DIRTT Environmental Solutions Ltd. (DRTT) on Q4 2021 Results - Earnings Call Transcript
Operator: Good day, and thank you for standing by. Welcome to the Q4 DIRTT 2021 Q4 Year-end Financial Results Conference Call. after the speaker's presentation, there will be a question-and-answer session. It is now my pleasure to turn the conference over to your speaker today, Kim MacEachern. Ma'am, please go ahead.
Kim MacEachern: Thank you, operator, and good morning, everyone. Welcome to today's call to discuss DIRTT's fourth quarter and year-end 2021 results. Joining me on the call are DIRTT's Interim Chief Executive Officer, Todd Lillibridge; and Chief Financial Officer, Geoff Krause management's prepared remarks today are accompanied by presentation slides. To access the slides, please view them from the Web page of this webcast. 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, will reference non-GAAP results, excluding special items. Please reference our Form 10-K as filed on February 23, 2022, 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 would now like to turn the call over to Todd.
Todd Lillibridge: Thank you, Kim. I'm pleased to participate in my first DIRTT quarterly call as interim CEO. It has been a little over a month since I took on this role. And as you can tell from our announcement earlier this week, a lot has happened here a DIRTT during that timeframe. We are making some very meaningful changes at DIRTT and changes that I believe will make us more focused, more strategic and ultimately, a more profitable company. The changes, which we will be discussing in some detail in this call, are the result of our entire leadership team, the Board and management, working through a comprehensive modification of our strategic plan so that we are better positioned to take advantage of market dynamics. For today's call, I'm going to ask Geoff to review our fourth quarter results first. Then I will speak about the initiatives we announced earlier this week and the impact that is expected to have on DIRTT. We will open the call following that to analysts. With that, I'd like to turn the call over to Geoff Krause. Geoff?
Geoff Krause: Thanks, Todd, and good morning, everyone. Starting on Slide 4. Revenue for the fourth quarter was $42.9 million, consistent with our expectations and showing a 25% improvement over the third quarter, which was adversely impacted by the Delta variance. For the full year, revenue in 2021 of $147.6 million declined 14% from 2020 levels, as we continue to be challenged with project deferrals and market uncertainty related to the pandemic. The majority of the decrease occurred in the first quarter of 2021, when the full impact of the contraction in construction activity was experienced and again in the third quarter with the resurgence of the Delta variance. Turning to Slide 5. Gross profit for the quarter was 19.6%, a decline from 27.4% for the prior year period, but a significant sequential improvement from the third quarter. For the full year, gross profit was 15.9%, a decline from 31.1% for the full year of 2020. Of the 15.2% difference in gross profit as a percentage of revenue in the year ended 2021 versus 2020, approximately 6% related to higher material, transportation and packaging costs, 2% to negative fixed cost leverage, 2% to the incremental South Carolina facility fixed cost and 2% of the stronger Canadian dollar with the balance related to inherent labor inefficiency at low revenue levels and reduced timber provision reversals. Adjusted gross profit for the quarter was 25.3%, a decline from 32% in the prior year period, but again, showing strong sequential improvement from the third quarter. For the full year, adjusted gross profit declined to 23.1% from 37% in 2020. We have taken action to reverse the downward pressure on gross margins in several ways. As Todd will elaborate on, the decision to close our Phoenix plant, production overhead headcount reductions and the optimization of our order process to reduce standby production capacity are all anticipated to reduce both fixed and variable manufacturing expense going forward. Specifically, the Phoenix plant closure and our production overhead headcount reductions are expected to result in annualized cost savings of approximately $2.4 million and $2.8 million, respectively, excluding onetime costs. On the pricing side, we implemented a price increase of approximately 6.5% in November of 2021 to address inflationary impacts on raw materials, and transportations and have just announced a further 5% increase effective June 1. Looking at a breakdown of operating expenses on Slide 6. Sales and marketing expenses for the quarter increased by $1.7 million over the same quarter last year. For the full year, sales and marketing expenses increased by $3 million over 2020. The increases were largely related to increased salary and wage expense, higher depreciation and operating expenses as we completed our Chicago and Dallas DXCs, and increased travel, meals and entertainment as restrictions on travel have eased. We anticipate that travel, meals and entertainment expenses and increased marketing investment will continue as we support our sales efforts. As we stated in our press release yesterday or on Tuesday, we have finalized an organization-wide restructuring on positions that reduce our salary headcount by approximately 18%. Taking this into account, we anticipate an overall annualized saving of $4 million in our sales and marketing expenses as a result of the reduction in workforce. General and administrative expenses for the quarter increased by $2.3 million over the same quarter last year. General and administrative expenses increased $3.9 million for the full year 2021 over the prior year. Increases were attributable to higher salaries, benefits and severance costs as well as incremental professional services fees, including $0.8 million incurred in the fourth quarter. In addition, the year ended December 31, 2020, included a $1.2 million reversal of a provision in the fourth quarter relating to a claim for severance by one of our former founders and a $0.6 million credit loss, both of which were not repeated in 2021. Similar to our sales and marketing expenses as a result of the reduction in workforce and other cost savings initiatives, we anticipate an annualized net reduction in general and administrative expenses of $4 million. Operations support expenses for the quarter increased $0.2 million over the same quarter last year, and technology and development expenses increased $0.3 million for the quarter over the same quarter last year. On an annual basis, both operations support and technology and development expenses remained consistent with 2020. The cost reduction initiatives are expected to result in an annualized reduction in operation support expense of approximately $1 million and an annualized reduction in technology and development expense of approximately $1 million. Similar to adjusted gross profit, operating expenses were also impacted by the stronger Canadian dollar on Canadian-based operating expenses in 2021. Looking at the full 2021 year, we estimate that impact to be about $2.7 million. On Slide 7, adjusted EBITDA and adjusted EBITDA margin for the quarter decreased to a $9.7 million loss or negative 22.7% versus a $2.9 million loss or negative 6.8% in the same quarter last year despite slightly higher revenue levels. This reflects the decrease in adjusted gross profit described earlier, largely impacted by inflationary pressures on material, transportation and packaging and increased operating expenses also previously discussed. For the full year, adjusted EBITDA and adjusted EBITDA margin decreased by $34.1 million to a $41.3 million loss or negative 28.0% in 2021. This decrease primarily reflects a $29.4 million decrease in adjusted gross profits and increased operating expenses, as previously discussed. On Slide 8, net loss for the quarter increased to $16 million or $0.19 net loss per share for the quarter from a net loss of $4.2 million or $0.05 net loss per share for the same quarter last year. This is a result of a $3.1 million decrease in gross profit, a $6.2 million increase in operating expenses, including a $1.4 million goodwill impairment expense, a $0.9 million increase in interest expense as a result of the convertible debenture issuances in the year, and a $2.9 million decrease in government subsidies due to the suspension of the Canadian emergency wage subsidy in October of 2021. These increases were offset by a $0.5 million decrease in income tax expense and an $0.8 million decrease in foreign exchange loss. For the full year, net loss increased to $53.7 million or a negative $0.63 or $0.63 net loss per share for the year ended December 31, 2021, compared to a net loss of $11.3 million or $0.13 net loss per share for the year ended December 31, 2020. The results are largely driven by a $29.8 million decrease in gross profit, a $10.8 million increase in operating expenses, including $1.4 million of goodwill impairments, and a $2.4 million increase in stock-based compensation expense, a $2.8 million increase in interest expense as a result of the convertible unsecured subordinated debenture issuances and draws on our leasing facilities, and a $1.3 million decrease in government subsidies. These decreases were partially offset by a $2.3 million decrease in income tax expense and a $0.2 million decrease in foreign exchange losses. Turning to Slide 9. We finished the year with $60.3 million of unrestricted cash compared to $43.3 million at September 30, 2021. This reflects net proceeds of $25.6 million from the convertible debenture offering completed in December and cash usage of approximately $10 million. Cash used in operations was $7 million, an improvement from the third quarter of 2021, while capital expenditures were $1.9 million and debt repayments under our leasing facilities were $0.6 million. Days sales outstanding, net of deposits, income taxes and government subsidies receivables continue to run at under 30 days. Net working capital at December 31, 2021, was $66.7 million compared to $53.5 million at December 31, 2020, and includes the $60.3 million of unrestricted cash balance and $3.1 million of restricted cash as per the terms of our undrawn credit facility. Our current ratio at December 31 was 2.8x compared to 2.7x last year. In summary, as we look forward to 2022, we currently anticipate first quarter '22 revenues to be between $38 million and $42 million. We are budgeting for annual 2022 revenues between $170 million and $180 million. This is based on a project pipeline at December -- at January 1, 2022, of $302 million. We are increasing our transparency around our pipeline and expect to disclose a 12-month forward-looking pipeline each quarter. This is visibility into the projects and opportunities that our team is chasing which are in various stages of development from early stage negotiations and bidding to awarded contracts. Historically, we've seen a conversion rate on this pipeline at an average annual rate of around 55%. Our Pipeline relates to potential product and transportation revenues only and exclude service and license revenues, which are incremental to these numbers. Based on budgeted annual revenue levels and considering the initiatives we announced on Tuesday, and excluding the related onetime restructuring costs, which we expect to be incurred during the first and second quarter of this year and to total approximately $5 million, we anticipate that our annual adjusted EBITDA loss and net loss will demonstrate a significant improvement from 2021 levels and shift to positive adjusted EBITDA in 2023 and with a corresponding decrease in net loss. Let me turn things back to Todd.
Todd Lillibridge: Thanks, Geoff. Geoff's outlook referenced some of the changes we announced earlier this week, and I would like to speak more directly to those beginning on Slide 10. Let me begin, though, with some observations from what has been a little over 30 days on the job as interim CEO. First, I cannot overstate the commitment and the capabilities of our leadership team here at DIRTT. They have surfaced actionable, well-fought ideas that have ultimately become the initiatives and modifications to our strategic plan that we announced over the past days and will serve to reset priorities and guide our return to profitability, which will enable us also to return to growth. Second, I've had the good fortune to speak to many of our partners. In fact, I've been doing this since I became Board Chair. And what I'm hearing from them has been very consistent over that period of time. They love DIRTT's construction system. They believe DIRTT can and should be a growing part of their business, and they want to see us succeed. While we have competitors, there is limited competition to our full-scale solution, which works across multiple verticals. For us to be successful, we need to leverage their insights. Earlier this week, I connected with roughly 200 partner representatives who joined in person and online at a fireside chat. It was a very valuable session and gave us a chance to announce our new partner Advisory Council. This will be a forum where our team can work in close collaboration with our partners to better pursue opportunities and overcome challenges. There was an overwhelming support for this initiative than others. The council will start April 1, but I will be meeting with a large group again next week answering questions that have come out regarding the changes we have recently announced. We need to listen, learn and take action based upon a partner telling us. However, the biggest concerns they have expressed to me is our financial strength. They want us to make the necessary changes to get us on better financial footing. The initiatives that we have been making over several months and have taken on greater urgency clearly as a result of third quarter results. While I am new to the management position, I've been on the Board for several years and became Board chair last year. The drive to adapt our strategic plan started there, and my job over the last month has been to operationalize those ideas along with our management team. And thanks to their combined efforts, we got to where we are this week with our thoughtful optimization plan. So let me run through some of the key changes we have announced. If you turn to Slide 11, our master facility plan is structured such that we have a robust manufacturing capabilities in both the East and West. We will expand our aluminum manufacturing in Calgary and Savannah. Productivity gains from process improvement have made it possible to support our customers' current and future needs using these plans. This will allow us to close our Phoenix facility, affecting approximately 26 positions. We will realize annualized cost savings of approximately $2.4 million, and our closing the Phoenix should occur by the end of the second quarter. We will expand capabilities in Rock Hill to include Thermofoil panels and back-painted glass. This can be done with no material capital cost as we will transfer existing equipment from other facilities, including Phoenix. The move will reduce shipping time and cost for our Thermofoil panels to customers located in the East and Midwest. Furthermore, it leverages the state-of-art automation of Rock Hill to improve overall production efficiency, and we eliminate single factory risk. After these changes, we retained physical manufacturing capacity of close to $500 million in annual revenues. This is sufficient to remain responsive to fluctuations in demand and to accommodate mid-term growth. By altering our order process as outlined on Slide 12, we believe we can facilitate a reduction in standby protection capacity, effective May 1, our current standard payment terms for our clients will be on shipment instead of order. By separating deposit requirements from order placement, we believe we can encourage earlier order entry, thereby improving both revenue forecasting ability and production scheduling. We anticipate that longer term, we can reduce standby production labor capacity by up to 20% with this greater visibility. Geoff referenced a 5% price increase in response to continued inflationary impact on our material costs. At the same time, we are identifying those areas where we can be more aggressive on reducing pricing to capture greater market share. This includes our reflect and inspired lines of glass wall products and our Applied Headwalls, which are a compelling stand-alone product that works in harmony with base building. And again, these are the kinds of changes that our partners widely support. In our announcement, we referenced an organizational-wide restructuring that will see the elimination of approximately 18% of our salaried workforce affecting 102 individuals, including those in Phoenix. Reducing our expenses is a critical step on the road to profitability, and we have done this without impacting our continued ability to meet the needs of our customers. Turning to Slide 13. We cannot simply cut our way to growth. To better capture new opportunities, we will rebrand and reposition DIRTT so that we are seen as an enabler with the emphasis on elevating clients and their outcomes as their ability to use the DIRTT construction system. A formal rebrand will launch later in Q2, but the positioning is already taking shape with customers as they restart delayed projects or launch new ones. So let me illustrate a few examples. We have been working with a leading global technology company on reconfiguring 3 of their campuses. That work got underway in 2021. However, multiple projects were delayed because of the pandemic. They have now shifted into this year, and our pipeline now has more than 2x the level of work in 2022 from this one client. There is ongoing change in banking as financial institutions are finding the need to downsize larger brands, build smaller ones and make better use of the spaces they currently own. This has led to a win for us with a global financial services firm this year with significant potential for additional scope and expansion. We are also working with several branches of a regional bank which has opened the door for us to grow the business over the next 2 years. In health care, we are seeing continued shift from inpatient to outpatient or ambulatory care. This allows patients to access all types of treatment closer to home and in the community setting. DIRTT's speed to market solution is proving to be a considerable interest to both regional and national health care organizations as they expand their presence through design standardization. We are further helped in health care through our work with Premier as a national group purchasing organization or GPO, which gives us a broader market exposure throughout the U.S. It is important to underscore that our work in health care is at a much larger scale. We are effectively leveraging our clients' growing footprint, and we are working with major multistate health systems, where if we are successful in selling our systems once it will get to pull through multiple locations. And there are additional examples in education and the government I could talk to you about as well, all of which points to a very encouraging signs of improvement. Our strategic accounts team has played a critical role in establishing relationships with many of these organizations over the past 2 years. While getting these larger clients on board take longer, they realize some of the greatest benefits of DIRTT's value proposition. For us, they offer considerable scale and are expected to increasingly contribute to our sales pipeline and to drive profitable growth. Two new initiatives will also help us improve sales and profitability. Our ICE software is critical to our partners and clients as it allows them to envision and design their spaces. We will make new investments to include more core products and improve its ease and use. The focus on core product drives sales of higher-margin products, and we announced a new product development filter to support that effort. Concluding on Slide 14. Many of these changes reflect what our partners and our customers want to see. They want to see an easier ability to work with their and they want to have continued predictability in our schedules and costs that have always delivered. It is a difficult balancing act and the changes we are introducing are complex and necessary and can only be accomplished with a leadership team as well as a Board and management team. Our directors have a rich multidisciplinary experience in verticals in which we operate and the technology that drives our business. They started this process several months ago, and my job stepping into the interim CEO role has been to unleash our leadership team and allow them to execute our plan. Management is taking charge of these changes. And through their combined efforts, we have a plan that will result in an overall reduction in annualized operating expenses, excluding onetime costs of approximately 14%. Rightsizing our organization and taking advantage of changing market dynamics gives us the momentum that we need here at DIRTT. We believe the changes we announced this week, coupled with the encouraging signs we are seeing in the marketplace, puts us on the track to profitability within the next 18 months. I think this is a good place to stop. Please open up the call for questions. Thank you.
Operator: And your first question comes from the line of Greg Palm from Craig-Hallum.
Greg Palm: I wanted to start with guidance. Frankly, a little bit surprised that you put some numbers out there just given kind of past visibility. So can you maybe talk a little bit about sort of the decision to put some guidance out there? And then maybe more specific appreciate the pipeline commentary. But curious what else sort of seen out there in terms of quoting. It seems like this sort of back to office is certainly accelerating in recent weeks or months. So just kind of curious what maybe gives you the confidence that we might see some growth here in the months and quarters to come.
Geoff Krause: I'll take the first part of that question, and I'll throw it over to Todd for the second part. As it relates to guidance, we have received numerous questions from shareholders and analysts like yourself to provide visibility into what we are seeing in our overall pipeline. We've been tracking pipeline for quite a long time. And ever since I joined these 3.5 years ago, we've been working very hard to improve that process, improve the tracking around those processes and those sorts of things. That includes putting in place a CRM system, but also improving the accountability that goes along with that. As we moved into this year and looking at where we're at, and looking as we come out of the pandemic, we feel good looking at kind of that base pipeline level. We believe that there are incremental factors associated with that. But I think it's also fair that our investors have a better view as to what's going on in the business. And by reporting a 12-month forward pipeline, we can show whether we are growing or not with that 12-month moving forward and how it is shifting. With that, I'll turn it over to Todd in terms of the other pieces.
Todd Lillibridge: And I think a couple of comments that I would hit on as it relates to pipeline and probably more importantly, what we're seeing. As I mentioned in my remarks, having been on the job now for the last 30 days, but again, having a good portion of reaching out to a number of our partners over the last 6-plus months, I think I would say the following from kind of external intel to include probably the 20 calls that I've had directly with partners over the last 30 days. And there's no doubt they're seeing a pickup, certainly in activity. And I think that's just the reality of kind of where we are relative to back to work. I think there's no doubt, though, that the back-to-work environment will in fact look like, feel like a true hybrid model. In that hybrid model, as I think we all are learning to embrace in some form or fashion, will be a fairly substantial percentage of collaborative space, huddle rooms, private offices and then what I would say, technology that will be embedded in conference areas will clearly -- will be part and parcel of that. So the combination of not only partners, but I've also had the good fortune of speaking directly with a couple of our clients in the financial institutions. And I think that the financial institutions are also seeing the need to gain market share through their branch banking expansion exercise. That's as much of how to fill white space with get their facilities out into the market in face of the consumer, take deposits. But again, it's as much of a marketing strategy. And then we're seeing a huge pickup, obviously, in health care. It is a growing percent of our business overall. And I think that just comes from, again, the consumerism that is occurring in health care, the necessity to put all levels of care back into the community and closer to the patient. And I think we've seen that. I've seen that in my 30-some-odd years in health care as a growing trend. And I think, again, as I commented earlier, that DIRTT is extremely well positioned there. But I also have spent a fair amount of time in my 30 days with our internal teams, both at the strategic accounts level, who are obviously out talking to a number of organizations throughout the 4 verticals. And they, too, are seeing activity that is beginning to pick up as we kind of go on the other side of what the mandates and the lifting of mandates throughout the U.S., which again, we think is a positive impact. But again, I don't think it's a gold rush yet, but I do think these are positive signs that really position DIRTT for the future.
Greg Palm: Geoff, I don't know if I missed it or if I didn't. Maybe you're willing to disclose. But how is average daily order activity been quarter-to-date or year-to-date versus what you saw in Q4?
Geoff Krause: We haven't disclosed it, but I'd say it's reasonably consistent looking at what the revenue guidance that we've given for the first quarter is relative to what we did in Q4.
Greg Palm: And Todd, just backing up to my question. I think you were sort of alluding to this, but obviously, a lot has changed in the last few years as it relates to the workplace. I mean how do you think DIRTT's value proposition has changed over this period as well?
Todd Lillibridge: Well, I don't think the value proposition has necessarily changed. I think that the market has changed clearly and therefore, the necessity for what we have to offer, I think, has come into a brighter focus, clearly, because the solutions that we have from the glass wall all the way through to a full solution is very suitable to the hybrid model. There isn't a better connection between what we have to offer and what the market is in pursuit of. The days of a traditional full office with a bunch of private offices is over. And I think the reality is that corporate America is seeing necessity to create environments in which their employees are willing not only to come back, but to remain, for some stay, whether that's 1 day, 2 days or 3 days. It is really now a place to touch down, to network, to collaborate and to interact. It's not to come and sit for 5 days, as they traditionally have done. You don't need to come into an office to sit and have private time. You need to come and collaborate with others. Therefore, conference rooms, huddle rooms, and all of the rooms that we're talking about and the spaces that DIRTT creates is extremely consistent with what our clients are looking for. And therefore, it gives us the optimism that we believe will get out of the workforce, at least the workforce environment. Keeping in mind, that's a good 55%, almost 60% of our business. And obviously, we look forward to that sector and vertical to recover. But we're also seeing activity and as I said, in our other verticals, which is very encouraging as well.
Greg Palm: And I guess just last one is more of a housekeeping. But the $10 million in cost savings, does that include legal fees that you may not be incurring going forward as it relates to some of the dismissals of the lawsuits?
Geoff Krause: Yes. There's a portion of that as well.
Greg Palm: That's included or that would be in addition?
Geoff Krause: No, that is included. Yes, it's part of included in cost savings.
Operator: Your next question comes from the line of from National Bank.
Unidentified Analyst: My question is related to the cash burn rate that you're expecting in 2022. Do you think your current cash balance is going to be sufficient to fund your operations until you turn cash positive, some were in 2023?
Geoff Krause: The incremental monies that we brought in as a result of the debenture issuance that we did in December 1 increased -- certainly increased our overall cash balance, which you would have seen. I think it is fair to say that as a result of both the timing of when these optimization efforts have been announced and are occurring, combined with the amount of the restructuring costs, we will see a fairly significant cash burn in Q1. But with those costs then removed and an improving environment and also driven profitability, it reduces that cash burn significantly. I think the other piece to note is when you look at '21, we did about $14 million of capital expenditures. We've significantly pulled that program back to $7 million this year, given that we've completed the Rock Hill plant. We've completed the very successful Dallas DXC and our Chicago DXC. And so I would say '22, from a CapEx perspective, is more of a maintenance mode.
Unidentified Analyst: And just as a follow-up, how should we look at the cash drag from the new payment terms? So the deposits now being required on shipping rather than on order.
Geoff Krause: We figure it's about a onetime working capital impact of probably about $1.5 million to $2 million. Remember, this is only -- we're only talking a 2-week period. So 2 weeks -- moving from 2 weeks on order to 2 weeks to ship. So it's not a very long period where that's moving. The second piece is we have, over the course of, I guess, I would say, eternity, had situations where we are willing to waive those deposits or in circumstances, where we're unable to get them from government agencies. So it's not across every single order. It is across a portion of orders, but it's about $1.5 million to $2 million, which would be a onetime move.
Unidentified Analyst: And one last one, if I may. You mentioned $7 million is your CapEx program for 2022. Does that include your rebranding and new investments in your ICE software? Or should we see those expenses as in addition to the CapEx?
Todd Lillibridge: It includes rebranding and new websites and those sorts of things. It does include our ongoing development and investments in ICE. And we are continuing to evaluate different approaches where we can accelerate that, although those are in early stages right now.
Operator: And there are further questions at this time. And there are no further questions at this time. I'll hand it back over to Todd for any closing remarks.
Todd Lillibridge: In closing, the changes we have discussed today have been in the making for several months, and they are complex but necessary to return us to a path of profitability. And I remain as confident as ever in this opportunity as it lies ahead for us. Again, I would like to thank you again for taking the time to be with us today. Thank you so much.
Operator: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.
