DIRTT Environmental Solutions Ltd. Wednesday announced its financial results for the three- and 12-month periods ended December 31, 2017, including record annual revenue of $293.4 million. This news release contains references to Canadian dollars and United States dollars. Canadian dollars are referred to as “$” and United States dollars are referred to as “US$”.

“This an important time for DIRTT, as we move forward from a significant 2017 investment year with a clear path toward profitable growth,” says DIRTT interim CEO Michael Goldstein. “Our fourth quarter and year-end results are evidence that we have invested ahead of the curve to prepare for growth. We are seeing a build of significant projects in 2018, with revenue expectations for the first quarter of 2018 in the range of $78 million to $80 million.”

Selected Highlights

For fiscal year 2017 and the three-month period ended December 31, 2017, the Company reported:

2017 highlights:

Financial

Revenue increased by $26.4 million, or 9.9% over 2016, to $293.4 million;
Gross profit increased by $6.3 million, or 5.4% over 2016, to $122.5 million. Gross profit % decreased over 2016 from 43.5% to 41.8%;
Adjusted gross profit of $127.7 million. Adjusted gross profit % of 43.5%;
Adjusted EBITDA of $15.9 million, or 5.4%; and
Net loss was $7.4 million, net loss per share was $0.09.

Operational

Increased sales, marketing, and business development staff by 5.6% over 2016 to 114;
Selected for significant new wins including a new 158,000 square foot downtown San Francisco medical office building;
Delivered first significant healthcare project in Kuwait;
Developed a modular code-supported flexible medical gas solution for healthcare applications;
Conducted specialized training at more than 100 events across North America to support our continued growth; and
Launched proprietary multi-user virtual reality app for construction.

DIRTT’s interim chief financial officer, Peter Henry, attributes unusually high expenses in the fourth quarter and fiscal 2017 to several known factors. “We booked a number of expenses that, while not unexpected, were not anticipated to hit simultaneously,” says Henry. He cites the most significant of these expenses as follows:

$2.2 million relating to the go-forward restructure of DIRTT’s largest trade show, DIRTT Connext, into two separate events;
$2.3 million in severance and associated legal costs, unrelated to the January 2018 management transition; and
$4.3 million for development costs related to DIRTT’s initiatives in timber and residential. Approximately 85% of that cost was allocated to research and development, and marketing expenses, connected to the construction of DIRTT founder Mogens Smed’s primary residence, called Hygge.

“Hygge was a working case study to refine DIRTT’s capabilities in timber and other new solutions, and the home now acts as a regular venue for clients,” says Henry, adding that it’s been the site of more than 180 client events in 2017 and has more than 20 so far in 2018. “The residence is an excellent way to demonstrate DIRTT’s scope of work, both generally and as it relates to the residential design elements that can be used across our market verticals.”

Q4 2017 select highlights:

Revenue decreased by $4.0 million, or 5.1% from Q4 2016, to $74.3 million;
Gross profit decreased by $4.1 million, or 12.2% from Q4 2016, to $29.8 million;
Gross profit % decreased from Q4 2016 from 43.3% to 40.1%;
Adjusted gross profit was $31.5 million and adjusted gross profit % was 42.4%;
Adjusted EBITDA was $(1.0) million and adjusted EBITDA % was (1.4%); and
Net loss was $7.3 million and net loss per share was $0.09.

Revenue for Q4 2017 decreased by $4.0 million (5.1%), over Q4 2016. This decrease was primarily due to the weakening of the US dollar against the Canadian dollar. The US dollar (average rate) decreased from 1.3344 in Q4 2016 to 1.2713 in Q4 2017, resulting in a negative impact on overall revenue in the period, as compared to the same quarter in 2016. In addition, autumn 2017 saw an unusual string of record-breaking hurricanes, resulting in a negative impact on overall revenue in Q4 2017.

Revenue for 2017 increased by $26.4 million (9.9%) over 2016. The increase is attributable to a general increase in activity from small and medium-sized projects across a range of industry segments. These segments include technology, which increased from 8% of total revenue in 2016 to 12% in 2017; health care, which increased from 16% of total revenue in 2016 to 17% in 2017; construction which increased from 2% of total revenue in 2016 to 4% in 2017 and government, which increased from 8% of total revenue in 2016 to 10% in 2017. In addition, the Company recorded installations revenue in 2017 of $11.8 million compared with $5.2 million in 2016.
The average US dollar exchange rate decreased from 1.3245 in 2016 to 1.2986 in 2017, resulting in a negative impact on overall revenue in the year, as compared to 2016.

Gross Profit

Gross profit decreased to $29.8 million in Q4 2017 from $33.9 million in Q4 2016, a decrease of 12.2%. Gross profit % declined to 40.1% from 43.3%. The decrease in gross profit % was due primarily to higher aluminum costs, higher depreciation and amortization expense relating to increased investment in manufacturing-related assets, changes in product/service revenue mix and greater volatility in the timing of monthly production volumes.

Adjusted gross profit decreased to $31.5 million in Q4 2017 from $34.8 million for Q4 2016, a decrease of 9.3%. Adjusted gross profit % declined to 42.4% from 44.4% for the same reasons discussed above with respect to gross profit, excluding the impact from increased depreciation and amortization expense relating to increased investment in manufacturing-related assets.

Gross profit improved to $122.5 million in 2017 from $116.3 million in 2016, an increase of 5.4%. However, gross profit % for 2017 declined from 43.5% to 41.8%. This decrease was due primarily to higher aluminum costs, higher depreciation and amortization expense relating to increased investment in manufacturing-related assets, changes in product/service revenue, greater volatility in the timing of monthly and quarterly production volumes, and an increase in installations revenue, which typically results in lower gross profit than our standard manufacturing process.

Adjusted gross profit for 2017 improved to $127.7 million from $119.5 million in 2016, an increase of 6.9%. However, adjusted gross profit % declined from 44.7% to 43.5%, for the same reasons discussed above with respect to gross profit, excluding the impact from increased depreciation and amortization expense relating to increased investment in manufacturing-related assets.

SG&A

Selling, general and administrative (“SG&A”) as a percentage of revenue increased significantly from 35.6% to 50.5% in Q4 2017 compared with Q4 2016. SG&A expenses increased by $9.7 million, or 34.7%, for Q4 2017 compared with Q4 2016. The increase reflects DIRTT’s accelerated investment in long-term growth initiatives throughout 2017. The significant increases relate to research and development and marketing expense of $3.2 million of which $2.9 million was allocated between research and development and marketing expense with respect to the build of Mogens Smed’s primary residence, named Hygge. Hygge represents a collaborative, shared-risk effort between Mr. Smed and the Company, with Mr. Smed contributing more than $4.1 million to this flagship residential project. A portion of the project costs were expensed as research and development, as the project was used in part as a case study to refine and define DIRTT's capabilities in timber and residential, which have applications in all vertical markets, and to explore other new materials. The remainder was expensed as marketing, based on the benefit derived from the use of Hygge to showcase DIRTT through client events/tours. Other significant increases relate to the restructuring of DIRTT Connext and the DIRTT Fall Training Camp held in November 2017 in Phoenix, Arizona, of $2.2 million, severance and associated legal costs (unrelated to the recent management changes) of $1.5 million, reorganization costs of $1.5 million due to the recent management changes, general sales and marketing expense of $1.3 million and rent expense of $0.6 million. These increases were partially offset by decreases in stock-based compensation expense of $0.2 million and depreciation and amortization expense of non-manufacturing-related assets of $0.4 million.

Adjusted SG&A % increased significantly from 30.4% to 43.8% in Q4 2017 compared with Q4 2016. Adjusted SG&A expenses increased by $8.8 million, or 36.8%, for Q4 2017 compared with Q4 2016. The reason for the increase is the same as discussed above with respect to SG&A, excluding the impact from decreased non-cash depreciation and amortization of non-manufacturing-related assets, decreased stock-based compensation expense incurred in the period and reorganization costs.

SG&A % increased from 38.8% to 43.7% in 2017 compared with 2016. SG&A expenses increased by $24.8 million, or 23.9%, for 2017 compared with 2016. This increase reflects DIRTT’s improved revenue in the period and ongoing investment in long-term growth initiatives. The most significant changes can be attributed directly to sales related efforts as salaries and commissions increased by $8.7 million. These costs reflect the addition of personnel to generate and support higher business volumes, and commissions on the higher revenues attained in the period. Other significant increases include research and development and marketing expenses of $4.3 million relating to timber and residential applications, general sales and marketing expense of $4.3 million, severance and related legal costs (unrelated to the recent management changes) of $2.3 million, restructuring of DIRTT Connext and the DIRTT Fall Training Camp events of $2.2 million, reorganization costs of $1.5 million due to the recent management changes, and rent expense of $1.5 million. The remainder of the increase is related to depreciation and amortization expense of non-manufacturing-related assets of $0.4 million, other operating items of $0.2 million and partially offset by a decrease in stock-based compensation expense of $0.6 million.

Adjusted SG&A % increased from 32.8% to 37.8% in 2017 compared with 2016. Adjusted SG&A expenses increased by $23.4 million, or 26.8%, for 2017 compared with 2016. The reason for the increase is the same as discussed above with respect to SG&A, excluding the impact from increased non-cash depreciation and amortization of non-manufacturing-related assets and stock-based compensation expense in the year and reorganization costs.

The impact of the weakening US dollar to Canadian dollar average exchange rates during Q4 and the year compared to the prior periods in 2016 partially reduced the overall increase in SG&A and Adjusted SG&A expenses across the organization, as certain of these SG&A expenditures are denominated in US dollars.

Adjusted EBITDA
Adjusted EBITDA decreased by $12.3 million, or 109.1%, for Q4 2017 compared with Q4 2016. Adjusted EBITDA % for Q4 2017 declined significantly from 14.4% in Q4 2016 to (1.4%). The dollar decrease was primarily due to lower adjusted gross profit of $3.2 million, higher adjusted SG&A expenses of $8.8 million and an increase in foreign exchange loss of $0.2 million.

Adjusted EBITDA decreased by $15.4 million, or 49.2%, for 2017 compared with 2016. Adjusted EBITDA % for 2017 weakened from 11.7% in 2016 to 5.4%. The decrease in 2017 was mainly due to higher adjusted SG&A expenses of $23.4 million and an increase in foreign exchange loss of $0.2 million, partially offset by higher adjusted gross profit of $8.3 million.

Outlook
Following the management changes on January 2, 2018, the Company has intensified its focus on profitable growth. Changes to the business and business processes have been put in motion and continue to be implemented to (1) strengthen financial controls, (2) increase accountability, (3) and upgrade planning.

“We are working with management to strengthen our foundation for profitable growth,” says Goldstein. “Our focus moving forward will be a continued emphasis on growth, while building out this foundation of fiscal discipline.”

Near-term growth is strong, Q1 2018 revenue is targeted to be in the $78 million to $80 million range;
The Company is targeting its full year Adjusted EBITDA (non-IFRS) in the 13% – 15% range consistent with demonstrated revenue trends;
The leadership team is working diligently to support and deliver on DIRTT’s performance to customers, partners, employees, and shareholders;
We implemented shareholder engagement initiatives and continue to integrate shareholder feedback into our business plans; and
Searches for a permanent CEO and CFO are underway with the participation of management.