DIRTT Environmental Solutions Ltd. (NASDAQ:DRTT) Q1 2023 Earnings Call Transcript May 15, 2023

Operator: Thank you for standing by. This is the conference operator. Welcome to the DIRTT Environmental Solutions First Quarter 2023 Financial Results Conference Call. [Operator Instructions] I would now like to turn the call over to Shawna Mason, Director of Corporate Affairs. Please go ahead.

Shawna Mason: Thank you, operator, and good morning, everyone. Welcome to today’s call to discuss DIRTT’s first quarter 2023 results. Joining me on the call today will be DIRTT CEO and CFO, Benjamin Urban and Brad Little. Today’s prepared remarks are accompanied by presentation slides. To access the slides, please view them from the web page of this webcast or on our website at dirtt.com. Today’s call will include forward-looking statements within the meaning of applicable Canadian and United States securities laws. 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 reference non-GAAP results, excluding special items.

Please reference our Form 10-Q as filed on May 9, 2023, 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 tomorrow. I now turn the call over to Benjamin.

Benjamin Urban: Thank you, Shawna, and good morning, everyone. Before I begin, I want to start by thanking all of our team members, our approximately 70 partners and numerous end customers. Approaching the completion of my first full year with DIRTT, I am amazed to see the progress we are making in nearly every facet of our business. I am also encouraged by the level of enthusiasm from our partners regarding the future of DIRTT. We are seeing more and more partners investing in their own design centers. Our Partner Advisory Council and numerous other partners are giving us valuable feedback regarding what is and isn’t working in their markets and how we can best address those items. We are preparing to have our sales team in Calgary this week and next month, we will host Connext, our annual open house in Chicago that coincides with NeoCon.

I feel confident in saying that DIRTT is in a significantly better place than we were at this time last year. To that end, we are in the midst of a challenging macroeconomic environment with recessionary concerns and uncertainty across many fronts, especially the technology and finance sectors to which we clearly have exposure. As an example, one large project with a technology company with projected revenue of nearly $5 million was scheduled to order in the first quarter, then pushed to the second quarter and now expect it to be delivered in 2024. We look forward to delivering that project, but it certainly impacted our first quarter results and our 2023 pipeline. While we have seen an improvement in our order pace during April and into May and believe we have good line of sight to our second and third quarter orders, there is still uncertainty in our addressable markets.

As Brad will discuss, we continue to proactively remove unnecessary costs from the business and focus on cash-generating initiatives. All things we have control over, regardless of whatever comes our way from the economy. In the meantime, we haven’t slowed down our focus on strengthening our pipeline, our commercial organization and creating value for our partners and customers. Beginning in late Q4, we also restructured our commercial organization and refined our growth strategy centered around the following core elements: expansion and diversification of our construction partner network, increasing scope on projects as well as short-cycle sales opportunities, adding sales representatives, including vertical market specialists, and entering into new agreements with third-party integrators, new purchasing programs, manufacturing partnerships and negotiating standardization programs within our key customer base.

We are experiencing success with these initiatives and expect to see organic pipeline growth as a result within 2023 and into 2024. Just within the last month, we have been awarded large projects with Bechtel, Apache and Visa on projects expected to deliver this year. We are seeing an increase in quoting activity within the health care and education vertical markets. However, these are longer lead sales cycles and will take time to be realized as sales. As I mentioned, our construction partners also continue to invest in their own DIRTT Experience Centers and organizations bolstering our commercial efforts to continue to drive revenue growth. We talked about it in the Q4 earnings call, but we had a decrease in construction partners from 2019 to 2022.

We have added more than 16 either new or partners who have had their geographical territories expanded in the last 9 months. However, it takes time for them to get up to speed in generating revenue. DIRTT is known for innovation, not only within our solutions but also in our approach to manufacturing and that continues to prove beneficial with removing cost from the business while simultaneously improving our manufacturing efficiencies. Q1 has demonstrated that we have excelled in continuing to move the needle within manufacturing operations, showing the highest on-time and full production balanced with the lowest efficiency rates we have seen in years, layered with our lowest overtime labor costs. While accomplishing this, we also implemented the cost reduction measures we commented on in February, decreasing the distance to EBITDA and cash flow breakeven.

We will continue to optimize our business to be prepared for a variety of market conditions. The pace of innovation and product development has also increased as we rolled out new enhancements in Q3 and Q4 to specific product lines such as Inspire, but also with solutions that are universal across our product lines. With new door systems and acoustical enhancements, some of which have already been released with select premier customers, further enhancing our value proposition. We are also exploring opportunities for further development of innovative solutions with our manufacturing partners. As you have heard us talk about for the last couple of quarters we have been continuing to further develop our proprietary ICE software with additional libraries and features supporting many of our existing solutions while adding in the aforementioned innovations.

Some of our commercial initiatives also overlap with our technology solutions. For example, I am happy to announce our partnership with Armstrong World Industries who also utilize the ICE platform for their ProjectWorks software. This partnership not only provides commercial opportunities for both of our companies to leverage our complementary solutions, but also drives direct revenue to DIRTT and our partners. And with that, I’ll hand it over to Brad to comment on our financials as well as further elaborate on the cash initiatives in play. Brad?

Brad Little: Thank you, Benjamin, and good morning all. I would also echo Benjamin sentiments regarding our people, our partners and our customers. I would also extend that to our shareholders and our material suppliers. All of these parties have a shared dependence on DIRTT’s continued financial stability for the betterment of their families, their businesses and their portfolios. We do not take that lightly, and it’s why we’ve been working tirelessly to remove costs and improve the financial results. Thank you to all of you. As a reminder, we have issued a press release discussing our first quarter results and provided additional analysis in a supplemental presentation, which is now posted on our website. My comments this morning are designed to add additional color on our financial results for the quarter and update you on key developments impacting our liquidity and cash initiatives we’ve been discussing over the last several quarters.

Revenues for the first quarter were $36.7 million, down 4% from the same period in 2022. The modest year-over-year decrease in revenues are primarily related to lower volumes and a decrease in average order size, offset by improved pricing realizations and the price increases implemented over the previous 18 months. As Benjamin mentioned earlier, our first quarter was also impacted by the deferral of a large project within the technology sector. Turning to gross profit. We once again achieved significant year-over-year margin expansion despite the deleveraging effect from lower volumes. Compared to the first quarter of 2022, gross profit margin increased 1,507 basis points from 8.6% to 23.7% in the first quarter of 2023. Adjusted gross profit margin, which excludes the impact of depreciation, increased 1,086 basis points from 17.7% in the first quarter of 2022 to 28.5% in the first quarter of 2023.

The improved margin is due to the realization of the price increases and cost reduction initiatives executed from March 2022 through March 2023. Further, we have aligned our manufacturing costs with the current order pace, which has led to further margin improvement. Regarding operating expenses, we continue to see decreases across all of our normal back office operating expense line items, mostly from the cost reduction initiatives implemented throughout 2022, but also due to more disciplined discretionary spend. From January 2022 through March 2023, the company has reduced related head count by 81 or 20%. As a result of this headcount reduction and when combined with decreased third-party consulting spend and increased management of discretionary spend, first quarter 2023 recurring cash-based operating expenses are 19% lower the first quarter of 2022.

Adjusted EBITDA for the first quarter was a loss of $3.5 million, an improvement of $8.4 million or 70.5% from a loss of $12 million during the first quarter of 2022. This improvement has been driven by the reduction in operating expenses and an increase in gross profit margin just described. You can find further detail on these as well as other financial information in our supplemental presentation, which is again published on our website. Turning to liquidity and working capital. As I spoke about on our fourth quarter earnings call, in a normalized environment, the first quarter is typically the highest cash usage quarter as volumes are usually lower, and we have several annual cash commitments in that quarter. First quarter liquidity and working capital was impacted by two non-operational items.

First, we benefited by the partial receipt of our previously established tax receivable. In March, we received $4.8 million of the previously accrued $7.3 million. We expect to receive the remaining $2.5 million in 2023. Second, also during March, the company entered into an agreement to reimburse 22 Northwest a related party for the legal fees incurred and paid by 22 Northwest during the 2022 contested director elections. The company intends to settle the obligations in shares, not cash, subject to approval by our shareholders as required. As of March 31, this obligation was valued at $2.1 million. We finished the quarter with $8.1 million in unrestricted cash, down $2.7 million from $10.8 million at December 31, 2022. Cash consumed by operations for the first quarter was $1 million compared to cash consumed by operations of $19 million in the first quarter of 2022; liquidity, which includes our availability under our ABL credit facility, with $13.3 million as of March 2023.

Net working capital at the end of the quarter was $17.3 million, down $8.8 million from December, primarily due to seasonal operating patterns accentuated by the lower volumes and the establishment of the related party obligation previously discussed. As a reminder, during February, we extended our ABL facility by 1 year. Availability under that facility was $5.2 million at the end of the quarter. We did not need to draw on that facility in the first quarter and have not had to thus far in the second quarter of 2023. I also wanted to update you on our ongoing non-dilutive cash initiatives, excluding the tax receivable just discussed. First, we continue to see good adoption in compliance with our early pay discount customers in good standing.

Our days sales outstanding has improved from 27 days at December 2022 to 22 days at March 2023. And by comparison, days sales outstanding as of March 2022 was 25 days. Second, we are continuing to evaluate certain company-owned leased properties from a sell leaseback or sublease standpoint. Effective April 1, 2023, we have subleased our Plano, DXC to one of our construction partners in that specific market. We estimate total annualized savings from this arrangement to be approximately $1 million. We also made progress on a similar property and expect to have resolution on that during 2023. Lastly, we’ve been actively evaluating how to advance our vision and competitive advantage around the ICE software. As a result, and as we just released, we have entered into a joint arrangement with Armstrong World Industries for co-ownership of certain intellectual property interest in DIRTT’s ICE software and enhanced commercial partnership opportunities for cash consideration to be received during the second quarter.

More information on this transaction can be found within our Forms 10-Q and 8-K filed with the SEC yesterday. Turning to the outlook. As Benjamin mentioned earlier, over the past 60 to 90 days, we have seen continued weakening in economic conditions, especially in regions with concentrated sales to the technology and banking sectors. Our 12-month forward sales pipeline at April 1, 2023, excluding leads, was $252 million an increase of 2% from January 1, 2023, and a 4% increase year-over-year, primarily due to the recently awarded large projects Benjamin discussed. As disclosed in our Form 10-Q, we have refined our method of communicating pipeline to exclude leads from dollar value of pipeline as we believe this improves transparency and quality of our pipeline disclosures.

At April 1, 2023, qualified leads being pursued with expected projects in the next 12 months, was 969 compared to 721 at January 1, 2023, and 395 as of January 1, 2022. The increase in leads is a result of improved inside sales work over the last 6 months, mainly from improved communication and collaboration within the commercial group. Although orders declined during the first quarter of 2023 due to the factors discussed previously, we have experienced an uptick in order pace during mid-April and early May. In addition to the pipeline, we use the trailing 28-day order pace to gauge near-term revenue and overall demand. As of May 5, 2023, the trailing 28-day order pace reached $16 million the highest level it had been since mid-fourth quarter of 2022.

This isn’t a guarantee of future revenue run rate, but it is a positive indicator for us as it implies improved revenue performance in Q2 and Q3. While we are encouraged by the modest growth in the pipeline and the recent increase in order pace, we recognize the macroeconomic uncertainty in the medium to long-term. In response to this uncertainty and pipeline risk discussed, we have taken a thoughtful look at our cost structure over the past 3 months. During the first quarter of 2023, as we discussed on our previous earnings call, we took actions to reduce annualized operating expenses by approximately $5 million. In addition, during the second quarter to date, we have taken additional actions that will generate $4 million in annualized savings, including a planned headcount reduction with annualized savings of approximately $3.1 million, exclusive of termination benefits of $700,000.

These modest reductions, while never easy, were designed to improve efficiencies and streamline our back office and order fulfillment processes in light of the longer range of uncertainty. To that end, these actions are not expected to have a material impact on product delivery. We believe the combination of the cash initiatives just discussed along with improved margins from actions already taken to improve pricing and reduce the cost structure set us up to weather the economic uncertainty. We will continue to monitor and be proactive with pricing and cost structure in response to the ever-changing market conditions. And now we will open the call for your questions. Operator?

Q&A Session

Operator: [Operator Instructions] And our first question comes from Greg Palm with Craig-Hallum. Your line is open.

[18:08][indiscernible]:

Operator: [Operator Instructions] And I’m showing no further questions at this time. I would now like to turn the conference back to Benjamin Urban for closing remarks.

Benjamin Urban: Thank you. Yes. As Brad laid out, the year ahead of us includes market uncertainty and economic headwinds. Despite this, we believe the combination of business optimizations and cash initiatives already completed in these economies in the near future position DIRTT for long-term success. The employees and culture of DIRTT continue to prove strong and resilient to the rise to the challenge to drive change with those things that are within our control to increase partner and customer value, while also driving costs out of the business in 2023 and beyond. I’d like to thank you all for joining us today.

Operator: And this concludes today’s conference call. Thank you for participating. You may now disconnect.