Star Equity Holdings, Inc. Q2 FY2024 Earnings Call

Greetings, ladies and gentlemen, and welcome to Star Equity Holdings' Second Quarter 2024 Results Conference Call. Please note that the discussions on today's call may include forward-looking statements, which involve risks and uncertainties that could lead to actual results differing significantly from those projected. For a thorough overview of the risk factors that could influence these projections and assumptions, please refer to Star Equity’s latest 10-K, 10-Q, and other filings. The company will not update forward-looking statements based on new information, future events, or other circumstances. Additionally, management will discuss non-GAAP financial metrics, such as EBITDA, adjusted EBITDA, adjusted net income, and adjusted earnings per share, which are not recognized under U.S. GAAP. In accordance with SEC rules, these non-GAAP measures are reconciled to the most comparable GAAP financial metrics in our earnings release issued this morning. If you did not receive a copy of the earnings release but would like one after the call, please reach out to Star Equity at 203-489-9500 or contact its Investor Relations Representative, Lena Cati at The Equity Group at 212-836-9611. This call is being broadcast live over the Internet and can be accessed on Star Equity's website at www.starequity.com. A replay will also be available on the company's website shortly after the call. Now, I am pleased to introduce Rick Coleman, Chief Executive Officer of Star Equity.

Thank you, Drew. Good morning everyone. We appreciate you joining us today for our second quarter 2024 results conference call. On the call today with me are our Executive Chairman, Jeff Eberwein, and our Chief Financial Officer, Dave Noble. I will start today by providing an overview of our recent business developments and financial highlights. Then Dave will provide additional details on our consolidated financial results. Jeff will then discuss our Enservco investment announced yesterday morning. Before turning to second quarter highlights, I want to comment on a couple of recent transactions. On May 17th, we closed the acquisition of Timber Technologies. I'm pleased to report that the integration of that business into our Building Solutions division and the acquisition of its associated real estate assets are substantially complete. Although Timber Technologies, like EdgeBuilder and KBS, is a wood-based construction company, its distribution channels and end products vary in important ways. As a result, we believe its revenue streams are less prone to interest rate fluctuations and the general market softness we're experiencing in the rest of the segment. It also generates healthy cash flow and substantially improves our overall profitability. We continue to believe this was a valuable and accretive acquisition for our shareholders, both in the near and long term. Additionally, in July, we closed two sale-leaseback transactions for our South Paris, Maine and Big Lake Minnesota facilities, totaling approximately $7.2 million in net proceeds. Simultaneously, we entered into long-term lease agreements to continue to operate those facilities. Importantly, these financings should have no impact on operations at either business. The closing of these sale leasebacks aligns with Star's commitment to strategic capital allocation and the prioritization of EBITDA generating assets. We seek to make high-grade additions to our asset portfolio and optimize the cost of capital with the goal of growing net asset value per share over the long term. Accordingly, we announced this morning a $1 million share buyback program to capitalize on what we believe is a dislocation in the market value of our common stock. Moving on to the financial and operating highlights for the second quarter of 2024. Our second quarter revenue increased 51.6% over the second quarter of 2023, while gross margin declined by 14.9%, primarily due to a one-time purchase price adjustment related to the Timber Technologies acquisition. The revenue increase was driven by the inclusion of Timber Technologies revenue beginning May 17th and the inclusion of a full quarter of revenue from our Q4 2023 acquisition of Big Lake Lumber. The decline in Building Solutions performance on an organic basis reflects the continued customer impact of credit tightening on project funding and timing. While our sales pipeline remains strong, the conversion of these opportunities to sign backlog has been slower than historical norms. However, I want to emphasize that generally, we're not seeing large project cancellations, only delays and timeline extensions. We believe our reputation as a reliable and high-quality partner in the markets we serve gives us a unique and sustainable position, which we will continue to leverage as the construction sector regains strength. Furthermore, we continue to focus on all elements of our growth strategy, including Building Solutions division expansion, acquisitions that would mark our entry into new industries, and exploring new opportunities at our Investments division. As exemplified by our acquisition and integration of Timber Technologies, identifying, evaluating, and completing accretive acquisitions remains an important pillar of our holding company strategy for delivering long-term growth and shareholder value. Now, I will turn the call over to Dave Noble, our CFO, to provide additional second quarter consolidated financial highlights.

Thank you, Rick, and good morning. Let's now turn to Star Equity's consolidated financial results. I'd like to note that due to our sale of the Healthcare business on May 4th of 2023, all results and historical comparisons relate only to continuing operations, which include Construction and Investments. Digirad Health is now reported as part of our discontinued operations and does not appear at all in our 2024 results. In Q2 2024, SG&A increased by 26.8% versus Q2 of 2023. This was largely attributable to a one-time $1.3 million impairment related to our cost method equity investment in TTG, which we acquired through a rollover equity stake as part of the Digirad sale last year. We reported this impairment after analyzing the financial performance of TTG and considering comparable company EBITDA valuation multiples. Moving on to the bottom line results for Star Equity, we reported a net loss from continuing operations of $3.8 million in Q2 of 2024 compared to a net loss from continuing operations of $1.4 million in Q2 last year. Non-GAAP adjusted net loss from continuing operations in Q2 was $0.9 million, which is roughly the same as in Q2 of 2023. Non-GAAP adjusted EBITDA for continuing operations was a loss of $0.5 million in Q2 versus a loss of $0.8 million in the same period last year. Consolidated cash flow from continuing operations for Q2 was an outflow of $4.3 million versus an inflow of $1.9 million in Q2 of 2023. The negative cash flow from operating activities is attributable to weaker operating performance as gross margins were lower than in the previous year despite higher revenues. As of June 30th, 2024, our consolidated balance sheet and liquidity reflect a considerable cash outlay associated with our acquisition of Timber Technologies and its related real estate. At the end of our second quarter, our consolidated unrestricted cash balance stood at $2.5 million as compared to $21.4 million a year ago. As Rick mentioned, in July, we closed two sale leaseback transactions, which added approximately $7.2 million in cash to our balance sheet. Turning to our Investments divisions, our holdings in public securities at the end of the quarter amounted to $3.8 million versus $4.8 million a year ago. Our private common equity investment and note receivable from the sale of Digirad to TTG were valued at $4.7 million and $7.8 million, respectively.

Thank you, Dave. We were excited to announce yesterday our investment in Enservco. This investment advances Star's expansion strategy by further diversifying our portfolio beyond Building Solutions, marking our initial entry into the energy services and transportation and logistics sectors. We believe the strength of Enservco's management team and its ongoing reorganization position it well for long-term growth. We look forward to participating in Enservco's future success and believe this investment will be highly accretive to our shareholders. Creating value in microcap companies undergoing change has been a core tenet of Star's public holding company strategy since inception, and we're excited to partner with Enservco on this investment to further validate this strategy. I'll now turn the call over to the operator for questions.

We will now begin the question-and-answer session. The first question comes from Tate Sullivan with Maxim Group. Please go ahead.

Thank you. Good morning all. Jeff, starting with Enservco, can you talk about the benefits of how you structured the acquisition of the share interest versus buying the entire company?

Yes, we believe our common stock is significantly undervalued, which is why we announced the $1 million stock repurchase program. We had a productive discussion about how to assist in closing the deal related to the acquisition of Buckshot while also enhancing shareholder equity. We decided to take an initial stake of about 20% in the company in exchange for preferred stock, which gives us a common equity interest and a Board seat. This allows us to monitor the transition. At this time, we are keeping all options open and strongly believe this approach provides us an opportunity to observe, assist, and learn about these two sectors.

Great. Thank you. Dave, will you mark-to-market the share interest in Enservco going forward? It will be part of the investments division. How will the accounting treatment be handled?

Yes, it will be in the Investments division. There are two aspects to this, and we are still determining the accounting for a loan provided to support the acquisition of Buckshot. However, it will not be consolidated since we do not have control over the entity. Therefore, it will be treated as a mark-to-market position.

But we do show the numbers as well. So, any unrealized gains or losses we have on equity securities or lumber derivatives that we use to hedge, we back those out of adjusted EBITDA, so investors can look at it. We give them the data to look at it both ways.

Okay. Thank you.

The next question comes from Theodore O'Neill with Litchfield Hills Research. Please go ahead.

Okay. Thanks very much. First question I have is about gross profit. In the prepared statement here, it says it's impacted by the Timber Tech acquisition? And then further on, it says the impact was $574,000, is that the entire amount that impacted cost of goods in the quarter?

Yes, the $574,000 is purely due to a valuation that we were required to do for Timber Tech and allocate that purchase price. So, that relates to Timber Tech; that's a one-time write-up of the finished goods inventory and we have to write that up to what we could sell it for. So, because we purchased that company and that finished goods existed, we had to write that up as part of that. So, it's really an accounting adjustment. It's a one-time thing. It's not going to reappear in future quarters. Additionally, we did suffer some decrease in gross margins in our legacy business, which was impacted by current market conditions.

Okay. And I'm just curious, this is purely an accounting issue, but the $1.3 million related to the cost method investment in TTG that impacted SG&A in the quarter, why isn't that just in other income? Why is that in SG&A?

It's just U.S. GAAP. I asked the same question of our accounting team and U.S. GAAP is what it is. I agree logically, you think it'd be in other income, not SG&A, but the GAAP requirements don't care about my logic.

And unfortunately, GAAP is one way as well. So, we took an impairment on that company and expect it will recover over time and produce more EBITDA. We're not allowed to write it back up until at some point we sell it.

And Theo, what we do on that is we just follow whatever the private equity firm does. We're not doing anything higher, lower, or different. They do an analysis every quarter, and if they write it down, we write it down.

We did diligence on that calculation and we deem it reasonable.

Regarding the overall business outlook, I understand there's mention in the press release about some matters being pushed to the second half. Are you confident as we move into that period, or do you anticipate that more issues will be carried into the first half of next year? What is the current situation out there?

Rick, why don't you take that one?

Sure. We're seeing visibility to the future is getting a little bit hazy in this environment as things are slipping to the right, if you will. But we feel like in the second half, we're going to see some improvement. We just don't have the ability to say how much. This is based primarily on the feedback that our customers are giving us about their ability to fund their construction projects and to acquire financing where that's required.

Okay. Thanks very much.

Go ahead, sorry.

Yes, this is Jeff. I want to mention that if there is any positive aspect, we're not witnessing project cancellations. It's primarily that construction is commencing later than initially planned, often due to delays in securing financing. There have also been some permitting and weather-related delays. Consequently, there's a general lack of urgency, and for those wanting to proceed quickly but reliant on financing, it’s taking longer to secure that financing than it did two years ago. However, the good news is that we're not seeing any projects get canceled; they're just being postponed.

That concludes today's question-and-answer session. I will now turn the call over to Rick Coleman for closing remarks.

Thanks, Drew. Thanks for your time today everyone. We appreciate your interest and your continued feedback and support. So, don't hesitate to contact us anytime. We're excited about the steps we're taking on your behalf and we look forward to updating you as our story develops.

Thank you for joining the Star Equity Holdings' second-quarter conference call. Today's call has been recorded and will be available on the Investor section of our www.starequity.com. Thank you. You may now disconnect your line.