DIRTT Environmental Solutions Ltd. Tuesday announced its financial results for the three and nine months ended September 30, 2018. This news release contains references to Canadian dollars and United States dollars. Canadian dollars are referred to as “$” and United States dollars are referred to as “US$”.
THIRD QUARTER 2018 HIGHLIGHTS
Revenue increased, respectively, by $12.6 million or 15.0% to $96.6 million, and by $38.9 million or 17.8% to $258.0 million for the third quarter and year-to-date periods of 2018, compared to the same periods of 2017, reflecting increased sales activity in Canada and the US, including continued penetration into the healthcare market;
Adjusted Gross Profit %(1) increased respectively to 45.5% (2017 - 44.8%) and 44.9% (2017 - 43.9%) in the third quarter and year-to-date periods of 2018, reflecting increased leverage on fixed manufacturing costs, partially offset by higher materials and direct labor costs primarily due to product mix;
Adjusted EBITDA(1) increased respectively by 65.2% to $17.8 million and 128.7% to $38.7 million in the third quarter and year-to-date periods of 2018 over the same periods of 2017, due to increased sales activity and gross profit margins in both periods, with no corresponding increase in Adjusted SG&A;
Adjusted EBITDA %(1) increased respectively to 18.4% (2017 - 12.8%) and 15.0% (2017 - 7.7%) in the third quarter and year-to-date periods of 2018; and
Net loss increased respectively to $4.9 million ($0.06 per share) and $0.5 million ($0.01 per share) in the third quarter and year-to-date periods 2018, from net income of $4.2 million ($0.05 per share) and net loss of $0.1 million ($0.00 per share) for the same periods of 2017, reflecting the impact of a $14.8 million impairment expense of DIRTT for Life and DIRTT Timber assets.
“DIRTT’s revenue performance this quarter illustrates the growing recognition of the industry’s need for a long-term construction solution that embraces technology and responds to individual building needs,” says Kevin O’Meara, who was appointed DIRTT’s chief executive officer in September 2018. “The quarter’s strong operational financial results also demonstrate the contribution that enhanced fiscal discipline can make to our performance going forward.
“Since I joined DIRTT, the executive leadership team has undertaken a comprehensive review of the company’s key markets, customer segments, operations and investment targets. While this review is ongoing, we recently decided to exit our DIRTT for Life residential services. The pure residential market requires different resources to address fully — resources we believe are better allocated to DIRTT’s core markets.
“In addition, we are shifting the way we approach the timber market with our DIRTT Timber solution. Although we remain very enthusiastic about the potential of DIRTT Timber, the North American timber market itself is still in its early stages and needs to develop significantly. Accordingly, we are moving from aggressive development to a commercialized approach focused on large, standalone timber projects and timber as a pull-through for other DIRTT solutions. This requires significantly less timber capacity and we will therefore be right-sizing our capacity by the end of this year.”
Mr. O’ Meara concludes, “DIRTT is one of the most exciting companies in construction today. The combination of our virtual reality technology, product design, precise manufacturing and partner network makes DIRTT a remarkable and logical answer to the industry’s most pressing challenges. As issues such as labor shortage and compressed schedules become more and more prevalent, I believe DIRTT’s market opportunity will continue to expand. I look forward to leading this outstanding company forward.”
Revenue
Revenue for the third quarter of 2018 increased by $12.6 million, or 15.0%, over the third quarter of 2017. On a year-to-date basis, revenue increased by $38.9 million, or 17.8%, over the same period of 2017. These increases are attributable to a general increase in sales activity across a range of industry segments. Third quarter revenues were positively impacted by a stronger US dollar in 2018 compared to 2017. During the third quarter, DIRTT continued to increase its penetration into the healthcare market. As a percentage of total revenue, sales to healthcare increased in the third quarter from 21% in 2017 to 27% and in the year-to-date period from 17% in 2017 to 20%. Apart from acute healthcare solutions, DIRTT’s solutions are industry agnostic.
Gross Profit / Adjusted Gross Profit / Gross Profit % / Adjusted Gross Profit %
Gross profit and gross profit % increased to $42.0 million or 43.5% of revenue in the third quarter of 2018, from $35.9 million or 42.7% of revenue in the third quarter of 2017. Adjusted Gross Profit and Adjusted Gross Profit % increased to $44.0 million or 45.5% of revenue in the third quarter of 2018, from $37.6 million or 44.8% of revenue in the third quarter of 2017. Gross profit % and Adjusted Gross Profit % increased as a result of improved installation margins and increased leverage on fixed manufacturing overhead costs, partially offset by higher direct materials and labor costs due to variability of product mix. Increases in depreciation included in cost of goods sold (“COGS”) for the third quarter and year-to-date periods of 2018 over the same period of 2017 reflect investments in manufacturing equipment in 2017.
For the year-to-date period, gross profit and gross profit % increased to $110.1 million or 42.7% of revenue in 2018, from $92.8 million or 42.3% of revenue in 2017. Adjusted Gross Profit and Adjusted Gross Profit % increased to $115.9 million or 44.9% of revenue in the first nine months of 2018, from $96.2 million or 43.9% of revenue in the same period of 2017. Gross profit % and Adjusted Gross Profit % as well as depreciation included in COGS increased for the same reasons as described above.
SG&A Expenses / Adjusted SG&A Expenses
In the third quarter of 2018, SG&A expenses increased to $33.0 million from $29.9 million in the same period of 2017, an increase of $3.1 million or 10.2%. Approximately $2.9 million of reorganization costs, comprised primarily of severance and related costs associated with executive changes announced in the third quarter of 2018, were included in the quarter's SG&A. Adjusted SG&A expenses decreased by $0.3 million, or 1.3%, to $26.1 million in third quarter of 2018, from $26.5 million in the same period of 2017. This decrease reflects reductions in non-essential travel and entertainment, office and other expenditures, substantially offset by increased salaries on a slightly higher headcount compared to the third quarter of 2017 and commissions on larger sales volume.
In the first nine months of 2018, SG&A expenses increased to $94.2 million from $90.8 million in the same period of 2017. Reorganization costs included in SG&A, associated with certain management changes, totaled $6.0 million in the first nine months of 2018. Adjusted SG&A expenses in the first nine months of 2018 decreased by $0.6 million or 0.8% to $77.7 million in 2018 from $78.3 million in the same period of 2017. Increased salaries due to a slightly higher headcount, and commissions on larger sales volume, as well as one-time costs associated with activist defense ($1.8 million) and the special committee of the board of directors ($0.9 million) were more than offset by reductions in non-essential travel and entertainment, office and other expenditures as well as targeted reductions in non-revenue generating marketing and tradeshow expenses.
Asset Impairment
In the third quarter of 2018, management commenced a review of its solution lines and, as a result, decided to exit its DIRTT for Life residential services in October 2018. In addition, management decided to shift from the early stage development of its DIRTT Timber market to a commercialized approach focused on large, standalone timber projects and timber as a pull-through for other DIRTT solutions. Management concluded that this strategy requires significantly less timber capacity than currently exists and is therefore taking steps to right-size its timber capacity by the end of 2018. Management also determined these decisions to be an indicator of impairment of the assets related to both of these solution lines as at September 30, 2018.
DIRTT for Life had intangible assets with a carrying value of $1.7 million at September 30, 2018. As these assets cannot be resold and there is no future use for the assets, the entire carrying amount was impaired and a corresponding impairment charge of $1.7 million was recorded in the third quarter of 2018.
Management also performed an assessment of the carrying values of DIRTT Timber’s property, plant and equipment, and intangible assets. The net book value of the assets was evaluated against the greater of value-in-use and fair value, less cost of disposal. The value-in-use of the timber assets reflects current assets for timber projects on a standalone basis and the pull-through impact to other DIRTT solutions. In its evaluation, management determined it was unable to reliably quantify the pull-through impact of timber on other DIRTT solutions. As a result, management concluded that the fair value less cost of disposal exceeded the standalone value-in-use of its timber assets. The equipment related to the timber market was custom built for DIRTT and there is no active market for resale. Therefore, the fair value was determined to be management’s estimate of scrap value for the specialized assets and an estimated resale value for less specialized assets that cannot be redeployed for DIRTT’s other solutions. Management estimated the expected resale values based on the current market and on experience of management in the industry. The fair value less cost of disposal of the timber assets was estimated to be $1.5 million. This assessment resulted in an additional impairment charge of $13.1 million in the third quarter, of which $8.0 million related to tangible assets and $5.1 million related to intangible assets.
Adjusted EBITDA / Adjusted EBITDA %
In the third quarter of 2018, Adjusted EBITDA increased by $7.0 million or 65.2% to $17.8 million, from $10.8 million in the third quarter of 2017. Adjusted EBITDA % for the third quarter of 2018 also increased to 18.4% from 12.8% in the third quarter of 2017. On a year-to-date basis, Adjusted EBITDA increased by $21.8 million or 128.7% to $38.7 million in 2018, from $16.9 million in the same period of 2017. Adjusted EBITDA % improved to 15.0% in the first nine months of 2018, from 7.7% in the same period of 2017. These improvements in profitability for the quarter and year-to-date periods reflect a 15.0% and 17.8% increase in sales activity in the third quarter and year-to-date periods, respectively, without a corresponding increase in Adjusted SG&A costs.
Liquidity and Capital Resources
At September 30, 2018, we had $54.5 million in cash and cash equivalents, compared to $79.6 million at December 31, 2017. We also had access to an undrawn US$18.0 million revolving credit facility.
Outlook
DIRTT provides a comprehensive interior construction solution empowered by best-in-class technology that addresses challenges frequently encountered within conventional construction. Such challenges include cost overruns, labor shortages, inconsistent quality and time delays. Of the approximate US$1.2 trillion construction market in the United States [Source: US Census Bureau 2017], there is an immediately addressable market of at least US$50 billion in the primary focus areas of commercial (which includes corporate, education, government and certain residential) and healthcare. The Company is focused on developing the strategies, disciplines and processes necessary to increase penetration of this largely untapped market.
The establishment of a permanent leadership team is a critical step toward this goal. DIRTT announced the completion of its CEO search on September 10, 2018, with the hiring of Kevin O'Meara. At the same time, DIRTT also announced the departure of its executive chairman, Mogens Smed. Management is undertaking a comprehensive review of DIRTT’s market opportunities and operations to develop a long-term strategy that drives continued profitable growth. In particular, we are defining the investments and actions necessary to accelerate market penetration using our existing Partner network, and to increase overall operational efficiency. To increase liquidity for its US shareholders, DIRTT is also actively working toward registering with the Securities and Exchange Commission (SEC), including a listing on an accredited US exchange.
The Company was pleased with the results of the third quarter with revenues of $96.6 million, an increase of 15.0% over the same period of 2017. Adjusted EBITDA also increased to $17.8 million or 18.4% of revenues, demonstrating the leverage possible in the business within our manufacturing, sales and administrative activities. While DIRTT’s revenues remain subject to inter-quarter volatility, the second half of the year has historically been the strongest, with 2018 being no different. The Company remains on track to achieve its stated Adjusted EBITDA % target of between 13% and 15% for 2018.