DIRTT Announces 2019 Third Quarter Financial Results
DIRTT Environmental Solutions Ltd. (“DIRTT,” the “Company,” “we” or “us”) (TSX: DRT, NASDAQ: DRTT), an interior construction company that uses technology for client-driven design and manufacturing, today announced its financial results for the three months ended September 30, 2019. All financial information in this release is presented in U.S. dollars, unless otherwise stated.
THIRD QUARTER 2019 VS. THIRD QUARTER 2018
- Revenue of $65.4 million vs. $73.9 million (down 12%)
- Gross Profit Margin of 38.1% vs. 40.7%
- Adjusted Gross Profit Margin of 41.8% vs. 44.0%
- Operating expenses of $17.6 million vs. $30.4 million
- Net income of $5.8 million or $0.07 per share vs. net loss of $(1.4) million or $(0.02) per share
- Adjusted EBITDA of $8.1 million vs. $13.1 million
- Adjusted EBITDA Margin of 12.3% vs. 17.7%
(2018 Operating expenses include a $6.1 million impairment, $2.2 million reorganization costs and $2.0 million of stock-based compensation expense. 2019 Operating expenses include a $2.4 million recovery of stock-based compensation)
THIRD QUARTER 2019 RESULTS
Kevin O’Meara, DIRTT’s chief executive officer, stated: “Our third quarter revenue of $65.4 million was 12% below the same quarter of 2018. Several factors continue to impact our 2019 revenue, including the disruption to our salesforce and distribution partner network from 2018’s management transition, the impact of an immature go-to-market approach, an inadequately supported sales force working on a long sales-cycle, as well as the revised timing of various projects and the loss of certain expected projects. It has become clear as the year progressed that the sales and marketing organization with which we entered 2019 has been unable to deliver on the opportunities identified and on which our prior guidance was based, and therefore, we anticipate fourth quarter revenue to be lower than expected. This has been driven largely by a historical lack of training, individual accountability and necessary processes and tools. Our belief in the size of our market opportunity — and the resonance of DIRTT’s value proposition within it — remains unchanged. Accordingly, we have embarked on a comprehensive transformation of these functions that we believe will create a scalable platform from which to generate profitable growth.
“During the quarter, we took significant steps to establish DIRTT’s commercial function. We began implementing our comprehensive sales and marketing strategy, which includes newly established sales roles to support growth, dedicated resources to strategic national accounts, and the creation of marketing programs, systems and communications to drive lead generation. Our commercial function is being spearheaded by our new chief commercial officer, Jennifer Warawa, who joined DIRTT effective September 16, 2019. While the expected benefits of these initiatives take time to realize, we believe they are the foundation of a robust and sustainable approach to generating future sales growth.
“Brandon Jones has joined DIRTT as vice president of strategy, effective September 30, 2019. He will be responsible for the project management of DIRTT’s commercial strategy implementation, supporting Ms. Warawa. Mr. Jones was most recently a project leader for the Boston Consulting Group and has a mechanical engineering degree from the University of Southern California and an MBA from the University of Chicago. He also served as a commercial general contractor for eight years prior to earning his MBA.
“In our manufacturing operations, we have been moving ahead with a metrics-based approach to lean manufacturing within our facilities, with a focus on Safety, Quality, Delivery, Inventory and Productivity (SQDIP). This approach is being implemented in all our facilities, along with related systems, and has begun to yield improvements. These improvements were offset, however, by lower leverage on fixed manufacturing costs and underutilized labor capacity from lower-than-expected revenue. Adjusted Gross Profit Margin decreased to 41.8% in the third quarter of 2019, compared to 44.0% in the third quarter of 2018. Accordingly, Adjusted EBITDA also decreased comparatively to $8.1 million, or 12.3% of revenue, reflecting both the lower sales and decreased gross margin, offset by a $1.3 million reversal of a claims provision.
“Moving forward with our manufacturing capacity expansion, in early October we entered into a lease agreement for our previously announced combined tile and millwork factory. The new facility will be located in the Charlotte metropolitan area, less than 30 minutes from the Charlotte Douglas International Airport in North Carolina, and will include a world-class DIRTT Experience Center (DXC). Charlotte Douglas is one of the busiest airports in the United States, and the new DXC will serve as our east coast sales and marketing hub.
“We expect the total cost of this new facility to be approximately $18.5 million, excluding the cost of the DXC, for which planning is currently underway. In August 2019, we paid $1.6 million to equipment suppliers for customized equipment for this facility that has an anticipated delivery in the second half of 2020. We expect this new location to maximize DIRTT’s production efficiency, allow us to better serve our customers geographically, and afford us the capacity to support growth while maintaining our rapid manufacturing lead times. We expect commercial operations to begin in the first quarter of 2021.
“Trading of our common shares on The Nasdaq Global Select Market (“Nasdaq”) commenced October 9, 2019. As a result of the listing, DIRTT’s financial statements are now reported under the accounting principles generally accepted in the United States (“GAAP”) and in U.S. dollars. We also ceased our offering of a cash-surrender option for employee stock options. Year-to-date one-time costs of the Nasdaq listing are approximately $2.5 million, and we expect to incur approximately $0.5 million of additional costs in the fourth quarter of 2019.
“Within the area of product development, Geoff Gosling, director of innovation, has decided to retire. Mr. Gosling, who ceased to be an executive officer earlier in the year, was one of DIRTT’s founders and our first leader of product development, and was one of the principal inventors of DIRTT’s solutions. His retirement will allow for him to spend well-deserved time with his family.
“Colin Blehm, who has been with DIRTT for over 15 years and has led the product development team for the last nine months, has been named vice president of product development and will continue reporting to me in this capacity. Mr. Blehm led the development of the groundbreaking Reflect™ ultra-minimalist wall we announced in October, and he is also responsible for leading efforts on a number of product innovations that resulted in patents for DIRTT. Prior to joining DIRTT, Mr. Blehm worked with Evans Consoles in the areas of product development and research and development.
“We began this year with the expectation that our fiscal 2019 revenue would be 5% to 10% higher than our 2018 revenue, with corresponding increases in net income and adjusted EBITDA. With increasing recognition of challenges associated with the overall management changes and the immature nature of our commercial function, we revised our expectation downward as the year progressed. In addition, we said that we expected Adjusted EBITDA to be impacted by certain one-time costs related to the sales and marketing plan, Nasdaq listing, and operating consulting costs. Management now expects 2019 revenue to be 7% to 10% lower than 2018 revenue, which equates to estimated fourth quarter revenue of between $52 million and $60 million. Management also expects Adjusted EBITDA to be negatively impacted by deleveraging of fixed costs on lower revenue.”
Mr. O’Meara added: “While 2019 has been a challenging year and we are clearly not satisfied with the results, it is a transition year. We have made significant strides toward enhancing our management team, our commercial organization and marketing strategy. Despite the revenue decline and associated one-time consulting and listing costs, we expect to exit 2019 in a strong financial position with a net cash balance at least equal to last year and increased liquidity from a larger credit facility.”
The Company’s Analyst Day for institutional investors and securities analysts is scheduled for November 12, 2019 in New York City. At that time, DIRTT’s management team will present the Company’s long-term growth strategy, including revenue and Adjusted EBITDA targets the Company is working to achieve by the end of 2023.
THIRD QUARTER FINANCIAL REVIEW
Revenue decreased in the three months ended September 30, 2019 by $8.5 million or 12% compared to the same period of 2018. Revenue decreased due to several factors, including the impact of a large healthcare project in 2018 that was not replaced in 2019. We also believe the distraction from significant management changes during 2018 on a long sales cycle combined with the current immature and transitional state of our sales and marketing function limited our ability to take advantage of the growth opportunities in our market. The recent enhancements to our organizational structure and senior management team have not yet positively affected sales due to, we believe, our long sales cycle.
Gross Profit / Gross Profit Margin / Adjusted Gross Profit / Adjusted Gross Profit Margin
Gross profit and gross profit margin decreased to $24.9 million or 38.1% for the three months ended September 30, 2019, from $30.1 million or 40.7% for the three months ended September 30, 2018. The decrease is largely due to an increase in unused labor capacity and reduced fixed cost leverage on lower revenue levels. Reductions in direct material and transportation costs, due to improved efficiency and product mix, offset the incremental material costs of $0.8 million (1.0% reduction in gross profit margin) that is expected to mitigate warping of our tiles.
Adjusted Gross Profit and Adjusted Gross Profit Margin decreased to $27.3 million or 41.8% in the third quarter of 2019, from $32.5 million or 44.0% in the same period of 2018, for the reasons described above.
Sales and marketing expenses
Sales and marketing expenses decreased $1.4 million to $8.6 million for the three months ended September 30, 2019, from $10.0 million for the three months ended September 30, 2018. Included in sales and marketing expenses in the three months ended September 30, 2019 were $0.7 million of one-time consulting costs related to a sales and marketing plan that was developed with the assistance of an internationally recognized consulting firm. This cost was offset by a $1.5 million reduction in commission expense on lower revenues. Additionally, we continued to benefit from decreases in travel, meals and entertainment costs as well as cost reductions related to trade shows. None of these expense reductions are expected to materially affect our future sales revenue.
General and administrative expenses
General and administrative (“G&A”) expenses increased $0.1 million to $7.3 million for the three months ended September 30, 2019 from $7.2 million for the three months ended September 30, 2018. Included in G&A was $1.4 million of one-time costs related to the Nasdaq listing incurred in the third quarter of 2019, offset by a $1.3 million reversal of a claims provision. Beginning in 2020, we anticipate incremental annual non-listing related costs as a result of becoming a U.S. registrant of approximately $1.5 to $2.0 million, driven largely by increased director and officer insurance premiums and the costs of maintaining two listings, as well as expected increases in audit, legal, and other compliance costs.
Operations support expenses
Operations support expenses increased $0.5 million to $2.4 million for the three months ended September 30, 2019, from $1.9 million for the three months ended September 30, 2018, largely due to an increase in consulting costs during the quarter. The consulting costs incurred were to assist with the evaluation of current operations and the rectification of the tile warping issue and increases in personnel costs due to increased headcount and an increased provision for variable compensation.
Technology and development expenses
Technology and development expenses increased $0.8 million to $1.7 million for the three months ended September 30, 2019, compared to $0.9 million for the three months ended September 30, 2018. The increase is due to a $0.3 million decrease in capitalized salaries for the three months ended September 30, 2019, as the current mix of projects undertaken included a higher portion of efforts related to business process improvements that were not eligible for capitalization. Additionally, we had a higher provision for variable compensation in the three months ended September 30, 2019, and $0.3 million additional salary and benefit costs were classified as cost of sales of technical services during the period.
Stock-based compensation reflected a $2.4 million recovery for the three months ended September 30, 2019, compared to an expense of $2.0 million for the same period of 2018. We recorded fair value adjustments on cash settled stock options during the three months ended September 30, 2019 with no fair value adjustment required in the respective prior year periods. Following our listing on the Nasdaq on October 9, 2019, we ceased allowing cash surrender of options. As a result, we will cease the associated liability accounting for our stock option plan, which required quarterly fair value adjustments while the cash surrender option was allowed.
Net income was $5.8 million or $0.07 per share in the third quarter of 2019, compared to a net loss of $1.4 million or $0.02 net loss per share for the third quarter of 2018. The variances are the result of changes in gross profit and operating expenses as described above. Net income for the three months ended September 30, 2019 includes a $2.4 million recovery in stock-based compensation, compared to a $2.0 million expense in the same period of 2018, and no reorganization or impairment expenses for the three months ended September 30, 2019, compared to $2.2 million and $6.1 million, respectively, in the same period of 2018.
Adjusted EBITDA / Adjusted EBITDA Margin
For the three months ended September 30, 2019, Adjusted EBITDA and EBITDA Margin decreased to $8.1 million or 12.3% from $13.1 million or 17.7% in the same period of 2018. This reflects the $5.2 million decrease in Adjusted Gross Profit, the impacts of $2.4 million of one-time costs in operating expenses (which included $0.7 million related to the Sales & Marketing Plan, $1.4 million of Nasdaq listing costs, and $0.3 million of operations consulting costs) partially offset by ongoing cost reductions, the reversal of a $1.3 million provision and a $0.5 million increase in foreign exchange gains.
Liquidity and capital resources
Cash and cash equivalents at September 30, 2019 totaled $56.6 million, an increase of $3.2 million from December 31, 2018. In July 2019, we entered into a C$50.0 million revolving operating facility with the Royal Bank of Canada (the “RBC Credit Facility”). Drawdowns under the RBC Credit Facility are available in both Canadian and U.S. dollars. The RBC Credit Facility replaced the $18.0 million revolving operating facility with Comerica Bank that expired on June 30, 2019.
To discuss these financial results in greater detail, a conference call and webcast for the investment community was held on Friday, Nov. 8, 2019, hosted by Kevin O’Meara, chief executive officer; Geoff Krause, chief financial officer; and Kim MacEachern, director of investor relations. A replay of the call and webcast will be available until 9:59 p.m. MST (11:59 p.m. EST) on November 15, 2019:
- By phone at +1-855-859-2056 with passcode 2577557;
- Online at https://edge.media-server.com/mmc/p/4aj92y9h; and
- On DIRTT’s website at dirtt.net/financial-reports.
DIRTT is a building process powered by technology. The Company uses its proprietary ICE® software to design, manufacture and install fully customized interior environments. The technology drives DIRTT’s advanced manufacturing and provides certainty on cost, schedule and the final result. Complete interior spaces are constructed faster, cleaner and more sustainably. DIRTT’s manufacturing facilities are located in Phoenix, Savannah and Calgary and the Company works with nearly 100 sales construction partners globally. DIRTT trades on the Nasdaq under the symbol “DRTT” and on the Toronto Stock Exchange under the symbol “DRT.” For more information, visit dirtt.com/investors.