Star Equity Holdings, Inc.

Greetings, ladies and gentlemen, and welcome to Star Equity Holdings Inc. fourth quarter and year-end 2021 results conference call. Please be advised that discussions on today's call may include forward-looking statements. Such forward-looking statements involve certain risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. Please refer to Star Equity's most recent 10-K report and 10Q filings for a more complete description of risk factors that could affect these projections and assumptions. The company assumes no obligation to update forward-looking statements as a result of new information, future events, or otherwise. Please also note that on-the-call management may refer to non-GAAP financial measures, including adjusted EBITDA, adjusted net income, adjusted earnings per share, which are all financial measures not recognized under U.S. GAAP. As required by SEC rules and regulations, these non-GAAP financial measures are reconciled to their most comparable GAAP financial measures in our earnings release issued this morning. If you did not receive a copy of the earnings release and would like one, please contact Star Equity at 203-489-5900 or its investor relation representative, Lena Katt, of the Equity Group at 212-836-9611. Also, this call is being broadcast live over the Internet and may be accessed at Star Equity's website via www.starequity.com. Shortly after the call, a replay will also be available on the company's website. It is now my pleasure to introduce Lena. Jeff Everwine, Chief Executive Chairman of Star Equity.

Thank you, Operator. Good morning, and thank you all for joining us today for our fourth quarter and year-end 2021 results conference call. On the call with me today are Chief Financial Officer David Noble, Chief Operating Officer Rick Coleman, and Matt Mulchen, CEO of Digirad Health. In the fourth quarter of 2021, our healthcare division continued to rebound to more normal levels with revenue increasing 16.9% versus the prior year quarter. Our construction division grew revenue by 42.3% due to higher output and pricing increases we implemented throughout the year to mitigate the impact of higher raw materials costs. Gross margin at our construction division also rebounded strongly in the fourth quarter due to increased pricing, improved operation, and commodity price risk mitigation. Our construction division gross margins improved significantly off the bottom in 2021, and we made progress toward our goal of gross margins exceeding 20% for this division. With the completion of our January 2022 equity offering for gross proceeds of $14.3 million, we're now well-positioned to fund high-return internal growth investments and pursue acquisitions, which could be either bolt-ons for our healthcare or construction divisions or entry into a new business sector. With that, I'll turn it over to our healthcare CEO, Matt Mulchin. Matt, please go ahead.

Thanks, Jeff. Revenue from our healthcare division in Q4 2021 increased by 16.9% to 15.6 million over the same period in the prior year. This was mainly driven by stronger diagnostic imaging camera sales. Gross profit for Q4 2021 reporting period increased by 22.3% and gross profit margin increased by 4.6% over the same period last year due to an increase in the number and a favorable product mix of cameras sold in the quarter. In diagnostic services, revenue and gross margin percentage for the fourth quarter of 2021 was 10.7 million and 13.5%, compared to 10.6 million and 16.3% in last year's fourth quarter. The relative gross margin percentage decrease was primarily due to a sharp decrease of customer, patient, and employee availability due to the COVID Omicron variant. This led to lower volumes and lower gross profit and gross margin. In our diagnostic imaging business, revenue and gross margin percentage for the fourth quarter of 2021 was 4.9 million and 35.9 percent, respectively, compared to 2.7 million and 32.7 percent, respectively, in the prior year fourth quarter. As mentioned earlier, the relative increase in diagnostic imaging revenue and gross margin was due to a higher number of cameras sold and a favorable product mix. Now I will turn the call over to Dave Noble, our CFO, who will provide additional financial highlights for the fourth quarter. Dave, please go ahead.

Thank you, Matt, and good morning. Let me first touch on the construction division. Fourth quarter 2021 construction revenue and gross margin were 14 million and 27% respectively. This compares to 9.8 million and 13.7% in the fourth quarter of 2020. The strong revenue growth year over year in construction is attributed with to both increased pricing and increased business activity in residential and commercial projects at each KBS and Edge Builder. The increase in gross margin percentage was due to the positive impact of our price increases and better risk management around commodity price volatility. In the fourth quarter, $1.1 million of the construction division gross profit was attributable to unrealized gains on Edge Builder's open derivative contracts, which are used to help protect our margins on certain long lead time commercial projects. Unrealized gains generally suggest an increase in lumber prices between the signing of a commercial contract or contracts and the purchase of the raw materials required, while unrealized losses generally suggest a decrease in lumber prices between the signing of a commercial contract or contracts and the purchase of the raw materials required. Turning to Star Equity Holdings on a consolidated basis, SG&A increased by 21.2% in Q4 2021 versus Q4 2020. This was due in part to headcount increases at corporate, as well as both an increase in headcount and sales commissions in the construction segment, which were needed to support the growth of those businesses. In addition, we took a non-cash charge to operating expenses of $1.3 million to write off cloud-based software implementation costs, and a $3.4 million charge for goodwill impairment at our KBS reporting unit. Moving on to bottom line results for Star Equity for the fourth quarter of 2021, We had a net loss from continuing operations of 4.4 million compared to a net loss from continuing operations of 0.5 million in the fourth quarter of 2020. Non-GAAP adjusted net income from continuing operations in the fourth quarter of 2021, which excludes the two write-offs I mentioned, was a positive 0.3 million. This compares to an adjusted debt loss of 1.6 million in the fourth quarter of 2020. Non-gap adjusted EBITDA increased to a positive $1 million for the fourth quarter of 2021, compared to a negative $0.7 million in the fourth quarter of 2020. This improvement was due to both an increase in demand for high-margin cameras in our healthcare business, as well as a strong turnaround at the bottom line in our edge builder business unit on the construction side. For the fourth quarter of 2021, we registered an operating cash inflow of $1.4 million. compared to an operating cash inflow of $3.1 million in the fourth quarter of 2020. As of December 31st, 2021, the outstanding balance in our credit facilities was $12.9 million. Our overall net debt position, including $4.5 million of cash and cash equivalents, was $8.3 million. Now I'd like to turn the call back to the operator for any questions.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove the question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Theodore O'Neill with Litchfield Hills Research. Please proceed.

Thanks very much. First question I have is that given the spike in diesel costs, can you give us any color on direct or indirect cost impacts? And I ask this because I did call a couple of local lumber yards here before the call, and they're not applying any surcharges yet, but it sounded like they might in the future.

Yeah, well, I mean, the two construction businesses, one is KBS where we do the modular homes. that's a pass through the transport for those homes. So, you know, you might imagine it could affect demand, although we have not seen any sign of that in terms of, you know, raising the overall price. But we pass those costs directly through to the customer. We do do some in-house transport on the edge builder side, but, you know, I don't think it's a super significant, you know, increase so far in terms of, you know, affecting that business. I mean, we'll We'll look into it and keep up on it, but I don't think it's a major concern at this point.

Okay. On the software write-off, the software implementation write-off of $1.3 million, what was that for, and what was it supposed to do that it's not doing anymore?

Yeah. We were looking to conform all of our ERP systems to one system, a cloud-based system, but over the two- or three-year process that we were attempting to implement the system, we realized it just didn't fit the needs perfectly well at each of the independent companies. So what we've done is we've kind of pivoted to upgrading the ERP systems at each of the operating entities to a system that makes the most sense for those entities.

Okay. And my last question is that your SG&A costs fell as a percent of sales, and I was wondering if we can expect that to continue.

Yeah, I mean, you know, we're always looking at ways to cut out unnecessary costs. We do think there's a lot of operating leverage in our businesses in general. So we would hope that that happens. I mean, I don't see that we're going to cut SG&A on an absolute level, but we would hope as a percentage of sales that it does fall over time. Thank you very much.

As a reminder, to star one on your telephone keypad if you would like to ask a question. Our next question is from Tate Sullivan with Maxim Group. Please proceed.

Thank you, David. Starting with you, if I may, on the hedge for Edge Builder. Are you using hedges for KBS or have you always used them for Edge Builder? Can you talk about the dynamic between the two?

We had used them in Edge Builder in the past. And we had paused that program for a while, but we've kind of brought it back. And these are really simple hedges thus far. They're typically futures hedges, sometimes options, but they really are matched exactly to specific contracts. So you can imagine if we sign a contract that's not going online for three or four or five months, there's a lot of time in between that guaranteed pricing. And so we've done a number of things in our contracts. One option is that we let some of the materials float and the customer will pay any increase in those costs. When we acquire the materials, another option is for the lumber portion, we will do the hedging. And that's worked actually really well for us over the last nine, 10 months at Edge Builder. As far as doing it at KBS, we are contemplating that. The issue there is there's a lot more inputs and really the only hedge instrument is on lumber itself, and that's a smaller percentage of a modular home than it is of a wall panel. So it's something we're looking into, but it doesn't provide as much cover or as much, you know, margin protection as it does on the edge builder side, but it's something we're looking into.

And then in building and construction, with your comment about margins exceeding, gross profit margin exceeding 20%, So, I mean, excluding the hedge, should I look at it excluding the hedge unrealized gain in 4Q, look at it almost a sequential improvement in gross profit margin throughout the year? Could it be a little bumpy or can you just talk a little about that target for greater than 20%?

Yeah, I mean, on the commercial side of Edge Builder, remember Edge Builder's two businesses, it has the distribution business and then the commercial wall panels. You know, we're targeting sort of high teens in gross margin over the long haul. The gross margin target at the modular side is a little bit higher than that. But if you take out the hedge gains, we were just talking about it, the 27% gross margin in the fourth quarter, we're around 20 if you take out those unrealized hedge gains. And that really was mostly edge builder, to be honest. I mean, we're still getting up to scale at KBS. But we do think that we can gradually increase those gross margins. KBS, we have a target, you know, over 20%. That's more complex in a way, you know, that product. But I would expect as we scale up that gross margins will generally, you know, drift upwards.

Great. Thanks. And Matt, shifting to medical imaging and diagnostic services, and you mentioned, can you just talk about what the total margin in healthcare is? with the camera sales and the diagnostic service? I mean, in an ideal environment with sort of, well, average environment with normal traffic, foot traffic, I mean, is the margin range in this business above 20%? Or can you talk about where it could approach if both camera sales and diagnostic services rebound, please?

Yes, for a combined gross margin. Yes, we believe that. That's correct, that we should be above 20% in a normalized business without, you know, further interruptions from COVID or anything like that. So, yes, that would be the goal for the healthcare sector, above 20%.

Thank you. And in 4Q for diagnosis services, can you just review your comments there? Was it just fewer people in the hospitals? in general?

Well, yeah, fewer people, fewer patients to scan because, you know, Omicron kind of hit pretty hard when it did hit, and it also affected our employees. We didn't have employees going out to be able to perform the scans as well. So that really, especially in the December month, really hit us hard, and that had an impact. because of our fixed costs that we weren't able to overcome. But I will say, though, you know, things have turned around here in the first quarter. You know, we still had some after effects early on in the quarter, but things are getting back to our new normal, you know, here as we end the first quarter here in 2022. Thank you.

Thank you, Matt. And last for me, if I may, Jeff, since the capital raise in January and with everything the market's done since then in geopolitics, can you update on the acquisition environment? Are you seeing more opportunities, less, or does it potentially delay deals? Can you just give a general comment, please?

Yeah, no, thanks for the question, Tate. No, we are. We think we're entering a period that's better for acquisitions. We are seeing more targets. We talked in a press release in January about looking at the healthcare staffing business. That's one area. And then there's also some interesting bolt-on opportunities in the construction sector. And we have the capital to pursue those. And we're looking at several And I would just say, stay tuned on that. But we think the environment for doing acquisitions has gotten stronger and is much better than it was, say, last year.

Okay. Thank you all.

As a reminder, just star one on your telephone keypad if you would like to ask a question. We will just pause for a brief moment to pull for our final questions. There are no further questions at this time. I would like to turn the conference back over to management for closing comments.

Thank you, operator. Before concluding the call, I'd like to note that we're always available to take your calls and discuss any questions you might have, so please don't hesitate to contact us. We'll continue to share our story with existing and potential investors in the coming weeks and months. As always, we appreciate all of our stockholders and your continued feedback and support. Thank you, have a good day.

Thank you, this does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.