Greetings, ladies and gentlemen, and welcome to Star Equity Holdings Inc. Second Quarter 2022 Results Conference Call. Please be advised that the discussion 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 and 10-Q filings for a more complete discussion 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 this call management will reference non-GAAP financial measures including EBITDA, adjusted EBITDA, adjusted net income and adjusted earnings per share, which all are -- which are all financial measures not recognized under US 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 after the call, please contact Star Equity at 203-489-9500 or its Investor Relations representative Lena Cati 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 at -- 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, Rick Coleman, Chief Executive Officer of Star Equity. Thank you. You may begin..

Thank you operator. Good morning and thank you all for joining us today for our second quarter 2022 results conference call. On the call today are our Executive Chairman, Jeff Eberwein; and our Chief Financial Officer, David Noble.

On a [Technical Difficulty] and operational performance with a 19% revenue increase, as well as a significant improvement in gross margins.

On a segment basis as compared to the second quarter of 2021, our Healthcare division revenue decreased by 6.4% to $13.9 million, predominantly driven by a decrease in revenue from fewer total scanning days due to the national shortage of nuclear medicine technologists.

However, gross margin improved by 3.5 percentage points to 26.4% and gross profit for the quarter increased by 7.9% both due to a better mix of products and services sold.

Our Construction division second quarter revenue grew by 53.7% due to large commercial projects at KBS and pricing increases that we implemented to mitigate the impact of higher raw materials costs. Gross margin improved substantially due to increased pricing, improved operations and commodity price risk mitigation.

We believe this quarter's performance shows continued progress toward our construction goal of generating a gross margin over 20%.

Finally, our January equity offering strengthened our cash position, which remains strong and leaves us well-positioned to fund high-return internal growth investments and to pursue acquisitions, which could be either bolt-ons for our existing divisions or entry into a new business sector.

Now I'll turn the call over to David Noble, our CFO to highlight additional Construction division and consolidated second quarter financial results. Dave, please go ahead..

Thank you, Rick, and good morning. Let me first touch again on the performance of our Construction division as it was a major driver to the turnaround in our financial results. Q2 construction revenue was $16.8 million versus $10.9 million in Q2 of 2021 for a 53.7% year-over-year increase.

Gross margin was a positive 14.8% versus a negative 16.9% in Q2 of 2021. The modular business specifically was even higher in terms of gross margin. The increase in revenues for the Construction division was driven mainly by multifamily and commercial scale modular projects at our KBS modular business.

In Q2, our Construction segment accounted for 54.7% of Star Equity's total consolidated revenues. The increase in gross margin percentage was due to significantly increased pricing levels to offset higher input costs in both residential and commercial projects as well as much better risk management around building materials price volatility.

Our construction backlog and sales pipeline remained very strong. Let's now turn to the Star Equity consolidated results. In Q2 2022, SG&A increased by 23% versus Q2 2021.

This increase was driven primarily by onetime litigation costs and secondarily by severance expense associated with executive management change both of these related to the Digirad Health business. As a result, SG&A as a percentage of revenue increased slightly in Q2 2021 to 22.4% versus 21.6% of revenues in Q2 of 2021.

Moving on to Q2 bottom line results for Star Equity. We had a net loss from continuing operations of $1.6 million, compared to a net loss from continuing operations of $1.8 million in Q2 of 2021. Non-GAAP adjusted net income from continuing operations in Q2 was a positive $0.5 million.

This compares very favorably to the adjusted net loss of $3.7 million in Q2 of 2021. Non-GAAP adjusted EBITDA increased to a positive $1.3 million in Q2, compared to a negative $2.9 million in Q2 of 2021.

This substantial improvement in consolidated adjusted EBITDA was due to operational improvement and a bottom line turnaround in our Construction division, where segment non-GAAP adjusted EBITDA swung from a negative $2.8 million in Q2 of 2021 to a positive $1.3 million in Q2 this year.

Importantly consolidated operating cash flow for Q2 was a positive $3.6 million versus a negative $5.4 million in Q2 of 2021. As of June 30, 2022, our balance and liquidity were very strong.

The outstanding balance in our interest-bearing credit facilities was $11.6 million, while our cash balance stood at $13.7 million leaving us with an overall net debt position of negative $2.1 million. Now, I'd like to turn the call over to the operator for any questions.

Operator?.

Thank you. [Operator Instructions] Our first question comes from the line of [indiscernible] with Litchfield Hills Research. .

Yes. Thank you. First of all congratulations at these tough times. You guys are putting up tremendous results. My first question is you have been making steady improvements in construction gross margins.

What is the upper limit for construction margins? Do you have a specific target?.

I don't think that -- I'm sorry. This is Rick. I don't think that we've identified an upper limit rather we've really taken a top-down approach to reengineering that business. This started over a year ago and is continuing today under new leadership that we brought in at the beginning of the first quarter or the beginning of the second quarter, sorry.

And what that means is, examining the business from contracts, to materials, to tools and processes that we're using. So we're making steady improvement. We feel like we've got the right team in place today and they're taking all the right steps to move the business forward.

Dave, I don't know if you want to add to that, but I feel like I don't think we want to set an upper limit. We just want to continue making steady improvement..

Yeah. I think that's right, Rick. I mean we used to look at 20% as sort of a benchmark number. We like to see something well into the 20s even mid-20s. But as Rick said, there's no real upper limit to that. I wouldn't -- I would suggest that there are certain projects we do that are over 30% gross margin.

Some of the more complex work, especially in the passive sort of energy-efficient space. But we're definitely driving to push gross margins up and we've been very successful. Our ASPs are double what they were just a year or so ago.

Obviously, there's some increase in material prices over the last couple of years, although they've been coming down for much of this year. So I wouldn't set an upper target, but projects in the mid-20s are good projects and some of them are higher..

Okay. Great. And my second question is in your prepared remarks you noted a shortage of nuclear medicine technologists for the reason for a decrease in health care revenue.

Is the shortage in this specialty different from the shortfalls in other areas of health care personnel? And if so what are the dynamics there?.

I think, there are some common elements across the health care industry. But with regard to nuclear medicine techs, specifically during COVID a lot of colleges that offered nuclear medicine technology program, really didn't – weren't able to get the students on-site to get the necessary clinical hours to fully graduate.

And of course, during that same time older nuclear medicine techs in the market were moving on to other positions, or retiring. That's what created the shortage of technicians just affecting us.

But we feel like now that the pandemic is mostly behind us, we're starting to see some improvement in the availability of technicians and think that things will mostly self-correct in the next 12 months to 18 months. .

Great. Thank you..

Our next question comes from the line of Tate Sullivan with Maxim Group. Please proceed with your question..

Thank you. Good morning.

Rick following up on the nuclear medicine technicians were the margins higher for health care in the quarter, because more camera sales, or does it imply that the nuclear medicine technician business is lower margin, please?.

No. The margins were higher mainly due to a product mix. We've got – in addition to the scanning work that we that our technicians do. We also of course are selling cameras. And we've got a range of cameras that we sell some of them new, some of them are refurbished.

And so depending on the mix of cameras that, come through the pipeline in a quarter can affect the margin significantly..

Okay. Thank you.

And then with – on modular construction is the modular construction trends in New England that you're seeing stronger than other areas in the US for modular construction, or are there special considerations in New England for demand for your modular construction business, please?.

Dave, you've done some work on that.

Do you want to comment on that one?.

Yeah. I don't know that, it's any different. I mean, on the modular side, it is a secular trend that modular is taking up a higher share of housing starts, both single-family and multifamily. So I don't know that, New England is different in that way.

I do know that, we have a relatively strong position, especially in the multifamily commercial scale modulars. We are based in New England. There's nobody else really in New England that provides the same product.

We do have some competition from Canada and Pennsylvania, but we're able to service those projects a lot better given our proximity to those projects, which tend to be in the Boston area or down on the Cape and island. So I think, obviously, everybody is wondering about interest rates rising and housing starts coming off a bit.

We feel within that we have some secular trends that are in our favor such as, like I said, the take up of modular as a percentage of housing starts. And also, our business is diversified.

We do single-family residential, both second homes and starter homes, but we really have pushed aggressively into the multifamily space and there is a big housing storage. And you can read in the papers every day that, governments are getting involved in encouraging multifamily housing, and that rentals are very strong right now.

So we think we've got some very positive factors given our location and our expertise..

And then, David you mentioned the Nantucket affordable housing project, earlier and then with the energy efficiency element to it.

Is that – will that help you win future projects in affordable housing with that, or can you talk about energy efficiency and modular construction? And how it might be – is it better than on-site construction in terms of integrating energy efficiency work complete?.

Yeah. I mean, you can do an energy-efficient whether you're building on site or building in a factory, but I would suggest that the quality is better when you do it in a factory, it's a controlled environment.

Not every public housing project or every municipal driven projects going to have an energy efficient element necessarily, but those are two themes, right? Servicing workplace and affordable housing and servicing projects that have energy efficiency element to them.

Often those are the same project, but those are both very important themes to be able to do that type of work, I think, is a real strength of our business..

And I would say, Dave, with each -- those are very distinct pipelines for our business. We're obviously mining those opportunities and more of them present themselves as we develop a reputation for being able to deliver..

Okay. Thank you and a couple more on the financials if I may. David, I mean, $3.6 million in cash flow from operations in the quarter, a great number. But then just backing into it, it looks like CapEx did increase.

Can you remind us what the CapEx requirements are? And is it mostly for KBS in the next couple of quarters as well?.

I don't have that number at my fingertips, but I mean the group as a whole, we spend about $1 million -- around $1 million a year, I believe in cash CapEx. We do add leases here and there on the health care business particularly, but CapEx is not a major component. We are a relatively capital-light business across the whole.

So that's not a huge factor..

Okay.

And last the preferred I think you recategorized the preferred into equity is that just going to go over the accounting treatment for that? And if that was a change from 1Q to 2Q please?.

Yes. There was a provision in that preferred that in a change of control the owners of the preferred could elect to have that redeemed and we changed that provision. We had a vote that allowed us to change that provision so that in the case of a change of control only the Board can decide whether or not to redeem that preferred.

So effectively, it's really -- it receives equity treatment based on the current form of that preferred. So we just dropped that into stockholders' equity..

Okay. All right. Thank you all. Thank you, Rick and thank you, David..

Thank you..

[Operator Instructions] Our next question comes from the line of Adam Waldo with Lismore Partners. Please proceed with your question..

Hi. Good day, Rick and Dave. Thanks very much for taking my questions.

I wonder -- if you can hear me okay?.

Yes we can. .

Okay.

So, can you speak to the new business pipeline on both principal division side? And can you give us some quantification as to what the new business pipeline and backlog look like at the end of the quarter?.

Sure which businesses particularly?.

Well, I'm particularly interested in the construction business, but to the extent that you're able to provide any directional quantification on the health care business side as well that would be helpful..

Sure. I'll take on the construction side of things. So we have really two companies in that Construction division. And the first one is the modular business in Maine called KBS. They have a very strong pipeline. I think it's in the sort of $50 million-ish range of identified opportunities.

As I mentioned before, they have single-family homes both energy-efficient regular homes, starter homes as well as, second homes and then we have the commercial scale we call it multifamily business. Both of those pipelines remain very strong. In fact, our production schedule is booking into early next year.

So we're full up for the rest of the year in terms of production and at very high ASPs like we've been experiencing all year. So that business remains very robust. Obviously, we look for signs of slowdown with the interest rates coming up and such, but so far that business has really held in there. I think there was a real shortage of capacity.

So it will take quite a while for that to turn around even if things slow down a bit. On the other side in Minneapolis on the Edge Builder business that's both sort of a retail lumberyard or professionally focused lumberyard as well as wall panel business. Both of those businesses remain strong.

On the wall panel side, we had a few projects that got delayed into the third quarter that we were hoping would be done in the second quarter, but our pipeline there remains as strong as it's ever been, as multi-family housing continues to be a very strong segment in the upper Midwest and that's the market that we serve with wall panels.

So we're cautiously optimistic. Those businesses remain very, very strong at this point in time..

Oh, sorry..

I’m sorry. Go ahead..

No, I’m sorry..

I was just going to say the same is true for our Healthcare business. We have a strong pipeline, carrying us forward at least through the remainder of the year.

The healthcare business is a bit different, because it's typically a doctor's office considering purchasing $0.25 million camera and a change in their operating methodology to allow us to do scanning on their behalf is a big decision.

But our pipeline of opportunities is strong and the same is true in terms of our existing scanning customers who have perhaps deferred some business and slowed down a bit during COVID are now ramping up and that is continuing..

So given the positive commentary around new business pipeline backlog in both divisions, are you comfortable that you have good visibility out through the end of the year into being able to post similar revenues for each division or perhaps even somewhat better than you posted during the second quarter?.

We're not going to forecast the revenues, but I would say that we do feel very comfortable with the health of the business and the backlog for the remainder of the year. .

Very helpful. Thank you. And then with respect to margin structures.

Obviously you've done a lot of things on the pricing side somewhat on the hedging side in the construction business, do you feel reasonably -- what time line do you think is reasonable for trying to meet or exceed your intermediate-term target for 20% plus gross margin on the consolidated construction businesses?.

Yeah. I mean, I'm not sure how much we can say on that. What I would say is we are there on the KBS side already. There's a little lumpiness in the other business, but I mean we're essentially there. We're pricing projects at our target gross margin, right? So we don't have any lower margin projects that are still in the pipeline.

As I mentioned, our year-over-year results are dramatically different. We had some projects last year that we got caught when commodity prices ramped up quickly and they were sub-par gross margin projects but we don't have any of that work to be completed. So everything going forward, we are pricing at our target gross margin level.

And everything -- sorry -- I was going to say everything in the current production pipeline everything that's currently on the line is at our target gross margin level..

Terrific. And so finally you've, obviously, had litigation expenses in the first half of the year that you continue to classify as onetime in nature.

How long a tail do you expect on those litigation expense as the most blow down should they be continuing through the end of the year? How do we think about that impacting the free cash flow profile of the business for the second half of the year?.

Yeah, that's -- we have that same question. We have one case. It's been quite expensive over the last couple of years that we're literally on the tail end of waiting for a judge's determination. So it's very difficult to forecast that one. But we're hopeful we'll be over soon..

Okay. That's fair. Thank you.

So it sounds like net-net that we should be seeing free cash flow -- operating and free cash flow in the second half of the year in each quarter that was similar to or possibly even a little better than what you posted in the second quarter based on everything you know now, is that a reasonable guesstimate on my part?.

Certainly our hope as well..

Terrific. Thanks very much..

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks..

Thank you operator. Before concluding, I'd like to note that we're always available to take your call. Please don't hesitate to contact us to discuss any additional questions you might have. And 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 shareholders and your continued feedback and support. Thank you. .

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day..