DIRTT Environmental Solutions Q1 2023 Earnings Call Transcript

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Provided by Quartr
May 10, 2023

There are 6 speakers on the call.

Operator

Thank you for standing by. This is the conference operator. Welcome to the DIRTT Environmental Solutions First Quarter 2023 Financial Results Conference Call. As a reminder, all participants are in a listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions.

Operator

I would now like to turn the call over to Shawna Mason, Director of Corporate Affairs. Please go ahead.

Speaker 1

Thank you, operator, and good morning, everyone. Welcome to today's call to discuss DIRTT's Q1 2023 results. Joining me on the call today will be DIRTT's 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 webpage of this webcast or on our website atdirt.com.

Speaker 1

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.

Speaker 1

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.

Speaker 2

Thank you, Shauna, 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 1st full year with DIRTT, I'm amazed to see the progress we are making in nearly every facet of our business. I'm 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.

Speaker 2

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 Connex, 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 $5,000,000 was scheduled to order in the Q1, then pushed to the Q2 and Now expected to be delivered in 2024.

Speaker 2

We look forward to delivering that project, but it certainly impacted our Q1 results and our 2023 pipeline. While we have seen 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 3rd party integrators, new purchasing programs, manufacturing partnerships and negotiating standardization programs within our key customer base.

Speaker 2

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've 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 healthcare 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 dirt experience centers and organizations, bolstering our commercial efforts to continue to drive revenue growth.

Speaker 2

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 whom have had their geographical territories expanded in the last 9 months. However, it takes time for them to get up to speed and 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 costs 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 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.

Speaker 2

The pace of innovation and product development has also increased as we roll 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 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'm happy to announce our partnership with Armstrong World Industries, who also utilize the ICE platform for their Project Worx software.

Speaker 2

This partnership not only provides commercial opportunity 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?

Speaker 3

Thank you, Benjamin. Good morning all. I would also echo Benjamin's 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.

Speaker 3

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 Q1 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 Q1 were $36,700,000 down 4% from the same period in 2022.

Speaker 3

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 Q1 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 Q1 of 2022, gross profit margin increased 1507 basis points from 8.6% to 23.7 percent in the Q1 of 2023.

Speaker 3

Adjusted gross profit margin, which excludes the impact of Appreciation increased 10.86 basis points from 17.7 percent in the Q1 of 2022 to 28.5 percent in the Q1 of 20 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 headcount by 81 As a result of this headcount reduction and when combined with decreased third party consulting spend and increased management of discretionary spend, 1st quarter 2023 recurring cash based operating expenses are 19% lower than the Q1 of 2022. Adjusted EBITDA for the Q1 was a loss of $3,500,000 an improvement of $8,400,000 or 70.5 percent from a loss of $12,000,000 during the Q1 of 2022.

Speaker 3

This improvement has been driven by the reduction in operating expenses and an increase in gross profit margin just 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 in our Q4 earnings call, in a normalized environment, the Q1 is typically the highest cash usage quarter as volumes are usually lower and we have several annual cash commitments in that quarter. 1st quarter liquidity and working capital was impacted by 2 non operational items. First, we benefited by the partial receipt of our previously established tax receivable.

Speaker 3

In March, we received $4,800,000 of Previously accrued $7,300,000 We expect to receive the remaining $2,500,000 in 2023. 2nd, Also during March, the company entered into an agreement to reimburse 22 Northwest, a related party, for the legal fees incurred and paid by 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 $2,100,000 We finished the quarter with $8,100,000 in unrestricted cash, down $2,700,000 from $10,800,000 at December 31, 2022. Cash consumed by operations for the Q1 was $1,000,000 compared to cash consumed by operations of $19,000,000 in the Q1 of 2022.

Speaker 3

Liquidity, which includes our availability under our ABL credit facility, was $13,300,000 as of March 2023. Net working capital at the end of the quarter was $17,300,000 down $8,800,000 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 $5,200,000 at the end of the quarter. We did not need to draw on that facility in the Q1 and have not had to thus far in the Q2 of 2023.

Speaker 3

I also wanted to update you on our ongoing non dilutive cash Excluding the tax receivable just discussed. First, we continue to see good adoption and compliance with our early paid 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. 2nd, we are continuing to evaluate Certain company owned leased properties from a sell, leaseback or sublease standpoint.

Speaker 3

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 1,000,000 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 Eye 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 Hi, software and enhanced commercial partnership opportunities for cash consideration to be received during the Q2. More information on this transaction can be found within our Forms 10 Q and 8 ks filed with the SEC yesterday.

Speaker 3

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 $252,000,000 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 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, 395 as of January 1, 2022.

Speaker 3

The increase in leads is a result Although orders declined during the Q1 of 2023 due to the factors discussed previously, we have experienced an uptick in order pace during mid April early May. In addition to the pipeline, we used 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 $16,000,000 the highest level it had been since mid Q4 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.

Speaker 3

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 Q1 of 2023, as we discussed on our previous earnings call, we took actions to reduce annualized operating expenses by approximately $5,000,000 In addition, during the Q2 to date, we have taken additional actions that will generate $4,000,000 in annualized savings, including a planned headcount with annualized savings of approximately $3,100,000 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 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.

Speaker 3

And now, we'll open the call for your questions. Operator?

Operator

And our first question comes from Greg Palm with Craig Hallum. Your line is open.

Speaker 4

Great. Thanks for taking the questions. I wanted to maybe start with just kind of trying to tie out your more, I don't know, maybe Cautious commentary around the macro and some of these potential recessionary headwinds with the first the large sequential increase in leads And then more importantly, your recent order activity, are you just seeing more benefits from some of these commercial initiatives or is there something else going on?

Speaker 2

Hey, Greg. Yes, it's definitely an outcome of some of these recent commercial initiatives. And as I think our sales cycles are significantly longer than many other products out there such that a 6 to 12 months, if it was a site is uncommon. So Our commentary around the uncertainty of the headwinds just basically making sure that we're prepared for what comes after Q4 and on, but we are seeing increased order pace and strengthening of the pipeline.

Speaker 4

In the trailing 28 day order pace of $16,000,000 that you talked about, does that take in To account any of the 3 large projects that you alluded to or those in addition?

Speaker 5

Hey, good morning, Greg. I hope things are good. No, that does not include the 3 large projects. Typically, our trailing 28 day order pace is a leading indicator for the following month's Revenue, so it's 1 month of orders that we look at. And the projects that we alluded to earlier Are expected to deliver in Q3 and into Q4.

Speaker 4

Okay. Thanks for the clarification. And then Taking into account the results from Q1, some of these additional cost cuts, what do you think a good level of revenue would be to achieve, Either breakeven or even profitability on an EBITDA basis. Has that changed significantly from maybe what you thought last quarter?

Speaker 3

Yes, good question.

Speaker 5

We're seeing good realization of price despite Lower than we would like volumes delivering close to 29% in gross profit margin adjusted. Our breakeven point is much lower in 2023 than it was in 2022 clearly. And we've continued to review and evaluate all of our cost structure, Manufacturing efficiencies, which we're seeing, and just trying to do things better, smarter And order fulfillment. I don't have an actual answer for you on what breakeven point is for the company, but it's lower than it was last year. And in terms of kind of how we see the year playing out, we talked about Q1 is our lowest It's typically our lowest seasonal quarter was the case in 2021, was the case again in 2022.

Speaker 5

So we expect that to be the case in 2023. We see sequential growth in Q2 and Q3 based on our pipeline and recent order increase. But just like everyone else, just what is going to happen with Congress and with the Spending the fiscal policy and interest rates and inflation, we've got decent visibility to Q2 and Q3 and we're just We're being very careful with the longer range structure.

Speaker 4

Yes, makes sense. And I guess last one, if you can maybe talk a little bit more about this deal with Armstrong, maybe a little bit About the background there and then just in terms of some of the commercial opportunities, The direct revenue potential of the partnership, how do you see that playing out over the next few years?

Speaker 2

Yes, Greg, it's a great question. It's I'm really excited to announce that partnership with Armstrong. We have participated with them in the past. They are in an adjacent sector to us. So they have very many of their products are complementary to the things and solutions that DIRTT provides.

Speaker 2

This is all breaking into 2 things for you. 1 on the software portion of it and their investment In the ICE technology that they're using for their platform, they see the same benefits that we see from Design, cost certainty, really helping move those projects forward Similar to how we use Ike for DIRTT, the other piece of it, Greg, is the commercial alignment, if you will, And that our sales team and our go to market strategy and their sales team and their go to market strategy are very complementary. And so this provides us a forum such that we can kind of work those commercial organizations at the same time. So It's a and we'll see how it evolves over the next few years here. But even in the immediate time frame, I think we'll see great things come from that partnership.

Speaker 4

Yes. Well, it's a big name. It seems like a big opportunity. So excited to see how that plays out. I'll leave it there.

Speaker 4

Thanks.

Speaker 2

Thanks, Greg. Yes. Thank you.

Operator

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.

Speaker 2

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 those accounts 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.

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DIRTT Environmental Solutions Q1 2023
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