DIRTT Environmental Solutions Ltd.

Thank you for standing by. This is the conference operator. Welcome to DIRT Environmental Solutions 4th Quarter 2022 Financial Results Conference Call. As a reminder, all participants are in a listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press the star 1 1 on your telephone keypad. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. I would now like to turn the call over to Shauna Mason, Director of Corporate Affairs.

Thank you, Operator, and good morning, everyone. Welcome to today's call to discuss DIRT's fourth quarter 2022 results. Joining me on the call today are Benjamin Urban, DIRT's CEO, and Brad Little, CFO. Today's prepared remarks are accompanied by presentation slides. To access the slides, please view them from the webpage of this webcast or on our website at DIRT.com. 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-K as filed on February 22, 2023, 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 tomorrow. I now turn the call over to Benjamin.

Thank you, Shauna, and good morning, everyone. It is my pleasure to be joining you today and to share the highlights of a very productive fourth quarter, closing out a challenging 2022, a year of turnover, market volatility, and disruption. It has been a particularly challenging year for our people, our partners, and our key stakeholders. On behalf of my entire leadership team, I want to personally thank all of you for continuing to support us through this year of great change and transition. Before I talk about the fourth quarter, I want to reflect on some of the critical observations I've made over my first two full quarters with the company. First, over the years, it is clear that we had gotten away from the emphasis we have historically placed on innovation and the importance it has played in the success of DIRT. Innovation is very much a participation sport, and we are getting back to a place where our customers and construction partners play an active role in our innovation of the solutions our ecosystem relies on. Second, if I look back at the key decisions that have been made over the past several years, The ones that have been most successful are the decisions that were made in the spirit with which dirt was created. Dirt was created in the spirit of adaptability, flexibility, customization, and removing risk from construction. We continue to provide solutions that support a rapidly changing workplace, a changing healthcare and education landscape. No one knows what the future holds, but we pride ourselves in supporting our end users through whatever comes their way. In retrospect, Some of the decisions made were not in service to this core principle, and we learned a tough lesson from that. And we will apply those lessons learned to future decisions and strategy. Lastly, maybe my greatest observation is the resiliency of our people. They have remained patient and loyal to DIRT and our founding vision through so many changes and challenges. Our people are our most valuable resource and are the single biggest reason we will be successful as we continue to improve for years to come. Turning to our fourth quarter performance, the improvements we made in the business earlier during 2022 paid off and improved financial results during the quarter. On our last call, we indicated that we had line of sight to cash flow and adjusted EBITDA break-even during the fourth quarter. And that is exactly what happened. As Brad will outline, we achieved positive adjusted EBITDA and an increase in cash flow from operations during a quarter for the first time since 2020. We continued our world-class safety record with zero recordable incidents during the fourth quarter, finishing the year with a total reportable incident frequency rate of 0.1. This equates to about one recordable incident every 2 million working hours. I've been amazed at the commitment from everyone in the organization around keeping our team members safe. On the commercial side of the business, We have added new construction partners and are further expanding and refining both our sales channels and go-to-market strategy. We continue to see adoption of our solutions within some of the most prestigious and recognizable companies like Visa, Google, and Frost Bank of Texas, among many others. We are gaining strategic advantages through collaboration with our construction partners in both innovation and efficiency, and this is resulting in a healthier sales pipeline. We see great opportunity for growth in 2023 and beyond, and we are channeling resources directly at our commercial organization in order to do that. We are operating with a high sense of urgency and recognize that time is of the essence. It is that vein that we have announced certain staffing changes and realigned responsibilities in order to maximize efficiency and direct communication to our people, construction partners, and end customers. I am personally leveraging my experience and will be taking on an even more active role in our commercial organization to help drive top line growth. I have also been actively involved with our partner success team as we continue to bolster that group with successful DIRT veterans that also know our business intimately. From an operations standpoint, Our team members in both Calgary and Savannah are hard at work improving production efficiencies and quality while mitigating against rising supply chain costs and overtime rates during the fourth quarter. Our improved gross margin is as much about their performance as it is from the pricing actions taking over the past year. While we have not restarted operations at Rockhill, We continue to maintain that facility and are actively monitoring demand levels in 2023 and 2024. We believe that this facility supports a critical aspect of future expansion and growth. We remain committed to our sustainability journey and our ESG commitments. We strive to build a better world, both through our products and by leveraging our solutions to help our customers achieve their sustainability commitments. We know that our proactive and transparent approach to establishing, measuring, and reporting on ESG factors impacts our bottom line. This year, as we publish our third annual ESG report, we celebrate our second IR Magazine nomination for the best ESG reporting by a small cap award. I would like to emphasize that we are never satisfied with our performance, be it safety, optimization, or profitability. With a full quarter to measure and observe the effects of our changes made in Q3, it has aided in further illuminating areas for additional refinement or alternatively required investment. Some of these changes have already been implemented at the beginning of Q1 2023 as we continue to move with precision and haste in tight alignment with our Board of Directors. The continued increase in the understanding of underlying factors that drive our costs efficiency, and pipeline further direct our investment and resources. Even with reaching positive adjusted EBITDA and operating cash flow in the quarter, we continue to be relentless with strategic initiatives to further improve our balance sheet as well as provide additional investment for growth. More so than financial results, our performance is continuing to build increased trust and credibility with our construction partners, customers, and employees. This renewed stability provides us with a solid operating platform for 2023 to both drive organic growth and implement our planned strategic initiatives. I am excited about the future of DIRT and the opportunities in front of us. I'll now turn it over to Brad to discuss our financial results in greater detail. Thank you, Benjamin, and good morning all. As is customary, we have issued a press release discussing our fourth quarter results and have provided additional analysis in a supplemental presentation, which is now posted on our website. My comments this morning are designed to add additional color on our financial results for the quarter and update you on the progress of the various liquidity initiatives we discussed last quarter. Revenues for the fourth quarter were $42.4 million, in line with prior years. As expected, revenue during the fourth quarter reflects virtually all of the price increases we have implemented over the previous 15 months. Revenue declined 9% compared to the third quarter of 2022, driven by a reduction in volume, offset by favorable impact from pricing. The volume decrease is primarily the result of a normal seasonal pattern with shipments and order pace slowing around the major holidays in the U.S. and Canada in the last two weeks of the fiscal year. This impact was muted during 2021 due to price increases announced early in the fourth quarter of 2021, which motivated our customers to accelerate delivery of materials to avoid the increases. Turning to gross profit, we continue to see meaningful expansion in gross profit margin. Compared to the fourth quarter of 2021, gross profit margin increased 770 basis points from 19.6% to 27.3% in the fourth quarter of 2022. Similarly, adjusted gross profit margin, which excludes the impact of depreciation, increased 670 basis points from 25.3% in the fourth quarter of 2021 to 32% in the fourth quarter of 2022. Compared to the third quarter of 2022, gross profit margin increased 1,232 basis points from 15% to 27.3% in the fourth quarter of 2022. Adjusted gross profit margin increased from 21.7% in the third quarter to 32% in the fourth quarter of 2022. The improved margin is due to the realization of the price increases just discussed and cost reduction initiatives executed during the second and third quarters. Additionally, we are continuing to see sequential quarter improvement in manufacturing efficiencies despite lower volumes during the fourth quarter of 2022. Regarding operating expenses, We saw, again, decreases across all of our normal back office operating expense line items, mostly from the cost reduction initiatives implemented throughout 2022, but also due to more disciplined discretionary spending. From January 2022 through January 2023, the company has reduced production overhead and G&A headcount by 111, or 20%. As Benjamin mentioned previously, we achieved adjusted EBITDA for the first time since the third quarter of 2022. Adjusted EBITDA for the fourth quarter improved to $600,000 from a $9.7 million loss in the period of 2021 and a loss of $5.4 million during the third quarter of 2022, despite approximately 15% lower volumes in both comparable periods. The improved profitability has been driven by the reduction in operating expenses and improvements in gross profit margin just described, all while still delivering at our historical short lead times. You can find further detail on these as well as other financial information in our supplemental presentation, which again is published on our website. Turning to liquidity, when I came on board, I indicated there was no larger priority than strengthening our balance sheet through improved financial results and implementing a number of strategic initiatives to drive improved cash flow. We finished the year with $10.8 million in unrestricted cash, up $4 million from $6.8 at September 30, 2022. Cash provided from operations for the fourth quarter was $3.2 million compared to cash consumed by operations of $10.7 million during the third quarter of 2022 and $7.3 million in cash consumed by operations during the fourth quarter of 2021. This marks the first time we have delivered sequential quarter improvement in cash flow from operations since the third quarter of 2020. The improvement from September 2022 was driven by a combination of improved profitability, the cash proceeds from the private placement offering announced in November, and increased rigor around our working capital management program. Liquidity, which includes our availability under our AVL credit facility with $16.1 million at December 2022, up $300,000 or 2% from September 30, 2022. The improved cash and liquidity at December 31, 2022 is particularly important as we shift into a seasonal period with increased cash and working capital requirements. Networking capital at the end of the quarter was $26.1 million or even with September 2022. Availability under our ABL facility was $5.3 million at the end of the quarter. We did not need to draw on that facility in the fourth quarter and have not had to thus far in the first quarter of 2023. Also of note, earlier in the month, we completed an extension of this facility through February 2024 with similar terms, giving us flexibility as we expect to invest in working capital as volumes and revenues improve. Availability under this facility is expected to range between $5 and $15 million during 2023. I also wanted to update you on the cash initiatives I discussed with you during our third quarter call. First, during the fourth quarter, we implemented certain customer-friendly incentives for those customers in good standing, including the ability to take advantage of modest discounts for early payment of receivables. This program contributed an incremental $2 million in cash to our fourth quarter, while only impacting revenue by approximately $50,000. During the third quarter of 2022, we recognized a tax receivable of $7.1 million associated with the Employee Retention Tax Credit Program in the United States. This remains accrued at December 31st, and we expect to receive this in 2023. We are continuing to evaluate certain company-owned properties from a sell, leaseback, or sublease standpoint. We made meaningful progress on two such properties to date and expect to have resolution on one or both of them as early as March. As a reminder, we do not intend to vacate these premises as they still serve a critical aspect of our value proposition. Lastly, we are continuing to evaluate multiple strategic initiatives to advance DIRT's long-term vision around the ICE platform. We have also made progress on this initiative during the fourth quarter and expect our evaluation to be completed within the next 90 days. Collectively, we expect these initiatives to generate meaningful cash flow during 2023 as early as the second quarter. Turning to 2023. Our 12-month forward sales pipeline at January 1, 2023 was $391 million, compared to $311 million at January 1, 2022, or about 26% higher driven by a combination of price and expected volume. In particular, we have seen year-over-year growth in projects at higher stages in the sales cycle, increasing the likelihood of ordering during the year. While we are encouraged by the pipeline growth, our order pace and quarterly revenue and supply chain forecasting continues to be challenged by high push-out rates and longer than normal engineering and design time associated with large and complex projects. We are closely monitoring our cost structure, including the underlying materials that comprise our products. Although we are somewhat insulated from the near-term effects from a potential recession in the United States or Canada, As our pipeline is largely comprised of projects that have already started, we are susceptible to the inflationary impact of labor and commodity pricing, particularly aluminum and wood. In response to the risk associated with these items, we have taken additional actions over the past two months that will reduce our annualized overhead costs by $3 to $5 million. These cost reductions were related to efficiencies in streamlining our back office and operational support functions, not pursuant to a planned restructuring program. We are also evaluating certain instruments that will hedge against inflation and volatility associated with our primary materials. We believe that the combination of growth in our sales pipeline, the improved margins from pricing actions already taken, and the reduced cost structure will set us up well to deliver year-over-year growth in revenue, gross margin, and adjusted EBITDA during 2023. And now we'll open the call for your questions. Operator?