2,093

 Total current assets
23,320

 
27,079

Property and equipment, net
29,048

 
31,407

Intangible assets, net
9,894

 
11,628

Goodwill
3,657

 
6,237

Deferred tax assets
20,623

 
27,019

Restricted cash
100

 
2,100

Other assets
976

 
793

Total assets
$
87,618

 
$
106,263

 
 
 
 
Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
5,571

 
$
6,514

Accrued compensation
3,566

 
3,962

Accrued warranty
167

 
196

Deferred revenue
2,751

 
3,123

Current portion of long-term debt

 
5,358

Other current liabilities
4,188

 
3,520

Total current liabilities
16,243

 
22,673

Long-term debt, net of current portion
18,500

 
16,070

Other liabilities
2,009

 
1,039

Total liabilities
36,752

 
39,782

 
 
 
 
Commitments and contingencies (Note 8)

 

 
 
 
 
Stockholders’ equity:
 
 
 
Preferred stock, $0.0001 par value: 10,000,000 shares authorized; no shares issued or outstanding

 

Common stock, $0.0001 par value: 80,000,000 shares authorized; 20,052,984 and 19,892,557   shares issued and outstanding (net of treasury shares) at September 30, 2017 and December 31, 2016, respectively
2

 
2

Treasury stock, at cost; 2,588,484 shares at September 30, 2017 and December 31, 2016
(5,728
)
 
(5,728
)
Additional paid-in capital
149,241

 
151,696

Accumulated other comprehensive loss

 
(52
)
Accumulated deficit
(92,649
)
 
(79,437
)
Total stockholders’ equity
50,866

 
66,481

Total liabilities and stockholders’ equity
$
87,618

 
$
106,263

See accompanying notes to the unaudited condensed consolidated financial statements.

5



DIGIRAD CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)  
 
Nine Months Ended September 30,
    (in thousands)
2017
 
2016
Operating activities
 
 
 
Net (loss) income
$
(13,747
)
 
$
12,324

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation
5,928

 
5,602

Amortization of intangible assets
1,734

 
1,735

Provision for bad debt, net of recoveries
119

 
525

Goodwill impairment
2,580

 

Stock-based compensation
829

 
754

Amortization of loan fees
165

 
280

Loss on extinguishment of debt
709

 

Gain on sale of assets
(71
)
 
(14
)
Impairment of investment
237

 
413

Deferred income taxes
6,707

 
(11,806
)
Other, net
(159
)
 
28

Changes in operating assets and liabilities, net of effect of acquisitions:
 
 
 
Accounts receivable
373

 
(201
)
Inventories
7

 
(1,331
)
Other assets
(102
)
 
(227
)
Accounts payable
(940
)
 
431

Accrued compensation
(396
)
 
(830
)
Deferred revenue
(362
)
 
(148
)
Other liabilities
490

 
(719
)
Net cash provided by operating activities
4,101

 
6,816

 
 
 
 
Investing activities
 
 
 
Purchases of property and equipment
(1,567
)
 
(3,962
)
Proceeds from sale of property and equipment
174

 
171

Purchases of securities available-for-sale
(17
)
 

Maturities of securities available-for-sale
917

 
1,896

Cash paid for acquisitions, net of cash acquired

 
(25,482
)
Net cash used in investing activities
(493
)
 
(27,377
)
 
 
 
 
Financing activities
 
 
 
Proceeds from long-term borrowings
31,819

 
34,257

Repayment of long-term debt
(35,282
)
 
(20,705
)
Change in restricted cash
3,017

 
(2,745
)
Loan issuance and extinguishment costs
(271
)
 
(504
)
Dividends paid
(3,092
)
 
(2,927
)
Issuances of common stock

 
371

Taxes paid related to net share settlement of equity awards
(192
)
 
(97
)
Cash paid for contingent consideration for acquisitions
(27
)
 
(27
)
Repayment of obligations under capital leases
(680
)
 
(577
)
Net cash (used in) provided by financing activities
(4,708
)
 
7,046

Net decrease in cash and cash equivalents
(1,100
)
 
(13,515
)
Cash and cash equivalents at beginning of period
2,203

 
15,868

Cash and cash equivalents at end of period
$
1,103

 
$
2,353

 
 
 
 
Non-Cash Investing Activities
 
 
 
Assets acquired by entering into capital leases
$
2,047

 
$
269

See accompanying notes to the unaudited condensed consolidated financial statements.

6



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 ("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, 2016 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, 2016 , filed with the SEC on Form 10-K on February 28, 2017, 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.
On January 1, 2016, we acquired Project Rendezvous Holding Corporation, the holding company of DMS Health Technologies, Inc. ("DMS Health"). The financial results for all periods presented include the financial results of DMS Health.
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.
Recently Adopted Accounting Standards
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , which simplifies the accounting for employee share-based payments. The new standard requires the immediate recognition of all excess tax benefits and deficiencies in the income statement, and requires classification of excess tax benefits as an operating activity as opposed to a financing activity in the statements of cash flows. This guidance will be applied either prospectively, retrospectively, or using a modified retrospective transition method, depending on the area covered in this update. We adopted this guidance during the first quarter of 2017. The primary impact of this guidance is the requirement to recognize all excess tax benefits and deficiencies on share-based payments in income tax expense. Upon the adoption of this requirement on a modified-retrospective basis, the previously unrecognized excess tax benefits on share-based compensation of $0.5 million were recorded through accumulated deficit and deferred tax assets as of January 1, 2017.
Recently Issued Accounting Standards
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by removing the second step of the two-step impairment test. The amendment requires an entity to perform its annual, or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.  The amendment should be applied on a prospective basis.  The pronouncement is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  We are currently evaluating the impact that implementation of this guidance will have on our financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. The pronouncement is effective for fiscal years beginning after December 15, 2017, and for interim periods within those periods, using a retrospective transition method to each period presented. We do not expect the impact on our consolidated financial statements to be material.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments . The pronouncement provides clarification guidance on eight specific cash flow presentation issues that have developed due to diversity in practice. The issues include, but are not limited to, debt prepayment or extinguishment costs, settlement of zero-coupon debt, proceeds from the settlement of insurance claims, and cash receipts from payments on beneficial interests in securitization transactions. The pronouncement is effective for fiscal years, and for interim periods within those fiscal years,

7



beginning after December 15, 2017, with early adoption permitted. We are currently evaluating the impact, if any, of adopting this guidance on our financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which amended the existing accounting standards for the accounting for leases. The amendments are based on the principle that assets and liabilities arising from leases should be recognized within the financial statements. The Company is required to adopt the amendments beginning in 2019. Early adoption is permitted. The amendments must be applied using a modified retrospective transition approach and the FASB decided not to permit a full retrospective transition approach. We currently expect that most of our operating lease commitments will be subject to the update and recognized as operating lease liabilities and right-of-use assets upon adoption. However, we are currently evaluating the effect that implementation of this update will have upon adoption on our consolidated financial position and results of operations.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amended the existing accounting standards for the accounting for financial instruments. The amendments require equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income. The new standard is effective prospectively for fiscal years beginning after December 15, 2017. We are currently evaluating the impact, if any, of adopting this guidance on our financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers which supersedes current revenue recognition guidance, including most industry-specific guidance. The guidance provides that an entity recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. The guidance allows for either full retrospective or modified retrospective adoption and is currently scheduled to become effective for us in the first quarter of 2018. We intend to adopt this guidance under the modified retrospective method. Our analysis has consisted of reviewing the nature and terms of our existing contracts under the provisions of the new guidance and assessing any operational changes and process updates required for compliance. Based on our evaluation of the guidance performed to date, we do not expect the adoption of the amended guidance to have a material impact on our consolidated financial statements, but will require expanded disclosures related to disaggregated revenue, contract balances and performance obligations. We will continue to evaluate the impact on this guidance on our consolidated financial statements and our preliminary assessments are subject to change. 
Note 2. Basic and Diluted Net Income (Loss) Per Share
For the three and nine months ended September 30, 2017 and 2016 , basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares and vested restricted stock units 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 income (loss) per share for the periods indicated:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(shares in thousands)
2017
 
2016
 
2017
 
2016
Weighted average shares outstanding - basic
20,009

 
19,618

 
19,974

 
19,532

Dilutive potential common stock outstanding:
 
 
 
 
 
 
 
Stock options

 

 

 
419

Restricted stock units

 

 

 
75

Weighted average shares outstanding - diluted
20,009

 
19,618

 
19,974

 
20,026


The following weighted average outstanding common stock equivalents were not included in the calculation of diluted net income per share because their effect was anti-dilutive:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(shares in thousands)
2017
 
2016
 
2017
 
2016
Stock options
248

 
418

 
283

 
14

Restricted stock units
64

 
73

 
68

 

Total
312

 
491

 
351

 
14

Note 3. Inventories
The components of inventories are as follows:
(in thousands)
September 30,
2017
 
December 31,
2016
Inventories:
 
 
 
Raw materials
$
2,508

 
$
2,494

Work-in-process
1,730

 
1,483

Finished goods
2,058

 
2,426

Total inventories
6,296

 
6,403

Less reserve for excess and obsolete inventories
(393
)
 
(416
)
Total inventories, net
$
5,903

 
$
5,987

Note 4. Property and Equipment
Property and equipment consists of the following:
(in thousands)
September 30,
2017
 
December 31, 2016
Property and equipment:

 

Land
$
1,170

 
$
1,170

Buildings and leasehold improvements
2,946

 
2,946

    Machinery and equipment
53,887

 
50,689

Computer hardware and software
4,590

 
4,486

Total property and equipment
62,593

 
59,291

Less accumulated depreciation
(33,545
)
 
(27,884
)
Total property and equipment, net
$
29,048

 
$
31,407



8



Note 5. Intangibles and Goodwill

Changes in the carrying amount of goodwill from December 31, 2015 to  September 30, 2017 , by reportable segment, are as follows:
(in thousands)
 
Diagnostic Services
 
Medical Device Sales and Service
 
Total
Balance at December 31, 2015
 
$
2,897

 
$

 
$
2,897

Acquisition of DMS Health
 

 
3,678

 
3,678

   Impairment of Telerhythmics
 
(338
)
 

 
(338
)
Balance at December 31, 2016
 
2,559

 
3,678

 
6,237

   Impairment of DMS Health
 

 
(2,580
)
 
(2,580
)
Balance at September 30, 2017
 
$
2,559

 
$
1,098

 
$
3,657

    
The Company tests goodwill for impairment annually during the fourth quarter of each year at the reporting unit level and on an interim basis if events or substantive changes in circumstances indicate that the carrying amount of a reporting unit may exceed its fair value. On September 28, 2017, the Company received notification from Philips Healthcare ("Philips") that our agreement to provide contract sales and services on Philips branded equipment would be terminated, effective December 31, 2017. As a result, the Company reduced its forecasted revenue, gross margin and operating profit within its Medical Device Sales and Services ("MDSS") reporting unit. These factors are considered indicators of potential impairment and as a result, the Company performed an interim goodwill impairment analysis during the third quarter of 2017.
In performing the first step of the goodwill impairment assessment, we determined the fair value of the MDSS reporting unit using both an income approach and a market approach. Under the income-based approach we use a discounted cash flow model in which cash flows anticipated over several future periods plus a terminal value at the end of that time horizon are discounted to their present value using an appropriate risk-adjusted rate of return. We use our internal forecasts to estimate future cash flows and include an estimate of long-term growth rates based on our most recent views of the long-term outlook for each reporting unit. Actual results may differ materially from those used in our forecasts. The discount rate used in the discounted cash flow analysis reflects the risks inherent in the expected future cash flows of the MDSS reporting unit. Determining fair value using a market approach considers multiples of financial metrics based on both acquisitions and trading multiples of a selected peer group of companies. From the comparable companies, a representative market multiple was determined which was applied to financial metrics to estimate the fair value of the MDSS reporting unit. We determined that the recorded carrying value of the MDSS reporting unit exceeded its enterprise value in the first step and performed the second step of the impairment test in which we allocated the enterprise fair value to the fair value of the reporting unit's net assets. The second step of the impairment testing process requires, among other things, the estimation of the fair values of substantially all of our tangible and intangible assets.  Any enterprise fair value in excess of amounts allocated to such net assets represents the implied fair value of goodwill for that reporting unit.  As a result, the Company recorded an impairment loss of $ 2.6 million associated with the impairment assessment of the MDSS reporting unit as of September 30, 2017 .
Estimating the fair value of the reporting units requires the use of estimates and significant judgments regarding future cash flows that are based on a number of factors including actual operating results, forecasted billings, revenue, and spend targets, discount rate assumptions, and long-term growth rate assumptions. The estimates and judgments described above could adversely change in future periods and we cannot provide absolute assurance that all of the targets will be achieved, which could lead to future impairment charges.

9




Intangible assets with finite useful lives consisted of the following:
 
 
September 30, 2017
 
December 31, 2016
(in thousands)
 
Gross Carrying Amount
 
Accumulated Amortization
 
Intangible Assets, Net
 
Gross Carrying Amount
 
Accumulated Amortization
 
Intangible Assets, Net
Customer relationships
 
$
10,363

 
$
(4,762
)
 
$
5,601

 
$
10,363

 
$
(4,117
)
 
$
6,246

Trademarks
 
4,610

 
(1,447
)
 
3,163

 
4,610

 
(891
)
 
3,719

Distribution Agreement
 
2,165

 
(1,151
)
 
1,014

 
2,165

 
(658
)
 
1,507

Patents
 
141

 
(133
)
 
8

 
141

 
(131
)
 
10

Covenants not to compete
 
251

 
(143
)
 
108

 
251

 
(105
)
 
146

Total intangible assets, net
 
$
17,530

 
$
(7,636
)
 
$
9,894

 
$
17,530

 
$
(5,902
)
 
$
11,628


Intangible assets with determinable lives are amortized over the estimated useful lives of the assets. These intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. If the carrying amount of an asset exceeds its estimated future undiscounted cash flows, an impairment loss is recorded for the excess of the asset’s carrying amount over its fair value. During the third quarter of 2017, due to the indications of impairment within our MDSS reporting unit described above, the Company reviewed finite-lived assets for impairment. The Company's interim test on its long-lived assets indicated that the carrying value of its long-lived assets was recoverable and that no impairment existed as of the September 30, 2017 testing date. The carrying value of the Philips distribution agreement intangible asset was $1.0 million as of September 30, 2017 , in which amortization expense will be accelerated over the remaining period of the agreement terminating on December 31, 2017.

Estimated future amortization expense is as follows (in thousands):
October 1 - December 31, 2017
$
1,427

2018
1,585

2019
1,573

2020
1,509

2021
1,496

Thereafter
2,304


Note 6. Financial Instruments
Assets and Liabilities Measured at Fair Value on a Recurring Basis.
The following table presents information about our financial assets and liabilities 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, 2017 and December 31, 2016 .
 
Fair Value as of September 30, 2017
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Corporate debt securities
$

 
$

 
$

 
$

  Equity securities
79

 
185

 

 
264

  Total
$
79

 
$
185

 
$

 
$
264

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Acquisition related contingent consideration
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 

10



 
Fair Value as of December 31, 2016
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Corporate debt securities
$

 
$
917

 
$

 
$
917

  Equity securities

 
255

 

 
255

  Total
$

 
$
1,172

 
$

 
$
1,172

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Acquisition related contingent consideration
$

 
$

 
$
84

 
$
84

 
 
 
 
 
 
 
 
The fair value of our corporate debt securities is determined using proprietary valuation models and analytical tools. These valuation models and analytical tools use market pricing or prices for similar instruments that are both objective and publicly available, including matrix pricing or reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, and/or offers. We did not reclassify any investments between levels in the fair value hierarchy during the nine months ended September 30, 2017 .
The investment in equity securities consists of common stock of publicly traded companies. The fair value of these securities is based on the closing prices observed on September 30, 2017 .
The acquisition related contingent consideration is related to our acquisition of MD Office Solutions ("MD Office") on March 5, 2015.  We reassess the fair value of the contingent consideration to be settled in cash related to our acquisition of MD Office using the income approach, which is a Level 3 measurement. Significant assumptions used in the measurement include probabilities of achieving EBITDA milestones.
Changes in estimated fair value of contingent consideration liabilities from December 31, 2016 to September 30, 2017 are as follows (in thousands):
 
 
MD Office Solutions Contingent Consideration
Balance at December 31, 2016
 
$
84

Contingent consideration payments
 
(27
)
Change in estimated fair value
 
(57
)
Balance at September 30, 2017
 
$


The fair value of the Company's revolving credit facility approximates carrying value due to the variable rate nature of our borrowings.
Securities Available-for-Sale
As of September 30, 2017 , securities available-for-sale consist of investments in equity securities that are publicly traded. These investments include shares held in Birner Dental Management Services ("Birner Dental"), a publicly traded company whose board of directors include a current Director of the Company. We classify all debt securities and a portion of equity securities as available-for-sale and as current assets, as the sale of such securities may be required prior to maturity to execute management strategies. One of our equity securities, Perma-Fix Medical S.A. ("Perma-Fix Medical"), is classified as an other asset (non-current), as the investment is strategic in nature and our current intent is to hold the investment over a several year period. Securities available-for-sale are carried at fair value, with the unrealized gains and losses reported as a component of accumulated other comprehensive loss in stockholders' equity until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis.
It is not more likely than not that we will be required to sell investments before recovery of their amortized costs. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the straight-line method and included in interest income. Interest income is recognized when earned. Realized gains and losses on investments in securities are included in other expense, net within the unaudited condensed consolidated statements of operations and comprehensive income (loss). The realized gains and losses on these sales were minimal for the three and nine months ended September 30, 2017 and 2016 .
A decline in the market value of any available-for-sale security below cost that is determined to be other than temporary will result in an impairment charge to earnings and a new cost basis for the security is established. During the three months ended September 30, 2017 , the Company recognized an other-than temporary impairment charge of $0.2 million related to its equity

11



investments, reflecting the write-down of these investments to its fair market value of $0.3 million . The Company reviewed various factors in making its determination, including the length of time and extent the fair value of these securities has been below cost basis. During the three months ended September 30, 2016 , the Company recognized other-than-temporary impairment charges of $0.4 million . These losses are included as a component in other expense, net in the unaudited consolidated statements of operations and comprehensive income (loss).
The following table sets forth the composition of securities available-for-sale as of September 30, 2017 and December 31, 2016 .
 
Maturity in
Years
 
Cost
 
Unrealized
 
Fair Value
As of September 30, 2017 (in thousands)
Gains
 
Losses
 
Corporate debt securities
Less than 1 year
 
$

 
$

 
$

 
$

Corporate debt securities
1-3 years
 

 

 

 

Equity securities
-
 
264

 

 

 
264

 
 
 
$
264

 
$

 
$

 
$
264

 
 
 
 
 
 
 
 
 
 
 
Maturity in
Years
 
Cost
 
Unrealized
 
Fair Value
As of December 31, 2016 (in thousands)
Gains
 
Losses
 
Corporate debt securities
Less than 1 year
 
$
917

 
$

 
$

 
$
917

Corporate debt securities
1-3 years
 

 

 

 

Equity securities
-
 
308

 

 
(53
)
 
255

 
 
 
$
1,225

 
$

 
$
(53
)
 
$
1,172

Note 7. Debt
A summary of long-term debt is as follows:
 
September 30, 2017
 
December 31, 2016
(in thousands)
Amount
 
Interest Rate
 
Amount
 
Interest Rate
Revolving Credit Facility
$
18,500

 
3.59%
 
$

 
 
Term Loan A (terminated June 21, 2017)

 
 
 
17,382

 
3.15%
Term Loan B (terminated June 21, 2017)

 
 
 
4,581

 
5.65%
Revolving Credit Facility (terminated June 21, 2017)

 
 
 

 
2.69%
Total borrowings
18,500

 
 
 
21,963

 
 
Less: net unamortized debt issuance cost

 
 
 
(535
)
 
 
Less: current portion

 
 
 
(5,358
)
 
 
Long-term portion
$
18,500

 
 
 
$
16,070

 
 
On June 21, 2017, the Company entered into a Revolving Credit Agreement (the “Comerica Credit Agreement”) with Comerica Bank, a Texas banking association (“Comerica”). The Comerica Credit Agreement provides for a five-year revolving credit facility with a maximum credit amount of $25.0 million maturing in June 2022. The Company’s subsidiaries are guarantors under the Comerica Credit Facility. Under the Comerica Credit Facility, the Company can request the issuance of letters of credit in an aggregate amount not to exceed $1.0 million at any one time.
The Company used $22.1 million of the financing made available under the Comerica Credit Facility to repay and terminate, effective June 21, 2017, that certain Credit Agreement, dated January 1, 2016, by and among the Company, the subsidiaries of the Company, the lenders party thereto and Wells Fargo Bank as administrative agent (the "Wells Fargo Agreement"). The Wells Fargo Credit Agreement provided for a five-year credit facility with a maximum credit amount of $40.0 million . The Company recognized a $0.7 million loss on extinguishment due to the write off of unamortized deferred financing costs associated with the former credit facility under the Wells Fargo Credit Agreement.
The Company incurred and capitalized $0.2 million of costs in connection with the Comerica Credit Facility, which are being amortized on a straight-line basis to interest expense over the five-year term of the new revolving credit facility.
At the Company’s option, the Comerica Credit Facility will bear interest at either (i) the LIBOR Rate, as defined in the Comerica Credit Agreement, plus a margin of 2.35% ; or (ii) the PRR-based Rate, plus a margin of 0.5% . As further defined in

12



the Comerica Credit Agreement, the "PRR-based Rate" means the greatest of (a) the Prime Rate in effect on such day (as defined in the Comerica Credit Agreement) plus 0.5% , or (b) the daily adjusting LIBOR Rate plus 2.50% . In addition to interest on outstanding borrowings under the Comerica Credit Facility, the revolving credit note bears an unused line fee of  0.25% , which is presented as interest expense. The borrowing availability under the Comerica Credit Agreement at September 30, 2017 was $6.5 million .
The Comerica Credit Agreement contains certain representations, warranties, events of default, as well as certain affirmative and negative covenants customary for credit agreements of this type. These covenants include restrictions on borrowings, investments and divestitures, as well as limitations on the Company’s ability to make certain restricted payments. These restrictions do not prevent or prohibit the payment of dividends by the Company consistent with past practice. The Comerica Credit Agreement requires us to comply with certain financial covenants, including fixed charge coverage and funded debt to Adjusted EBITDA ratios. The fixed charge coverage ratio is calculated based on the ratio of Adjusted EBITDA less capital expenditures and fixed charges (as defined in the Comerica Credit Agreement) measured on a quarterly basis as of the most recent fiscal quarter end. Per the Comerica Credit Agreement, we must maintain a fixed charge ratio of at least 1:25 for each trailing twelve month period as of the end of each fiscal quarter. The funded debt to Adjusted EBITDA ratio (as defined in the Comerica Credit Agreement) must be not more than 2:25 measured at each fiscal quarter.
Upon the occurrence and during the continuation of an event of default under the Comerica Credit Agreement, Comerica may, among other things, declare the loans and all other obligations under the Comerica Credit Agreement immediately due and payable and increase the interest rate at which loans and obligations under the Comerica Credit Agreement bear interest. Pursuant to a separate Security Agreement dated June 21, 2017, between the Company, its subsidiaries and Comerica Bank, the Comerica Credit Facility is secured by a first-priority security interest in substantially all of the assets (excluding real estate) of the Company and its subsidiaries and a pledge of all shares and membership interests of the Company’s subsidiaries.
At September 30, 2017 , the Company was in compliance with all covenants.

Note 8. Commitments and Contingencies
Capital Leases
We finance certain information technology, medical equipment, and vehicles under capital leases. Obligations related to capital leases are secured by the underlying assets and will be paid over the remaining lease terms through July 31, 2022. The future minimum lease payments due under capital leases as of September 30, 2017 are as follows (in thousands):
 
Capital Leases
October 1 - December 31, 2017
$
263

2018
790

2019
604

2020
509

2021
489

2022
71

Thereafter

Total future minimum lease payments
2,726

Less amounts representing interest
(241
)
Present value of obligations
2,485

Less: current capital lease obligation
(793
)
Total long-term capital lease obligations
$
1,692

Self-Insured Health Insurance Benefits
Effective January 1, 2017, the Company provided health care benefits to its employees through a self-insured plan with "stop loss" coverage. The Company records a liability that represents our estimated cost of claims incurred and unpaid as of the balance sheet date.  Our estimated reserve is based on historical experience and trends related to both health insurance claims and payments.  The ultimate cost of health care benefits will depend on actual costs incurred to settle the claims and may differ from the amounts reserved by the Company for those claims.

13



Litigation Matters
In May 2016, Shaun Smith ("Smith"), a former employee of Digirad Imaging Solutions and MD Office Solutions, filed a lawsuit against Digirad Corporation, Digirad Imaging Solutions, Inc., and certain current and former officers of these companies, on behalf of himself and class members (collectively, the "Class Members") in Alameda County Superior Court. In October 2016, Smith filed a First Amended Complaint adding MD Office Solutions as a named defendant. Digirad Corporation, Digirad Imaging Solutions, Inc., and certain current and former officers of these companies and MD Office Solutions are collectively referred to as the "Defendants." In March 2017, Smith filed a Second Amended Complaint adding David Dolan ("Dolan") and Robert Erskine ("Erskine") as named plaintiffs. Smith, Dolan and Erskine are collectively referred to as the "Plaintiffs."
The claim alleges that Defendants violated California laws by: failing to provide Class Members with off-duty meal and rest breaks, failing to furnish accurate wage statements, failing to timely pay all earned wages, and failing to pay all wages due upon a Class Member’s separation from Digirad Imaging Solutions, Inc. and MD Office Solutions, among other claims. In addition, Mr. Smith asserted individual claims for racial discrimination, retaliation and wrongful termination.
The parties to this action participated in a voluntary mediation and have reached a tentative settlement of the case and all claims. Preliminary court approval was received in September 2017. Subject to acceptance by Class Members and final court approval, the parties to this action agreed to settle the case for a total amount of approximately $1.3 million , which is accrued in the unaudited condensed consolidated statement of operations. If for any reason the tentative settlement is not accepted by a majority of the Class Members, the tentative settlement could be set aside and the case may continue to be litigated.
Other Matters
In addition to commitments and obligations in the ordinary course of business, we have been, and will likely continue to be, subject to 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 9. 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.
For the nine months ended September 30, 2017 , the Company recorded an increase of $ 8.5 million to its valuation allowance due to uncertainties related to our ability to utilize some of our net operating losses before they expire. This adjustment is predominantly related to the unanticipated termination of the Philips distribution agreement and its effect on our near term forecasted income. As the Company has a significant amount of net operating losses expiring in the next five years, changes to our forecasted income in the near term will have an impact on our ability to utilize those net operating losses. To the extent that it is more likely than not that the losses will not be utilized, the Company has established a valuation allowance against those deferred tax assets.
We will reassess the ability to realize the deferred tax assets on a quarterly basis. If it is more likely than not that we will not realize the recognized deferred tax assets, then all or a portion of the valuation allowance may need to be re-established, which would result in a charge to tax expense. Conversely, if new events indicate that it is more likely than not that we will realize additional deferred tax assets, then all or a portion of the remaining valuation allowance may be released, which would result in a tax benefit.
As of September 30, 2017 , we had unrecognized tax benefits of approximately $3.9 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 US 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 2012; however, our net operating loss and research credit carryovers arising prior to that year are subject to adjustment. It is our policy to recognize interest expense and penalties related to uncertain income tax matters as a component of income tax expense.

14



Note 10. Segments
Our reporting segments have been determined based on the nature of the products and/or 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) excluding litigation reserve expense, goodwill impairment, and transaction and integration costs. The Company does not identify or allocate its assets by operating segments. Our operating costs included in our shared service functions, which primarily consist of senior executive officers, finance, human resources, legal, and information technology, are allocated to our segments. During the first quarter of 2017, as part of our continual evaluation of our segment reporting, as well as our experience of use of shared costs in relationship to our acquisition of DMS Health on January 1, 2016, we modified the methodology in allocating shared costs to our segments. Results for the prior year have been recast to be comparable to the current year presentation. Segment information is as follows:

Three Months Ended September 30,
 
Nine Months Ended September 30,
(in thousands)
2017
 
2016
 
2017
 
2016
Revenue by segment:
 
 
 
 
 
 
 
Diagnostic Services
$
12,171

 
$
12,070

 
$
36,932

 
$
36,551

Diagnostic Imaging
2,975

 
2,703

 
8,701

 
9,703

Mobile Healthcare
10,496

 
11,755

 
32,148

 
35,945

Medical Device Sales and Service
2,913

 
4,558

 
9,640

 
12,134

Condensed consolidated revenue
$
28,555

 
$
31,086

 
$
87,421

 
$
94,333

Gross profit by segment:
 
 
 
 
 
 
 
Diagnostic Services
$
2,586

 
$
2,479

 
$
8,152

 
$
7,934

Diagnostic Imaging
1,318

 
1,177

 
3,497

 
4,743

Mobile Healthcare
1,452

 
2,236

 
4,894

 
7,768

Medical Device Sales and Service
1,284

 
2,409

 
4,237

 
6,686

Condensed consolidated gross profit
$
6,640

 
$
8,301

 
$
20,780

 
$
27,131

Income (loss) from operations by segment:
 
 
 
 
 
 
 
Diagnostic Services
$
511

 
$
143

 
$
1,249

 
$
346

Diagnostic Imaging
149

 
(40
)
 
(314
)
 
982

Mobile Healthcare
(174
)
 
219

 
(1,121
)
 
819

Medical Device Sales and Service
(294
)
 
494

 
(1,009
)
 
1,209

Segment income (loss) from operations
192

 
816

 
(1,195
)
 
3,356

Litigation reserve (1)

 

 
(1,339
)
 

Goodwill impairment (2)
(2,580
)
 

 
(2,580
)
 

Transaction and integration costs of DMS Health Technologies (3)

 
(127
)
 

 
(1,748
)
Condensed consolidated income (loss) from operations
$
(2,388
)
 
$
689

 
$
(5,114
)
 
$
1,608

(1) See Note 8 for further information.
(2) See Note 5 for further information.
(3) Includes diligence, transaction, and integration costs related to the acquisition of DMS Health Technologies on January 1, 2016.
Note 11. Subsequent Events
On November 3, 2017, the Company announced a cash dividend of $0.055 per share payable on November 30, 2017 to shareholders of record on November 20, 2017.




15



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, 2016 , which were included in our Form 10-K, filed with the SEC on February 28, 2017.
The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods.
Overview
Digirad 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 medical equipment and services, including diagnostic imaging and patient monitoring, provides hospitals, physician practices, and imaging centers throughout the United States with technology and services necessary to provide exceptional patient care in the rapidly changing healthcare environment.
Strategy
Our main strategic focus is to grow our business into an integrated healthcare services company that addresses the rapidly changing healthcare environment. We believe that there are many opportunities to provide outsourced and mobile healthcare services and solutions in the current healthcare environment. We believe this strategy will be accomplished by:
1. Focused organic growth from our core businesses;
2. Introducing new service offerings through our existing businesses or through acquisition; and
3. Acquiring similar or complementary healthcare service companies.
Business Segments
We operate the Company in four reportable segments:
1. Diagnostic Services
2. Mobile Healthcare
3. Diagnostic Imaging
4. Medical Device Sales and Service
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.
Diagnostic Services also offers remote cardiac event monitoring services through our Telerhythmics business. These services include provision of a monitor, remote monitoring by registered nurses, and 24 hours a day, 7 days a week monitoring support for our patients and physician customers. We offer modalities of mobile cardiac telemetry ("MCT"), mobile cardiac event monitoring (both in wireless and analog versions), holter monitoring, and pacemaker analysis. These services offer flexibility and convenience to our customers who do not have to incur the costs of staffing, equipment, and logistics to monitor patients as part of their standard of care. Our cardiac event monitoring services are provided primarily through an independent diagnostic testing facility model that allows us to bill Medicare, Medicaid, or one of the third-party healthcare insurers directly for our services, and is the only business at Digirad that bills Medicare, Medicaid, and private insurers.
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.

16



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.
Medical Device Sales and Service. Through Medical Device Sales and Service ("MDSS), we provide contract sales services, as well as warranty and post-warranty services, under our contract with Philips Healthcare ("Philips") within a defined region in the upper Midwest region of the United States. We primarily sell Philips branded imaging and patient monitoring systems, including CT, MRI, PET, PET/CT systems, ultrasound and patient and monitoring systems, and receive a commission on these sales. For our equipment contract sales services, we do not take title to the underlying equipment; it is delivered directly to the end user by Philips. We also provide warranty and post-warranty services on certain Philips equipment within this territory related to equipment we have sold or other equipment sold in the territory.
On September 28, 2017, we received a notice of termination (the “Termination Notice”) from Philips that the Consolidated Agreement, dated April 1, 2014, as amended on June 9, 2015, between Philips and DMS and the Remote Inside Sales Services Agreement dated March 23, 2016, will be terminated upon the normal close of business on December 31, 2017 (“Termination Date”). As a result of this Termination Notice, we expect significant changes to our MDSS segment from January 1, 2018 forward, and also expect to have operational impacts to our employees and operations from the date of the notice until December 31, 2017.
Effective January 1, 2018, it is our expectation the Termination Notice will have the following impact:
We will no longer sell Philips branded products and receive resulting commission revenue. We may have insignificant commission revenue in 2018 based on product sales orders booked prior to December 31, 2017 and delivered subsequent to this date.
The services portion of our MDSS business will no longer conduct or receive commission revenue from the installation or warranty services provided on Philips branded products sold in the Upper Midwest territory.
The services portion of our MDSS business subsequent to January 1, 2018 will still service all post-warranty maintenance contracts and recognize revenue on these performance obligations, as those contracts are directly between the end customer and the Company. However, we will be required to make some operational changes to our services business and we will no longer be able to market ourselves as an exclusive partner to Philips. Further, we must also source parts either from Philips directly under a new contract or from a third party under a new contract, in which the costs are still being determined. Finally, there are several other operational changes we will have to make since we are no longer deemed to be an Original Equipment Manufacturer.
Subsequent to the termination of the agreement on January 1, 2018, we will not be limited in our service sales capacity, as was previously the case. These constraints that will end include limitations to operate only in the Upper Midwest territory, a limitation to not approach a list of specific customers including governmental entities, a limitation of servicing only Philips brand and specific modalities of equipment. We are exploring these new opportunities based on our resources and capacity, but there is no guarantee that we will be able to capitalize on these new opportunities.
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, 2016 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates. Except as discussed below, we believe there were no other significant changes in those critical accounting policies and estimates during the nine months ended September 30, 2017 .

Insurance
On January 1, 2017, we converted our employee health insurance plan from a fixed cost policy to a self-insured plan. The Company self-insures from the first dollar of loss up to specified retention levels. Eligible losses in excess of self-insurance retention levels and up to stated limits of liability are covered by a combination of a captive and third party insurance programs.
For our policies under which we are responsible for losses, we record a liability that represents our estimated cost of claims incurred and unpaid as of the balance sheet date. Our estimated liability is not discounted and is based on a number of assumptions and factors, including historical trends, claim experience, and is closely monitored and adjusted when warranted by changing circumstances. Should a greater amount of claims occur compared to what was estimated or medical costs increase beyond what

17



was expected, our accrued liabilities might not be sufficient and additional expenses may be recorded. Actual claims experience could also be more favorable than estimated resulting in expense reductions. Unanticipated changes may produce materially different amounts of expense than that reported under these programs.
Valuation of Goodwill
We review goodwill for impairment on an annual basis during the fourth quarter, as well when events or changes in circumstances indicate that the carrying value may not be recoverable. We begin the process by assessing qualitative factors in determining whether it is more likely than not that the fair value of our reporting unit is less than its carrying amount. After performing the aforementioned assessment and upon review of the results of such assessment, we may begin performing step one of the two-step impairment analysis by quantitatively comparing the fair value of the reporting unit to the carrying value of the reporting unit, including goodwill. If the carrying value of the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test, whereby the carrying value of the reporting unit’s goodwill is compared to its implied fair value. If the carrying value of the goodwill exceeds the implied fair value, an impairment loss equal to the difference would be recorded.
Due to the termination of the Philips agreement, the Company reduced its forecasted revenue, gross margin and operating profit within its MDSS reporting unit. These factors are considered indicators of potential impairment and as a result, the Company performed an interim goodwill impairment analysis during the third quarter of 2017. In performing the first step of the goodwill impairment assessment, we determined the fair value of the MDSS reporting unit using both an income approach and a market approach. Under the income-based approach we use a discounted cash flow model in which cash flows anticipated over several future periods plus a terminal value at the end of that time horizon are discounted to their present value using an appropriate risk-adjusted rate of return. We use our internal forecasts to estimate future cash flows and include an estimate of long-term growth rates based on our most recent views of the long-term outlook for each reporting unit. Actual results may differ materially from those used in our forecasts. The discount rate used in the discounted cash flow analysis reflects the risks inherent in the expected future cash flows of the MDSS reporting unit. Determining fair value using a market approach considers multiples of financial metrics based on both acquisitions and trading multiples of a selected peer group of companies. From the comparable companies, a representative market multiple was determined which was applied to financial metrics to estimate the fair value of the MDSS reporting unit. We determined that the recorded carrying value of the MDSS reporting unit exceeded its enterprise value in the first step and performed the second step of the impairment test in which we allocated the enterprise fair value to the fair value of the reporting unit's net assets. The second step of the impairment testing process requires, among other things, the estimation of the fair values of substantially all of our tangible and intangible assets. Any enterprise fair value in excess of amounts allocated to such net assets represents the implied fair value of goodwill for that reporting unit. As a result, the Company recorded an impairment loss of  $2.6 million associated with the impairment assessment of the MDSS reporting unit as of September 30, 2017 .
Estimating the fair value of the reporting units requires the use of estimates and significant judgments regarding future cash flows that are based on a number of factors including actual operating results, forecasted billings, revenue, and spend targets, discount rate assumptions, and long-term growth rate assumptions. The estimates and judgments described above could adversely change in future periods and we cannot provide absolute assurance that all of the targets will be achieved, which could lead to future impairment charges.
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.
During the nine months ended September 30, 2017 , the Company recorded an increase of $8.5 million to its valuation allowance due to uncertainties related to our ability to utilize some of our net operating losses before they expire. This adjustment is predominantly related to the unanticipated termination of the Philips distribution agreement on our near term forecasted income. As the Company has a significant amount of net operating losses expiring in the next five years, changes to our forecasted income in the near term will have an impact on our ability to utilize those net operating losses. To the extent that it is more likely than not that the losses will not be utilized, the Company has established a valuation allowance against those deferred tax assets.
We will reassess the ability to realize the deferred tax assets on a quarterly basis. If it is more likely than not that we will not realize the recognized deferred tax assets, then all or a portion of the valuation allowance may need to be re-established, which would result in a charge to tax expense. Conversely, if new events indicate that it is more likely than not that we will realize additional deferred tax assets, then all or a portion of the remaining valuation allowance may be released, which would result in a tax benefit.
Results of Operations
Comparison of the Three Months Ended September 30, 2017 and 2016
The following table summarizes our results for the three months ended September 30, 2017 and 2016 :  
 
Three Months Ended September 30,
 
2017

Percent of 2017
Revenues

2016

Percent of 2016
Revenues

Change from Prior Year
  (in thousands)
Dollars

Percent
Total revenues
$
28,555


100.0
 %

$
31,086


100.0
 %

$
(2,531
)

(8.1
)%
Total cost of revenues
21,915


76.7
 %

22,785


73.3
 %

(870
)

(3.8
)%
Gross profit
6,640


23.3
 %

8,301


26.7
 %

(1,661
)

(20.0
)%
Total operating expenses
9,028


31.6
 %

7,612


24.5
 %

1,416


18.6
 %
(Loss) income from operations
(2,388
)

(8.4
)%

689


2.2
 %

(3,077
)

(446.6
)%
Total other expense
(461
)
 
(1.6
)%
 
(770
)
 
(2.5
)%
 
309

 
(40.1
)%
Loss before income taxes
(2,849
)
 
(10.0
)%
 
(81
)
 
(0.3
)%
 
(2,768
)
 
3,417.3
 %
Income tax expense
(6,050
)
 
(21.2
)%
 
(202
)
 
(0.6
)%
 
(5,848
)
 
2,895.0
 %
Net loss
$
(8,899
)

(31.2
)%

$
(283
)

(0.9
)%

$
(8,616
)

3,044.5
 %

In the context of results of operations discussions, the reportable segments Diagnostic Services and Mobile Healthcare are considered “Services,” and Diagnostic Imaging and Medical Device Sales and Service are considered “Product and Product-Related.”
Revenues
Services Revenue
Services revenue by segment is summarized as follows:
 
Three Months Ended September 30,
  (in thousands)
2017
 
2016
 
Change
 
% Change
Diagnostic Services
$
12,171

 
$
12,070

 
$
101

 
0.8
 %
Mobile Healthcare
10,496

 
11,755

 
(1,259
)
 
(10.7
)%
Total Services Revenue
$
22,667

 
$
23,825

 
$
(1,158
)
 
(4.9
)%
Diagnostic Services revenue increased $0.1 million , or 0.8% , compared to the prior year quarter due to higher volume of imaging days ran, partially offset by a decrease in the average mobile imaging rate per day.
Mobile Healthcare revenue decreased $1.3 million , or 10.7% , compared to the prior year quarter, attributable to decreases in provisional revenue of $0.8 million mainly from lower utilization, as well as decreases in mobile imaging revenue of $0.5 million due to an increase in cancellations. The activity and utilization of provisional assets can vary in each period based on sales execution, the number of imaging unit installations in the period (which require a provisional unit for the transition period), and imaging volume. The decrease during the year over year period is primarily due to sales execution. To address the decrease in provisional revenue that we have been experiencing in 2017 , we made changes in March 2017 in leadership, operations and sales approach in our Mobile Healthcare business unit. Though we believe there has been a positive impact as a result of our changes, the impact of lower provisional sales will take several quarters to correct, and ultimately will still be subject to macro market conditions, associated need, and utilization of our provisional assets.


18



Product and Product-Related Revenue
Product and product-related revenue by segment is summarized as follows:
 
Three Months Ended September 30,
  (in thousands)
2017
 
2016
 
Change
 
% Change
Diagnostic Imaging
$
2,975

 
$
2,703

 
$
272

 
10.1
 %
Medical Device Sales and Service
2,913

 
4,558

 
(1,645
)
 
(36.1
)%
Total Product and Product-Related Revenue
$
5,888

 
$
7,261

 
$
(1,373
)
 
(18.9
)%
Diagnostic Imaging revenue increased $0.3 million , or 10.1% , compared to the prior year quarter, primarily attributable to an increase in product sales of $0.3 million due to an increase in the number of cameras sold, partially offset by a less favorable product mix resulting in a lower blended average selling price per camera quarter over quarter.
MDSS revenue decreased $1.6 million , or 36.1% , compared to the prior year quarter, primarily attributable to a decrease in commission revenue generated on product sales of $1.2 million, as well as a decrease in maintenance service revenue of $0.4 million. During the three months ended September 30, 2017 , we experienced the year over year impact of losing a larger customer service contract in the prior year, as well as lower overall variable time and material revenue.
During the three months ended September 30, 2017 and 2016 in MDSS, we recognized $0.7 million and $1.8 million of product sales revenue, and $0.1 million and $0.2 million of installation and warranty service revenue, respectively. Due to the termination of the Philips agreement effective December 31, 2017, we will no longer generate revenue from product sales commissions, equipment installations, or warranties after December 31, 2017. These items amounted to $0.8 million and $2.1 million of revenue during the three months ended September 30, 2017 and 2016 , respectively. See further discussion regarding the Philips contract terminations in the Overview section above.
Gross Profit
Services Gross Profit
Services gross profit and gross margin is summarized as follows:
 
Three Months Ended September 30,
  (in thousands)
2017
 
2016
 
% Change
Services gross profit
$
4,038

 
$
4,715

 
(14.4
)%
Services gross margin
17.8
%
 
19.8
%
 
 
Diagnostic Services gross profit increased $0.1 million , or 4.3% , to $2.6 million in the current year quarter compared to $2.5 million in the prior year quarter, and the gross margin percentage was 21.2% in the current year quarter compared to 20.5% in the prior year quarter. The increase in gross margin percentage was mainly due to lower radiopharmaceutical costs as a result of favorable pricing under a new supplier contract entered into at the beginning of the year.
Mobile Healthcare gross profit decreased $0.8 million , or 35.1% , to $1.5 million in the current year quarter compared to $2.2 million in the prior year quarter, and gross margin percentage was 13.8% in the current year quarter compared to 19.0% in the prior year quarter. The decrease in gross margin percentage was primarily due to lower sales volume; partially offset by higher margins on provisional revenue compared to the prior year quarter.
Product and Product-Related Gross Profit
Product and product-related gross profit and margin is summarized as follows:
 
Three Months Ended September 30,
  (in thousands)
2017
 
2016
 
% Change
Product and product-related gross profit
$
2,602

 
$
3,586

 
(27.4
)%
Product and product-related gross margin
44.2
%
 
49.4
%
 
 
Diagnostic Imaging gross profit increased $0.1 million , or 12.0% , to $1.3 million in the current year quarter compared to $1.2 million in the prior year quarter, and the gross margin percentage was 44.3% in the current year quarter compared to 43.5% in the prior year quarter. The increase in gross margin percentage was primarily due to lower variable compensation.
MDSS gross profit decreased $1.1 million , or 46.7% , to $1.3 million in the current year quarter compared to $2.4 million in the prior year quarter, and the gross margin percentage was 44.1% in the current quarter compared to 52.9% in the prior year quarter. The decrease in gross margin was primarily due to lower revenue.

19



During the three months ended September 30, 2017 and 2016 in MDSS, we recognized approximately $0.3 million and $ 0.4 million respectively of expenses included within cost of revenues from product sales, equipment installations, and warranty services. Subsequent to the Philips contract termination on December 31, 2017, we no longer expect to incur these expenses on a forward basis. See further discussion regarding the Philips contract terminations in the Overview section above.
Operating Expenses
Operating expenses are summarized as follows:
 
Three Months Ended September 30,
 
Percent of Revenues
 
2017
 
2016
 
Change
 
2017
 
2016
  (in thousands)
 
Dollars
 
Percent
 
Marketing and sales
$
1,992

 
$
2,426

 
$
(434
)
 
(17.9
)%
 
7.0
%
 
7.8
%
General and administrative
3,878

 
4,608

 
(730
)
 
(15.8
)%
 
13.6
%
 
14.8
%
Amortization of intangible assets
578

 
578

 

 
 %
 
2.0
%
 
1.9
%
Goodwill impairment
2,580

 

 
2,580

 
100.0
 %
 
9.0
%
 
%
Total operating expenses
$
9,028

 
$
7,612

 
$
1,416

 
18.6
 %
 
31.6
%
 
24.5
%
Marketing and sales expenses decreased $0.4 million , or 17.9% , compared to the prior year quarter, primarily attributable to a decrease of $0.4 million in variable compensation as a result of lower sales, as well as lower headcount associated with changes made in leadership, operational, and sales approach to address lower provisional sales utilization in Mobile Healthcare.
General and administrative expenses decreased $0.7 million , or 15.8% , compared to the prior year quarter, primarily attributable to a decrease in employee related costs of $0.2 million, lower travel costs of $0.1 million, and lower legal and professional fees of $0.2 million.
Due to the termination of the Philips agreement, we anticipate a reduction of $2.5 million to overall marketing, sales, general and administrative expenses annually related to the reduction in our sales force subsequent to December 31, 2017, excluding any potential one-time severance costs related to elimination of these roles.
Goodwill non-cash impairment charges of $2.6 million were recognized during the three months ended September 30, 2017 related to our MDSS reporting unit. See Note 5 to the unaudited condensed consolidated financial statements for further information.
Total Other Expense
Total other expense is summarized as follows:
 
Three Months Ended September 30,
  (in thousands)
2017
 
2016
Other expense, net
$
(237
)
 
$
(428
)
Interest expense, net
(224
)
 
(342
)
Total other expense
$
(461
)
 
$
(770
)
Other expense, net for the three months ended September 30, 2017 and 2016 consisted of impairment losses recognized on our equity investments deemed to be other-than-temporarily impaired. See Note 6 to the unaudited condensed consolidated financial statements for further information.
Interest expense, net, for the three months ended September 30, 2017 and 2016 is predominantly comprised of cash interest costs and related amortization of deferred issuance costs on our debt. Interest expense, net decreased by $0.1 million compared to the prior year quarter primarily due to lower amortization of deferred issuance costs.
Income Tax Expense
Income tax expense was $6.1 million  for the three months ended September 30, 2017 compared to $0.2 million for the three months ended September 30, 2016 . For the three months ended September 30, 2017 , we recorded an increase of $6.4 million to our valuation allowance due to uncertainties related to our ability to utilize some of our net operating losses before they expire, predominantly as a result of the unanticipated termination of the Philips distribution agreement on our near term forecasted income. See Note 9 to the unaudited condensed consolidated financial statements for further information related to the Company's income taxes.

20



Comparison of the Nine Months Ended September 30, 2017 and 2016
The following table summarize our results for the nine months ended September 30, 2017 and 2016 :  
 
Nine Months Ended September 30,
 
2017
 
Percent of 2017
Revenues
 
2016
 
Percent of 2016
Revenues
 
Change from Prior Year
  (in thousands)
Dollars
 
Percent
Total revenues
$
87,421

 
100.0
 %
 
$
94,333

 
100.0
 %
 
$
(6,912
)
 
(7.3
)%
Total cost of revenues
66,641

 
76.2
 %
 
67,202

 
71.2
 %
 
(561
)
 
(0.8
)%
Gross profit
20,780

 
23.8
 %
 
27,131

 
28.8
 %
 
(6,351
)
 
(23.4
)%
Total operating expenses
25,894

 
29.6
 %
 
25,523

 
27.1
 %
 
371

 
1.5
 %
(Loss) income from operations
(5,114
)
 
(5.8
)%
 
1,608

 
1.7
 %
 
(6,722
)
 
(418.0
)%
Total other expense
(1,788
)
 
(2.0
)%
 
(1,506
)
 
(1.6
)%
 
(282
)
 
18.7
 %
(Loss) income before income taxes
(6,902
)
 
(7.9
)%
 
102

 
0.1
 %
 
(7,004
)
 
(6,866.7
)%
Income tax (expense) benefit
(6,845
)
 
(7.8
)%
 
12,222

 
13.0
 %
 
(19,067
)
 
(156.0
)%
Net (loss) income
$
(13,747
)
 
(15.7
)%
 
$
12,324

 
13.1
 %
 
$
(26,071
)
 
(211.5
)%
Revenues
Services Revenue
Services revenue by segment is summarized as follows:
 
Nine Months Ended September 30,
  (in thousands)
2017
 
2016
 
Change
 
% Change
Diagnostic Services
$
36,932

 
$
36,551

 
$
381

 
1.0
 %
Mobile Healthcare
32,148

 
35,945

 
(3,797
)
 
(10.6
)%
Total Services Revenue
$
69,080

 
$
72,496

 
$
(3,416
)
 
(4.7
)%
Diagnostic Services revenue increased $0.4 million , or 1.0% , compared to the prior year period due to a higher volume of imaging days ran, partially offset by a lower average mobile imaging rate per day, as well as a decrease of $0.2 million in revenue from our Telerhythmics business due to lower enrollments resulting from lower in-stock inventory availability to service patients. Though we believe we generally have sufficient inventory to service patients at Telerhythmics, we occasionally experience high demand periods that put pressure on meeting customer demand until more inventory becomes available.
Mobile Healthcare revenue decreased $3.8 million , or 10.6% , compared to the prior year period, attributable to decreases in provisional revenue of $2.6 million mainly due to lower utilization, as well as decreases in mobile imaging revenue of $1.3 million due to an increase in cancellations. The activity and utilization of provisional assets can vary in each period based on sales execution, the number of imaging unit installations in the period (which require a provisional unit for the transition period), and imaging volume. The decrease during the year over year period is primarily due to sales execution. To address the decrease in provisional revenue that we have been experiencing in 2017 , we made changes in March 2017 in leadership, operations and sales approach in our Mobile Healthcare business unit. Though we believe there has been a positive impact as a result of our changes, the impact of lower provisional sales will take several quarters to correct, and ultimately will still be subject to macro market conditions, associated need, and utilization of our provisional assets.
Product and Product-Related Revenue
Product and product-related revenue by segment is summarized as follows:
 
Nine Months Ended September 30,
  (in thousands)
2017
 
2016
 
Change
 
% Change
Diagnostic Imaging
$
8,701

 
$
9,703

 
$
(1,002
)
 
(10.3
)%
Medical Device Sales and Service
9,640

 
12,134

 
(2,494
)
 
(20.6
)%
Total Product and Product-Related Revenue
$
18,341

 
$
21,837

 
$
(3,496
)
 
(16.0
)%
Diagnostic Imaging revenue decreased $1.0 million , or 10.3% , compared to the prior year period, primarily attributable to a decrease in product sales of $0.8 million due to a decrease in the number of cameras sold and a less favorable mix, as well a decrease of $0.2 million in maintenance service revenue. During the prior year period, we sold a greater number of our Ergo and X-Act cameras, which have a higher selling price than our Cardius line of cameras. In addition, we experienced lower overall

21



revenue from camera maintenance services due to lower time and material activities, which are variable in nature and based on customer needs, as well as a lower volume of service contracts.
Though the timing of Diagnostic Imaging product sales are impacted by customer budgets and overall healthcare market, we believe since the second quarter of 2017 that we are seeing some delays in larger product purchases based on the current uncertainty of the Affordable Care Act and the potential repeal or replacement of the program. If this uncertainty continues, we believe our product sales could experience continued softness in future periods.
MDSS revenue decreased $2.5 million , or 20.6% , compared to the prior year period, primarily attributable to a decrease in product sales of $1.5 million and maintenance service revenue of $1.1 million. During the third quarter of 2016 , we had a larger customer transition their service contracts to other providers, which is the primary cause for the decrease in service revenue year over year.
During the nine months ended September 30, 2017 and 2016 in MDSS, we recognized $2.6 million and $4.0 million respectively in product sales revenue, respectively, and $0.4 million of installation and warranty service revenue in both periods. Due to the termination of the Philips agreement effective December 31, 2017, we will no longer generate revenue from product sales commissions, equipment installations, or warranties after December 31, 2017. These items amounted to $3.0 million and $4.4 million of revenue during the nine months ended September 30, 2017 and 2016 , respectively. See further discussion regarding the Philips contract terminations in the Overview section above.
Gross Profit
Services Gross Profit
Services gross profit and gross margin is summarized as follows:
 
Nine Months Ended September 30,
  (in thousands)
2017
 
2016
 
% Change
Services gross profit
$
13,046

 
$
15,701

 
(16.9
)%
Services gross margin
18.9
%
 
21.7
%
 
 
Diagnostic Services gross profit increased $0.2 million , or 2.7% , to $8.2 million in the current year period compared to $7.9 million in the prior year period, and the gross margin percentage was 22.1% in the current year period compared to 21.7% in the prior year period. The increase in gross margin percentage was mainly due to lower radiopharmaceutical costs as a result of more favorable pricing under a new supplier contract entered into at the beginning of the year.
Mobile Healthcare gross profit decreased $2.9 million , or 37.0% , to $4.9 million in the current year period compared to $7.8 million in the prior year period, and gross margin percentage was 15.2% in the current year period compared to 21.6% in the prior year period. The decrease in gross margin percentage was primarily due to lower revenue compared to prior year; partially offset by higher margins on provisional revenue compared to the prior year period.
Product and Product-Related Gross Profit
Product and product-related gross profit and margin is summarized as follows:
 
Nine Months Ended September 30,
  (in thousands)
2017
 
2016
 
% Change
Product and product-related gross profit
$
7,734

 
$
11,430

 
(32.3
)%
Product and product-related gross margin
42.2
%
 
52.3
%
 
 
Diagnostic Imaging gross profit decreased $1.2 million , or 26.3% , to $3.5 million in the current year period compared to $4.7 million in the prior year period, and the gross margin percentage was 40.2% in the current year period compared to 48.9% in the prior year period. The decrease in gross margin percentage was primarily due to an unfavorable volume and mix of camera sold, as well as lower revenue associated with camera maintenance contracts.
MDSS gross profit decreased $2.4 million , or 36.6% , to $4.2 million in the current year period compared to $6.7 million in the prior year period, and the gross margin percentage was 44.0% in the current period compared to 55.1% in the prior year period. The decrease in gross margin was primarily due to lower revenue.
During the nine months ended September 30, 2017 and 2016 in MDSS, we recognized approximately $1.2 million and $1.1 million respectively of expenses included within cost of revenues from product sales, equipment installations, and warranty services. Subsequent to the Philips contract termination on December 31, 2017, we no longer expect to incur these expenses on a forward basis. See further discussion regarding the Philips contract terminations in the Overview section above.

22



Operating Expenses
Operating expenses are summarized as follows:
 
Nine Months Ended September 30,
 
Percent of Revenues
 
2017
 
2016
 
Change
 
2017
 
2016
  (in thousands)
 
Dollars
 
Percent
 
Marketing and sales
$
6,661

 
$
7,888

 
$
(1,227
)
 
(15.6
)%
 
7.6
%
 
8.4
%
General and administrative
14,919

 
15,900

 
(981
)
 
(6.2
)%
 
17.1
%
 
16.9
%
Amortization of intangible assets
1,734

 
1,735

 
(1
)
 
(0.1
)%
 
2.0
%
 
1.8
%
Goodwill impairment
2,580

 

 
2,580

 
100.0
 %
 
3.0
%
 
%
Total operating expenses
$
25,894

 
$
25,523

 
$
371

 
1.5
 %
 
29.6
%
 
27.1
%
Marketing and sales expenses decreased $1.2 million , or 15.6% , compared to the prior year period, primarily due to lower variable compensation of $0.9 million, as a result of lower sales, as well as lower headcount and professional marketing costs of $0.4 million associated with changes made in leadership, operational, and sales approach to address lower provisional sales utilization in Mobile Healthcare.
General and administrative expenses decreased $1.0 million , or 6.2% , compared to the prior year period. The decrease was primarily due to $1.7 million of legal and professional fees incurred in the prior year period related to the acquisition and integration of DMS Health, lower variable compensation of $0.4 million, and lower bad debt expense of $0.4 million due to improved collections; partially offset by a $1.3 million litigation charge recorded during the period relating to a tentative settlement of a wage and hour lawsuit. See Note 8 to the unaudited condensed consolidated financial statements for further information.
Due to the termination of the Philips agreement, we anticipate a reduction of approximately $2.5 million to overall marketing, sales, general and administrative expenses annually related to a reduction in our sales force subsequent to December 31, 2017, excluding any potential one time severance costs associated with elimination of these roles.
Goodwill non-cash impairment charges of $2.6 million were recognized during the nine months ended September 30, 2017 related to our MDSS reporting unit. See Note 5 to the unaudited condensed consolidated financial statements for further information.
Total Other Expense
Total other expense is summarized as follows:
 
Nine Months Ended September 30,
  (in thousands)
2017
 
2016
Other expense, net
$
(237
)
 
$
(414
)
Interest expense, net
(842
)
 
(1,092
)
Loss on extinguishment of debt
$
(709
)
 
$

Total other expense
$
(1,788
)
 
$
(1,506
)
Other expense, net for the nine months ended September 30, 2017 and 2016 consisted of impairment losses recognized on our equity investments deemed to be other-than-temporarily impaired. See Note 6 to the unaudited condensed consolidated financial statements for further information.