Company Quick10K Filing
DIRTT Environmental Solutions
Price-0.00 EPS0
Shares85 P/E-0
MCap-0 P/FCF-0
Net Debt-57 EBIT8
TEV-57 TEV/EBIT-7
TTM 2019-09-30, in MM, except price, ratios
10-K 2020-12-31 Filed 2021-02-24
10-Q 2020-09-30 Filed 2020-11-04
10-Q 2020-06-30 Filed 2020-07-29
10-Q 2020-03-31 Filed 2020-05-06
10-K 2019-12-31 Filed 2020-02-26
10-Q 2019-09-30 Filed 2019-11-07
8-K 2021-02-12 Enter Agreement, Exhibits
8-K 2021-01-25 Enter Agreement, Off-BS Arrangement, Exhibits
8-K 2021-01-07 Enter Agreement, Exhibits
8-K 2020-11-04
8-K 2020-07-29
8-K 2020-06-23
8-K 2020-05-22
8-K 2020-05-06
8-K 2020-03-14
8-K 2020-02-25
8-K 2019-11-12
8-K 2019-11-07
8-K 2019-11-07

DRTT 10K Annual Report

Part I
Item 1. Business.
Item 1A. Risk Factors.
Item 1B. Unresolved Staff Comments.
Item 2. Properties.
Item 3. Legal Proceedings.
Item 4. Mine Safety Disclosures.
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Item 6. Selected Financial Data.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Item 8. Financial Statements and Supplementary Data.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Item 9A. Controls and Procedures.
Item 9B. Other Information.
Part III
Item 10. Directors, Executive Officers and Corporate Governance.
Item 11. Executive Compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Item 14. Principal Accounting Fees and Services.
Part IV
Item 15. Exhibits, Financial Statement Schedules.
Item 16. Form 10 - K Summary
EX-10.16 drtt-ex1016_650.htm
EX-21.1 drtt-ex211_9.htm
EX-23.1 drtt-ex231_10.htm
EX-31.1 drtt-ex311_11.htm
EX-31.2 drtt-ex312_12.htm
EX-32.1 drtt-ex321_13.htm
EX-32.2 drtt-ex322_14.htm

DIRTT Environmental Solutions Earnings 2020-12-31

Balance SheetIncome StatementCash Flow
190152114763802018201820192020
Assets, Equity
705642281402018201820192020
Rev, G Profit, Net Income
3.00.4-2.2-4.8-7.4-10.02018201820192020
Ops, Inv, Fin

10-K 1 drtt-10k_20201231.htm 10-K drtt-10k_20201231.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 001-39061

 

DIRTT ENVIRONMENTAL SOLUTIONS LTD.

(Exact name of Registrant as specified in its Charter)

 

 

 

 

Alberta, Canada

N/A

(State or other jurisdiction of

incorporation or organization)

(IRS Employer

Identification No.)

 

 

7303 30th Street S.E.

Calgary, Alberta, Canada

T2C 1N6

(Address of principal executive offices)

(Zip code)

Registrant’s telephone number, including area code: (403) 723-5000

 

Securities registered pursuant to Section 12(b) of the Exchange Act:

 

 

 

 

 

 

Title of Each Class

 

Trading

Symbol(s)

 

Name of Each Exchange on Which Registered

Common Shares, without par value

 

DRTT

 

The Nasdaq Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes      No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes      No  

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

Accelerated filer

 

 

 

 

Non-accelerated filer

Small reporting company

 

 

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes      No  

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the closing price of the shares of common shares on The Nasdaq Stock Market on June 30, 2020, was $102,464,450.

The registrant had 84,681,364 common shares outstanding as of February 24, 2021.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement relating to the Annual and Special Meeting of Shareholders, scheduled to be held on May 6, 2021, are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 


 

 

 

TABLE OF CONTENTS

 

 

 

 

Page

PART I

 

 

 

Item 1.

Business

 

6

Item 1A.

Risk Factors

 

14

Item 1B.

Unresolved Staff Comments

 

21

Item 2.

Properties

 

21

Item 3.

Legal Proceedings

 

21

Item 4.

Mine Safety Disclosures

 

21

 

 

 

 

PART II

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

22

Item 6.

Selected Financial Data

 

23

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

24

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

40

Item 8.

Financial Statements and Supplementary Data

 

41

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

72

Item 9A.

Controls and Procedures

 

72

Item 9B.

Other Information

 

72

 

 

 

 

PART III

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

 

73

Item 11.

Executive Compensation

 

73

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

73

Item 13.

Certain Relationships and Related Transactions, and Director Independence

 

73

Item 14.

Principal Accounting Fees and Services

 

73

 

 

 

 

PART IV

 

 

 

Item 15.

Exhibits, Financial Statement Schedules

 

74

Item 16.

Form 10-K Summary

 

77

 

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EXPLANATORY NOTE

Currency and Exchange Rate Information

Unless otherwise indicated, references in this Annual Report to “$” or “dollars” are expressed in U.S. dollars (US$). References in this Annual Report to Canadian dollars are noted as “C$.”

Our consolidated financial statements that are included in this Annual Report are presented in U.S. dollars. Unless otherwise stated, all figures presented in Canadian dollars and translated into U.S. dollars were calculated using the daily average exchange rate as reported by the H.10 statistical release of the Board of Governors of the Federal Reserve System on January 29, 2021 of C$1.2776 = US$1.00.

Market and Industry Data

Certain market and industry data contained in this Annual Report, including Item 1. “Business” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are based upon information from government or other third-party publications, reports and websites or based on estimates derived from such publications, reports and websites. Government and other third-party publications, reports and websites do not guarantee the accuracy or completeness of their information. While management believes this data to be reliable, market and industry data are subject to variations and cannot be verified with complete certainty due to limits on the availability and reliability of raw data, the voluntary nature of the data-gathering process, and other limitations and uncertainties inherent in any statistical survey.

 

3


 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Annual Report are “forward-looking statements” within the meaning of “safe harbor” provisions of the United States Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”) and “forward-looking information” within the meaning of applicable Canadian securities laws. All statements, other than statements of historical fact included in this Annual Report, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects, plans and objectives of management are forward-looking statements. When used in this Annual Report, the words “anticipate,” “believe,” “expect,” “estimate,” “intend,” “plan,” “project,” “outlook,” “may,” “will,” “should,” “would,” “could,” “can,” the negatives thereof, variations thereon and other similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. In particular and without limitation, this Annual Report contains forward-looking information pertaining to the effect of our strategic priorities on increasing value creation; the availability of additional or substitute manufacturing space and the Company’s expectations regarding the building of a new combined tile and millwork facility in Rock Hill, South Carolina; the effect that complying with applicable law and regulations, current claims against the Company and expiring patents will have on the Company’s business, financial condition, results of operations and growth prospects; and the effect the rating systems established by the U.S. Green Building Council will have on demand for products, systems and services in the U.S. market. Forward-looking statements are based on certain estimates, beliefs, expectations and assumptions made in light of management’s experience and perception of historical trends, current conditions and expected future developments, as well as other factors that may be appropriate.

Forward-looking statements necessarily involve unknown risks and uncertainties, which could cause actual results or outcomes to differ materially from those expressed or implied in such statements. Due to the risks, uncertainties and assumptions inherent in forward-looking information, you should not place undue reliance on forward-looking statements. Factors that could have a material adverse effect on our business, financial condition, results of operations and growth prospects include, but are not limited to, the severity and duration of the coronavirus (“COVID-19”) pandemic and related economic repercussions and other risks described in Item 1A. “Risk Factors,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Annual Report. These factors include, but are not limited to, the following:

 

the impact of the COVID-19 pandemic on our business

 

our ability to implement our strategic plan;

 

our ability to maintain and manage growth effectively;

 

competition in the interior construction industry;

 

competitive behaviors by our co-founders and former executives;

 

our reliance on our network of Distribution Partners (as defined herein) for sales, marketing and installation of our solutions;

 

our ability to introduce new designs, solutions and technology and gain client and market acceptance;

 

defects in our designing and manufacturing software and warranty and product liability claims brought against us;

 

material fluctuations of commodity prices, including raw materials;

 

shortages of supplies of certain key components and materials or disruption in supplies due to global events;

 

global economic, political and social conditions and financial markets;

 

our exposure to currency exchange rates, tax rates and other fluctuations, including those resulting from changes in laws or administrative practice;

 

legal and regulatory proceedings brought against us;

 

infringement on our patents and other intellectual property;

 

cyber-attacks and other security breaches of our information and technology systems;

 

damage to our information technology and software systems;

 

our requirements to comply with applicable environmental, health and safety laws;

 

our ability to generate sufficient revenue to achieve and sustain profitability;

 

our periodic fluctuations in results of operations and financial conditions;

4


 

 

 

volatility of our share price;

 

the effect of being governed by the corporate laws of Alberta, Canada, including obstacles to investors seeking to acquire control of our company;

 

the effect of being governed by the corporate laws of a foreign country, including the difficulty of enforcing civil liabilities against directors and officers residing in a foreign country;

 

turnover of our key executives and difficulties in recruiting or retaining key employees;

 

the availability of capital or financing on acceptable terms, which may impair our ability to make investments in the business;

 

future mergers, acquisitions, agreements, consolidations or other corporate transactions we may engage in; and

 

other factors and risks described under the heading “Risk Factors” in Item 1A. of this Annual Report.

These risks are not exhaustive. Because of these risks and other uncertainties, our actual results, performance or achievement, or industry results, may be materially different from the anticipated or estimated results discussed in the forward-looking statements in this Annual Report. New risk factors emerge from time to time, and it is not possible for our management to predict all risk factors nor can we assess the effects of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in, or implied by, any forward-looking statements. Our past results of operations are not necessarily indicative of our future results. You should not rely on any forward-looking statements, which represent our beliefs, assumptions and estimates only as of the dates on which they were made, as predictions of future events. We undertake no obligation to update these forward-looking statements, even though circumstances may change in the future, except as required under applicable securities laws. We qualify all of our forward-looking statements by these cautionary statements.

 

5


 

PART I

Item 1.

Business.

Overview

DIRTT Environmental Solutions Ltd. is an innovative manufacturing company featuring a proprietary software and virtual reality visualization platform, coupled with vertically integrated manufacturing that designs, configures and manufactures prefabricated interior solutions used primarily in commercial spaces across a wide range of industries and businesses. We combine innovative product design with our industry-leading, proprietary ICE® Software (“ICE” or “ICE Software”), and technology-driven, lean manufacturing practices and sustainable materials to provide end-to-end solutions for the traditionally inefficient and fragmented interior construction industry. We create customized interiors with the aesthetics of conventional construction but with greater schedule and cost certainty, shorter lead times, greater future flexibility, and better environmental sustainability than conventional construction.

Our ICE Software allows us to sell, design, visualize (including 3D virtual reality modeling of interiors), configure, price, communicate, engineer, specify, order and manage projects, thereby reducing challenges associated with traditional construction, including cost overruns, change orders, inconsistent quality, delays and material waste. While other software programs and virtual reality tools are used in the architectural and construction industries, we believe our ICE Software provides end-to-end integration and management, from design through engineering, manufacturing and installation. Our interior construction solutions include prefabricated, customized interior modular walls, ceilings, and floors; decorative and functional millwork; power infrastructure; network infrastructure; and pre-installed medical gas piping systems. We strive to incorporate environmentally sustainable materials and reusable components into our solutions while creating flexible, functional and well-designed environments for the people who will use them.

We offer our interior construction solutions throughout the United States and Canada, as well as in select international markets, through a network of independent distribution partners (“Distribution Partners”) and an internal sales team. Our Distribution Partners use ICE to work with end users to envision and design their spaces, and orders are electronically routed through ICE to our manufacturing facilities for production, packing and shipping. Our Distribution Partners then coordinate the receipt and installations of our interior solutions at the end users’ locations.

Our name “DIRTT” stands for Doing It Right This Time. DIRTT was incorporated in Alberta, Canada, under the Business Corporations Act (Alberta) (“ABCA”) on March 4, 2003. Our headquarters are located at 7303 30th Street S.E., Calgary, Alberta, T2C 1N6, Canada, and our telephone number at that address is (403) 723-5000. Our manufacturing facilities are in Calgary, Alberta; Phoenix, Arizona; and Savannah, Georgia; with an additional facility under construction in Rock Hill, South Carolina.

We completed our initial public offering in Canada in November 2013 and listed our common shares on The Nasdaq Global Select Market (“Nasdaq”) in October 2019. Our common shares trade on the Toronto Stock Exchange (“TSX”) under the ticker symbol “DRT” and on Nasdaq under the ticker symbol “DRTT.”

Unless otherwise specified or the context otherwise requires, references to “we,” “us,” “our,” “its,” “the Company” or “DIRTT” mean DIRTT Environmental Solutions Ltd. and, where the context so requires, includes our subsidiaries.

Available Information

We file or furnish annual, quarterly and current reports, proxy statements and other documents with the U.S. Securities and Exchange Commission (“SEC”) under the Exchange Act. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers, including DIRTT, that file electronically with the SEC. We are also subject to requirements of applicable securities laws in Canada, and documents that we file with the securities commissions or similar regulatory authorities in Canada may be found at www.sedar.com.

We make available free of charge through our website (www.dirtt.com) our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC or the securities commissions or similar regulatory authorities in Canada. In addition to the reports filed or furnished with the SEC and the securities commissions or similar regulatory authorities in Canada, we publicly disclose information from time to time in our press releases, investor presentations posted on our website and at publicly accessible conferences. Such information, including information posted on or connected to our website, is not a part of, or incorporated by reference in, this Annual Report or any other document we file with or furnish to the SEC or the securities commissions or similar regulatory authorities in Canada.

6


 

We will provide without charge to you, upon your request, a copy of our annual report on Form 10-K for the year ended December 31, 2020 filed with the SEC and the applicable securities commissions or similar regulatory authorities in Canada. Requests for copies should be addressed to 7303 30th Street S.E., Calgary, Alberta, T2C 1N6, Canada, Attention: Investor Relations.

Our Solutions

We offer a wide array of interior construction solutions powered by technology that address the challenges inherent in traditional interior designing and construction methods. Unlike traditional interior construction, including traditional prefabricated products, our solutions do not have predetermined shapes, sizes or configurations, so clients are free to design any shape, size or configuration that is necessary to meet their needs. Our design and visualization technologies integrate with our manufacturing capabilities and enable short and precise manufacturing times. With a strong network of Distribution Partners, we are able to complete an interior construction project in as few as 30 days, from visualization and completion of design to installation and move-in. Because our solutions remain highly adaptable over time, clients are able to change and customize our solutions even after installation to maintain satisfaction with the functionality and aesthetics of their space as their needs change.

Sustainability practices are a core part of our business, from design and manufacturing to installation and beyond. Our solutions are form-fit, so the only waste produced at job sites is packing material, which is biodegradable, recyclable or able to be returned to DIRTT for reuse.

DIRTT Solutions

Our solutions typically encompass over 90% of an interior space. Walls, doors, cabinetry, access floor, ceilings, power solutions, data networks, heavy timber and medical gas components are all fabricated in our manufacturing facilities and shipped to the site for final assembly and installation. The following table provides a brief description of our primary solutions (together with related complementary offerings, “DIRTT Solutions”):

 

DIRTT Solution 

 

Description 

 

 

 

DIRTT Walls

 

Prefabricated, customized, modular solid or glass interior wall solutions that support new and legacy furniture, that include glass walls, doors or windows, and that support integrated technology for commercial, healthcare, education, hospitality and other industries and medical gas piping systems for healthcare.

 

 

 

DIRTT Millwork

 

Fully customized modular cabinetry that may be used in a variety of industries, including commercial, healthcare, education and hospitality.

 

 

 

DIRTT Floors

 

Low-profile floors that allow quick access to modular power and network infrastructure, facilitating future adaptation and reconfiguration in both existing facilities and new buildings.

 

 

 

DIRTT Ceilings

 

Prefabricated custom ceilings that increase sound privacy and reduce noise.

 

 

 

DIRTT Power

 

Quick-connect, pre-tested adaptable power solutions that are prefabricated to arrive on-site in correct lengths with factory components ready for installation and use, eliminating waste and providing future flexibility.

 

 

 

DIRTT Networks

 

Prefabricated pre-tested and componentized passive optical networks utilizing single mode fiber cables instead of traditional copper cables. Similar to DIRTT Power, data infrastructure components arrive on the job site pre-cut to correct lengths and with components ready for quick-connect installation and use.

 

 

 

DIRTT Timber

 

Prefabricated timber construction for interior mezzanines, structural elements for low-rise buildings, and other architectural elements, including completely customized cross-laminated timber and glue-laminated (glulam) timber.

 

Our DIRTT Power and DIRTT Networks solutions may be integrated with DIRTT Walls, and DIRTT Networks solutions may also be integrated with DIRTT Floors and DIRTT Ceilings. DIRTT Millwork solutions may be added to DIRTT Walls for decorative and functional purposes. Additionally, DIRTT Walls, DIRTT Floors, DIRTT Ceilings and DIRTT Timber may be integrated among each solution.

ICE® Software

Our manufacturing approach is built on a foundation of technology, the core of which is our proprietary ICE Software. We use ICE to sell, design, visualize, configure, price, communicate, engineer, construct, specify, order and manage projects. ICE enables us to efficiently manufacture fully custom interiors while addressing challenges associated with traditional construction, including cost

7


 

overruns, inconsistent quality, delays and significant material waste. ICE also gives our clients control over the look, cost and timing of their interior construction projects.

Clients typically engage an architect or designer and initially design their interior including space planning, materials, colors, finishes, which are then often presented in two-dimensional renderings or a building information model (“BIM”). A Distribution Partner imports this design into ICE and prices projects in real time. Clients can make changes after the design is imported into ICE, which will immediately be reflected in the price quote. Throughout these iterations, clients can explore and walk through their proposed space in immersive and interactive 3D virtual reality, on-screen computer renderings, and floorplan details so they can more readily understand the design. Throughout every stage of the process design changes can be made easily and in real time. We believe this is a significantly enhanced experience for our clients as compared with the experience of reviewing a two-dimensional blueprint or CAD drawing or user expertise intensive BIM file. In addition to the ICE tools that enable these experiences at each of our Distribution Partners, we currently have four specialized virtual reality walk-through centers, including one at our corporate headquarters, that allow clients to use virtual reality headsets to physically walk through a 3D virtual reality model of their design. ICE’s virtual and augmented reality technology, including applications for phones, tablets and PCs, allows project stakeholders in different physical locations to meet in real time to visualize, move about, interact with, discuss and edit their future spaces without having to visit one of our virtual reality walk-through centers. ICE also provides the ability to export a BIM file for use in design reviews of an entire project consisting of non-DIRTT construction elements coming from many different types of software.

Once the client is satisfied with the design in ICE, the specifications are transmitted to our manufacturing facilities, where the physical product solutions are created to the exact design standards and specifications set forth in the design. ICE’s detailed bill of material data output is key to managing the many aspects of the manufacturing process, including product inventory and cataloguing, price quotation, order submission, parts manufacturing, and production management, thereby facilitating the delivery of custom solutions with shorter production times. We allocate production among our manufacturing facilities based on proximity to the job site and available capacity. ICE’s information allows a project to be tracked in detail across the entire life of the project, from sales, production, delivery, and installation. The ICE file (containing a project’s engineering and manufacturing data) generated during the design and specification process is preserved and can be used for optimizing future reconfigurations, renovations, technology integration initiatives and changes to a client’s space at lower cost than traditional construction methods.

Our Business Strategy

Our goal is to help clients envision and design interior construction projects and then build and deliver those projects faster, cleaner, more efficiently and with a better overall client experience and satisfaction than traditional construction methods. The modular aspect of our DIRTT Solutions allows them to be easily reconfigured with a minimal amount of waste as client space needs change. Our innovative, technology-driven approach includes outstanding product design that is customized for each client application and delivered on time and on budget.

Our strategy is founded on the following priorities:

 

The identification and pursuit of client segments that benefit most from DIRTT’s value proposition;

 

Client-centric, continuous innovation in DIRTT Solutions and our technology to enhance product differentiation and drive market penetration and growth;

 

Technology-enabled manufacturing processes that facilitate short lead times, a reliable client service platform, and outstanding quality on a cost-effective basis; and

 

Ongoing development and support of our Distribution Partners to ensure flawless execution and a superior end client experience.

In combination with a focus on cost-discipline, a continuous improvement philosophy, and a focused approach to capital investment, we believe these strategic priorities will drive increased value creation for our employees, clients, Distribution Partners, and shareholders.

Our Competitive Strengths

We believe the following attributes provide us with competitive strengths in the interior solutions manufacturing industry:

 

Leader in Integrated Design and Manufacturing Technology. We believe our ICE Software is the only interior construction technology that efficiently integrates the design, configuration, and virtual reality visualization processes

8


 

 

with the manufacturing process. The use of 3D technology in a design environment, utilizing video game technology for real time decision making, is an approach pioneered by DIRTT.

 

Easy and Intuitive Software Interface. Our ICE Software is a fast, powerful tool with an intuitive user interface. Our software’s ease of use enables rapid time-to-value for our clients and collaboration among all the stakeholders involved in the design, reconfiguration, budgeting and manufacturing processes. Our use of 3D virtual reality and augmented (mixed) reality technologies enables clients to visualize and modify their designs before manufacturing begins, thereby reducing cost and time to completion.

 

Proprietary Solutions Components. The physical components that comprise our DIRTT Solutions have been designed to provide clients with numerous options and full modularity. As a result, we are able to create interior environments that are fully customizable and not limited by a pre-set product list. The modular nature of our components allows them to be reconfigured easily, with minimal disruption to the occupants of the space and with minimal job site waste.

 

Strong Distribution Partner and Sales Network. Our strong network of Distribution Partners and DIRTT sales representatives allows us to maximize our geographic reach, helps build brand awareness in the interior construction market, and enhances our positioning in our target markets.

 

Superior Results Compared to Traditional Design and Construction. We believe we produce superior client results as compared with traditional design and construction methods in sequencing, certainty, budget allocation, and outcome.

 

Effective Sequencing. Conventional construction generally follows a rigid sequencing process. Typically, wall framing is constructed first, followed by floors and electrical and data networks. This process is then followed by drywall installation, painting, and flooring, and then installation or building of millwork and fixtures. These steps generate significant waste and create opportunities for delay, change orders, cost overruns and rework. In contrast, DIRTT Solutions design and integrate the walls, floors and ceiling, including the finish, electrical wiring and data networks. They are manufactured off-site and arrive on-site organized, labeled and ready to be installed. This enables the interior solutions to be produced concurrently with on-site construction work, thereby reducing on-site time and the overall construction schedule.

 

Certainty. Our technology-based design and manufacturing solutions address changes in design, communications with clients, and material costs with more certainty than conventional construction methods, which often involve retrofitting electrical and data networks, change orders, uncertain timelines, and costly rework. Our controlled manufacturing environment reduces deficiencies and errors and produces more consistent solutions in predictable time frames.

 

Budget. Because of our integrated design, visualization and manufacturing technologies, we can price the effect of design choices and changes immediately and deliver the fully designed, manufactured interior solutions ready to install. This provides budget certainty both in the cost of our DIRTT Solutions as well as in on-site labor for the installation process.

 

Outcome. Our interior spaces look like the images our clients expect from the design drawings and virtual visualizations, because those same drawings and visualizations drive the manufacturing process. Plumbing, electrical, A/V and data networks are integrated into the architecture of our DIRTT Solutions. For example, DIRTT Walls carry an aesthetic of permanent walls, but if an IT or facilities team needs to get inside the wall for any reason, they can use a tool to remove the surface of the wall to examine the wall cavity quickly, cleanly and quietly. This eliminates the need to knock down, and then patch and repaint, drywall or reconfigure fixtures and cabinetry. Our modular designs offer flexibility and interconnectivity with any technology, furniture, millwork or DIRTT Solutions that were previously used or that will be used in the future, allowing clients to reconfigure and repurpose their space while reducing disruptive and time-consuming demolition and waste removal.

Distribution Partners and Sales Network

We primarily sell DIRTT Solutions through a network of independent Distribution Partners working in conjunction with local DIRTT sales representatives, as well as internal DIRTT industry specialists, business development professionals and a dedicated Distribution Partner support team. Distribution Partners and local sales representatives are located in cities throughout the United States and Canada, as well as in select international markets. The use of a dispersed network of Distribution Partners greatly enhances our ability to drive awareness of the DIRTT brand throughout our markets.

As part of our distribution agreements, our 72 Distribution Partners are typically required to invest in their own DIRTT Experience Center (“DXC”) so that they are able to effectively showcase DIRTT Solutions. These DXCs are showrooms that provide

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mock-ups of DIRTT Solutions and related product offerings. As well, DIRTT maintains DXCs in Calgary, Toronto, Chicago, New York City, Savannah, Phoenix, Salt Lake City, with an additional DXC under construction in Dallas.

Our Distribution Partners operate under agreements that outline sales goals and marketing territories which are generally non-exclusive. We expect our Distribution Partners to build regional DIRTT-dedicated teams (sales, design and project management) and to use our ICE Software in the sales process. In addition to sales and marketing, our Distribution Partners provide value throughout the construction process. At the pre-construction stage, Distribution Partners provide design assistance services to the architect and designer; throughout the construction process, Distribution Partners act as a specialty subcontractor to the general contractor and provide installation and other construction services. Post-move in, Distribution Partners provide warranty work, ongoing maintenance and reconfiguring support. Local DIRTT sales representatives work closely with the Distribution Partners throughout the process to ensure successful project implementation and the highest client satisfaction. Distribution Partners generally place orders for DIRTT Solutions directly with us and pay us directly for such orders.

We have the ability to bring on new Distribution Partners in a wide range of geographic areas, which permits us to quickly establish a presence in new market areas. Our Distribution Partners also scale our virtual reality technology, such as our phone- and tablet-based applications, to fit their capacity and needs.

At December 31, 2020, we had a total of 72 Distribution Partners and 61 sales representatives across North America. We are not dependent on any one Distribution Partner or sales representative.

Manufacturing and Properties

Our DIRTT Solutions are manufactured at our facilities in Calgary, Alberta; Phoenix, Arizona; and Savannah, Georgia. Our wall surfaces (which we call tiles), millwork and timber solutions are manufactured in Calgary, while aluminum, glass and power components are manufactured at all three locations. Through distributed manufacturing we can shift production of some components among our manufacturing sites, reduce transportation times and costs, and meet targeted lead times. In 2019, we conducted an evaluation of our aluminum, tile and millwork capacities under various growth scenarios and concluded that the capacity of our aluminum manufacturing facilities is currently sufficient to support our anticipated growth. Given the longer lead time to acquire tile and millwork manufacturing equipment, combined with a lack of redundancy in those manufacturing facilities, we also concluded that we should commence construction of a new combined tile and millwork facility. In the fourth quarter of 2019, we entered into a lease for a building located in Rock Hill, South Carolina, which will provide for approximately 130,000 square feet of manufacturing space for the combined tile and millwork factory. We currently expect construction of this factory to be substantially completed and commissioned in the second quarter of 2021. Should the need arise, we have the expansion rights to lease an additional 130,000 square feet of space. Should we experience additional growth, we may need to add or expand additional manufacturing facilities.

Suppliers and Raw Materials

Our inventory balances consist primarily of raw materials, which are kept on hand as components of our custom manufacturing process. Managing our raw material inventory is essential to our business, given our short lead times from order to shipment and our high level of order customization. Our key manufacturing materials are aluminum, hardware, wood and glass. For the twelve months ended December 31, 2020, aluminum accounted for approximately 30.9% of our purchased materials, while hardware, wood and glass accounted for approximately 14.1%, 11.2%, and 7.2%, respectively. While we maintain multiple suppliers for key materials, for the twelve months ended December 31, 2020, two suppliers accounted for approximately 28% and 24% of our aluminum supply, two suppliers accounted for approximately 50% and 46% of our wood supply and one supplier accounted for approximately 41% of our hardware supply.

Materials are sourced domestically and, to a much lesser extent, overseas. Approximately 97% of our materials are manufactured and purchased in North America. Purchase decisions are made on the basis of cost, quality and ability to meet delivery requirements. We do not typically enter into long-term agreements with suppliers. In general, adequate supplies of raw materials are available to all our operations, although aluminum purchases may be subject to market capacity constraints.

Technology and Development

We continue to focus on developing client-centric innovations and enhancements of both ICE Software and DIRTT Solutions with a primary focus on improving client experience, increasing market penetration and growing key markets. At December 31, 2020, we employed 105 employees within our technology and development groups and, including capitalized amounts, invested $11.6 million, $11.3 million and $9.4 million in 2020, 2019 and 2018, respectively, in innovation activities.

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Clients

DIRTT’s principal geographic markets are the United States, Canada, and, to a more limited extent, select international markets. Our revenue is derived almost entirely from projects in North America sold by our North American Distribution Partners.

Our revenue opportunities primarily come from commercial projects, including both new construction projects and renovations of existing buildings. Clients range from small owner-managed businesses to multinational Fortune 500 companies across a variety of industries, including healthcare, education, financial services, government and military, manufacturing, non-profit, energy, professional services, retail, technology and hospitality. We view DIRTT Solutions as generally industry agnostic, with applications in many different industries with minimal adjustments. We are not dependent on any one client or industry segment. No single client represented more than 10% of our revenue for the years ended December 31, 2020, 2019 or 2018.

Competition

The overall market for interior construction is fragmented and highly competitive. The principal competitive factors in the interior construction industry include price (including cost certainty), speed, quality, customization and service. Our main competitors are comprised primarily of conventional construction firms, individual tradespeople (including framers, drywall installers, and interior product designers) and modular systems manufacturers. Additionally, conventional construction firms are beginning to develop customizable wall paneling and other interior construction solutions and may directly compete with our DIRTT Solutions. We also compete with commercial furniture manufacturers, such as Teknion Corporation, Haworth Inc. and Allsteel Inc., who offer a variety of prefabricated interior wall solutions. We expect competition to increase as new entrants or solutions enter the interior construction market. See Item 1A. “Risk Factors”.

Seasonality

The construction industry has also historically experienced seasonal slowdowns related to winter weather conditions and holiday schedules, which affect shipping and on-site installation dates, in the fourth and first quarters of each calendar year. Our business has generally, but not always, followed this trend with a slight time lag, leading to stronger sales in the second half of the year versus the first half. Weather factors can also influence third-party exterior construction schedules and site conditions, which may in turn affect timing of interior renovations.

Due to the fixed nature of certain of our manufacturing costs, such as our facilities leases and related indirect operating costs, periods of higher revenue volume tend to generate higher gross profit and operating income margins while periods of lower volume tend to result in lower gross profit and operating income margins. Quarters that contain consistent monthly manufacturing volumes tend to generate higher gross profit than those where manufacturing levels vary significantly from month to month.

Patent and Intellectual Property Rights

Our success depends, in part, upon our intellectual property rights relating to our products, production processes, our technology, including our ICE Software, and other operations. We rely on a combination of trade secret, nondisclosure and other contractual arrangements, as well as patent, copyright and trademark laws, to protect our proprietary rights and competitive advantage. We register our patents and trademarks as we deem appropriate and take measures to defend patents where we deem others are infringing on our patents. The following table presents the status as of December 31, 2020 of our issued and pending patents relating to various aspects of DIRTT Solutions and ICE Software:

 

 

 

Granted

 

 

Applications

 

Jurisdiction

 

Patents

 

 

Pending

 

Canada

 

 

63

 

 

 

41

 

United States

 

 

108

 

 

 

21

 

European Union

 

 

40

 

 

 

34

 

Singapore

 

 

21

 

 

 

5

 

Patent Cooperation Treaty

 

 

-

 

 

 

14

 

Other

 

 

57

 

 

 

4

 

Total

 

 

289

 

 

 

119

 

 

Our issued patents expire between 2021 and 2039. We do not believe that the expiration of any individual patent will have a material adverse effect on our business, financial condition or results of operations. As we develop innovations and new technology, we expect to file additional and supplemental patents to protect our rights in those innovations and new technology.

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Sustainability and Environmental Matters

Conventional construction typically generates substantial waste. According to the Environmental Protection Agency’s 2018 Fact Sheet, approximately 189 million tons of building construction and demolition waste was generated in 2018, approximately 30% of which was related to wood products, drywall and plasters. Imprecise calculations or last-minute design changes may result in excess materials on the job site, such as wiring, drywall, wood, paint and flooring, that are sometimes unable to be reused or recycled. Measuring and cutting materials on-site leads to scrap waste that generally is sent to landfills. Sustainability is an integral component of our corporate brand identity and DIRTT Solutions. DIRTT Solutions are designed for disassembly, are form-fit and allow for less materials waste throughout the manufacturing and installation process. We integrate environmentally friendly elements into our business wherever possible, including utilizing solar energy at most of our factories to offset a portion of the cost of electricity and the environmental impact of our operations, and utilizing materials with high recycled content in our DIRTT Solutions. We also ship DIRTT Solutions with recyclable or reusable packing and shipping materials.

The adoption of environmentally responsible building codes and standards, such as the Leadership in Energy and Environmental Design (“LEED”) rating system established by the U.S. Green Building Council, also has the potential to increase demand for products, systems and services that contribute to building sustainable spaces. All of our DIRTT Solutions can contribute to the award of LEED credits and other green building rating systems. We continue to develop new products, systems and services to address market demand for products that enable construction of buildings that require fewer natural resources to build, operate and maintain. Our EnzoTM line of wall components received the Canadian Green Building Council’s Green Building Product of the Year Award in 2015 due to its ingenuity and application, particularly as a benefit to healthcare facilities. With the help of Climate Earth Inc., in 2014 DIRTT was the first modular wall manufacturer to complete a full scope Life Cycle Assessment, resulting in 15 Environmental Product Declarations. In May 2019, we completed our second Life Cycle Assessment and released updated Environmental Product Declarations.

Government Regulations

The operation of our business is subject to stringent and complex laws and regulations pertaining to health, safety and the environment. As an owner or operator of various manufacturing facilities, we must comply with these laws and regulations at the federal, state, provincial and local levels in both the United States and Canada. Failure to comply with environmental laws and regulations may trigger a variety of administrative, civil or criminal enforcement actions, including the assessment of monetary penalties, the imposition of investigative or remedial requirements, or the issuance of orders limiting current or future operations. Certain environmental statutes impose strict, joint and several liability for costs required to clean up and restore sites where hazardous substances or industrial wastes have been mismanaged or otherwise released.

While we do not believe that compliance with federal, state, provincial or local environmental laws and regulations will have a material adverse effect on our business, financial position or results of operations, we cannot provide any assurances that future events, such as changes in existing laws or regulations, the promulgation of new laws or regulations, or the development or discovery of new facts or conditions related to our operations will not cause us to incur significant costs.

Legal and Regulatory Proceedings

We may be involved from time to time in various lawsuits, claims, investigations and other legal matters that arise in the ordinary course of business, including matters involving our products, intellectual property, relationships with suppliers, relationships with Distribution Partners, relationships with competitors, employees and other matters. We may, for example, be a party to various litigation matters that involve product liability, tort liability and claims under other allegations, including claims from our employees either individually or collectively. We do not believe that any current claims, individually or in the aggregate, will have a material adverse effect on our financial condition, liquidity or results of operations. For additional information regarding our current legal proceedings, see Item 3. “Legal Proceedings.”

Implications of Being an Emerging Growth Company

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”) enacted in April 2012. Certain specified reduced reporting and other regulatory requirements are available to public companies that are emerging growth companies. These provisions include:

 

an exemption from the auditor attestation requirement in the assessment of our internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002;

 

an exemption from the adoption of new or revised financial accounting standards until they would apply to private companies;

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an exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about our audit and our financial statements; and

 

reduced disclosure about our executive compensation arrangements.

We will continue to be an emerging growth company until the earliest of:

 

the last day of our fiscal year in which we have total annual gross revenues of $1.07 billion (as such amount is indexed for inflation every five years by the SEC to reflect the change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics, setting the threshold to the nearest $1 million) or more;

 

the last day of our fiscal year following the fifth anniversary of the date of our first sale of common equity securities pursuant to an effective registration statement under the Securities Act of 1933 (“Securities Act”);

 

the date on which we have, during the prior three-year period, issued more than $1 billion in non-convertible debt; or

 

the date on which we are deemed to be a “large accelerated filer” under the rules of the SEC, which means the market value of our common shares that is held by non-affiliates (or public float) exceeds $700 million as of the last day of our second fiscal quarter in our prior fiscal year.

We have elected to take advantage of certain of the reduced disclosure obligations in this Annual Report and may elect to take advantage of other reduced reporting requirements in future filings. As a result, the information that we provide to our shareholders may be different than what you might receive from other public reporting companies in which you hold equity interests. However, we have irrevocably elected not to avail ourselves of the extended transition period for complying with new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Human Capital Resources

As of December 31, 2020, DIRTT employed 1,013 employees, 98% full time, 2% part time. We had 1,013 full-time employees consisting of 606 employees in production, 115 employees in sales and marketing, 105 employees in technology and development, 102 employees in operations support, and 85 general and administrative employees. At year-end, approximately 54% of our workforce are salaried employees and approximately 46% are compensated on an hourly basis. As of December 31, 2020, approximately 32% of our workforce was based in the United States, and approximately 68% was based on Canada. Our 2020 hiring efforts were directed towards both our manufacturing and non- manufacturing functions. This reflects the build out of our commercial organization, accounting for 30% of our new hires, and streamlining our operations space, accounting for 55% of our hiring activities. The Company’s recent gender diversity data shows that 28% of our employees are female company wide. In 2020 we hired 175 employees, with 41% of new employees being female.  

Diversity & Inclusion

DIRTT recognizes the importance of progressing conversations and initiatives around diversity and inclusion. “Grow through diversity” is one of our core values. Our strategy encompasses leadership training around key topics related to unconscious bias, allyship and the value of attracting and retaining a diverse and inclusive organization.  The strategy further focuses on the establishment and deployment of learning streams, mentoring circles, incorporating inclusive language into our offer packages and benefit materials, and the implementation of a diversity counsel.  Our efforts begin at the early stages of the employee life cycle, where diversity candidates are highlighted and presented to hiring managers for review.  We seek to hire based on talent and skill / capability needs and fit.  DIRTT has also incorporated diversity into various internal programs including succession planning and risk profiles.  

 

Culture & Engagement

DIRTT has put new measures in place to assess and enhance the level of engagement and satisfaction of our employees.  Specific activities include the deployment of a performance management tool, catered to drive discussions around team goals, performance and development opportunities, and greater transparency around policy and procedures, tied to cost and risk mitigation.  

 

In the second quarter of 2020 we deployed our first company-wide engagement survey focused on core themes of meaningful work, supportive management, positive work environment, growth opportunity, trust in leadership and mental health awareness.  

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Targeted initiatives were put in place company wide to assess the progression of themes from the survey on overall employee engagement and experience. Results from the fourth quarter of 2020 indicated an average positive increase of 4% enhancement of employee engagement through a variety of targeted measures.  

 

Additional initiatives that we attribute to the progression of culture and engagement include launching learning and development opportunities, enhanced communication platforms, employee recognition programs, and a company-wide philanthropic organization.  

 

Connecting to our community is a critical piece of the DIRTT story. Re-establishing a stronger corporate social responsibility program that demonstrates our drive to put community at the center of the business was a focus area in the third quarter of 2020. This involved developing a strategy, carving out a roadmap of initiatives and establishing a committee of 20 employees across the organization. As part of our strategy we are focusing our efforts on establishing meaningful engagement opportunities, creating inclusive giving campaigns, driving sustainable impact and enabling our employees to connect on philanthropic efforts. In the fourth quarter of 2020, we kicked off our 2020 holiday giving campaign which was a coordinated virtual effort in support of foodbanks across North America. The support for this campaign helped to reconnect DIRTT employees’ desire to give back with tangible outcomes for their communities.  

Our core commitment to organizational safety resulted in a total recordable incident rate (“TRIF”) of 0.48 in 2020, more than 75% below the industry average and a significant improvement from 4.9 TRIF in 2019. Our enhanced safety protocols and robust contact tracing have been effective thus far in mitigating the spread of COVID-19 infections within our facilities and have helped us to avoid any material production disruptions.

We use a range of compensation incentives which vary by role, including: annual variable compensation determined based on a combination of achieving team objectives and financial targets for the Company; quarterly bonuses paid on adherence to targets related to safety, quality, delivery, inventory and productivity; and commissions based on sales goals. We also use various forms of stock-based compensation as a retention tool and to further align employee interests with the interests of our shareholders. We monitor our retention by way of voluntary turnover, which was 14% in 2020.

In response to the COVID 19 pandemic, DIRTT established a business continuity and response committee to develop robust

company-wide COVID-19 protocols and guidelines. The committee has prepared easily accessible COVID-19 guidelines for all areas

of the business, including manufacturing, travel, client tours and day-to-day operations. In addition, we have established protocols for

reporting and contact tracing, and have limited access to our facilities, offices and other spaces to essential operations to minimize the

risk of exposure to COVID-19. We have also implemented enhanced cleaning protocols, increased signage, shift rotations in

cafeterias, limited headcounts in conference and meeting rooms, adopted policies with respect to essential workers, and work-from home guidelines and best practices, including ergonomics. In addition, we have taken measures to address the mental health of our

employees through a variety of company-wide initiatives. We also provide personal protective equipment to all of our employees, and

to clients that are engaged in essential tours. We have established a safety champions committee responsible for ensuring any

employee or visitor coming into our spaces is briefed on our COVID-19 protocols and guidelines. Lastly, we have implemented an app for reserving workspaces to help our employees adhere to our social distancing protocols, provide for greater support of contact tracing and ensure we adhere to capacity levels that will help us maintain safety protocols related to COVID-19.

None of our employees are covered by collective bargaining agreements. We have never experienced labor-related work stoppages or strikes, and we believe we currently have a positive relationship with our employees.

Item 1A.

Risk Factors.

Investing in our common shares involves a high degree of risk. You should carefully consider the risks described below, as well as the other information in this Annual Report, including our consolidated financial statements and the related notes and Part II, Item 7. entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in any documents incorporated in this Annual Report by reference, before deciding whether to invest in our common shares. The occurrence of any of the events or developments described below could harm our business, financial condition, results of operations, and growth prospects. In such an event, the market price of our common shares could decline, and you may lose all or part of your investment. Although we have discussed all known material risks, the risks described below are not the only ones that we may face. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also impair our business operations. Certain statements below are forward-looking statements. See also “Special Note Regarding Forward-Looking Statements” in this Annual Report.

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Risks Related to Our Business and Industry

The COVID-19 pandemic has had, and is expected to continue to have, a significant and adverse effect on our business.

The COVID-19 pandemic has created significant volatility, uncertainty and economic disruption. The extent to which COVID-19, or other public health pandemics or epidemics, impact our employees, operations, customers, suppliers and financial results will depend on numerous evolving factors that we may not be able to accurately predict, including: the duration and scope of the COVID-19 pandemic (and whether there is a resurgence or multiple resurgences of the virus in the future, including as a result of strain variations); the actions taken by governments and public health officials in response to the pandemic; the availability and effectiveness of vaccines, approvals thereof and the speed of vaccine distribution; the impact on construction activity; the effect on our customers’ demand for our DIRTT Solutions; our ability to manufacture and sell our products; and the ability of our customers to pay for our products. For example, while many of our products support life sustaining activities and essential construction, we, and certain of our customers or suppliers, may be impacted by state or provincial actions, orders and policies regarding the COVID-19 pandemic, including temporary closures of non-life sustaining businesses, shelter-in-place orders, and travel, social distancing and quarantine policies, the implementation and enforcement of which may vary by individual jurisdictions. Any of these events could have a material adverse effect on our business, liquidity or results of operations.

We may not be successful in implementing our strategic plan or managing growth.

In November 2019, we unveiled a four-year strategic plan to scale our business based on three key pillars: commercial execution, manufacturing excellence and innovation. We have implemented several steps in furtherance of our strategic plan, including improvements in our commercial function and enhancements to our product suite and software platform.  

While we are confident in our strategy, implementation will require maturity of systems and processes across the organization. There is also no assurance that successful implementation will lead to sustainable, profitable growth, and may itself be disruptive to the Company. Failure to implement our strategic plan could materially and adversely affect our near-term sales, commercial activities, and ability to develop and sustain profitable growth.  

Our strategy also depends in part on our ability to maintain and manage growth effectively.  Growth in our headcount and operations may place significant demands on our management and operational and financial resources. Additionally, managing growth of our operations and personnel requires continuous improvement of our internal controls and reporting systems and procedures. Failure to effectively manage growth could result in difficulty providing current DIRTT Solutions and introducing future solutions, difficulty in securing clients and Distribution Partners, declines in quality or client satisfaction, increases in costs or other operational difficulties. Any of these difficulties could lead to a loss of investor confidence and adversely affect our business performance, financial condition and results of operations.

Our industry is highly competitive, and we may not be successful in educating potential clients about the benefits of our innovative and unique approach to interior construction as compared to traditional interior construction methods.

We operate in the highly competitive interior construction industry that is constantly developing and changing. We compete against conventional construction firms, individual tradespeople and modular systems and commercial furniture manufacturers.  New market entrants and conventional construction firms are also beginning to develop customizable wall paneling and other modular interior construction solutions, and we expect this trend to continue. In addition, we may face pricing pressure from competitors or new market entrants who take on projects at reduced prices or employ other competitive strategies. While we believe our innovative design, quality, schedule and cost certainty, and network of Distribution Partners makes us well-positioned in the market, increasing competition could make it difficult to secure new projects at acceptable operating margins.

Our products are unique and offer an alternative to traditional construction techniques. Although offsite construction methods are gaining market acceptance, this still represents only a fraction of all construction methods and the overall construction market. Our ability to grow and increase market share depends, in part, on our success in continuing to increase demand for modular construction methods and products as an alternative to more traditional construction methods. While we intend to follow a strategy of innovative product development and strategic marketing efforts to enhance our position, there is no assurance that our solutions will attain a degree of market acceptance sufficient for sustained profitable operations. Failure to compete effectively by, among other things, meeting consumer preferences, developing and marketing innovative solutions, maintaining strong client service and distribution relationships, growing market share, and expanding our solutions capabilities could have a material adverse effect on our liquidity, financial condition, or results of operations.

Our former co-founders’ competitive behavior against us could have an adverse effect on our business, financial condition and results of operations.

Our co-founders and former executives, Mogens Smed and Barrie Loberg, have started an interior construction and manufacturing company that we believe competes with us. They, along with a number of our former employees and Distribution

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Partners who have joined their company have in-depth knowledge about our business, including our customers, employees, products and prospects, and we may be adversely affected by increased competition arising out of this business venture.  We are engaged in litigation with Messrs. Smed and Loberg, entities with which they are involved, and other individuals relating to, among other things, enforcement of non-competition and non-solicitation obligations, alleged patent infringement, and alleged misappropriation of proprietary information by them or by us. See Item 3. “Legal Proceedings.” If Messrs. Smed and Loberg further engage in a competitive business against us or if we are not successful in litigation, our business, financial condition and results of operations may be adversely affected.

We depend heavily on our network of Distribution Partners, and the loss or inattention of our Distribution Partners, or the failure of our Distribution Partners to meet their obligations to us, could materially and adversely affect our business, financial condition and results of operations.

We currently do not engage in many direct sales projects and rely almost exclusively on our network of Distribution Partners to promote brand awareness, sell and market DIRTT Solutions, and provide design, installation, distribution and other services to clients on each project. While we are not dependent on any single Distribution Partner, sales generated by approximately 10% of our Distribution Partners comprised approximately 40% of our total revenues for 2020. The loss of any top performing Distribution Partners, particularly to our competitors, may negatively affect our sales, financial condition or results of operations.  It may further impair our ability to maintain a market presence in a particular geographic region until a new Distribution Partner relationship is established, which would require significant time and resources.

Although we provide our Distribution Partners with training, education and support, they may be unable to successfully sell our DIRTT Solutions, execute projects or manage client experiences and relationships. In addition, our Distribution Partners and their clients may face financial difficulties or may become insolvent, which could result in the delay or cancellation of their plans to purchase DIRTT Solutions or lead to our inability to obtain payment of accounts receivable that they may owe.   If we are unable to maintain a successful Distribution Partner network, our business, financial condition and results of operations could be materially and adversely affected.

Risks Relating to Our Products and Software

We may be unsuccessful in designing, introducing or selling new, innovative solutions, solution features or software.

Our future success depends in part on our continuing ability to promote and demonstrate the value proposition of DIRTT Solutions, as well as our ability to develop and sell new, innovative solutions, solution features or software that differentiate our solutions and achieve market acceptance in a timely and cost-effective manner. We incur significant costs associated with the investment in our research and development in furtherance of our strategy that may not result in increased revenue or demand for DIRTT Solutions and that could negatively affect our results of operations. Rapidly changing technology, evolving regulatory and industry standards, and changing consumer trends, demands and requirements require us to continuously innovate and develop new, high-quality solutions, solutions features and software. Additionally, such rapid technological changes, standards and preferences could render the complex and proprietary technology of our software and solutions obsolete. We may also be unable to successfully address these developments on a timely basis, or at all. New solutions, solution features or software may also be less successful than we anticipated, and such offerings may fail to achieve market acceptance. If we fail to respond quickly and cost-effectively to a changing market and changing consumer preferences, our competitive position, financial condition and results of operations could be materially and adversely affected.

Our software and products may have design defects, deficiencies, or risks, and we may incur additional costs to fix any defects, deficiencies or risks, or be subject to warranty or product liability claims.

Our software and solutions are complex and must meet the technical requirements of our clients and applicable building codes and regulations. Our solutions may contain undetected errors or design and manufacturing defects, and our software may experience quality or reliability problems, or contain bugs or other defects. Software defects may also cause errors in our manufacturing or miscalculations in ordering pricing and could lead us to incur losses and lose market share to competitors. Product or software defects could cause us to incur warranty costs, product liability costs, and repair and remediation costs. Although we maintain warranty reserves based on production, historical claims and estimates, future warranty claims may exceed this amount.  Similarly, while we maintain insurance of the types and amounts we consider commercially prudent and consistent with industry practice, such insurance coverage may not be sufficient to protect us against substantial claims. Such claims can be expensive to defend, could divert the attention of management and other personnel for significant periods, regardless of the ultimate outcome, and could result in negative publicity. Increased costs to address product warranty claims or to defend against product liability claims may result in increased expenses and adversely affect our financial condition and results of operations.

We are subject to fluctuations in the prices of raw materials and commodities which could adversely affect our liquidity, operating margins and financial condition.

We purchase raw materials, including aluminum, glass and wood, from a number of local and global suppliers.  The costs of these commodities can fluctuate due to changes in global supply and demand, speculation in commodities futures, and changes in

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tariffs or trade barriers, which can also interrupt supply.  In addition, we have not historically entered into long-term agreements with vendors and may be exposed to short-term and long-term price fluctuations as a result.

Aluminum represents the largest component of our raw materials consumption. We have experienced fluctuations in the price of aluminum and anticipate that these fluctuations will continue in the future. Since 2018, the U.S. government has imposed tariffs on steel and aluminum and limited the amounts of steel and aluminum coming into the United States based on the countries of origin of those imports. In 2019 and 2020, we sourced the majority of our aluminum from North America and sourced under 10% of our raw materials from outside North America. Nonetheless, substantial, prolonged upward trends in aluminum and other commodity prices, along with tariffs and import limitations, could significantly increase our costs and adversely affect our liquidity, operating margins and financial condition.

We rely on a limited number of outside suppliers for certain key components and materials, and failure or delay in obtaining the necessary components or materials could delay or prevent the manufacturing or distribution of our DIRTT Solutions.

We rely on certain key suppliers for raw materials and components, including aluminum, glass, wood and hardware. We maintain multiple suppliers for key materials, although for the year ended December 31, 2020, two suppliers accounted for approximately 28% and 24% of our aluminum supply, two suppliers accounted for approximately 50% and 46% of our wood supply, and one supplier accounted for approximately 41% of our hardware supply. While we believe there are other vendors for most of our key requirements, certain materials and components meeting our quality standards are available only through a limited number of vendors. If we are required to obtain another source for these materials or components, we may not be able to obtain pricing on as favorable terms or on terms comparable to our competitors. Any failure or delay in obtaining the necessary raw materials or components in the quantities and quality required may result in increased costs and delays in manufacturing or distributing our products, which could have a material adverse effect on our liquidity, financial condition, or results of operations. A vendor may also choose, subject to existing contracts, to modify its relationship with us due to general economic concerns or specific concerns relating to that vendor or us, at any time. These modifications might include additional requirements from our suppliers that we provide them additional security in the form of prepayments or with letters of credit. Any significant change in the terms that we have with our key suppliers could materially and adversely affect our liquidity, financial condition or results of operations.

Risks Relating to Market Conditions

Global economic, political and social conditions and financial markets may impact our ability to do business and adversely affect our liquidity, financial condition and results of operations.

Our industry is cyclical and highly sensitive to macroeconomic conditions. Overall declines or reductions in construction and renovation due to economic downturns, unemployment and office vacancies, difficulties in the financial services sector and credit markets, and imposition of trade barriers can impact the demand for our products.  Financial difficulties experienced by our suppliers, Distribution Partners or clients could also result in, among other things, inadequate project financing, project delays, inability to pay accounts receivable or disruptions in our supply chain. Any general economic, political or social conditions that may contribute to financial difficulties experienced by us, our suppliers, Distribution Partners or clients may adversely affect our liquidity, financial condition and results of operations.

We are exposed to currency exchange rates, tax rates and other fluctuations, including those resulting from changes in laws.

Our revenues and expenses are collected and paid in different currencies, including the U.S. dollar and Canadian dollar. Fluctuations in the relative values of any such currency expose us to foreign exchange risk and could have a material and adverse effect on our cash flows, revenues and results of operations. We also have currency exchange exposure to the extent of a mismatch between foreign-currency denominated revenues and expenditures – in particular, where U.S. dollar revenues do not equal U.S. dollar expenditures. We are not currently using exchange rate derivatives to manage currency exchange rate risks. There are currently no significant restrictions on the repatriation of capital and distribution of earnings to foreign entities from any of the jurisdictions in which we operate. There can be no assurance that such restrictions will not be imposed in the future.

Compliance with new or amended tax laws and regulations could have a material adverse effect on our business. We base our tax positions upon our understanding of the tax laws (including, applicable tax treaties) of the countries in which we have assets or conduct business activities. However, our tax positions are subject to review and possible challenges by taxing authorities, including computation and allocation of income, transfer pricing and other complex issues. This includes adverse changes to the manner in which Canada, the United States and other countries tax local and foreign corporations and interpret or change their tax laws and applicable tax treaties. We cannot determine in advance the extent to which such jurisdictions may review our tax positions or assess additional taxes or interest and penalties on such taxes. In addition, our effective tax rate may be increased by changes in the valuation of deferred tax assets and liabilities, our cash management strategies, local tax rates, or interpretations of tax laws.

17


 

Risks Relating to Intellectual Property and Information Security

We may be unable to protect our intellectual property adequately from infringement by third parties, and we may also be subject to claims that we infringe on intellectual property rights of others.

We rely on a combination of contract, copyright, patent, trademark and trade secret laws, confidentiality procedures and other measures to protect our intellectual property.  There can be no assurance that our various patents, copyrights or trademarks will offer sufficient protection and prevent misappropriation of our proprietary rights in our products, software or processes. We also may not be granted patents, copyrights or trademarks on our pending or proposed applications, and granted applications may be challenged, invalidated or circumvented in the future. Despite our precautions, it may be possible for unauthorized third parties to copy our applications and use information that we regard as proprietary to create products or services that compete with ours. We enforce our intellectual property rights where appropriate, but the cost of doing so may be substantial and could outweigh the potential benefits, and we may be unsuccessful in our enforcement efforts. Failure to protect or maintain the proprietary nature of our intellectual property could adversely affect our ability to sell original products and materially and adversely affect our business, financial condition and results of operations.

Additionally, our competitors or other third parties may own or claim to own intellectual property in technology areas relating to our technology, including ICE Software, manufacturing processes, and DIRTT Solutions. Although we do not believe that our software or DIRTT Solutions infringe on the proprietary rights of any third parties, claims may arise regarding infringement or invalidity claims (or claims for indemnification resulting from infringement claims). Such assertions or prosecutions, regardless of their merit, may subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from assembling or licensing certain of our products, subject us to injunctions restricting our sale of products, cause severe disruptions to our operations or the marketplaces in which we compete, or require us to satisfy indemnification commitments with our clients, including contractual provisions under various license arrangements. A damages award against us could include an award of royalties or lost profits and, if the court finds willful infringement, treble damages and attorneys’ fees. This may cause us to expend significant costs and resources, and could adversely affect our business, financial condition or results of operations.

If we are unable to protect our information systems against data corruption, cyber-based attacks or network security breaches, our operations could be disrupted and our reputation and profitability could be negatively affected.

In the ordinary course of our business, we generate, collect and store confidential and proprietary information, including intellectual property and business information. The secure storage, maintenance, and transmission of and access to this information is important to our operations and reputation. We use automated software and hardware solutions to protect our on-premise and cloud infrastructure; conduct routine third-party evaluations and vulnerability testing to identify and mitigate risks; and deploy training programs throughout the company. We have experienced cyber-based attacks, but to our knowledge, we have not experienced any material disruptions or breaches of our information technology systems or platforms. However, there is no guarantee that our security systems, processes or procedures are adequate to safeguard against all data security breaches, misuse of data, cyber-attacks, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential information of a client, Distribution Partner, employee, supplier or Company information could result in financial losses, exposure to litigation risks and liability (including regulatory liability), damage to our reputation, and disruptions in our operations, all of which could have a material adverse effect on our business, financial condition and results of operations. While we maintain cybersecurity insurance of the types and amounts, we consider it commercially prudent and consistent with industry practice, such insurance may not be sufficient to cover all losses relating to an information security breach. 

The regulatory environment related to information security, data collection and use, and privacy is increasingly rigorous, with new and frequently changing requirements, and compliance with those requirements could result in additional costs. The costs associated with information security, such as increased investment in technology, the costs of compliance with privacy laws, and costs incurred to prevent or remediate information security breaches, could be substantial and adversely affect our business. A significant compromise of sensitive employee, Distribution Partner, client or supplier data in our possession could result in legal damages and regulatory penalties. In addition, the costs of defending such actions or remediating breaches could be material.

Damage to our information technology and software systems could impair our ability to effectively provide DIRTT Solutions and adversely affect our reputation, relationships with clients, financial condition and results of operations.

Our information technology and software networks and systems, which include the processing, transmission and storage of information, are integrated with our manufacturing processes and essential to our business operations. These systems are vulnerable to, among other things, damage or interruption from power outages, network failures or natural disasters, loss or corruption of data, human error, employee misconduct and difficulties associated with upgrades, installations of major software or hardware, and integration with new systems. While we maintain retention backups to geo-diverse digital and physical locations and have a recovery data center, the data center and other protective measures we take could prove to be inadequate. Any disruption in our systems or unauthorized disclosure of information could result in delayed manufacturing and delivery of our DIRTT Solutions, legal claims, a

18


 

loss of intellectual property and a disruption in operations, all of which could adversely affect our reputation, relationships with clients, financial condition and results of operations.

Risks Relating to Government Regulations and Enforcement

We may incur significant costs complying with environmental, health and safety laws and related claims, and failure to comply with these laws and regulations could expose us to significant liabilities, which could materially adversely affect our business and results of operations.

We are subject to laws, regulations, and other requirements with respect to workers’ health and safety and environmental matters in the United States, Canada and other countries in which we operate.  Environmental laws and regulations impose, among other things, restrictions, liabilities and obligations in connection with the production, processing, preparation, handling, storage, transportation, disposal and management of wastes and other substances, and the prevention and remediation of environmental effects. Health and safety laws and regulations impose, among other things, requirements designed to ensure the protection of workers.  New or more stringent laws and regulations, including those relating to climate change and greenhouse gas emissions, may be adopted in the future and could impact our facilities, raw material suppliers, the transportation and distribution of our solutions, and our clients, which could reduce demand for our solutions or cause us to incur additional operating costs. In addition, certain foreign laws and regulations may affect our ability to export products outside of or import products into the United States or Canada. Failure to comply with these requirements may result in civil or criminal liability, damages and fines, and our operations could be curtailed, suspended or shutdown and our reputation, ability to attract employees, and results of operations could be adversely affected. Private lawsuits, including claims for remediation of contamination, personal injury or property damage, or actions by regional, national, state and local regulatory agencies, including enforcement or cost-recovery actions, may materially increase our costs.

These factors may materially increase the amount we must invest to bring our processes into compliance with legal requirements and impose additional expenses on our operations. In addition, any changes in these laws or regulations or changes in our manufacturing processes may require us to request changes to our existing permits or obtain new permits. We may also be unable to obtain or maintain, from time to time, all required environmental regulatory approvals. A delay in obtaining any required environmental regulatory approvals or the failure to obtain and comply with such approvals could materially adversely affect our business and results of operations.

Risks Relating to Financial Results

We have experienced a history of losses, and despite certain periods of profitability in recent years, we may not be able to generate sufficient revenue to achieve and sustain profitability.

We have incurred significant losses since commencing business. We incurred net losses of $11.3 million and $4.4 million for the years ended December 31, 2020 and 2019, respectively. At December 31, 2020, we had an accumulated deficit of $57.3 million. These losses and accumulated deficits were due in part to the substantial investments made to grow our business and acquire clients, to further develop our service offerings through product and software development, and to ensure that we have sufficient production capacity and capability to deliver on our commitment of rapid delivery times. Past results may not be indicative of our future performance, and there can be no assurance that we will generate net income in the future.

We have experienced, and may experience in the future, quarterly and yearly fluctuations in results of operations and financial condition.

Our results of operations and financial condition may continue to fluctuate from one quarter or year to another due to a number of factors, some of which are outside of our control. For example, we usually experience seasonal slowdowns in the first and fourth quarters of each calendar year, leading to stronger sales in the second half of the year versus the first half, and weather conditions may also delay delivery and installation on some projects.  Furthermore, sales that we anticipate in one quarter may be pushed into another quarter, affecting both quarters’ results, and our actual or projected results of operations may fail to match our past performance.  These events could in turn cause the market price of our common shares to fluctuate. In particular, if our results of operations do not meet the expectations of securities analysts or investors, who may derive their expectations by extrapolating data from recent historical results of operations, the market price of our common shares will likely decline. Due to our high fixed manufacturing costs and operating expenses, quarterly volatility in sales volumes could result in periods of low operating cash flow and negatively affect our liquidity. Due to these risk factors, quarter-to-quarter or year-to-year comparisons of our results of operations may not be an indicator of future performance.

Risks Related to Our Common Shares and Corporate Structure

Our share price has been and may continue to be volatile, which could cause the value of your investment to decline.

Our common shares are currently listed on the TSX under the symbol “DRT” and on Nasdaq under the symbol “DRTT.” The price of our common shares has in the past fluctuated significantly, and may fluctuate significantly in the future, depending upon a number of factors, many of which are beyond our control and may adversely affect the market price of our common shares. These factors include: (i) variations in quarterly results of operations; (ii) deviations in our earnings from publicly disclosed forward-looking

19


 

guidance; (iii) changes in earnings estimates by analysts; (iv) our announcements or our competitors’ announcements of significant contracts, acquisitions, strategic partnerships or joint ventures; (v) general conditions in the offsite construction and manufacturing industries; (vi) sales of our common shares by our significant shareholders; (vii) fluctuations in stock market price and volume; and (viii) other general economic conditions.

In the past, following periods of volatility in the trading price of a company’s securities, securities class action litigation has been brought against that company. If our share price is volatile, we may become the target of securities litigation in both the United States and Canada. Securities litigation could result in substantial costs and divert management’s attention and resources from our business and could have an adverse effect on our business, financial condition and results of operations.

We are governed by the corporate laws of Alberta, Canada, which in some cases have a different effect on shareholders than the corporate laws of the United States.

We are governed by the ABCA and other relevant laws, which may affect the rights of shareholders differently than those of a company governed by the laws of a U.S. jurisdiction, and may, together with our charter documents, have the effect of delaying, deterring or discouraging another party from acquiring control of our company by means of a tender offer, a proxy contest or otherwise, or may affect the price an acquiring party would be willing to offer in such an instance. The material differences between the ABCA and Delaware General Corporation Law (“DGCL”), that may have the greatest such effect include, but are not limited to, the following: (i) for certain extraordinary corporate transactions (such as amalgamations or amendments to our articles), the ABCA generally requires the voting threshold to be a special resolution passed by not less than two-thirds of the votes cast by the shareholders who voted in respect of the resolution, whereas DGCL generally only requires a majority vote; and (ii) under the ABCA, registered holders or beneficial owners (as defined in the ABCA) of not less than 5% of our common shares in aggregate can requisition our directors to call a special meeting of shareholders, whereas such right does not exist under the DGCL. We cannot predict whether investors will find our company and our common shares less attractive because we are governed by the corporate laws of Alberta, Canada.

Because we are a corporation incorporated in Alberta and some of our directors and officers are residents of Canada, it may be difficult for investors in the United States to enforce civil liabilities against us or our directors and officers based solely upon the federal securities laws of the United States. Similarly, it may be difficult for Canadian investors to enforce civil liabilities against our directors and officers residing outside of Canada.

We are a corporation amalgamated and existing under the laws of Alberta with our principal place of business in Calgary, Alberta, Canada. Some of our directors and officers are residents of Canada and a substantial portion of our assets and those of such persons are located outside the United States. Consequently, it may be difficult for U.S. investors to effect service of process within the United States upon us or our directors or officers who are not residents of the United States, or to realize in the United States upon judgments of courts of the United States predicated upon civil liabilities under the Securities Act. Investors should not assume that Canadian courts: (i) would enforce judgments of U.S. courts obtained in actions against us or such persons predicated upon the civil liability provisions of the U.S. federal securities laws or the securities or blue sky laws of any state within the United States or (ii) would enforce, in original actions, liabilities against us or such persons predicated upon the U.S. federal securities laws or any such state securities or blue sky laws.

Similarly, some of our directors and officers are residents of countries other than Canada and all or a substantial portion of the assets of such persons are located outside Canada. As a result, it may be difficult for Canadian investors to initiate a lawsuit within Canada against these non-Canadian residents. In addition, it may not be possible for Canadian investors to collect from these non-Canadian residents judgments obtained in courts in Canada predicated on the civil liability provisions of securities legislation of certain of the provinces and territories of Canada. It may also be difficult for Canadian investors to succeed in a lawsuit in the United States, based solely on violations of federal, provincial or territorial securities laws.

General Risks

Difficulties in recruiting and retaining qualified employees, or experiencing labor shortages or disruptions, could have a material adverse effect on our business and results of operations.

Our success will depend in part on our ability to attract, develop and retain qualified personnel as needed. We may be affected by labor shortages or disruptions, particularly in locations where we operate manufacturing facilities. If we fail to attract or retain qualified personnel, or experience labor shortages or disruptions, we could incur higher recruiting expenses, a loss of manufacturing capabilities, or inability to respond to significant increases in demand, all of which could have a material adverse effect on our business and results of operations.

We may have additional capital needs in the future and may not be able to obtain additional capital or financing on acceptable terms.

We plan to continually invest in business growth and may require additional funds to respond to business opportunities, such as expanding our sales and marketing activities, developing new software, acquiring complementary businesses, products or technology,

20


 

and expanding or enhancing our manufacturing capabilities, including factory automation. To the extent that our existing capital is insufficient to meet our requirements, we may need to undertake equity or debt financings to secure additional funds. Further issuances of equity or convertible debt securities may result in significant share dilution. Additional new equity securities issued could have rights, preferences and privileges superior to those of our currently issued and outstanding common shares. Additional debt financings may involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities. We cannot provide any assurance that sufficient debt or equity financing will be available for necessary or desirable expenditures or acquisitions, or to cover losses, and accordingly, our ability to continue to support our business growth and to respond to business challenges could be significantly limited, and our liquidity could be materially and adversely affected.

We may engage in future mergers, acquisitions, agreements, consolidations or other corporate transactions that could adversely affect our business, financial condition, and results of operations.

While we currently have no specific plans to acquire any businesses, we may, in the future, seek to expand our business and capabilities through acquiring compatible technology, products or businesses. Additionally, we may explore other corporate transactions, including mergers, agreements, consolidations, or joint ventures, that we believe may be beneficial to our business or further specific business goals. Acquisitions involve certain risks and uncertainties, including, among other things, (i) difficulty integrating the newly acquired businesses and operations in an efficient and cost-effective manner; (ii) inability to maintain relationships with key clients, vendors and other business partners of the acquired businesses; (iii) potential loss of key employees of the acquired businesses; (iv) exposure to litigation or other claims in connection with our assumption of certain claims and liabilities of the acquired businesses; (v) diversion of management’s time and focus; and (vi) possible write-offs or impairment charges related to the acquired businesses. The occurrence of any of these risks could adversely affect our business, financial condition, and results of operations.

Item 1B.

Unresolved Staff Comments.

None.

Item 2.

Properties.

Our principal executive offices are located in Calgary, Alberta, where we lease approximately 73,000 square feet of office and manufacturing space. Our lease expires in September 2022. Our principal manufacturing facilities are located in Calgary, Alberta; Phoenix, Arizona; and Savannah, Georgia. Our wall tiles, millwork and timber solutions are manufactured in Calgary, while aluminum, glass and power components are manufactured in all three locations. In Calgary, we lease an aggregate of approximately 358,000 square feet of manufacturing space across three facilities (excluding our principal offices), which leases expire in January 2023 and January 2024. In Phoenix, we lease approximately 130,000 square feet of manufacturing space across two facilities, which leases expire in March 2022 and March 2027. In Savannah, we lease approximately 81,000 square feet of manufacturing space, which lease expires in February 2029. In October 2019, we entered into a 15-year lease, which DIRTT may extend for two additional 5 year periods at its option, for a combined tile and millwork factory of approximately 130,000 square feet in Rock Hill, South Carolina. Should the need arise, we have the expansion rights to lease an additional 130,000 square feet of space. In March 2020, we entered into an 8 year lease, which DIRTT may extend an additional 5 years at its option, of approximately 18,000 square feet of space for a DXC in Dallas, Texas.

Our ICE development offices are located in Calgary, Alberta and Salt Lake City, Utah. In Calgary, we sublease approximately 8,700 square feet of office space pursuant to a lease that expires on July 31, 2021. In our Salt Lake City development office, which also houses a DXC, we lease approximately 6,600 square feet of office space pursuant to a lease that expires in December 2023. In Chicago, Illinois, we own approximately 6,200 square feet of office space, which we use to operate a DXC.

Through distributed manufacturing we can shift production of some components among our manufacturing sites, reduce transportation times and costs, and meet targeted lead times. We believe that our current and planned facilities are adequate for our current needs and that suitable additional or substitute space would be available if needed.

Item 3.

Legal Proceedings.

See Item 21 of the Notes to the Consolidated Financial Statements.

Item 4.

Mine Safety Disclosures.

Not applicable.

21


 

 

PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information; Holders of Record

Our common shares are traded on the TSX under the symbol “DRT” and on Nasdaq under the symbol “DRTT.”

As of February 24, 2021, there were 84,681,364 common shares outstanding and 201 shareholders of record.

Dividends

We have not declared or paid any cash dividends on our common shares to date. The declaration and payment of dividends is at the discretion of the Board, taking into account (i) our earnings, capital requirements and financial condition, (ii) restrictions on our ability to pay dividends under our New RBC Facility (as defined below), and (iii) such other factors as the Board considers relevant. Our New RBC Facility generally limits our ability to pay any dividends or make any other distribution on our outstanding common shares. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Credit Facility” for more information.

Performance Graph

The following graph illustrates a comparison of the total cumulative shareholder return of our common shares with the cumulative return of the S&P/TSX Composite Index and the S&P 600 Building Products Index for the period commencing December 31, 2015 and ending on December 31, 2020. The graph assumes an initial investment of $100 on December 31, 2015, in our common shares, the shares comprising the S&P/TSX Composite Index, and the shares comprising the S&P 600 Building Products Index. The below shareholder return calculations are based on the exchange rates as reported by the H.10 statistical release of the Board of Governors of the Federal Reserve System as of the year-end exchange rate for the applicable period. The comparisons in the table are required by the SEC and applicable securities laws in Canada and are not intended to forecast or be indicative of possible future performance of our common shares. This graph and related materials shall not be deemed “soliciting material” or be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that section, and shall not be deemed to be incorporated by reference into any of our filings under the Securities Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

 

 

$100 investment in common shares

 

 

 

December 31,

 

 

December 31,

 

 

December 31,

 

 

December 31,

 

 

December 31,

 

 

December 31,

 

or index

 

Ticker

 

2015

 

 

2016

 

 

2017

 

 

2018

 

 

2019

 

 

2020

 

DIRTT Environmental Solutions Ltd.

 

DRT

 

$

100.00

 

 

$

93.12

 

 

$

107.38

 

 

$

89.30

 

 

$

65.38

 

 

$

47.53

 

S&P/TSX Composite Index

 

SPTSX

 

$

100.00

 

 

$

121.12

 

 

$

137.75

 

 

$

111.66

 

 

$

140.03

 

 

$

146.35

 

S&P 600 Building Products Index

 

SML

 

$

100.00

 

 

$

152.79

 

 

$

166.20

 

 

$

127.80

 

 

$

152.10

 

 

$

183.40

 

 

Recent Sales of Unregistered Securities; Issuer’s Purchases of Equity Securities

None.

22


 

Item 6.

Selected Financial Data.

The selected consolidated financial data set forth below are derived from our audited consolidated financial statements and may not be indicative of future operating results. The following selected consolidated financial data should be read in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto included elsewhere in this Annual Report. The consolidated selected financial data in this section are not intended to replace our consolidated financial statements and the related notes included elsewhere in this Annual Report. Our historical results are not necessarily indicative of our future results.  

 

 

 

 

Years Ended December 31,

 

 

 

2020

 

 

2019

 

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

(in thousands, except per share data)

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

 

$

166,689

 

 

$

240,659

 

 

 

 

$

266,434

 

 

$

216,216

 

 

$

196,482

 

Service revenue

 

 

4,818

 

 

 

7,076

 

 

 

 

 

8,247

 

 

 

10,323

 

 

 

4,882

 

Total revenue

 

 

171,507

 

 

 

247,735

 

 

 

 

 

274,681

 

 

 

226,539

 

 

 

201,364

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product cost of sales

 

 

113,445

 

 

 

153,128

 

 

 

 

 

161,844

 

 

 

131,326

 

 

 

117,600

 

Costs of under-utilized capacity

 

 

2,010

 

 

 

2,240

 

 

 

 

 

 

 

 

 

Service cost of sales

 

 

2,769

 

 

 

5,943

 

 

 

 

 

5,828

 

 

 

9,724

 

 

 

4,620

 

Total cost of sales

 

 

118,224

 

 

 

161,311

 

 

 

 

 

167,672

 

 

 

141,050

 

 

 

122,220

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

53,283

 

 

 

86,424

 

 

 

 

 

107,009

 

 

 

85,489

 

 

 

79,144

 

Total operating expenses(1)(2)

 

 

74,555

 

 

 

88,875

 

 

 

 

 

101,315

 

 

 

91,990

 

 

 

72,114

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

 

(21,272

)

 

 

(2,451

)

 

 

 

 

5,694

 

 

 

(6,501

)

 

 

7,030

 

Government subsidies

 

 

12,721

 

 

 

-

 

 

 

 

 

-

 

 

 

-

 

 

 

-

 

Foreign exchange gain (loss)

 

 

(576

)

 

 

(1,324

)

 

 

 

 

3,214

 

 

 

(665

)

 

 

(433

)

Interest income

 

 

238

 

 

 

529

 

 

 

 

 

425

 

 

 

399

 

 

 

457

 

Interest expense

 

 

(305

)

 

 

(131

)

 

 

 

 

(503

)

 

 

(500

)

 

 

(213

)

Net income (loss) before tax

 

 

(9,194

)

 

 

(3,377

)

 

 

 

 

8,830

 

 

 

(7,267

)

 

 

6,841

 

Income taxes

 

 

2,104

 

 

 

1,019

 

 

 

 

 

3,280

 

 

 

458

 

 

 

2,942

 

Net income (loss)

 

 

(11,298

)

 

 

(4,396

)

 

 

 

 

5,550

 

 

 

(7,725

)

 

 

3,899

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.13

)

 

$

(0.05

)

 

 

 

$

0.07

 

 

$

(0.09

)

 

$

0.05

 

Diluted

 

$

(0.13

)

 

$

(0.05

)

 

 

 

$

0.07

 

 

$

(0.09

)

 

$

0.05

 

 

(1)

In 2019, 2018 and 2017, we incurred $4.6 million, $7.4 million and $1.1 million in reorganization expenses, respectively.

(2)

In 2018, we incurred $8.7 million in impairment expenses.

 

 

 

As of December 31,

 

 

 

2020

 

 

2019

 

 

2018

 

 

2017

 

 

 

(in thousands)

 

Balance Sheet

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

45,846

 

 

$

47,174

 

 

$

53,412

 

 

$

63,484

 

Total Assets

 

$

183,144

 

 

$

175,563

 

 

$

175,911

 

 

$

174,438

 

Total Liabilities

 

$

66,613

 

 

$

50,576

 

 

$

52,397

 

 

$

47,919

 

 

23


 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations for the fiscal years ended December 31, 2020 and 2019 together with our consolidated financial statements and related notes and other financial information appearing in this Annual Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business, operations, and product candidates, includes forward-looking statements that involve risks and uncertainties. You should review the sections of this Annual Report captioned “Risk Factors” and “Special Note Regarding Forward-Looking Statements” for a discussion of important factors that could cause our actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

We have revised our calculation of Adjusted EBITDA and Adjusted Gross Profit, which are non-GAAP financial measures, for the presented periods. For additional information, see “– Non-GAAP Financial Measures – EBITDA and Adjusted EBITDA for the Years Ended December 31, 2020, 2019 and 2018.” and “– Non-GAAP Financial Measures – Adjusted Gross Profit and Adjusted Gross Profit Margin for the Years Ended December 31, 2020, 2019 and 2018.”

Overview

We are an innovative manufacturing company featuring a proprietary software and virtual reality visualization platform, coupled with vertically integrated manufacturing that designs, configures and manufactures prefabricated interior solutions used primarily in non-residential spaces across a wide range of industries and businesses. We combine innovative product design with our industry-leading, proprietary ICE Software, and technology-driven, lean manufacturing practices and sustainable materials to provide end-to-end solutions for the traditionally inefficient and fragmented interior construction industry. We create customized interiors with the aesthetics of conventional construction but with greater schedule and cost certainty, shorter lead times, greater future flexibility, and better environmental sustainability than conventional construction.

Our ICE Software allows us to sell, design, visualize (including 3D virtual reality modeling of interiors), configure, price, communicate, engineer, specify, order and manage projects, thereby reducing challenges associated with traditional construction, including cost overruns, change orders, inconsistent quality, delays and material waste. While other software programs and virtual reality tools are used in the architectural and construction industries, we believe our ICE Software is the only interior construction technology that provides end-to-end integration, from design through engineering, manufacturing and installation. Our interior construction solutions include prefabricated, customized interior modular walls, ceilings, and floors; decorative and functional millwork; power infrastructure; network infrastructure; and pre-installed medical gas piping systems. We strive to incorporate environmentally sustainable materials and reusable components into our solutions while creating flexible, functional and well-designed environments for the people who will use them.

We offer our interior construction solutions throughout the United States and Canada, as well as in select international markets, through a network of independent Distribution Partners and an internal sales team. Our Distribution Partners use ICE to work with end users to envision and design their spaces, and orders are electronically routed through ICE to our manufacturing facilities for production, packing and shipping. Our Distribution Partners then coordinate the receipt and installations of our interior solutions at the end users’ locations.

Summary of Financial Results

 

Revenues for the year ended December 31, 2020 were $171.5 million, a decline of $76.2 million or 31% from $247.7 million for the year ended December 31, 2019. We believe this decrease principally reflects the severe economic and social impact of the COVID-19 pandemic, including a major contraction in construction activity levels in North America due to non-essential business closures, work-from-home requirements, lock-down measures and other regulatory responses implemented by governments and public health officials.

 

Gross profit for the year ended December 31, 2020 was $53.3 million or 31.1% of revenue, a decline of $33.1 million or 38% from $86.4 million or 34.9% of revenue for the year ended December 31, 2019. This reduction was largely attributable to our decline in revenues and the impact of fixed costs on lower revenues. During the year ended December 31, 2020, we incurred $1.0 million of severance costs to reduce headcount in response to excess labor capacity caused by lower revenues. These costs were offset by reversals of the timber provision of $1.8 million in 2020. In 2019, we provided $2.5 million of timber provision because we determined that timber included in certain projects installed between 2016 and 2019 may not have met certain building class fire retardant specifications under which the projects were sold. The timber liability was reduced from the prior estimated liability following further analysis of building code requirements for the specific projects sold, the validation of an in-situ remediation solution, and related discussions with our affected customers. The year ended December 31, 2019 also included $2.5 million of costs incurred to mitigate future tile warping.

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Adjusted Gross Profit (see “– Non-GAAP Financial Measures”) for the year ended December 31, 2020 was $63.4 million or 37.0% of revenue, a $34.5 million or 35% decline from $97.9 million or 39.5% of revenue for the year ended December 31, 2019 for the above noted reasons. Excluded from Adjusted Gross Profit in 2019 and 2020 are $2.2 million and $2.0 million, respectively, of costs of overhead associated with operating at lower than normal capacity levels, which were charged directly and separately to cost of sales rather than as costs attributable to production.

 

Operating expenses for the year ended December 30, 2020 were $74.6 million, a $14.3 million or 16% decline from $88.9 million for the year ended December 31, 2019. The reduction in operating expenses reflects lower commissions on reduced sales activities, as well as cost reductions, both deliberate and as a result of the COVID-19 pandemic, a $1.5 million decrease in stock based compensation and a $1.2 million reversal of a provision relating to a claim for severance by one of our former founders, offset by $2.3 million in higher professional fees and consulting costs. Additionally, in 2019 we incurred $2.0 million of costs related to our sales and marketing plan, $2.6 million related to the listing of our common shares on Nasdaq, $1.1 million of operations consulting costs and $4.6 million of reorganization costs partially offset by the reversal of a $1.3 million claims provision.

 

Net loss for the year ended December 31, 2020 was $11.3 million, an increase of $6.9 million from net loss of $4.4 million for the year ended December 31, 2019. Compared to the prior year period, the increase in net loss is attributable to the above noted reduction in gross profit and a $1.1 million increase in income tax expense, partially offset by a $14.3 million reduction in operating costs, a $0.7 million decrease in foreign exchange losses, and government subsidies of $12.7 million.  

 

Adjusted EBITDA (see “– Non-GAAP Financial Measures”) for the year ended December 31, 2020 was a $7.2 million loss or (4.2)%, a decline of $25.4 million or 140% from $18.2 million or 7.4% for the year ended December 31, 2019 for the above noted reasons. We changed our calculation of Adjusted EBITDA beginning in the fourth quarter of 2019 to exclude the impacts of foreign exchange to improve year-on-year comparability of Adjusted EBITDA.

Outlook

On November 12, 2019, DIRTT unveiled a four-year strategic plan for the Company, based on three key pillars: commercial execution, manufacturing excellence and innovation. This plan laid out a roadmap to transform a founder-led start-up into a professionally managed operating company. Our long-term objective is to scale our operations to profitably capture the significant market opportunity created by driving conversion from conventional construction to DIRTT’s process of modular, prefabricated interiors.

Since its declaration as a global pandemic in March 2020, COVID-19 has had severe and ongoing impacts on commercial construction activity in North America, driven largely by regulatory responses implemented by governments and public health officials, lock-down measures and work-from-home requirements for non-essential workers. While commercial construction projects that were underway at the commencement of the pandemic generally continued to completion, albeit with some experiencing COVID-19 driven delays, North America experienced a significant contraction in the development of new projects as the pandemic took hold. As a result, DIRTT’s 2020 revenue declined 31% compared to 2019, driven largely by a 35% and 37% decline in our commercial and education vertical sales, respectively, partially offset by more moderate declines in our healthcare vertical. Quarterly revenues remained relatively consistent throughout 2020 as small projects and projects in process at the start of the pandemic were completed during the year.  

In early 2021, we experienced further softening of our commercial vertical sales. We expect this softness to continue through the first half of 2021 which reflects the aforementioned contraction in new project development, the continuation of a pronounced second wave of infections in North America with new lockdown measures and the inherent reluctance of end customers to commit to construction projects while such lockdowns and work from home restrictions are ongoing. We are cautiously optimistic, however, that a recovery will begin in the second half of 2021 based on third-party industry indices combined with the general sentiment of our clients and partners and the commencement of major vaccination programs across North America.

While in general we have not seen a strong correlation between third-party indices and DIRTT performance given our low market penetration, and, thus, tend not to rely on these indices to manage our business, the scope and scale of the impact of the pandemic make such indicators more relevant for 2021. The Architecture Billing Index (ABI), which measures increases or decreases in architectural and design billings and is considered a leading indicator for non-residential construction activity nine to twelve months in the future, during 2020, reported an approximate 50% drop from the February to March and April periods with a significant recovery in September and October, albeit below expansion level. This improvement indicates the potential for a recovery in the second half of 2021. Similarly, Dodge Data & Analytics expects commercial construction to increase by approximately 5% in 2021.

Return to office planning is ongoing across North America as industry leaders recognize the need for in-person employee interaction to drive collaboration and innovation and address the inherent challenges and limitations of the current work-from-home environment. A critical consideration of this process is the office environment that employees are willing to return to and resulting

25


 

changes required thereto. Through our improved sales force, targeted marketing plans and strategic accounts, we are seeing increases in overall activity to support this planning activity. The timing of when this activity translates to sales is dependent upon when business leaders are willing to commit capital. Through the improvements we have made to our manufacturing operations, combined with the anticipated capacity and capabilities our new South Carolina facility, we expect to be poised and ready to deliver when these end customers commit to move forward.

Ultimately, we believe the long-term impact of COVID-19 will be a higher demand for flexible spaces that can be easily adapted post-installation. We expect that this will be a positive catalyst for the conversion from conventional site-built construction to the prefabricated, offsite solution provided by DIRTT. As a result, our objective throughout the pandemic has been to continue the prudent implementation of our strategic plan, while balancing the safeguards of our balance sheet and liquidity with our desire to enhance and improve our commercial and operational capabilities to take advantage of expected increases in demand when the recovery of non-residential construction occurs.

In early 2021 we took steps to further bolster our liquidity in the face of continued uncertainty and near-term sales softness. In January 2021, we completed a C$40.3 million (approximately $31.6 million) issuance of convertible debentures with a five-year term and convertible into common shares at a price of C$4.65 per share. In early February, we completed the conversion of our undrawn existing cash-flow-based credit facility to an asset-backed facility, eliminating the need for a covenant holiday and ensuring future borrowing availability based upon accounts receivable and inventory balances. We expect to draw approximately $11 million on our existing equipment leasing facilities in the first half of 2021, financing the equipment purchases for our new South Carolina facility, largely paid for in instalments in 2019 and 2020. We also intend to apply for further government subsidy programs, including the Canadian Emergency Wage Subsidy program (CEWS) to the extent that it is applicable. In 2020, we qualified for $12.7 million of government subsidies of which $11.0 million was received with the balance expected to be received in 2021. This financial foundation provides the basis for us to continue to execute our strategic plan while the recovery from the COVID-19 pandemic takes hold, enables us to avoid costly retrenchments of the transformational investments we have made, and increases our flexibility should the recovery take longer than expected.

Our commercial transformation is the key pillar of our growth strategy, against which we made significant progress in 2020.   This includes the hiring of personnel for key roles in the commercial organization and the establishment of both strategic marketing and strategic account and enterprise sales functions. We completed our Customer Relationship Management infrastructure buildout and are now in the process of rolling it out to all our sales representatives with full deployment expected in the first half of 2021. Our total cost of ownership tool, which provides an objective comparison with conventional construction, has been fully developed and deployed and further refinements and expansion of the tool’s capabilities will be a focus in 2021. During 2020 we added eight new Distribution Partners and expanded the territory of five others, mitigating the effects of partners who we chose to terminate due to performance or competitive issues. In 2021, we expect to build upon the work completed in 2020. This will include priority hires to drive enhanced market coverage, the buildout of our DXC in Dallas, with completion expected in the third quarter, the continuation of our strategic marketing campaigns focused on return to work and the nurturing of new and existing strategic account relationships.

Manufacturing excellence is the second pillar of our growth strategy. Our core commitment to organizational safety resulted in a TRIF of 0.48 in 2020, more than 75% below the industry average and included the Company’s first ever recordable incident-free quarter. Our enhanced safety protocols and robust contact tracing have been effective thus far in mitigating the spread of COVID-19 infections within our facilities and have helped us to avoid any material production disruptions. During 2020, we realized production efficiencies and yield improvements at both our aluminum manufacturing plants, and at our Calgary tile facility through changes in process flow. We also completed strategic sourcing agreements for major suppliers and enhanced quality and delivery processes. Having achieved continuous improvement by year end, in 2021, we will focus on the maturation and further integration of our processes to drive ongoing advancements in all areas of quality, delivery, inventory and productivity. We also remain on schedule for the commencement of commercial operations at our South Carolina tile facility in the second quarter of 2021.

The third pillar of our growth strategy is innovation. During 2020, in response to the needs of the pandemic, we developed four interior and exterior free-standing kiosks for COVID-19 testing and vaccinations, which we are currently marketing to healthcare organizations, retailers and large employers.  Regardless of whether these kiosks drive incremental sales, we believe they increase the prominence of our brand and demonstrate our overall capabilities to a new set of potential customers. From a software perspective, we released ICE 21, our most significant ICE release to date, allowing more people to experience ICEreality with added Android and Windows desktop platform capability and expanded functionality across a broader range of virtual reality head-mounted display hardware. In 2021, we expect innovation within our interior solutions and software to continue, including expanded functionality of our Inspire low profile modular and Reflect ultra-sleek glass wall solutions and ongoing improvements to the integration and core functionality of ICE.

Throughout the last two years, we have made improvements in cost control and investment discipline which has served us well, particularly during the COVID-19 pandemic. In addition, we have benefited from reduced expenditures on travel and entertainment due to travel restrictions and deliberate reductions of certain discretionary expenditures until such time as the recovery occurs. Our capital expenditure program in 2021 is expected to total approximately $14 million, of which approximately $3.5 million relates to our

26


 

investment in the Dallas DXC, $3.0 million relates to the equipment and commissioning of our South Carolina tile and millwork facility, $3.0 million relates to the investments in our technology platform, with the remaining associated with  required maintenance capital and certain corporate initiatives.

In November 2019, our strategic plan articulated financial targets of $450 million to $550 million in revenue and 18% to 22% adjusted EBITDA margins to be achieved by the end of 2023. While the non-residential construction market is much less favorable than in late 2019 and our 2020 revenues were more than 30% below our 2019 revenues, the operating environment and transformation of the Company are sufficiently dynamic, which lead us to believe these goals are still achievable.

Non-GAAP Financial Measures

Note Regarding Use of Non-GAAP Financial Measures

Our consolidated financial statements are prepared in accordance with GAAP. These GAAP financial statements include non-cash charges and other charges and benefits that we believe are unusual or infrequent in nature or that we believe may make comparisons to our prior or future performance difficult.

As a result, we also provide financial information in this Annual Report that is not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. Management uses these non-GAAP financial measures in its review and evaluation of the financial performance of the Company. We believe that these non-GAAP financial measures also provide additional insight to investors and securities analysts as supplemental information to our GAAP results and as a basis to compare our financial performance period-over-period and to compare our financial performance with that of other companies. We believe that these non-GAAP financial measures facilitate comparisons of our core operating results from period to period and to other companies by removing the effects of our capital structure (net interest income on cash deposits, interest expense on outstanding debt and debt facilities, or foreign exchange movements), asset base (depreciation and amortization), the impact of under-utilized capacity on gross profit, tax consequences and stock-based compensation. In addition, management bases certain forward-looking estimates and budgets on non-GAAP financial measures, primarily Adjusted EBITDA.

In the fourth quarter of 2019, we removed the impact of all foreign exchange from Adjusted EBITDA. Foreign exchange gains and losses can vary significantly period-on-period due to the impact of changes in the U.S. and Canadian dollar exchange rates on foreign currency denominated monetary items on the balance sheet and are not reflective of the underlying operations of the Company. We have presented a reconciliation to our prior calculation of Adjusted EBITDA for all years presented. Additionally, in the fourth quarter of 2019, we excluded from Adjusted Gross Profit costs associated with under-utilized capacity. Fixed production overheads are allocated to inventory on the basis of normal capacity of the production facilities. In periods where production levels are abnormally low, unallocated overheads are recognized as an expense in the period in which they are incurred.

Reorganization expenses, impairment expenses, government subsidies, depreciation and amortization, stock-based compensation, and foreign exchange gains or losses are excluded from our non-GAAP financial measures because management considers them to be outside of the Company’s core operating results, even though some of those expenses may recur, and because management believes that each of these items can distort the trends associated with the Company’s ongoing performance. We believe that excluding these expenses provides investors and management with greater visibility to the underlying performance of the business operations, enhances consistency and comparativeness with results in prior periods that do not, or future periods that may not, include such items, and facilitates comparison with the results of other companies in our industry.

The following non-GAAP financial measures are presented in this Annual Report, and a description of the calculation for each measure is included.

 

Adjusted Gross Profit, as previously presented

 

Gross profit before deductions for depreciation and amortization

 

 

 

Adjusted Gross Profit

 

Gross profit before deductions for costs of under-utilized capacity, depreciation and amortization

 

 

 

Adjusted Gross Profit Margin

 

Adjusted Gross Profit divided by revenue

 

 

 

EBITDA

 

Net income before interest, taxes, depreciation and amortization

 

 

 

Adjusted EBITDA, as previously presented

 

EBITDA adjusted for non-cash foreign exchange gains or losses on debt revaluation; impairment expenses; stock-based compensation expense; government subsidies; reorganization expenses; and any other non-core gains or losses

 

 

 

27


 

Adjusted EBITDA

 

EBITDA adjusted for foreign exchange gains or losses; impairment expenses; stock-based compensation expense; reorganization expenses; and any other non-core gains or losses

 

 

 

Adjusted EBITDA Margin

 

Adjusted EBITDA divided by revenue

 

You should carefully evaluate these non-GAAP financial measures, the adjustments included in them, and the reasons we consider them appropriate for analysis supplemental to our GAAP information. Each of these non-GAAP financial measures has important limitations as an analytical tool due to exclusion of some but not all items that affect the most directly comparable GAAP financial measures. You should not consider any of these non-GAAP financial measures in isolation or as substitutes for an analysis of our results as reported under GAAP. You should also be aware that we may recognize income or incur expenses in the future that are the same as, or similar to, some of the adjustments in these non-GAAP financial measures. Because these non-GAAP financial measures may be defined differently by other companies in our industry, our definitions of these non-GAAP financial measures may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.

EBITDA and Adjusted EBITDA for the Years Ended December 31, 2020, 2019 and 2018

The following table presents a reconciliation for the year-to-date results of 2020, 2019 and 2018 of EBITDA and Adjusted EBITDA to our net income (loss), which is the most directly comparable GAAP measure for the periods presented:

 

 

For the Year Ended December 31,

 

 

 

2020

 

 

2019

 

 

2018

 

 

 

($ in thousands)

 

Net income (loss) for the period

 

 

(11,298

)

 

 

(4,396

)

 

 

5,550

 

Add back (deduct):

 

 

 

 

 

 

 

 

 

 

 

 

Interest Expense

 

 

305

 

 

 

131

 

 

 

503

 

Interest Income

 

 

(238

)

 

 

(529

)

 

 

(425

)

Income Tax Expense

 

 

2,104

 

 

 

1,019

 

 

 

3,280

 

Depreciation and Amortization

 

 

11,706

 

 

 

12,242

 

 

 

13,699

 

EBITDA

 

 

2,579

 

 

 

8,467

 

 

 

22,607

 

Stock-based Compensation

 

 

2,351

 

 

 

3,876

 

 

 

3,661

 

Non-cash Foreign Exchange Gain on Debt Revaluation

 

 

-

 

 

 

(211

)

 

 

546

 

Government Subsidies

 

 

(12,721

)

 

 

-

 

 

 

-

 

Reorganization Expense

 

 

-

 

 

 

4,560

 

 

 

7,380

 

Impairment Expense

 

 

-

 

 

 

-

 

 

 

8,680

 

Adjusted EBITDA, as previously presented(1)

 

 

(7,791

)

 

 

16,692

 

 

 

42,874

 

Other Foreign Exchange (Gains) Losses

 

 

576

 

 

 

1,535

 

 

 

(3,760

)

Adjusted EBITDA

 

 

(7,215

)

 

 

18,227

 

 

 

39,114

 

Net Income (Loss) Margin(2)

 

 

(6.6

)%

 

 

(1.8

)%

 

 

2.0

%

Adjusted EBITDA Margin, as previously

   presented(1)

 

 

(4.5

)%

 

 

6.7

%

 

 

15.6

%

Adjusted EBITDA Margin

 

 

(4.2

)%

 

 

7.4

%

 

 

14.2

%

 

(1) 

As discussed previously, in prior filings, only foreign exchange movements on debt revaluation was included in Adjusted EBITDA.

(2) 

Net income divided by revenue.

As discussed above, we have removed the impact of all foreign exchange gains or losses from Adjusted EBITDA and have presented a reconciliation to our prior calculation of Adjusted EBITDA for the periods presented above.

For the year ended December 31, 2020, Adjusted EBITDA and Adjusted EBITDA Margin decreased to a $7.2 million loss or (4.2)% from $18.2 million or 7.4% in the same period of 2019. This decrease reflects a $34.5 million decrease in Adjusted Gross Profit, partially offset by an $8.2 million aggregate decrease in sales and marketing, general and administrative, operations support and technology and development expenses as discussed in more detail below.  


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Adjusted Gross Profit and Adjusted Gross Profit Margin for the Years Ended December 31, 2020, 2019 and 2018

The following table presents a reconciliation for the years ended December 31, 2020, 2019, and 2018 of Adjusted Gross Profit to our gross profit, which is the most directly comparable GAAP measure for the periods presented:

 

 

 

For the Year Ended December 31,

 

 

 

2020

 

 

2019

 

 

2018

 

 

 

($ in thousands)

 

Gross profit

 

 

53,283

 

 

 

86,424

 

 

 

107,009

 

Gross profit margin

 

 

31.1

%

 

 

34.9

%

 

 

39.0

%

Add: Depreciation and amortization expense

 

 

8,110

 

 

 

9,195

 

 

 

9,528

 

Adjusted Gross Profit, as previously presented

 

 

61,393

 

 

 

95,619

 

 

 

116,537

 

Add: Costs of under-utilized capacity

 

 

2,010

 

 

 

2,240

 

 

 

-

 

Adjusted Gross Profit

 

 

63,403

 

 

 

97,859

 

 

 

116,537

 

Adjusted Gross Profit Margin, as previously

   presented

 

 

35.8

%

 

 

38.6

%

 

 

42.4

%

Adjusted Gross Profit Margin

 

 

37.0

%

 

 

39.5

%

 

 

42.4

%

 

Gross profit and gross profit margin decreased to $53.3 million or 31.1% for the year ended December 31, 2020, from $86.4 million or 34.9% for the year ended December 31, 2019. Adjusted Gross Profit and Adjusted Gross Profit Margin decreased to $63.4 million or 37.0% for the year ended December 31, 2020, from $97.9 million or 39.5% for the year ended December 31, 2019. The decreases are largely due to reduced fixed cost leverage caused by reductions in revenues and excess labor capacity prior to headcount reductions discussed below combined with $1.0 million of related severance costs incurred during the first six months of 2020.

During the fourth quarter of 2019, we determined that we were carrying abnormal excess capacity in our manufacturing facilities as a result of the slowdown in sales and determined certain production overheads should be directly expensed in cost of sales, representing production overheads that were not attributable to production. In the first quarter of 2020, we separately classified $2.0 million as costs related to our under-utilized capacity (1.2% of gross profit margin) in cost of sales. We took steps to manage our excess capacity, including the reduction in staffing by 14%, with a further 12% reduction in April 2020, and the undertaking of planned factory curtailments. The staffing reductions realigned our capacity with then expected activity levels; however, our fixed costs will affect our Adjusted Gross Profit Margin, which we expect to remain below historical percentages until sales improve. Prospectively, we expect our fixed cost of sales to be approximately $6.4 million per quarter, and remaining costs of sales to be approximately 50% to 55% of revenues comprising materials that are variable and dependent on product mix, and labor which is quasi-variable as we match our shifts to order volumes to the extent possible.

Following the completion of third-party testing in 2019, we determined that timber included in certain projects installed between 2016 and 2019 potentially did not meet the fire-retardant specifications under which the projects were sold. As a result, we recorded a $2.5 million provision in the fourth quarter of 2019 and have been contacting customers to determine whether remedial actions are required. In the second quarter of 2020, we identified and validated an in-situ solution that we believe will meet the fire-retardant specification under which the projects were sold and reduced the associated provision to $1.3 million, which represents expected costs to prepare impacted sites and apply the in-situ solution. In the third quarter of 2020, we completed building code reviews of the affected projects and determined that the timber as installed met the requisite building code requirements as it related to fire retardance. We further reduced our timber provision by $0.5 million as we believe this reduces any obligation to remediate previously installed projects. Additionally, we entered into agreements with certain customers to compensate them for product charges not fulfilled.

In 2019, we incurred approximately $2.5 million of costs, representing 1.1% of gross profit margin, to mitigate future warping of our tiles. In the first quarter of 2020, we commissioned new equipment to prime our medium density fiberboard (“MDF”). The use of primed MDF addressed the tile warping issues that occurred in late 2018 and early 2019 due to higher than expected moisture absorption. Additionally, our costs associated with remediating deficiencies decreased in 2020.

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Results of Operations

Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019

 

 

 

For the Year Ended December 31,

 

 

 

2020

 

 

2019

 

 

% Change

 

 

 

($ in thousands)

 

Revenue

 

 

171,507

 

 

 

247,735

 

 

 

(31

)

Gross Profit

 

 

53,283

 

 

 

86,424

 

 

 

(38

)

Gross Profit Margin

 

 

31.1

%

 

 

34.9

%

 

 

(11

)

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

Sales and Marketing

 

 

28,049

 

 

 

33,939

 

 

 

(17

)

General and Administrative

 

 

26,663

 

 

 

27,645

 

 

 

(4

)

Operations Support

 

 

9,381

 

 

 

11,037

 

 

 

(15

)

Technology and Development

 

 

8,111

 

 

 

7,818

 

 

 

4

 

Stock-based Compensation

 

 

2,351

 

 

 

3,876

 

 

 

(39

)

Reorganization

 

 

-

 

 

 

4,560

 

 

 

(100

)

Total Operating Expenses

 

 

74,555

 

 

 

88,875

 

 

 

(16

)

Operating Income (Loss)

 

 

(21,272

)

 

 

(2,451

)

 

 

768

 

Operating Margin

 

 

(12.4

)%

 

 

(1.0

)%

 

 

1,140

 

Revenue

The following table sets forth the contribution to revenue of our DIRTT Solutions and related offerings.

 

 

For the Year Ended December 31,

 

 

 

2020

 

 

2019