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Edited Transcript of DRT.TO earnings conference call or presentation 8-Nov-19 3:00pm GMT

Q3 2019 DIRTT Environmental Solutions Ltd Earnings Call

CALGARY Nov 17, 2019 (Thomson StreetEvents) -- Edited Transcript of DIRTT Environmental Solutions Ltd earnings conference call or presentation Friday, November 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Geoffrey D. Krause

DIRTT Environmental Solutions Ltd. - CFO

* Kevin P. O'Meara

DIRTT Environmental Solutions Ltd. - President, CEO & Director

* Kim MacEachern

DIRTT Environmental Solutions Ltd. - Director of IR

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Conference Call Participants

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* Colin Healey

Haywood Securities Inc., Research Division - Research Analyst of Mining

* Elizabeth Johnston

Laurentian Bank Securities, Inc., Research Division - Analyst

* Gregory William Palm

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Joshua Kenneth Wilson

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Rupert M. Merer

National Bank Financial, Inc., Research Division - MD and Research Analyst

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Presentation

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Operator [1]

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Good morning, and thank you for standing by. I am the operator on today's call. Welcome to the DIRTT Environmental Solutions 2019 Third Quarter Financial Results Conference Call. (Operator Instructions)

I will now turn the call over to Ms. Kim MacEachern, Director of Investor Relations for DIRTT. Ms. MacEachern. Please go ahead.

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Kim MacEachern, DIRTT Environmental Solutions Ltd. - Director of IR [2]

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Thank you, operator. Good morning, everyone, and welcome to today's call to discuss DIRTT's Q3 results. Joining me on the call are DIRTT's Chief Executive Officer, Kevin O'Meara; and Chief Financial Officer, Geoff Krause.

Management's prepared remarks today are accompanied by presentation slides. To access the slides, please view them from the web page of this webcast or go to the Investors section of DIRTT's website. The earnings press release that was issued yesterday afternoon can also be found on our website. We will begin with opening remarks from Kevin on Slide 4, followed by Geoff providing a review of our results and our current outlook. We will then move to the Q&A portion of the call.

Today's call will include forward-looking statements, and because these statements are based on the company's current intent, expectations and projections, they are not guarantees of future performance. A variety of factors could cause actual results to differ materially, including factors discussed during this call and in the Risk Factors section of our Form 10 as filed on September 20, 2019, with the Securities and Exchange Commission, or SEC; our Form 10-Q filed on November 7, 2019, with the SEC and other reports and filings with the SEC.

In addition, as this call will include references to non-GAAP results, excluding special items, please reference the company's management discussion and analysis available in the Investors Section of dirtt.com, or on sedar.com, or edgar.com for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results. I will also remind you that this webcast is being recorded, and a replay will be available today at approximately 1:00 p.m. Eastern Time.

I now turn the call over to Kevin.

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [3]

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Thank you, Kim, and thank you to everyone joining us today to review the results of our third quarter. Revenue of $65.3 million for the quarter was 12% below last year and was lower than our expectations.

This decrease reflects several factors that continue to impact our 2019 revenue, including the disruption to our sales force and distribution partner network from 2018's management transition, the impact of an immature go-to-market approach, an inadequately supported sales force working on a long sales cycle as well as the revised timing of various projects and the loss of certain expected projects.

It has become clear as the year progressed that the sales and marketing organization with which we entered 2019 has been unable to deliver on the opportunities identified, and on which our prior guidance was based. This has been driven largely by a historical lack of training, individual accountability and necessary processes and tools. In turn, this has led to the determination that fourth quarter revenue will be between $52 million and $60 million. We also expect adjusted EBITDA to be negatively impacted by deleveraging of fixed costs on lower revenue.

Looking a bit further out, we want to be very clear: Our view of DIRTT's end-market opportunity and the strength of our value proposition remains unchanged. We continue to see tremendous growth potential by winning market share from conventional construction, and we've been making significant changes to ensure we have the ability to capitalize on that opportunity.

Our near-term emphasis is on comprehensively transforming these functions to create a scalable platform from which to generate profitable growth. We have commenced many initiatives, including the addition of newly established sales roles to support growth and the creation of marketing programs, systems and communications to drive lead generation.

The implementation of our comprehensive commercial strategy is being accelerated under the leadership of our new Chief Commercial Officer, Jennifer Warawa, and centers on 4 key things: one, people, roles and organizational structure; two, strategic marketing, including lead generation and tracked conversion rates; three, sales excellence, including customer segmentation and sales execution; and four, a redefined and strengthened partner experience.

In September, we welcomed Brandon Jones to the DIRTT team as Vice President of Strategy. Brandon will work closely with Jennifer in a project management capacity on the implementation of our commercial strategy.

He joined us most recently having served as a project leader for the Boston Consulting Group. Brandon has a mechanical engineering degree, an MBA from the University of Chicago, and 8 years' experience as a commercial general contractor. He's an excellent addition to the DIRTT team.

Turning to manufacturing. Earlier this year, we introduced a metrics-based approach to lean manufacturing within our facilities. The focus is on safety, quality, delivery, inventory and productivity. In early October, we entered into a lease agreement for our previously announced tile and millwork facility. The new facility will be located in Rock Hill, South Carolina, which is in the Charlotte Metropolitan area. It's less than 30 minutes from the Charlotte Douglas International Airport, which is one of the busiest airports in the United States.

This location will help us to maximize production efficiency, allow us to optimally serve our customers geographically, and will ensure we can support growth while maintaining our short manufacturing lead times.

Given that location's ease of access, the facility will also house a world-class DIRTT Experience Center that will serve as our East Coast sales and marketing hub. We recently rebranded our Green Learning Centers, or GLCs, as DIRTT Experience Centers, or DXCs, to better identify these facilities as interactive showcases for our revolutionary interior construction solutions.

In October, we completed our listing on the NASDAQ Global Select Market and celebrated by ringing the opening bell at the NASDAQ market site just a few weeks ago. This listing marks an important step toward a broadened awareness of DIRTT across North America within the financial community and among our current and future clients, consistent with where we see opportunities going forward.

Moving to innovation. Geoff Gosling, one of DIRTT's founders and our Director of Innovation, has decided to retire. Geoff has become a close friend over the 13 months we've worked together, and I know that he'll remain a passionate and supportive champion of DIRTT as we continue his work going forward. I'm very pleased to announce that Colin Blehm, who's been with DIRTT since our beginning, has been named Vice President of Product Development. Colin has been involved in every major DIRTT product innovation, and he's listed as a co-inventor on many of DIRTT's patents. He's led our product development team for the last 9 months and also led the development of the groundbreaking reflect wall that we announced in October.

Finally, I look forward to welcoming institutional investors and security analysts to our DIRTT Analyst Day in New York this coming Tuesday. Our management team will present DIRTT's long-term growth strategy, including the revenue and adjusted EBITDA targets we're working to achieve by the end of 2023. As a reminder, the presentation will be webcast live and available for replay through the Investors section of our dirtt.com website.

With that, I will turn the call over to Geoff for a financial review.

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Geoffrey D. Krause, DIRTT Environmental Solutions Ltd. - CFO [4]

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Thank you, Kevin. As you know, we filed our 10-Q yesterday on both EDGAR and SEDAR. We have identified an immaterial error on Page 20 in the calculation of our non-GAAP financial measure of adjusted net income for the 3 months ended September 30, 2018, the comparative period.

Restructuring costs in this calculation incorrectly included the 9-month amount as opposed to the third quarter 2018 amount. As such, after correcting this item and the related income tax effects, adjusted net income for the comparative 3-month 2018 period should be $6,991,000. There is no change to the 9-month calculation, nor to any other part of the document, and we will not be making any adjustment to our filings as it is not material.

Starting on Slide 5, as Kevin mentioned, revenue for the quarter was down $8.5 million or 12% from the third quarter of 2018. Specifically, in the third quarter of last year, we completed a large healthcare project, and we did not have a comparable project of that size in 2019.

On a year-to-date basis, revenue was $194.5 million compared to $200.2 million last year, down about 3%. As a percentage of product revenue for the quarter, healthcare was 15% versus 26% in Q3 of 2018. On a year-to-date basis, healthcare was 17% of total product revenue in 2019 versus 21% last year. This is a result of the lumpiness caused by large projects on a small revenue base.

We remain optimistic about healthcare's potential for growth in the future based on its superior customer value proposition and fundamental changes occurring in the delivery of healthcare services in the United States.

Turning to Slide 6. Adjusted gross profit [margin] for the quarter was 41.8% versus 44% in the third quarter of 2018. This reduction reflects the lower-than-anticipated revenue levels impacting utilization of plant labor and leverage on fixed costs. With that said, and as Kevin noted, we are encouraged to see that operational efficiencies, led by our Chief Operating Officer and his team, are beginning to materialize.

As the solution to our previously disclosed tile warping incident, we began using a medium-density fiber board material that is primed on both sides. We were able to offset the higher cost of this raw material with savings in other direct material and transportation costs. Further, as we noted previously, we intend to bring this process in-house. The equipment has been ordered and is expected to be in operation in the first quarter of 2020.

Slide 7 details the breakdown of operating expenses. In our operating expenses, we have continued to see the positive impacts of cost discipline and our enhancements to departmental management and related accountabilities. I'm pleased to report that even with the effects of these specific onetime costs, such as our sales and marketing plan, U.S. listing costs and operating consulting costs, the total of our sales and marketing, G&A, operations support and technology and development costs are consistent with last year.

Sales and marketing expenses decreased $1.4 million for the quarter compared to Q3 of 2018. The decrease is a result of $1.5 million reductions in commission expense on lower revenue offset by $700,000 of onetime consulting costs related to the sales and marketing plan. We also continued to realize reductions in travel, meals and entertainment costs as well as reduced trade show-related costs.

As we implement our sales and marketing plan, we intend to reinvest some of these savings, which we will discuss in more detail during our Analyst Day next week.

G&A expenses for the quarter increased $100,000 compared to Q3 of 2018. Included in G&A for the third quarter of this year was $1.4 million of onetime costs related to the NASDAQ listing offset by a $1.3 million reversal of a previously accrued claims provision. Beginning in 2020, we anticipate approximately $1.5 million to $2 million of incremental annual non-listing-related costs as a result of becoming a U.S. registrant.

This will be largely attributable to increased D&O insurance premiums, the costs of maintaining 2 listings as well as expected increase in audit, legal and other compliance costs.

Operations support expenses increased $0.5 million for the quarter compared to Q3 of 2018, mainly due to consulting costs incurred in the quarter. As a reminder, these consulting costs pertain to the evaluation of current operations and to assist with the rectification of the tile warping issue.

Technology and development expenses increased by $800,000, in part reflecting a $300,000 reduction in capitalized salaries for the quarter. As we have discussed earlier this year, the mix of products currently under -- projects currently undertaken by the group includes a higher proportion of efforts related to business process improvements that are not eligible for capitalization. In addition, we have a higher provision for variable compensation as well as increased salary and benefits costs.

Moving to Slide 8. Adjusted EBITDA and adjusted EBITDA margin for the quarter decreased $8.1 million -- decreased to $8.1 million and 12.3%, respectively, from $13.1 million and 17.7% last year. This $5.2 million decrease in adjusted gross profit was the primary driver behind this decrease. We are able to absorb the impacts of $2.4 million of onetime costs in operating expenses to keep them effectively flat year-on-year.

Net income was $5.8 million or $0.07 per share in the third quarter of 2019, up from a net loss of $1.4 million or $0.02 per share for the third quarter of 2018. Aside from the changes in gross profit and operating expenses discussed previously, primary drivers for the change included a $2.4 million recovery in stock-based compensation compared to a $2 million expense in the same period of 2018, and no reorganization or impairment expenses in the current period.

As of the October 9 listing of our shares on NASDAQ, we ceased cash settlement of employee stock options and their associated liability accounting as at that date. Accordingly, on a go-forward basis, we will see reduced volatility related to the cycle.

Turning to the balance sheet. We continue to maintain the financial strength of DIRTT. Cash and cash equivalents were $56.6 million at the end of September with no debt compared to cash at year-end of $53.4 million and debt of $5.6 million. Our working capital efficiency is improved with DSOs reduced to 27 days compared to 48 days at the end of last year. In July of this year, we entered into a CAD 50 million 3-year credit facility, all of which is undrawn, thereby further increasing our financial capacity.

From a capital expenditure perspective, total CapEx year-to-date was $10.1 million compared to $11.6 million last year. In the third quarter, we placed a $1.6 million initial deposit on equipment for our new Charlotte area facility, with an additional $3 million of deposits expected to be placed in the fourth quarter.

As Kevin noted, our fourth quarter revenue is expected to be lower, resulting in our full year revenue being down approximately 7% to 10% from 2018 levels. Despite this reduction as well as incurring associated onetime consulting and listing costs, we expect to exit 2019 maintaining our financial strength with cash on hand comparable to last year with no debt and increased liquidity from a larger credit facility.

Furthermore, we continue to believe our significant transformational efforts and investments will result in attractive revenue growth, improved profitability and strong cash generation into the future.

I will turn the call over to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Greg Palm with Craig-Hallum Capital.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

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I guess, just starting off with the guidance reduction, can you help sort of bucket, quantify the impacts from whether it's project push-outs, cancellations or just sort of lack of orders on an absolute basis for us?

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Geoffrey D. Krause, DIRTT Environmental Solutions Ltd. - CFO [3]

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Greg, it's Geoff here. I would say that we've seen about -- projects that we lost was around $2 million to $4 million, but, quite frankly, we lose projects on an ongoing basis, and it is not unusual from this.

We have seen project push-outs and scope reductions, which accounts for the balance of the reduction, and it's really centered around the ability of our salespeople to execute on the forecast that they provided and on the time that they provided.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

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And do you get the sense that it's more from lack of, I guess, putting aside the project losses, the order push-outs or just the lack of orders? I mean, is it more on the scale of orders on an absolute basis or a lack of large deals? And I guess it'd be helpful to get some color on sort of what you saw in terms of large deals, your $1 million-plus deals in second half '18 for comparative purposes?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [5]

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Greg, this is Kevin. I think that what you need to realize, when we use the term, and I put in quotes "lost projects", we need to be very thoughtful about that. And when -- that's in the eye of the beholder of the sales rep in order to decide, do I think this is going to happen, and I put it in our pipeline, okay? And when you don't have regional sales management in place to be part of that process and bring the cold light of reality on it, it's entirely possible that, that project was never real to begin with, and that you have salesmen, who by definition are very optimistic people, put it in the pipeline and thought that it was real. And then when it comes out, it turns out that, that was never a real project anyway. And so the way that we're attacking that is by putting in a regional management structure so we have people in place that are in the markets, monitoring that on a daily basis. Where we stand on that is, as we've discussed previously, we've created 4 regional management roles, 2 of them have been relatively recently filled. And so we're on our way to attacking that. So that's the first thing that I would suggest to you.

There's nothing structurally that's been an issue in the quarter that we would really point to. The other thing that I would highlight for you on a U.S. dollar basis is this comparable that we were working against was a record high last -- this time last year. It was the first time that the business had ever hit $70 million in a quarter and was reflective of the several large projects that Geoff alluded to.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6]

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And can you just quantify those at all? I mean, were they a couple of million-dollar-type deals? Were there several that were in excess of that? I mean, it would just be helpful for us to get some kind of comparative numbers.

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Geoffrey D. Krause, DIRTT Environmental Solutions Ltd. - CFO [7]

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Sure. As we look at last year, the large projects that we saw last year was a $7 million deal in the third quarter, and we saw about $9 million of large deals in the fourth quarter.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [8]

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And presumably, you don't have a whole lot of large deals here in Q4. Is that the right assumption?

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Geoffrey D. Krause, DIRTT Environmental Solutions Ltd. - CFO [9]

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That would be a fair assumption. There are certainly opportunities that we continue to work towards, partly as a result of our national accounts strategy and partly as normal course of business. The problem with large deals on our small revenue size is that they can have a material impact. And secondly, large deals, by their nature, move around. And as they move around, we see the impacts of that.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [10]

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Got it. Understood. Last one from me, Kevin, just following up on your earlier answer. I mean, so as we sit here today, I mean, is the sales structure, whether it's the team, the structure, the strategy, is it in place, what it needs to be? Or are there still additional people, additional turnover that you expect in the near term?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [11]

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No, it's nowhere near in place. Not necessarily working for turnover, but we are supplementing. We've got 2 regional sales roles that we're currently recruiting. We also are recruiting roles as it relates to strategic sales and large project sales, et cetera, and an entire strategic marketing-focused function that has never existed. I think a big part of what we're going to talk about next Tuesday is laying all of that out and showing where we are, what the vision is for the future, and then where we stand on that journey.

And so there is a lot to be added going forward on the people side as well as on the systems side. And that's -- the lion's share of Tuesday will be that discussion.

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Operator [12]

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And your next question comes from the line of Josh Wilson with Raymond James.

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [13]

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Continuing with the prior line of questioning, can you give us a sense of what some of the key mileposts are in terms of a time line for some of these hires and systems updates?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [14]

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I think that we can go through that in much greater detail on Tuesday. However, it's ongoing, it's in process. As I mentioned before, we've put several in place, the regional sales directors, the current -- the one person in strategic accounts which we're adding to, and we've got a number of searches in place. There's a balance in what we're doing between having a sense of urgency, which we have as well as making sure that we get quality people in place. And so that's the -- what we're balancing now.

And so it's difficult to conjecture exactly when that will be done and how that will come about as we balance that.

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [15]

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What are your current planning assumptions for 2020 sales, given that?

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Geoffrey D. Krause, DIRTT Environmental Solutions Ltd. - CFO [16]

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We're -- as we'll talk about in the Analyst Day on Tuesday, we'll be laying out what our 2023 plan is, and as we're looking forward to the end of the year, continuing to evaluate where we sit for next year and decide on how we discuss it at that point.

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Joshua Kenneth Wilson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [17]

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And can you give us some color on what you think the health of the end markets are? Is this entirely internal? Or are there certain pockets or regions where there's more to it?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [18]

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No, it is 110% indicative of the transformation the company is going through. Nothing has fundamentally changed in the markets, and nothing has fundamentally changed with our enthusiasm for the business. It is 110% related to the transformation. And just as a reminder, the company is 15 years old, founded by a group of incredibly talented people, who built it to a certain level. And now we're in the process of putting the tools and structure in place that you need to, to build a truly scalable enterprise. And that's what this has all been about this year, and then we will continue going forward. Certain pieces are nicely in place, for instance, on the innovation side. We're well on our way on the manufacturing side. And on the commercial side, that will take a little bit longer to come together.

So there's nothing that is systemic that happened, there's nothing in the marketplace. Our market share is so small that looking at the commercial construction market really isn't a focus of ours. What our real focus is on is making sure that we are, as effectively as possible, articulating our customer value proposition and then identifying those target segments where that resonates, which has very little correlation with the overall commercial construction market.

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Operator [19]

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Your next question comes from the line of Rupert Merer from National Bank.

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Rupert M. Merer, National Bank Financial, Inc., Research Division - MD and Research Analyst [20]

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So looking at guidance for Q4, you've got a range of $52 million to $60 million. It seems like a fairly large range given that we're pretty close to the middle of the quarter, if you assume the sort of 2- to 3-week lead time. Can you talk about what drives the assumptions on either end of that range? Are you looking at, potentially, some large jobs that might get pushed out in Q4 as well? Or is this sort of a typical variance you'd expect in any given quarter?

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Geoffrey D. Krause, DIRTT Environmental Solutions Ltd. - CFO [21]

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So Rupert, there's 2 aspects to it. First of all is, based upon the experience that we've had since August, we want to make sure that we don't have a repeat. The second piece is, and what drove us to these numbers, is evaluating what our daily sales results have been over the period since September 3 through to yesterday. Where we see it is, we've seen some variability within those numbers, which comes to the things that we've discussed about on the ability of our salespeople to execute on the sales deals. We are keenly focused on putting the pieces in place, including freeing up our resources to make sure that we focus on sales execution. But we're being, I think, rightfully cautious right now, given our experience over the last few months.

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Rupert M. Merer, National Bank Financial, Inc., Research Division - MD and Research Analyst [22]

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All right. Great. And on the pipeline, I understand you may need to take another look at the pipeline and scrub the pipeline. But how does it look today relative to where it has been at various points over the last year?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [23]

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Rupert, I think at this point in time, we're probably going to defer commenting on that.

There's 2 things going on within our sales organization. One is the selling process and closing sales. And then the other is taking your day-to-day activities and translating that into building a pipeline and then building a forecast. And on an individual representative basis, historically, the way that we've been approaching that is not what our sales reps have been asked to do. And so that is something that's fairly new. And as Geoff has alluded to, we've struggled with that internally. And so I kind of -- I'm reticent to share that with you in an abundance of caution because of our recent experience.

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Rupert M. Merer, National Bank Financial, Inc., Research Division - MD and Research Analyst [24]

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All right. Very good. And just quickly, given where the shares are today and your cash balance, do you have any thoughts on share buybacks?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [25]

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At the moment, we're very focused on sales in the marketplace. We're in a strong position financially, not to say that at some point in time we might consider that. But we feel very good about our financial position. But at the moment, we are very focused on our transformation plan and on driving sales in the marketplace.

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Operator [26]

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(Operator Instructions) And our next question comes from the line of Elizabeth Johnston with Laurentian Bank Securities.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [27]

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Just in terms of the sales cycle, I understand the reasons for which that it is longer. Do you think -- looking at what you've seen over this year and what you're looking forward to doing next year with the strategy, do you think there's an opportunity to somehow shorten the cycle? Do you think that what we have -- what it has been historically is appropriate length or the right length? Any comments on that?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [28]

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Sure. I think we need to talk about it in terms of individual clients, and then we need to talk about it in terms of, overall, in asking people to convert from conventional construction to building on a prefabricated basis. Because of the 15-year track record the business has generated being very successful, the conversion process is easier. We have case studies that we can point to. We have other people who have done -- built this way and it's -- that process in converting people is easier every day than it was the day before.

Now one of the reasons that we're setting up the strategic accounts is with clients that do business across North America, we want to take a success in one area and then leverage that in a different area. And typically, those decisions are made on a local or regional basis, and that's -- we don't have that functionality currently, and that's why we're in the process of standing that up.

And so hopefully, you use that to shorten the cycle with that individual in the region who hasn't used us before, okay? Now for a specific project, no, we can't shorten the sales cycle. It is what it is. And it's -- and they're going to decide when they decide. And it's going to come together -- as it comes together, there's other people involved in the job site that have to get it ready and so on and so forth.

So I guess, in summary, I would tell you that, conceptually, as we are converting the way people build, it gets easier and easier every day. As we put in more tools in place in our business, we should be able to leverage that and leverage successes we've had in the past. But on an individual project basis, there really is very little that we can do. There's too many people involved and too many variables that we can't influence.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [29]

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Okay. No, understood. And when it comes to -- you've already talked about this, Geoff, you mentioned in your remarks about how, given your size, larger contracts can create lumpiness quarter-to-quarter and certainly make comparables more difficult. Is there any strategic method, do you think, that'd be able to grow smaller contracts versus larger ones? Is there any way you think that you could change the model that somehow the revenue would be less lumpy? Or is it just -- this is the way it will be? As you grow larger, certainly, there'll be less volatility, but for now, this is sort of what we should expect, still, going forward?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [30]

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I think that expecting lumpy sales quarter-to-quarter going forward is prudent, okay? Now the best way for us to address the lumpiness you alluded to is growth, okay? The best way to drive growth is, believe it or not, focusing on larger projects, okay? Because rather than having to convince hundreds of people in local markets on relatively small jobs, deploying a myriad of partner sales reps and our sales reps, it's a fairly concentrated effort.

Now one of the things that you have to understand, and one of the reasons why we are setting up a stand-alone function to address those opportunities is because of the way that both our sales representatives and the partner sales representatives are compensated, okay?

One of these large projects can take upwards of 2 years in the planning process. And there's all kinds of complications, there is working with the local general contractors, et cetera, et cetera, just in the sales process, okay? So then you get to where they have to make a decision. And then they can just fairly capriciously decide, oh, we've decided for whatever reason to build conventionally rather than to build on a prefab basis.

Because both our reps and our partner's reps are compensated on a commission basis, they are much better served by going after the local law firm, accounting firm, what have you, and letting those larger projects go by the wayside, so we're under-penetrated in that area, okay?

So what we're in the process of standing up is a group that is focused on those, that is compensated accordingly, and so they're not living and dying on commission based on, "We just lost that big project", and you keep enough in the pipeline. So I think contrary to putting a focus on the local effort, we'll continue a very strong effort on the local effort, and we'll talk about that in more detail, but it's supplementing it with these large projects.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [31]

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Okay. Great. And then my final question on competition. I mean, you mentioned already your market share is so small on a national basis, or global even. But have you seen any change in the competitive landscape in your major markets, more competition, something along the lines of more people looking at a nontraditional option? Any sort of headwinds from that perspective?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [32]

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At this point in time, we have not seen headwinds from a change in the competitive activity. We do have any number of competitors of a varying range and capability, but there's nothing going on in the marketplace that is making a material difference in either our sales results in the third quarter or what our perspective is going to be going forward.

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Operator [33]

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Your next question comes from the line of Colin Healey with Haywood.

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Colin Healey, Haywood Securities Inc., Research Division - Research Analyst of Mining [34]

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You guys mentioned that your -- that you lose projects all the time, and I assume that's a reference to not converting projects that are bid on in the pipeline into sales. I'm just wondering about the trend. Has the conversion rate or win rate materially deteriorated in 2019?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [35]

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I'm going to give you 2 answers. I'm going to give you -- the first answer is 100% gut feel. And I don't think our win rate has changed.

Now let me give you the specific answer. What I want to be able to tell you is that our win rate a year ago was 62.3%, and our win rate this year was 58.9%, okay? I can't tell you that because we don't have the systems and processes in place to be able to track that, okay? That exact question that you asked is an excellent question. We can't do it now with the degree of rigor that we need to be able to do it with, and that is one of the things that is incumbent and what we're putting together in our commercial function.

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Colin Healey, Haywood Securities Inc., Research Division - Research Analyst of Mining [36]

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Okay. I appreciate that answer, and it answers the second question, was -- I was going to ask about efficiency stats because I'm really interested in kind of measuring the progress or success of the changes that you make and that seems like a logical place to start. Obviously, we can measure revenue improvement, but efficiency of the sales force is going to be important.

Another question. I noticed in the notes that there's a lawsuit for $30 million from fault build. Can you just comment on the validity of that? I know there's comments in there about the probable strategic nature of that given that you guys initiated the legal proceedings against Mogens and Barrie back in May. But what specific IP are they claiming that DIRTT misappropriated or misused?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [37]

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I think that the language in our 10-Q is very thought out, and I think did a fabulous job of explaining the situation and our perspective on it. So I think what I'm going to do is let that language stand on its own.

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Colin Healey, Haywood Securities Inc., Research Division - Research Analyst of Mining [38]

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Okay. Is there any update in terms of the time line for that?

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [39]

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No.

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Operator [40]

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Thank you for your questions. That concludes the Q&A session for today's call. I will now turn the call back over to Mr. O'Meara for closing remarks.

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Kevin P. O'Meara, DIRTT Environmental Solutions Ltd. - President, CEO & Director [41]

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This has been a challenging year, and we're not satisfied with the results that we just discussed. Nevertheless, we're thrilled with the quality of the people in our DIRTT team, confident in our strategic plan and its execution and excited about the company's prospects. We're well on our way to becoming a well-run, world-class company that capitalizes on this opportunity with aggressive growth and attractive profitability. We look forward to introducing our team to DIRTT's investors and analysts next Tuesday in New York as we share our strategic plan and financial targets. This concludes today's call.

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Operator [42]

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This concludes today's conference call. You may now disconnect.