DIRTT Environmental Solutions Ltd. (NASDAQ:DRTT) Q2 2023 Earnings Call Transcript

DIRTT Environmental Solutions Ltd. (NASDAQ:DRTT) Q2 2023 Earnings Call Transcript August 6, 2023

Operator: Thank you for standing by. This is the conference operator. Welcome to the DIRTT Environmental Solutions Second Quarter 2023 Financial Results Conference Call. As a reminder all participants are in a listen-only mode and the conference is being recorded. [Operator Instructions]. I would now like to turn the conference over to Shauna 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 second quarter 2023 results. Joining me on the call today will be Benjamin Urban, CEO; Brad Little, CFO; and Fareeha Khan, Vice President of Finance. Today’s prepared remarks are accompanied by presentation slides. To access these 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 security 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 August 2, 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, Shauna, and good morning, everyone. Before I begin, I want to start by thanking all of our team members, our partners and numerous end customers. Looking back on the completion of my first full year with DIRTT, I’m proud of the successful efforts all of our team members and partners who have helped transform this company. We have more work to do. However, we have better line of sight to consistent profitability and growth with Q2 results proving that out. The positive feedback shared from our customers and construction partners continues to grow. On the heels of our most successful connect, our open house in Chicago that coincides with NeoCon. The sentiment was a strong DIRTT is back, buzz with attendance up 30% over last year.

More importantly, with an attendee mix of more first-time attendees, both customers as well as architects and designers. The revised strategy within our commercial organization continues to provide improved results in the last quarter. During Connext, our product development team unveiled seven new competitive product solutions, which received overwhelmingly positive feedback from our customers and construction partners. We will continue to roll out additional products and enhancements throughout the second half of the year. DIRTT has undertaken a strategic initiative and aimed at augmenting and broadening our partner network. In line with this objective, we have successfully onboarded a new partner in both Florida and Alabama. And additionally, we have strengthened our presence by expanding partnerships in Northern California and Winnipeg, alongside six grand openings of new experience centers in the last quarter with five more before the end of the year.

These experience centers are a critical component to our success by growing and converting sales opportunities. In May, we conducted our first inaugural in-person master class for all of our sales representatives in Calgary, making the first such event in the last four years. The feedback from our sales representatives and leadership is that we haven’t been this aligned as a commercial organization in recent memory. In addition to the sales training, our sales force is also growing. We added six new sales reps and a health care vertical specialist the last quarter, and we’ll fill four more roles in the second half of the year. We also successfully secured four new commercial agreements, exemplifying our commitment to strategic growth and expansion.

These agreements encompassed two third-party integrators in the laboratory environments and multifamily residential, a purchasing program for one of the largest general contractors in the United States and a manufacturing partnership with a magnesium oxide manufacturer. We also added two standardization programs for key accounts with two major financial institutions. During our previous earnings call, I highlighted some large wins, and we are witnessing the fruition of those projects they progress into the ordering phase, underscoring the robustness of our pipeline. We continue to see large project wins in our pipeline grow with examples like Armstrong School District, CFG Bank and Maverick Natural Resources which will all order and deliver this year.

In our relentless pursuit of safety excellence, we remain steadfast in our commitment to achieve our journey to zero recordable incidents and being seen as a world-class leader in safety performance. Notably, our dedication and exceptional safety programs have been recognized by Canadian occupational safety as a 2023 excellence Awardees. The extensive list recognizes dozens of organizations who have demonstrated excellence in their safety programs and a commitment to ensuring the health and safety of their employees, the people they serve and the environments in which they operate. We are one of 12 companies certifying for Canada’s safest manufacturing employer. Our year-to-date total recordable incident frequency is 0.6 compared to our year-to-date June ’22 frequency of 0.2. The Bureau of Labor and Statistics Standard Benchmark for DIRTT’s peer manufacturing industry is a TRIF of 5.1. DIRTT is 80% below the industry benchmark.

We continue to focus on quality improvement as well. During the second quarter, we had 6.62 external defects per million dollar of revenue, a 40% improvement from prior year. Also, our on-time performance during the second quarter was 98%, a major improvement from the 83% on-time performance during the second quarter of last year. We launched a significant update to our proprietary ICE technology platform with more than 10 unique functions. More importantly, these improvements were from direct feedback from our construction partners that were of the most value to them as we continue to develop the platform. In conclusion, our unwavering commitment to excellence and innovation has driven sustainable growth and profitability while prioritizing safety, product development and customer satisfaction.

With this foundation, we are poised for greater achievements in the future. And with that, I’ll hand it over to Brad to comment on our financials. Brad?

Brad Little: Thank you, Benjamin, and good morning all. As a reminder, we’ve issued a press release discussing our second quarter results and have 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 second quarter were $44.8 million, about flat with the same period in 2022 and up 22% from the first quarter of 2023. The sequential quarter increase was driven by a combination of normal seasonal shipping patterns, amplified by the commencement of previously delayed projects.

Turning to gross profit. We once again achieved significant year-over-year margin expansion. Compared to the second quarter of 2022, gross profit margin increased 1,850 basis points from 14% to 32.5% in the second quarter of 2023. Adjusted gross profit margin, which excludes the impact of depreciation, increased 1,733 basis points from 18.9% in the second quarter of 2022 to 36.2% in the second quarter of 2023. This improved margin is due to pricing and cost reduction initiatives executed between March 2022 and June 2023 as well as improved product mix as we continue to incentivize full solution projects. Manufacturing cost and efficiencies continue to track better than prior year, which has also led to further improve our margins. Operating expenses for the second quarter were $16.8 million, a 34% decrease over the same period in 2022.

The reduction in costs are primarily from the cost reduction initiatives implemented over the past 12 months as well as more disciplined discretionary spending. During the second quarter of 2023, we took additional actions to proactively remove cost, including a planned headcount reduction with annualized savings of approximately $2.6 million, exclusive of termination benefits of $700,000. From January 2022 through June 2023, the company has reduced related head count by 147 or 15%. Adjusted EBITDA for the second quarter was $1.9 million, an improvement of $11.3 million or 120% from a loss of $9.4 million during the second quarter of 2022. This improvement has been driven by a 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 again is published on our website. Turning to liquidity and working capital. We finished the quarter with $18.9 million in unrestricted cash of $8.1 million from $10.8 million at December 31, 2022. Cash provided by operations for the second quarter was $3.8 million compared to cash consumed by operations of $17.8 million during the second quarter of 2022. And for the six months ended June 2023, we generated cash flow from operations of $2.8 million compared to cash consumed of $36.8 million through the six months ended June 2022. Liquidity, which includes $9.2 million of availability under our ABL credit facility was $28.1 million as of June 2023.

We did not need to draw on that facility in the second quarter and have not had to thus far in the third quarter of 2023. Beyond the non-dilutive cash initiatives that I’ll talk about shortly, we’ve also been working hard to improve our conversion and lower the overall investment in working capital. Net working capital at the end of the quarter was $26.5 million, up $9.2 million from March 2023, primarily due to the proceeds from the AWI agreement and an increase in demand commensurate with seasonal operating pattern. Our day’s sales outstanding has improved from 27 days at December 2022 to 20 days at June 2023. By comparison, days sales outstanding as of June 2022 was 29 days. Our DSO has been favorably impacted by certain programs to incentivize faster payment of receivables.

As cash flow and profitability have improved, we have decided to discontinue this program effective August 1. While this will likely return our collection times to historical levels, we will achieve higher margin on the applicable projects by eliminating the associated discount. We have also been working to actively reduce our inventory levels through improved sales, inventory and operational planning processes. This serves to not only identify and manage our slow-moving or obsolete inventory but the improved sales forecasting will allow us to better manage inventory purchasing of our core raw materials. Year-over-year, we have reduced our inventory levels by $5.9 million or 23% to $19.4 million at June 2023. We expect that balance to decrease by December 31, providing a positive cash flow impact and offsetting the DSO impact previously discussed.

As I have alluded, we have also been executing various non-dilutive cash initiatives designed to bolster our cash position. As we discussed in our previous earnings call, we entered into an agreement with Armstrong World Industries for co-ownership of certain intellectual property interest in DIRTT ICE software and an enhanced commercial partnership opportunity for cash consideration of $10 million, which was received during the second quarter. A portion of the proceeds was used to pay off certain equipment leases. Also in the second quarter, effective April 1, we have subleased our Plano DIRTT experience entered one of our construction in that specific market with annualized savings of approximately $1 million. Lastly, we received the remainder of the IRS tax receivable in May, contributing about $2.6 million in cash as of June 30, 2023.

Turning to the outlook. Throughout the first six months of 2023, we have seen continued volatility in economic conditions, especially in regions with concentrated sales to the technology and banking sectors. In some aspects, the macroeconomic uncertainty is subsided and various inflation metrics have improved over the past three months and certain indications of the recession has eased. We’ve seen improved demand for our products beginning in mid-April. From May 1 to June 30, 2023, the company generated $33.3 million in total revenue and an associated $3.5 million in adjusted EBITDA, with adjusted gross profit during the same period of 39.2%. As we discussed in our last call, we were awarded several projects during the second quarter of 2023, including Bechtel, Apache and Visa, two of which have begun to order and all are expected to deliver a combined $10 million to $15 million in aggregated revenue during 2023.

As previously discussed, we achieved a 22% increase in revenue between the first and second quarter of 2023. We expect a sequential increase in revenue in the third quarter over the second quarter of 2023, though not to the same extent. For 2023, we continue to project low to mid-single-digit growth in total revenue over 2022, a trend we expect to continue into 2024 based on our current 12-month forward pipeline. We believe that the combination of cash initiatives discussed, along with improved margins from actions already taken to improve the pricing and reduce the cost structure set us up to respond to the ever-changing market conditions. Before we open it up for questions, I wanted to address two other matters. First, our compliance with NASDAQ stock requirements.

As you know, our stock trades thinly for a variety of factors, and our stock price has not exceeded $1 for the previous 10 months. At this time, assuming our NASDAQ price does not exceed $1 consistently by September 5, it is our intention to withdraw from the NASDAQ and for our stock to trade over the counter rather than perform a reverse stock split. I will remind you that we’ve been trading on the Toronto Stock Exchange under the ticker symbol DRT since 2013. We absolutely intend on continuing that into the future. Lastly, as we released last night, I have made the very difficult and deeply personal decision to leave DIRTT. Working at DIRTT has been an incredibly fulfilling experience, and I want to express my heartfelt gratitude to the Board of Directors and the entire team for the support and comradery that I’ve experienced here.

I also want to take a moment and share why I have decided to leave DIRTT and where I’m going next. Firstly, I’ve loved my time at DIRTT. It’s also been a challenge personally for me, but the work being largely remote with long commutes. Family is about most importance to me. And after much contemplation, I’ve come to realize that I need to work closer to my family in Fort Worth, Texas. With that in mind, I’ve accepted a position at Sabre Industries as its Chief Financial Officer. Sabre Industries is a market leader in both utility and telecom engineered structured end markets, and I’m excited to be joining their team once we finish my transition. In closing, I want to express my gratitude to the entire DIRTT family for making my time here truly memorable and I wish DIRTT and his team continued success in the future.

Benjamin?

Benjamin Urban: Thank you, Brad. I would also like to share some additional thoughts regarding the change to our leadership team that we announced in yesterday’s earnings release. Firstly, I want to take a moment to acknowledge and express my gratitude to Brad Little, our Chief Financial Officer, who has decided to step down from his position. Brad’s dedication and contributions to DIRTT have been invaluable. He has been instrumental in helping us reestablish credibility with our people, partners and most importantly, our clients. On behalf of the entire team at DIRTT, I want to thank Brad for his many contributions and leadership. Over the past year, Brad led several company-wide efforts to reduce our fixed cost structure for manufacturing and operations and improve our operational planning and sales and revenue forecasting.

Largely because of these foundational improvements, we were able to produce more accurate product costing models and better align our product mix with market demand and opportunity. All of these actions have helped fuel significant margin expansion over the past 4 quarters, leading to meaningful growth in both EBITDA and liquidity. Brad is not only a strong CFO but also a tremendous team leader and mentor. He has built a strong and disciplined finance team that understands the critical role they must play in helping our business lead further stabilize cash flow, improve our revenue and sales forecasting and be more diligent and thorough in operational planning. While we are sad to see Brad leave, we understand and fully respect his decision.

We also take great solace in knowing we have a strong team behind them, one that will continue leading us forward without missing a beat. I’ll have more to share on that front in just a moment. But first, I want to close by personally thanking you, Brad for your commitment to our company and the positive influence you’ve instilled in each of us. We all wish you and your family well in your future endeavors. Would you like to say a few words on your final DIRTT earnings call?

Brad Little: Thank you, Benjamin, for those kind words. We have accomplished so many great things over the past year, and that would not have happened without the hard work, focus and expertise of my colleagues in finance and all of our dedicated team members here at DIRTT. It’s been my distinct honor to lead and support each of them over the past year. And although I’m embarking on a new journey personally, I know I’m leaving everyone at DIRTT in good financial hands. The company broadly and the finance team specifically is prepared and well positioned to continue what we’ve begun, ensuring that the company continues to produce improved growth and margin expansion. I’m very excited to watch albeit from the sidelines now as a shareholder first. A final day will be August 25, and I hope to remain part of the DIRTT family forever. Benjamin?

Benjamin Urban: Thank you, Brad. With your stewardship, we’ve enhanced our financial management practices and aligned our financial strategy with our broader business objectives. I have personally benefited from your steady counsel and strategic insight. And I’m proud of the team you’ve built, cultivated and motivated since joining us. Now I’d like to introduce you to Fareeha Khan, who will be stepping into the role of Chief Financial Officer, succeeding Brad on August 25. Fareeha has been an integral part of our team for the past five years, most recently serving a DIRT as the Vice President of Finance. Fareeha has served in several key roles at DIRTT and is uniquely prepared for the additional duties she will assume as CFO.

Firstly, Fareeha has worked side-by-side with Brad on a majority, if not all of the finance initiatives I just highlighted. These initiatives are driving our strong results and improved profitability for the company. With over 20 years of finance experience, Fareeha grew up in Zimbabwe, where she completed her chartered accountancy with Deloitte and obtained her Bachelor’s and Accounting Services at the University of South Africa. After completing her studies, Fareeha moved to the United States and worked at Deloitte in their Houston and Fort Lauderdale offices. Following her time at Deloitte, Fareeha joined a PricewaterhouseCoopers working in Pakistan and later in Calgary before joining DIRTT in 2019. During her tenure with PricewaterhouseCoopers, Fareeha worked with private and public companies and SEC registrants in various roles, including audit, training, buy-side financial due diligence, settlements and advisory.

Fareeha is a member of the Institute of Chartered Accountants in England and Wales and the Institute of Chartered Accountant in Zimbabwe. Of importance to me personally, Fareeha comes from within our ranks. And because of that, she has a deep understanding of the business, and I know she holds the respect of her colleagues across the company. I’m confident in Fareeha’s ability to ensure a seamless transition and lead our financial team with excellence. Fareeha, would you like to say a few words?

Fareeha Khan: Thank you, Benjamin, and hello to everyone. I’m incredibly excited about this opportunity and honored by the trust that the company continues to place in me. I have thoroughly enjoyed my time at DIRTT, and I’m looking forward to continuing to serve our company in the role as the Chief Financial Officer. As we move forward, I am committed to upholding the financial strength and integrity of DIRTT. I also look forward to joining these calls in the future and collaborating more closely with our investors, the investment community and our valued clients. I also want to take a moment to thank Brad for his leadership and mentorship over the past year. Because of him, we have a strong and unified venture finance talent that is both prepared and highly capable as we advance the business. Benjamin?

Benjamin Urban: Thank you, Fareeha. We are delighted to have you in this new role, and we have no doubt that you excel as our CFO. We are also taking the necessary steps to ensure a smooth transition. To this end, Brad will work closely with Fareeha to pass on his remaining duties, ensuring a seamless handover of all CFO responsibilities on August 28. I also want to highlight that Brad has graciously agreed to provide ongoing counsel to Fareeha and our team throughout Q3. His continued support will be invaluable during this transition period, demonstrating the strong sense of teamwork and comradery we have within our organization. We believe that this carefully planned approach will set Fareeha and the entire financial team up for success, and we look forward to a bright future for DIRTT under Fareeha’s leadership. We will now open the line for questions.

Q&A Session

Operator: [Operator Instructions] And for your first question, it comes from the line of Danny Eggerichs from Craig-Hallum Capital Group. Danny your line is open, please ask your question.

Danny Eggerichs: Congrats on the really good results, guys. I guess just starting, it sounds like demand trends really improved as we moved throughout the quarter. I guess just kind of overall, have you seen that continue into July? And I guess, early August, now what’s the overall feel for the market right now?

Brad Little: Yes, sure. As we indicated, started after Easter — and our second quarter pace improved rapidly, quite a combination of demand, which you just mentioned, but also we had some delays in projects that were supposed to start in Q1 that started in Q2, and so we got a bit of a bump there. That pace has generally continued into Q3. So last year, going from Q2 to Q3, we experienced a 4% to 8% [ph] increase. We see that trend continuing potentially a little better in the third quarter of this year.

Danny Eggerichs: Yes. Got it. And then it looks like maybe health care seemed like a really positive spot in this quarter. Was that just based on some of those larger orders hitting? Are you seeing that as a whole come back stronger? I heard you announced, you hired a new health care vertical specialists. So I guess just what are you seeing in that market right now that cause the strength this quarter?

Brad Little: Yes. I’ll start from a quantitative standpoint and then hand it to Benjamin, to talk more broadly about our approach. We had two or three fairly large projects, one in the Northeast and then one in Houston that was originally scheduled to commence in late Q1 that pushed into Q2 and those were both large health care projects. So we see the trend will continue, but just Q1 was lighter than normal, not really indicative of what we have in our pipeline, Benjamin?

Benjamin Urban: Yes, good commentary, Brad. Yes, you’re right. We are seeing growth in the health care vertical. A large part of that is due to the efforts that we look for in the previous years and to where we are now. Those projects tend to have a bit longer lead cycle on them versus a traditional commercial project. And we are seeing growth into 2024 and 2025. The upside also that is many times, those projects tend to be quite large in nature, and the adoption rate for the solutions we provide continues to improve as that industry change.

Danny Eggerichs: Okay. That’s good. Maybe if I can just hit on that gross margin quick. Obviously, it came in well above what we and I think many others were expecting. You said that in July and August, you kind of hit that 39.2% margin. I think that was on an adjusted basis. So I guess going forward, as volumes continue to improve, should we expect that to continue to see some modest expansion? Or how should we think about that?

Brad Little: Great question, Danny. So when we think about the first half of the year and really the second quarter, first off, the dollar was fairly — it is [indiscernible] relative to Canadian dollar. A lot of our costs are in Canada. So we had a little tailwind on that front in the second quarter. We have really good product mix as well in the quarter. Now the 39% that we achieved in a combination of May and June that we discussed on the call, a lot of that was driven by leverage of our fixed cost structure as we started to push past further — significantly past our breakeven point. So I think the 36.2% also reflects the very low volumes that we had in April. So on balance, I feel like mid-30s, upper 30s is probably fair as we get into pushing past $45 million to $50 million per quarter run rate, not suggesting that to be a consistent run rate going forward. But I think our margins are well positioned, well stated right now.

Danny Eggerichs: Okay. That’s very helpful. Maybe I’ll just end here question on AWI, now that’s completed. I guess, how has that relationship progressed? Have they brought in any new leads yet? Or is it still just kind of too early to tell?

Benjamin Urban: Yes. Danny, I’ll take that question. It’s a bit early in the relationship. I will say we have begun to see some beneficial outcomes from that agreement within the commercial organization on some opportunities cutting loose. I think we will see that accelerate in addition to — or alongside that, if you will, some of the product integration and collaboration that we’re going to be doing with them. So I think there’ll be more to see from that in the future. Similarly, to some of the other commercial partnerships that we’ve touched on over the Q as well as in the first half of the year. As you know, many of our lead cycles and sales cycles can be 12 to 18 months. So I think what you’ll start to see some of those opportunities starting to unfold into our pipeline.

For now, it’s just at the early stages of the AWI commercial agreement. But I will say that it is going quite well, and we are all aligned and beginning to get our sales forces working together as well as our product development and research.

Danny Eggerichs: All right. Great. I’ll leave it there. Thanks everyone.

Operator: [Operator Instructions] Ladies and gentlemen, there are no further questions at this time. Thank you for participating in today’s conference. This concludes the program. You may now disconnect, and have a wonderful day.