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Thank you for standing by, and welcome to DIRTT's 2021 Q1 Financial Results Conference Call. [Operator Instructions]It is now my pleasure to hand the conference over to Ms. Kim MacEachern. Please go ahead.
Thank you, operator, and good morning, everyone. Welcome to today's call to discuss DIRTT's First Quarter 2021 Results. Joining me on the call are DIRTT's Chief Executive Officer, Kevin O'Meara; 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 or on our website. 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 5, 2021 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 now turn the call over to Kevin.
Thank you, Kim, and thank you to everyone joining us today. Beginning on Slide 4. As we discussed in February when we released our year-end results, we expected the slowdown in the first half of 2021 compared to the fourth quarter of 2020. Projects that were in flight when the pandemic commenced were largely completed in 2020, and as a result, sales in the first quarter of 2021 bore the full brunt of the COVID induced downturn in North American nonresidential construction activity. We believe this quarter's revenue of $29.5 million represents our low point in the pandemic-impacted operating environment. It should be noticed this $29.5 million does not include approximately $2 million from the COVID vaccination trailers we sold in February, an order we discussed on our last quarterly call and which were delivered in April. We are reasonably confident revenues in the second quarter will be at or near the quarterly revenue range we experienced in the first half of 2020. We also remain cautiously optimistic that robust government stimulus plans across North America and the growing success of vaccination rollouts will increase business confidence and drive a recovery in the second half of 2021. The specific timing and magnitude of this recovery remains uncertain, and thus results are still subject to the effects of the pandemic. Additional waves of infections, such as the one Canada is currently experiencing due to the prevalence of COVID-19 variants, can create individual project delays and uncertainty, thereby, impacting the timing of sales.In addition, supply chain delays with other billing trades that come before us in the construction process can delay projects, and thus, our sales. Similar to what we experienced with the vaccination trailers, a few days movement in the shipping of around the end of a reporting period can shift revenue from 1 quarter to another. Despite the onset of COVID-19 last year, our commitment to the prudent execution of our strategic plan has been relentless, including our approach to creating commercial organization capable of driving the aggressive sales growth and market penetration, I believe to be possible when I joined DIRTT in 2018. This commitment positions us to take advantage of a resumption of normalized activity in nonresidential construction to grow sales. We're encouraged by the growing customer engagement we see through increase demand for tours, both virtual and in-person, at our DIRTT experience centers and an ongoing high level of project quoting activity. While we're unable to quantify quoting activity into a reported backlog, we see ample anecdotal evidence that our new commercial capabilities are working synergistically to allow us to speak to a broad range of prospective clients in a more coherent, coordinated and thoughtful manner than ever before. This is evident across all 3 focus areas within our sales force, which includes our territory sales reps our segment sales specialists, including health care specialists and our strategic accounts team.To support all these areas and our distribution partners, our strategic marketing team has been working closely with both our product development group and our sales team to strengthen how we convey our value proposition. They've developed sales tools to illustrate the breadth of our unique capabilities while also conveying the depth and specificity of our offering in some of the more technical aspects of construction including acoustics and power network integration. The strategic marketing team also continues to evolve our brand awareness, strengthening our voice in the market as a thought leader and generate a growing pool of sales lead. Our total cost of ownership, or TCO tool, is beginning to generate results. With the use of the tool to guide the conversation, we recently won a project working with a premium architectural firm. Although they were historically reluctant to embrace DIRTT, the detailed articulation of our value proposition over the life of a project won them over and empowered them to deploy their newfound knowledge of DIRTT to convince their clients to build with DIRTT. Moreover, it helped transform what was initially a $50,000 glass front project into a full solution sale many orders of magnitude larger. Simply said, the TCO tool makes it easier to compare and contrast the conventional construction process with the DIRTT project as well as quantify the day 1 economics and long-term value DIRTT brings. We are optimistic the clarity it brings to the sales conversation is resulting in deeper understanding, support and enthusiasm for DIRTT. Organizationally, our regional sales directors have now been in place for over year and are working well with our partnered network to leverage their relationships into sales opportunities. Our strategic accounts team is increasing the relationships in development which now stand at 40 versus 35 at year-end. The culmination of this work is that we are seeing opportunities to compete for projects of all sizes and are doing so more confidently and with a clear articulation of our value proposition. As construction activity picks up and building programs resume at a more normalized pace, the groundwork we have relayed in establishing our organizational capabilities, developing relationships and actively pursuing early stage sales conversations, will put us in a competitive position to win projects. Further increasing our competitiveness in these new sales opportunities is our Rock Hill, South Carolina facility, which began producing salable tiles during the month of April with full commissioning on track for early June 2021. As a reminder, this new facility, which is highly automated, operates with approximately 1/6 of the labor required for similar production capacity in our Calgary plant, reduces single-plant risk and increases our total tile capacity. Physical proximity to customers located on the East Coast resulted in an improvement of up to 4 days in shipping time with commensurate reductions in freight costs for the end customer. Adding this facility to our existing operations ensures we have ample manufacturing capacity to compete for large projects. From a broader market perspective, we monitor conventional construction closely as we believe that is our biggest competitor and where we have the greatest opportunity to gain market share. In conventional construction, we are observing increases in the price of steel and wallboard as well as shortages of some raw materials. This is negatively impacting project budgets, and in some cases, delaying project schedules. As DIRTT is installed in the final stages of a project, any pre-installation schedule delays risk negatively impacting the timing of project delivery. However, we ultimately believe the current challenges facing conventional construction have the potential to drive demand for DIRTT due to the increasing price competitiveness of our solutions as well as our ability to help preserve project schedules with our short lead times. DIRTT's 2 largest raw material inputs are medium density fiberboard and aluminum. While they experienced some price increases, it has not been nearly to the same extent as steel and wallboard. We've largely been able to mitigate these increases through efficiency improvements in our manufacturing process to date, and we've not experienced any major raw material shortages. We further believe that increased activity, partially driven by the resulting price competitiveness between our solution and conventional construction will further allow us to absorb commodity price inflation by leveraging plant fixed cost. That said, this is something we are watching. And if we see inflation outside the bounds of which we believe we can reasonably absorb, we will take action. We also provided an update on our Falkbuilt litigation in our most recent Form 10-Q. As you will see, we've been very actively prosecuting our multiple lawsuits against our founders and their new venture, aggressively taking the fight to them. As an example, we recently defeated an application for partial summary dismissal that sought to have the restrictive covenants that we believe were clearly violated, declared and unenforceable. The Alberta court sided with us and dismissed their application, and that decision was upheld on appeal. In addition, we have been busy questioning defendants and witnesses in the Canadian case with more to come over the next few months. As we said in our 10-Q, we believe the results of the question give strong support to our allegations, and we intend to continue to pursue the case rigorously. Before concluding, I'd like to provide a quick update on our commitment to our first formal ESG report. As I mentioned last quarter, sustainability is one of the founding pillars of DIRTT. The fundamental design advantage of our solution prolongs the useful life of a built space, allowing reconfiguration and ongoing adaptability rather than creating landfill waste by demolishing and replacing conventionally built spaces. Our proprietary ICE software and deployment of lean manufacturing techniques in our plants allows us to minimize the waste generated in producing our solutions. But our commitment goes beyond that. We operate with sustainability in mind throughout our business, and we recognize the importance of transparency in all of our efforts. As a result, I'm pleased to confirm that we expect to release our sustainability report later this quarter. In conclusion, while activity levels this quarter were slow and we are not out of the woods yet in terms of the effects of COVID-19 on our business, we are confident in the progress we have made in our strategic plan. We see a market that is demanding flexibility and adaptability in their physical spaces, and this is no longer unique to a discussion of return-to-work initiatives but is more pervasively being considered in all projects. Our ability to empower people to build sustainably for the future with cost certainty and on an accelerated schedule is unique to the industry, and we are better positioned than ever before to execute on that exciting opportunity. With that, I will turn the call over to Geoff for a review of the financials.
Thank you, Kevin. As we've done in recent quarterly calls, I'm going to start with a quick review of our liquidity on Slide 5. Our working capital management focus continued in the first quarter with no reportable disruptions or delays in accounts receivable collections. Days sales outstanding, net of deposits and income taxes receivable continue to run at under 30 days. We finished the first quarter of 2021 with $58.7 million of cash compared to $45.8 million at year-end. The increase reflects $29.5 million of net proceeds from the convertible debenture issuance in January offset by cash used in operations of $12.1 million and CapEx of $3.6 million. Cash used in operations included noncash working capital usage of $4.4 million. Important to note is that subsequent to quarter end, we completed a $7.2 million draw of our U.S. equipment facility primarily related to our South Carolina plant and anticipate drawing an additional $3 million to $4 million during the second and third quarter of this year. In short, we remain in a very strong financial position, which enables us to continue the prudent execution of our strategic plan, but the flexibility to pivot quickly should we need to. Our net working capital at March 31 was $70.5 million, and our current ratio improved to 3.4x from 2.7x at December 31, 2020. Updating on government subsidies. In the first quarter, we qualified for $4.1 million through 2 Canadian government programs, the Canadian Emergency Wage Subsidy and the Canadian Emergency Rent Subsidy. From a cash perspective, in the first quarter of 2021, we received $1.7 million that was outstanding at December 31, 2020 and $2 million from the 2021 amounts, with the balance to be received in the second quarter. Both programs are considered for extension to September 25, 2021, and we will continue to evaluate our eligibility for each qualifying period. Turning to the financial results on Slide 6. Revenue for the quarter was $29.5 million, a decline of $11.5 million or 28% from $41 million for the first quarter of 2020. This reflects, for the first time, the full impact of the slowdown in nonresidential construction activity under its business. As Kevin noted earlier, this does not include approximately $2 million of revenue from the COVID vaccination trailers we discussed last quarter, as those were delivered to the customer after quarter end. On Slide 7. Adjusted gross profit was $7.2 million or 24.3% of revenue, a decline from $15.6 million or 38% of revenue for the quarter ended March 31, 2020. Adjusted gross profit margin was negatively impacted by lower revenue levels and negative fixed cost leverage as well as the inherent inefficiency that comes with these low activity levels. As a result, in the first quarter of 2021, we separately classified $1.8 million of overhead costs related to our underutilized capacity or 6% of gross profit margin in cost of sales. In the first quarter of 2020, $2 million of overhead costs were excluded from adjusted gross profit due to operating at lower than normal capacity levels in that period as well. It is important to note that we have deliberately maintained manufacturing headcount in the first quarter of 2021 despite the shortfall in revenues relative to capacity. In light of the positive indicators that Kevin described, we are preserving our skilled workforce and ability to respond to the anticipated recovery of demand in the second half of 2021. We mitigated the cost of this strategy to a certain extent by implementing planned furlough days. In addition, I would reiterate my comments from last quarter. Our variable factory labor is sticky to the downside, particularly at slow or highly variable revenue levels. There is a minimum amount of staffing we need to keep at our facilities to keep them running and responsive to activity levels. As a result, we expect adjusted gross profit to remain below historical percentages until sales improve, which, as Kevin mentioned, we believe, will begin happening in the second quarter. Turning to the breakdown of operating expenses on Slide 8. All categories were down slightly in the first quarter of 2021 compared to the first quarter of 2020. Sales and marketing expenses decreased due to the reduction in commission expenses on lower revenue and lower travel, meals and entertainment expenses as a result of ongoing COVID-19 travel restrictions. It is reasonable to assume that when the pandemic and associated restrictions ease, we will see an increase in expenses from current levels. General and administrative expenses declined as a result of lower professional fees and a $0.6 million credit loss recorded in the first quarter of 2020 that was not repeated in 2021, partially offset by increased severance costs in 2021. On Slide 9. Adjusted EBITDA and adjusted EBITDA margin for the quarter decreased to an $11.4 million loss or minus 38.6% from a $5.5 million loss or minus 13.4% in the same period of 2020. This reflects an $8.4 million decrease in adjusted gross profits, partially offset by a $0.3 million lower cost of underutilized capacity, as I described earlier, lower professional fees, reduced commissions on lower revenues and cost reductions as a result of reduced activity related to COVID-19. In the first quarter of 2020, as I said, we increased our provision for expected credit losses by $0.6 million, which partially offset these reductions. Turning to Slide 10. Net loss increased to $12.5 million or $0.15 net loss per share in the first quarter of 2021 from a net loss of $5.3 million or $0.06 net loss per share for the first quarter of 2020. The increased loss is primarily the result of a $7.9 million decrease in gross margin, a $2.5 million net decrease in foreign exchange gains, a $1.4 million increase in income tax expense and a $0.6 million increase in net interest expense, partially offset by a $1.2 million decrease in operating expenses and $4.1 million of government subsidies in 2021. In conclusion, on Slide 11, Q1 of 2021 was a challenging quarter for DIRTT. The impact of COVID-19 induced slowdown on our revenues resulted in cash utilization within the business, particularly as we hold our manufacturing capacity steady in anticipation of responding to increased revenue levels beginning in the second half of 2021. The steps we've taken to bolster our liquidity, including lease financing to cover the majority of the cost of our South Carolina facility and the convertible debenture financing in January, give us the confidence to stay the course as we see encouraging early indications of the commercial success of our strategic plan and improvements in economic conditions. While we remain ready to take action, should business conditions deteriorate, we plan to maintain our current cost and manufacturing capacity structure to ensure that when the inevitable return to a more normalized construction environment happens, we are well poised, both from a sales and production standpoint, to take full advantage of what we believe will eventually be a very active market. Operator, we would now like to open the call for questions.
[Operator Instructions] The first question will come from the line of Greg Palm.
This is actually Danny Eggerichs on for Greg Palm today. Just wondering if you could give maybe a little color on cadence of order activity throughout Q1, what you saw there? And maybe if you could, what you're maybe seeing daily order rates as we move through April and that compared to Q1 last year?
Danny, it's Geoff here. As we came through Q1, from a cadence perspective, January was certainly the lowest period that we saw with improving sequentially on a month-over-month basis. I think as we moved into April, we've continued to see that pattern, and we'll see how that plays out for the rest of the second quarter. One thing I would point you to is on the balance sheet, if you look at customer deposits at December 31, 2020, versus customer deposits for the March 31, 2021 period, you can see a dramatic increase in that, which is reflective of the increased activity that's coming at us in the second quarter.
Got it. That's good. And then maybe as it relates to order activity, was there any geographies or end markets that maybe surprised you guys to the downside?
I think, we're not really surprised us. The Canadian market continues to be very slow. You can see that in our segmented note. The Canadian orders were about 10% of revenues compared to the U.S. The overall commercial segment from 2020 to '21 was down 43%, and education was down 57%. But we did see improvements on the health care side as well as the government side. Both of the commercial and education are reflective of the lockdowns that we've seen across North America. But I think it's also fair to say that we are seeing quoting activity and those sorts of things pick up as the U.S. begins to reopen.
Got it. And how much of that was driven by new construction, I guess, compared to like a renovation type?
I don't really have that data at my fingertips. I think, in general, though, it's a function of projects that have been brought along over time. I think what we've been seeing is end customers that are bringing projects to a point and then pausing as they trying to figure out when is the time to bring the right people back into the office, and so I think it's more of that. But the first quarter was definitely that slowdown from not having 2020 in-process stuff coming through?.
Okay. Makes sense. And then last one for me. It looks like during the quarter, maybe shed a few more distribution partners. I guess when do you expect that the kind of churn in the distribution channel to level out or maybe start to increase the amount of partners again?
This is Kevin. It's leveling out, but you'll always see some. There's always going to be a bottom 10%. There's always going to be places where we feel like we're underpenetrated. And so I think that you will see that it will be a continued activity. And I don't think that you necessarily can draw a correlation between number of partners in our sales because as we upgrade partners and improve penetration, it's possible that we actually are able to improve our sales per partner so that we grow even with a stable plus or minus shrinking or growing set of partners.
The next question will come from the line of Rupert Merer with National Bank.
Can you give us some more color on your strategic accounts? I see you increased them in the quarter to 40%. Can you talk about how the relationships are developing, but also what's defined in the relationship, if any, commitments are made on either side?
Rupert, can you repeat your second question? I think I missed something. You may have cut out.
So just looking at your strategic accounts, if you can talk about how they're developing, but also what's defined in your relationship with the strategic accounts? For example, are you offering some pricing commitments to them? Are there any volume commitments from the strategic account? Just give us some color on how the relationship is defined.
Got it. The relationships are coming from all different areas. It's people that we have done business with in the past, in one market where historically the company didn't have the capability to build on that relationship and help them in other geographies. We've seen an increase in companies issuing RFPs that historically, we weren't in a position to respond to, so we formulized processes. Some of it comes from individual personal relationships from a variety of people within the company. So it can really arise anywhere. I think what's characterized by most of these are typically multibillion-dollar companies, 1 or 2 exceptions, but they also have real estate needs across North America. And they also benefit from having somebody like us that has design standards in place that can codify exactly how they build. With some of these clients, we literally have a manual that says, "Okay, when you're doing a project for this particular customer, here's exactly how it's supposed to go." In terms of commitment, it varies. It's based on whatever their needs are. In an ideal world, what we do is at a high level kind of define our commitment to them. There may or may not be some sort of comments as it relates to pricing. We do prefer that on a project-by-project basis, they enter into an agreement with our individual distribution partners. And what we're doing from a strategic account standpoint is providing a single point of contact and consistency of experience.
Great. And are you seeing much of your revenue coming from that group yet? Are you seeing traction from the relationships?
It's starting to build, and we are seeing some revenue coming in even where we'll be in an RFP process and we haven't heard a formal decision. But the next thing that we've gotten several projects from them along the way. So yes, we clearly are seeing increased activity from the strategic account side of the business.
And then on your strategic marketing initiatives, you mentioned the more targeted now. Can you talk about your resource allocation by topography? Or I mean, are you finding any pockets of the market that look particularly attractive for you right now that may be different from where the company used to focus?
We are finding pockets, but they're consistent with where the company is focused historically. On the commercial side, I would say talent-intensive businesses, the more high-tech companies, many of whom have done extraordinarily well coming through the pandemic. There's a lot of interest there. There's a lot of activity there; health care as well. The lessons that various health care providers have learned coming through the pandemic really accentuates the value of adaptable spaces. And so we're seeing renewed interest there. So -- but that -- both of those are consistent with pre pandemic and consistent with how we put together our strategic plan overall.
The next question will come from the line of Josh Wilson with Raymond James.
Wanted to get into the change in activity a little more. To what extent is the increase in activity completely brand-new projects versus maybe projects that were put on hold prior to the pandemic?
We haven't quantified that, but a significant number of them are ones that were put on hold prepandemic. And a lot of what's happening is, it's projects that could be anywhere between 70% to 90% on the way ready to go. And then we're getting calls and say, "Okay, we're ready to go." And what that's doing is compressing the sales cycle. And so we made comments in the prepared remarks about having a hard time turning activity in the backlog. That's part of the reason. We'll get phone calls out of the blue that say, "Okay, we're ready to go." And we'll dramatically increase both the size of the project as we might have reflected it in our pipeline as well as the timing. So that is a very definite aspect of what we're doing, and I think we'll continue for the next quarter or 2.
Got it. And then on that topic of the sales cycle, any changes you're seeing in conversion rate either because of where we are in the pandemic recovery or because of the new tools you've rolled out?
Anecdotally, I think it's higher. We're still relying on our CRM system to be able to capture that and know specifically. But we are having, what feels to me, in the markets, a higher degrees of success in conversion rates.
And is the increase in activity focused in any end markets or regions within the U.S.
No. It's more -- I don't say opportunistic, but episodic based on people's needs and how they are thinking about their individual projects. There's no correlation that could really draw you to.
Got it. And then last one for me. You talked about taking action if inflation gets worse. Could you run through the menu of actions? And how you might rank them? Or how you might consider responding if that doesn't play out?
I mean, it's primarily as much as we don't want to do it looking at our pricing structure. I think that's -- we did a pretty comprehensive supply chain review over the last year or so, and we were able to take some cost out that way. We've talked in many number of quarters as our sales were declining of the impact of negative operating leverage. And so we'll take advantage of the first, the second one. And I think we'll just kind of happen naturally -- as we shift production into the Rock Hill facility, that will help as well. But ultimately, about the only lever you have at the end of the day if those aren't sufficient just to start looking at your pricing structure.
And with that, we are showing no further audio questions at this time. I'll now hand the conference back to Mr. Kevin O'Meara for the closing remarks.
As always, I would like to thank our tremendous employees and distribution partners who continue to demonstrate resiliency and commitment in the face of extraordinary challenges. I continue to strongly believe that the path we're on, guided by our strategic plan and executed by the incredibly talented team we have at DIRTT, will propel our organization forward in 2021 as we continue to refine the commercial capabilities that are beginning to deliver tangible results in the market. Thank you for joining us today.
This does conclude today's conference call. We thank you for your participation and ask that you please disconnect your line.