DIRTT Environmental Solutions Ltd. (DRTT) Q3 2020 Earnings Call Transcript

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DIRTT Environmental Solutions Ltd. (NASDAQ:DRTT)
Q3 2020 Earnings Call
Nov 5, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to DIRTT 2020 Third Quarter Financial Results Conference Call. [Operator Instructions]

I would now like to hand the conference over to your host, Ms. MacEachern, Director of Investor Relations. Ma’am, the floor is yours.

Kim MacEachernInvestor Relations

Thank you, operator. Good morning, everyone, and welcome to today’s call to discuss Third Quarter 2020 Results. Joining me on the call are DIRTT’s Chief Executive Officer, Kevin O’Meara, Financial Officer, Geoff Krause. Management’s prepared remarks today are companied by presentation slides. To access the slides, please, see them from the web page of this webcast or go to the Investors section of DIRTT’s website. The earnings press release that was issued yesterday afternoon can also be found on our website. Today’s call will include forward-looking statements within the meaning of applicable Canadian and United States securities law. These statements are based on the company’s current intent, expectations and projections, they are not guarantees of future performance. In addition, this call will include references to not all, excluding special items, please reference our Form 10-Q as filed on November 4, 2020, with the Securities and Exchange Commission, or SEC, and other reports and filings with the SEC for information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results. I will also remind you that this webcast is being recorded, and a replay will be available today at approximately 1:00 p.m. Eastern Time.

I now would like to turn the call over to Kevin.

Kevin O’MearaChief Executive Officer

Thank you, Kim, and thank you, everyone joining us today. Starting on slide four. It is a challenging time in commercial construction as the industry works to adjust to the ongoing impacts of the COVID-19 pandemic, and we continue to see volatility around the timing of projects in our pipeline. Regardless, our $46.2 million of revenue in the third quarter was slightly higher than both the first and second quarters of the year. We delivered modest positive adjusted EBITDA, driven by adjusted gross profit that benefited from our decision earlier this year to rightsize our factory labor. Our $51 million cash balance at quarter end was higher than at the end of both the first and second quarters of the year. Healthcare represented 36% of total product and transportation revenue this quarter as we delivered three large healthcare projects. As a reminder, we defined a large project is a sales-generating over $2 million to any one end user. One of the projects was with existing strategic account and the second was for the delivery of acute care rooms for using a prefabricated temporary hospital, an opportunity arising from the current pandemic and our healthcare rapid response initiative in the spring. Further demonstrating our capabilities to innovate execute rapidly on COVID-19 grow projects, we recently developed four freestanding kiosks for COVID-19 testing and vaccinations. We are currently marketing these healthcare organizations, retailers, educational institutions and large employers. These stand-alone structures called constructive clinical enclosures. We’re developing a partnership with a leading healthcare innovation company and facilitate direct contact with physical separation between healthcare professionals and patients during examinations and treatments. They’re available in 14 days of order, if assembled on site. While we’re seeing opportunities in healthcare, we remain cautious on our short-term outlook.

The contraction in commercial construction is having a prolonged negative impact on demand, with more and more projects being delayed or reconsidered. We continue to believe the long-term impacts of the pandemic have the potential to be positive for our business by accelerating the shift to prefabricated construction, but we yet to see a significant increase in such projects. We have also yet to see meaningful orders from our modeling projects in preparation for people to reoccupy their spaces. October average daily order activity was consistent with the first three quarters of the year. However, in the absence of significant traction on our short lead-time projects, we’re anticipating lower volume as we move into the final two months of 2020 and early 2021. Despite these challenges, we remain focused on financial management and moving forward with the key elements of our strategic plan and our goal to effectively drive market share growth. Turning to slide five. It has now been one year since we presented our strategic client investors, and I think it’s appropriate today to reflect on the progress we’ve made this year in addition to reporting on this quarter’s accomplishments. We believe the initiatives we’ve undertaken, particularly in sales and marketing were necessary to realize the full potential for a unique business model and thereby achieving sustainable profitable growth and resulting stakeholder value. As we previously discussed, we’ve adjusted the implementation of our strategic plan to reduce the cost in light of the uncertainty of the COVID-19 pandemic, while capturing all of the intended benefits. Starting with commercial execution. In the last 12 months, we’ve hired 36 new people into the commercial organization compared to the over 50 contemplated by our pre-pandemic strategic plan. We have attracted professionals with proven track records who made immediate impact on our organization. We’ve structured the commercial team into five areas, specifically marketing, sales, client experience, partner success and commercial operations with individuals in place to lead each area. Reviewing these five areas in turn, first, it was impaired that we created a strategic marketing function.

Dedicated resources deployed to increase brand awareness, supported by clear value proposition, a consistent DIRTT story and lead generation programs specific return in key customer segments are critical to supporting a successful sales function. We hired a Vice President of Strategic Marketing, added six people to the team, and in July, launched our first-ever strategic marketing campaign called Make Space For Possibility. Initial responses exceeded our expectations, allowing us to refine a targeted audience for reengagement, and we can continue to nurture both digitally and through our sales team. For the first time in DIRTT’s history, lead generation from a strategic marketing campaign and the website are being tracked through a CRM system and vented by redevelopment team for followed by our sales force and distribution partners. The next phase of the campaign will include a thought leadership piece, featuring influential industry leaders, including our new Board member, Michael Ford, who has real estate and security globally for Microsoft. This piece will explore the future of space its impact on people and how that influences the decisions businesses make about their in carriers. We believe that how the network of advocates of prefabricated construction we have assembled builds on our brand imminence and puts us at the forefront of industry thinking. Through our strategic marketing function, we’ve also identified influencers in the construction process that had been historically over proprietary. We’re developing communication strategies and tools to increase our engaging regeneral contractors, architects and designers, all important decision-makers who should be hearing our story directly and consistently.

Turning next to sales. In addition to adding regional directors to manage and develop the core sales team, we identify strategic accounts as an important source of future growth. I’m pleased to say that the number of conversations under way with potential clients as well as existing clients who are candidates to be served as strategic accounts is higher now than ever. We have also made great strides structurally in equipping the organization to win this highly competitive business. We hired a Director of Strategic. Director strategic accounts and enterprise sales with over 30 years of experience and have added three people to his team. They’ve generated a qualified list of end users, and they’re actively carving. Turning to slide six. In the face of COVID-19 travel restrictions, our enhanced client experience team demonstrated our commitment to innovation across every aspect of our business. Creating a virtual client tour of that, we believe, maintains the effectiveness of the many in-person tours we hosted pre pandemic. There are also broadened that virtual approach to include comprehensive employee and partner onboarding programs. I expect these tools, while created out of adversity to become standard offerings for DIRTT. Our distribution partner network is critical to our success, and we’ve invested heavily to improve support and engagement. In addition to our lead generation activities, we now have seven people dedicated to our partner success team. Our partner portal will launch following the second phase of our CRM system rollout. We are designing a program to ensure we support and reward all partners for continued growth in their DIRTT business. We’ve held five of our existing partners expanding in new territories and are onboarding eight new partners this year. Finally, we established a vendor financing program in partnership with a major North American financial institution to make financing easier and more straightforward for our distribution partners and clients without DIRTT incurring any credit exposure. In commercial operations, we have strengthened our internal analytical and forecasting capabilities and are developing tools to equip our sales teams and distribution partners to more effectively execute.

As part of the second phase of our CRM system implementation, we plan to fully integrate companywide lead tracking capabilities to maximize our sales effectiveness. While this is a basic building block of the sales organization, it is a new capability for DIRTT. We developed our total cost of ownership tool, which empowers our sales force to concisely communicate the DIRTT cost on day one and over time compared to conventional construction and addresses a key challenge in our sales process. And lastly, we’re in the process of migrating from 2,700 pieces of sales collateral to a curated set of 30 types of tools to support our core offering and market segments. Turning to manufacturing operations on slide seven. I am very pleased to report that the third quarter represented our first recordable incident-free quarter. Implementing a rigorous safety culture has been a top priority and are immensely proud of everyone who worked so diligently to make DIRTT a safe place to work. The ongoing work of our operations team to improve our factories to help mitigate pressure on our gross margins this quarter despite negative fixed cost leverage compared to the third quarter of 2019. Over the past 12 months, we appointed leaders in both safety and quality, establish an operational team, implement a variety of lean manufacturing tools and have made step-change improvements across all aspects of our operations. In addition to safety, we have made sustainable process improvements, a balanced capacity and demand and driven cost reductions from enhanced material and labor efficiencies. We’re moving forward with our New South Carolina tile plant, which with a significant increase in automation, should deliver even greater improvements in labor material efficiency. Turning to innovation on slide eight. Our product development team has been integral in developing COVID-19-related solutions on exceptionally tight time frames and enter into the immense uncertainty of the pandemic.

Our inspire and reflect all offerings were brought to market under a newly formalized new product introduction process that include sales, training and supporting marketing materials. I would also like to highlight the tremendous accomplishments of our ice team who in October, introduced our most significant software release to date, offering enhanced virtual reality and broader testability through Android and Windows platforms. All of the changes I just articulated would be a major accomplishment in a normal environment, much less during a once a century global pandemic and enormous personal, financial and operational uncertainty in broad. The reason we’ve been able to do this comes down to one word, people. When I joined DIRTT just over two years ago, I quickly realized I had the honor to be working with the best, most passion group of people I’ve ever worked with over my entire 30-plus year business career. We’ve been able to augment this fabulous group with equally talented, passionate people who quickly saw our incredible business model and appreciate our unique company. I look forward to aggressively attacking the opportunities and challenges ahead of us with this amazing group of people.

I’d now like to turn the call over to Geofff to review the financials.

Geoffrey KrauseChief Financial Officer

Thank you, Kevin. Before turning to the quarterly results, I’d like to quickly go over some points from a liquidity standpoint on slide nine. As we have discussed in the previous two quarters, early in 2020, we undertook a fulsome review of our credit facilities. During the third quarter, our RBC credit facility remained undrawn with approximately $11.6 million of availability subject to a covenant holiday which allows us to draw on the facility to the end of the fourth quarter. We have signed an indicative term sheet to convert this existing cash flow based facility to an asset-backed loan facility with completion of definitive documentation expected in the fourth quarter. In the third quarter, we drew $3.5 million of our previously disclosed U.S. equipment leasing facility to find equipment purchases for the South Carolina plant, with further draws expected upon receipt of the remaining pieces of major equipment, likely in early 2021. In the third quarter, we qualified for an additional $4.5 million of Canadian emergency wage subsidies from the Canadian government on top of the $4.3 million recognized in the second quarter. Of these $8.8 million of subsidies, we have already received $6.1 million and expect to receive an additional $2.7 million in the fourth quarter. In the September 2020 internal speech, the Canadian minority government announced its intentions to extend this program to the summer of 2021, but no legislation has been passed to date. We intend to continue applying for such steps, if applicable. Our working capital management focus also continued in the third quarter with no reportable disruptions or delays in accounts receivable collections and with days sales outstanding, net of deposits continuing to run at under 30 days. As a result, we’ve finished the third quarter with cash balances of $50.7 million, an increase from the $44.6 million at June 30. Our net working capital at September 30 was $56.7 million compared to $52.2 million at June 30, and our current ratio remains very healthy at 2.6 times.

Now let’s turn to the third quarter results, beginning on slide 10. Revenue for the third quarter was $46.2 million, a decline of 29% from the 2019 quarter, but up marginally from both the first and second quarters. As Kevin said, the pandemic has had severe impacts on commercial construction activity levels and decision-making behavior among users. In the context of an ongoing spike in COVID-19 infections, we are finding it to be increasingly difficult to quantify the effect that this is having on customer decision-making. Project size, design and timing are all impacted. On slide 11, adjusted gross profit was 39.3% of revenue, a decline from 41.8% for the comparable period of 2019. This decrease is primarily the impact of fixed costs on lower revenue. This negative leverage, however, has been partially offset by the labor force reductions we made earlier in the year combined with continued progress to improve the efficiency and effectiveness of our manufacturing processes. During the quarter, we also reduced a warranty provision related to timber, as previously discussed by $0.5 million. Turning to the breakdown of operating expenses on slide 12. Similar to last quarter, I would specifically call out the drop in sales and marketing expense during Q3. And this decrease reflects lower commission expense on decreased revenue and continued attention to cost discipline. We also continue to record materially lower travel, meals and entertainment expense as a result of COVID-19. It is reasonable to assume that when the pandemic and associated restrictions ease, we will see an increase from current levels. General and administrative expenses similarly benefited from lower travel and entertainment as well as reduced building operating expenses, reflecting the work from home status of most of our head office employees. Looking at slide 13. Adjusted EBITDA and adjusted EBITDA margin for the quarter decreased to $0.9 million and 1.8%, respectively, compared to $7.9 million and 12%, respectively, for the 2019 period. The reduction reflects a $9.1 million decrease in adjusted gross profit and a $0.4 million of increased professional fees, partially offset by the reduced commission on lower revenue. And decreased expenses, as I already mentioned.

I would note that this quarter’s adjusted EBITDA includes the $0.5 million timber provision reversal. Like Q2, adjusted EBITDA excludes the Canadian urgency wage subsidy of $4.5 million. On slide 14, net loss for the quarter was $2.1 million or negative $0.02 per share compared to net income of $5.8 million or $0.07 per share for the third quarter of 2019. The decrease was a result of changes in gross profit and operating expenses, as I have discussed, a $0.7 million increase in foreign exchange loss and a $1.4 million increase in income tax expense, partially offset by $4.5 million in government subsidies. During the third quarter, we recorded a $3.1 million valuation allowance against our deferred income tax assets, reflecting the significant uncertainty and decline in our Canadian entity sales and profitability caused by the pandemic. Finally, let’s touch on our outlook on slide 15. As Kevin mentioned, our average daily order entry levels for October has been consistent with what we’ve seen for 2020 thus far. However, we are seeing indications of softness in our core business for the balance of the year, with such impacts yet to be offset by COVID-19 opportunities or our newly strengthened commercial capabilities. That said, we will continue to actively manage our costs in the same manner as we have in the past two quarters, and we’ll continue to execute our strategic plan. As you know, we have already deprioritized some of our sales and marketing hiring and selected less costly alternatives for some sales tools. The substantial progress within our commercial organization, the improvements within our manufacturing operations and our solid balance sheet can support operations at current levels. We continue to actively monitor the situation and remain ready to take action, should business conditions deteriorate. We also expect to begin to realize positive incomes from our strategic plan implementation.

Operator we would now like to open the call for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Your first question will come from the line of Rupert Merer from National Bank. Your line is now live. Go ahead please.

Rupert MererNational Bank — Analyst

Okay. Good morning, everyone. So you’re seeing some headwinds from COVID, but you have been investing in your sales force and your processes. I wonder, can you give us some examples of progress that you’re seeing with your improved CRM and your new sales staff and sales processes?

Kevin O’MearaChief Executive Officer

Probably the single biggest indicator is our Make Space campaign and the leads that it generated where literally, we know the exact number of leads they said through the CRM system, they were distributed to the appropriate reps bedded to make sure that they were qualified leads. That’s probably the single biggest — single easiest embodiment of what we’ve been able to accomplish because it involves a marketing campaign that has never been done before. It involves marketing, and then it translates into sales, and sales leads that then get passed to our reps to pursue.

Rupert MererNational Bank — Analyst

Are you able to quantify the benefit, maybe how much of your sales you can attribute to sort of new ways of doing business?

Kevin O’MearaChief Executive Officer

Eventually, we should be able to — unfortunately, given the long sales cycle that we operate under, it’s too early to be able to do that. But at a certain point in time, we should be able to say, OK, this lead came through Make Space. It was given to this rep and it led to the sale. We absolutely should be able to quantify that over time.

Rupert MererNational Bank — Analyst

Okay. And then similarly, with — you’ve got some new partners, new dealers, are you able to give us a sense of how much progress they are making, maybe how much of a contribution they’re making to your sales pipeline?

Kevin O’MearaChief Executive Officer

It is early days. We are doing a great job onboarding them. They also have the headwinds of the pandemic. And it can also be difficult to get traction, for instance, in a commercial market like New York, it has been largely shut down through the spring and into the summer. Our sense is, is that they will acclimate at least twice as quickly as partners historically, if not more.

Rupert MererNational Bank — Analyst

Okay. And then moving to the new plant in South Carolina. So you’re making progress there. Can you remind us what’s the schedule for bringing that online? And maybe talk to us about how you’ll integrate that plant into your operations. And in the event that activity levels are unchanged, are you going to be able to flex the other operations without driving the costs up too much in the near term?

Kevin O’MearaChief Executive Officer

So to answer your first question, we’re expecting it to come online in the first half of the year. We will balance — we’re also to point out, it is a chromacoat tile plant, meaning candid tiles, which is about 70% of our volumes. So there’s a 30% of our typical product mix that, that plant is not going to be able to address at least initially. We will look to first rationalize based on geography to reduce freight costs and then ramp up from there. And our expectation is if activity levels stay where they are currently, we will flex our existing operation. Unclear if it would be a direct one-to-one offset or how it would compare. But no, we would anticipate flexing our current facility to a certain extent to accommodate the added capacity.

Rupert MererNational Bank — Analyst

Thanks. I’ll get back in the queue.

Operator

Thank you, sir. Your next question will come from the line of Greg Palm from Craig Hallen Capital. Your line is now live. Go ahead please.

Danny EggerichsCraig Hallen Capital — Analyst

Hey guys, this is actually Danny Eggerichs on for Greg today. I guess, thanks for the color on the October trends. Is there just anything more — any color on the market pipeline over the next couple of quarters? Any certain geographic weakness or particular end markets you want to get out there?

Kevin O’MearaChief Executive Officer

I don’t know necessarily. So — I mean, I can — I’m happy to share what we’re seeing with our partners and our clients and how they’re thinking about things and how that plays out. There’s obviously a lot going on. There’s a U.S. election that hasn’t been settled. Obviously, 2020 is a year that everybody would like to forget. People are watching when treatments come in for the coronavirus when viruses get rolled out in any substance. And what we’re seeing consistently is companies trying to juggle that and pace their activities accordingly. The one thing that I will highlight that’s very different from past commercial construction downturns where typically it’s business cycle driven and so it impacts basically all sectors. As you guys, obviously, have seen, this is very bimodal. There are some sectors of the economy that are in depression. And just wouldn’t take the time to call on and there are others that actually are doing better. And so part of what we’ll be doing from a strategic marketing and a sales tactic standpoint is obviously spending time with those companies that have the financial wherewithal and where the pandemic is actually causing them to grow to spend time driving sales within rather than with anybody who’s been really adversely hurt. So it’s talent intensive for businesses and companies like that.

Danny EggerichsCraig Hallen Capital — Analyst

Yes. That makes sense. I guess moving on to these kind of COVID kiosks that you guys launched, I mean, what can you say about the market opportunity for that? And any additional color on maybe how you’re bringing these solutions to market?

Kevin O’MearaChief Executive Officer

It’s early days to really quantify. The interest level has been significant. But it’s hard to quantify what that will translate into sales. We’re marketing in several different ways. We’ve got a marketing campaign that we’ve kicked off. We’re working through our core partner network and our sales force. We are deploying our strategic account group. I am frankly helping to sell these with larger clients. And then the partner that we mentioned that help design them, they also are undergoing involved in the sales effort. So it’s basically all hands on deck working to sell these solutions.

Danny EggerichsCraig Hallen Capital — Analyst

All right. Great. And then last one for me. I guess, just curious, I know you added that drywall partner, I guess, this past summer, I’m curious if you’re going after more noncore partners like that, is that part of the strategy?

Kevin O’MearaChief Executive Officer

Potentially. We want to see how that plays out and use it as a test case. We’ve got a handful of general contractors that are distribution partners. So depending upon how that rolls out, we did well, made you more of that in the future. We just have to see.

Danny EggerichsCraig Hallen Capital — Analyst

Okay, great. That’s all from me guys, thanks.

Operator

Thank you, sir. [Operator Instructions] Your next question will come from the line of Josh Wilson from Raymond James. Your line is now live. Go ahead please.

Josh WilsonRaymond James — Analyst

Good morning, Kevin. And Jeff, thanks for taking my questions. On the large projects in healthcare, were those completely delivered in the quarter or is there still some left on those?

Kevin O’MearaChief Executive Officer

I think those were — I think largely they got completed in the quarter. We may have a little bit of punch list and follow, but they were largely completed in the quarter.

Josh WilsonRaymond James — Analyst

And what does your pipeline look like for large projects going forward?

Kevin O’MearaChief Executive Officer

I don’t know that we have really gotten into that — to that level of detail, and I think your question is really seeking. I think it’s reflective of kind of the comments that I made earlier, which is it’s very unsettled time. I guess, you gave a little bit of additional color. What we are seeing is the quoting level has been fairly substantial. There’s a lot of activity, a lot of what we’re doing across our organization with the sales force, with the marketing, with our strategic account approach has generated an enormous amount of activity and reasonably skip it leads. The question is, whether and when those will translate into orders and sales. And because of everything that’s going on in the broader economy and political environment that timing is uncertain.

Josh WilsonRaymond James — Analyst

Okay. That makes sense. And then as we think about your cash needs going forward, can you give us a sense of what you think capex will be in the fourth quarter and in 2021?

Geoffrey KrauseChief Financial Officer

Sure. Yes, it’s Geofff here. As we look at capex for Q4, it’s going to be around $2.5 million to $3 million as we finish off the Carolina — the next phase of the Carolina payment stream as well as our software development costs that we incur on a normal basis, which tend to be in that $1 million range. As we look at next year, it is probably at similar levels to what we have this year as we continue to build out our dirt experience centers is off our path facility and do the — do our normal software development enhancements that we do.

Josh WilsonRaymond James — Analyst

Got it. Good luck with the next quarter. Thanks.

Geoffrey KrauseChief Financial Officer

Thank you.

Operator

Thank you. [Operator Instructions] All right. Presenters, I’m seeing no further questions in the queue. I would like to hand the call over back to Mr. Kevin O’Meara for closing remarks.

Kevin O’MearaChief Executive Officer

Thank you, operator. Before closing, I’d like to again thank our tremendous employees and partners who continue to demonstrate resiliency and commitment in the face of extraordinary circumstances. Their indication to DIRTT and our collective mission is propelled our organization forward in innumerable ways this year, and they are the foundation of our future success. Thanks for joining us today.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Kim MacEachernInvestor Relations

Kevin O’MearaChief Executive Officer

Geoffrey KrauseChief Financial Officer

Rupert MererNational Bank — Analyst

Danny EggerichsCraig Hallen Capital — Analyst

Josh WilsonRaymond James — Analyst

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