Dirtt Environmental Solutions' (DRTTF) President Scott Jenkins on Q2 2016 Results - Earnings Call Transcript

| About: Dirtt Environmental (DRTTF)

Dirtt Environmental Solutions Ltd (OTC:DRTTF) Q2 2016 Earnings Conference Call August 4, 2016 9:00 AM ET

Executives

Scott Jenkins - President

Derek Payne - CFO

Analysts

David Quezada - Raymond James

Neil Linsdell - Industrial Alliance

Elizabeth Johnston - Laurentian Bank Securities

Steve Hong - National Bank Financial

Gabriel Leung - Beacon Securities

Operator

Good morning ladies and gentlemen, and thank you for standing by. Welcome to the DIRTT Environmental Solutions 2016 Second Quarter Results Conference Call. At this time, all participants are in listen-only mode. Following the presentation we will conduct a question-and-answer session for analysts. [Operator Instructions] I would like to remind everyone that this conference call is being recorded today, Thursday, August 4, 2016 at 9:00 AM Eastern Time.

I would now like to turn the conference call over to Mr. Scott Jenkins, President of DIRTT. Mr. Jenkins, please go ahead.

Scott Jenkins

Thank you operator and good morning everyone and welcome to the DIRTT Environmental Solutions 2016 second quarter results conference call. And with me today is also Derek Payne, our CFO. Now before we begin, I'd like to remind you that certain information on today's call, including responses to questions posed could constitute forward-looking statements that are subject to risks and uncertainties relating to DIRTT's future financial or business performance. Actual results could differ materially from those anticipated in these forward-looking statements. Risk factors that may affect results are detailed in DIRTT's filings with the Canadian Securities Commissions which can be accessed at www.sedar.com. Please note that DIRTT is under no obligation to update any forward-looking statements discussed today except as required by applicable law and investors are cautioned not to place undue reliance on these statements. With respect to today’s agenda, I will provide an overview for the quarter and talk about a few key operational initiatives before turning to our outlook and then Derek is going to provide some context around our financial results before we open up the call to questions.

We were happy to show a healthy return to growth in the quarter with revenue increasing 15.9% over the same period last year. More compelling was our revenue growth in the critical US market where sales increased 24.7% versus the same quarter a year ago. Now, while the Canadian market and in particular the energy sector continues to see challenges, our results highlight the ongoing diversification of our business. Revenue was CAD61.3 million for the quarter and importantly at these levels we were able to demonstrate further adjusted gross profit expansion of 410 basis points over the prior year to 46.1%. We believe we continue to demonstrate the scalability of our business model as we increase revenues, improve efficiencies and demonstrate the potential of our technologies. We also want to highlight to investors that our business can show some quarterly volatility from time to time and the first quarter was an example of this. We believe a better metric of our overall growth is trailing 12-month revenue which was CAD244.2 million versus CAD214.2 million in the prior 12-month period.

Now I’ll let Derek speak in greater detail about our financial results both for the quarter and year-to-date shortly. Every year during the second quarter, we host DIRTT Connext, our annual major sales, marketing and industry showcase. DIRTT Connext now stands two full weeks in June and has grown in importance in every year. It is our single most critical event for our network of distribution partners; its core to our annual sales team training and strategic planning sessions and it is our greatest opportunity to showcase the latest DIRTT solutions and technologies to key stakeholders such as architects, designers, facility planners, executives and others involved within interior construction projects. While the expenditures associated for DIRTT Connext are recognized fully in the second quarter, it truly is an investment for the following year and beyond. This year DIRTT Connext saw few important milestones and announcements. The first item I want to highlight which we believe speaks for future prospects is our distribution partner attendance at the event. Our distribution partners paid to have their DIRTT related team travel to Chicago and attend our training, peer-to-peer learning events, sales and marketing leadership sessions et cetera. This year we saw 55% increase in distribution partner attendance.

Our second major achievement in DIRTT Connext was the unveiling of ICEreality. ICEreality allows architects, designers, DIRTT clients and really anyone working through a renovation or newbuild of an interior to see a real-time 3D representation overlaid on the existing space that they want to remodel or build. Perhaps known in other context as mixed reality or augmented reality, the key benefit for the construction industry is the real-time collaboration between multiple users with on-the-fly live changes and alterations to the design from within the ICEreality environment. Our goal by this fall is to be able to provide our clients with an even more immersive and creative experience during their project design process knowing that at the same time ICE is generating real-time pricing, engineering, architectural drawings and manufacturing information that allow us to deliver our customized solution on rapidly lead times. I would invite listeners on this call and investors and other key stakeholders to visit dirtt.net to see a video with our co-founder Barry Loberg and the announcement for ICEreality to really get a good sense of the ongoing evolution of our proprietary technology and how we are planning to further disrupt the construction industry.

I now want to spend some time discussing our strategies for future growth and prospects as we move into the second half of 2016 and perhaps more importantly towards 2017. Our growth strategy remains centered on five key initiatives. First, increasing the penetration of existing markets by providing continued support and increased investment in our sales, marketing, business development and to our distribution partners throughout North America. Second, expanding into new geographies such as the Middle East, United Kingdom and Singapore by capitalizing on recent and continued investment alongside new international partners. Third, focusing on key growth verticals such as healthcare and education alongside new industry verticals such as residential. Four, continuing to invest in ICE a new innovative interior construction solutions such as adaptive residential interiors and timber frame construction. And lastly, partnering with industry leaders to integrate and monetize innovative solutions. Our first core initiative is related to increasing sales in concert with our North American distribution partners.

As we discussed in our earnings release, we have strategically added to our sales, marketing and business development teams and specific regional markets while also adding to our industry specialist teams for both education and healthcare. If you include our new team members added in July, we've actually increased the size of our team by more than 20% from June 30 in the prior year. Our sales and business development team works closely with our distribution partners who also continue to invest in our business. Year-to-date we have seen a 97% increase in our partner investments in new and refreshed Green Learning Centers with the [indiscernible] solutions are showcased just as one data point for our listeners. We have also been very pleased with the rollout of the DIRTT Movers Program which we began in February of this year. The DIRTT Movers Program was a mutual investment along with a select group of partners in peer-to-peer learning events alongside our top performing partners where attendees and participants receive additional business development and marketing support, they participate in targeted training events and while it is still early on we are very happy with preliminary results as we are seeing growing sales momentum and receiving very positive feedback from the partners participating in this program.

In addition to the DIRTT Movers Program, we have previously discussed our new Green Learning Center loan program, which was rolled out at the very end of 2015. To-date, six partners have participated and we are expecting others to join the program in addition to the three who are just finalizing their designs right now. To summarize the program, we are providing a three-year industry loan of up to CAD105,000 for new and updated Green Learning Centers, provided our partners meet certain design criteria for the new GLC such as including a healthcare component, showcasing Corning Willow Glass and having integrated technology et cetera. We also have some partners who, well not participating in the loan program, have spent hundreds of thousands of dollars on completely new GLCs in the past year and are seeing fantastic momentum in their local markets. And I just personally want to thank all those partners who are investing in our business as they see the potential for DIRTT. While our main focus is on the core North American market, where we believe we are still very small percentage of the total adjustable opportunity, we are also happy with the progress we're making in targeted international markets which is the second strategic growth initiative we have outlined.

Subsequent to quarter-end, the first phase of our Green Learning Center in Singapore was installed. We are excited about our long-term prospects in Singapore where the government has already announced supportive measures including the requirement, the developments on government land must use modular building techniques. We also hope to have our Green Learning Center in London, England open by the fall. This Green Learning Center will support marketing efforts for London and more importantly in the Middle East, where we are seeing good momentum in the healthcare sector in particular. At the end of the quarter, we also started production of small but unique project in partnership with Corning for their European Technology Center outside of Paris, France, where we intend to showcase DIRTT solutions to many of Corning’s partners and guests. The third key growth initiative I mentioned was our continuing investment of strategic verticals such as healthcare, education, residential and timber frame. We believe our value proposition of delivering custom built interiors with cost certainty, integrated technology, flexibility for the future and on shorter timelines and conventional construction is a tremendous advantage for healthcare providers in particular.

We’re seeing growing momentum in our healthcare sales pipeline, but we do want to caution investors that the sales cycle is long in this space. Furthermore, our focus on education sales including adding additional education business development specialists has contributed to a 32% year-to-date increase in sales versus the same period a year ago in this vertical. With respect to residential initiatives, we delivered the previously announced project in Barrow Alaska during the quarter and continue to develop new innovations for the segment which I’ll talk about more shortly. Our timber solutions continued to generate significant interest in both the commercial and residential sectors but I do want to reiterate our comments from previous communications that our ongoing investment in residential and timber is part of a longer term strategy that we believe will also further support long-term sales growth of our existing DIRTT solutions. With respect to our fourth key growth initiative, increasing investment in our proprietary solutions and technologies, I want to start out by saying this is always been core to our business philosophy. We believe in the need for constant innovation and we believe we are accelerating the pace of that innovation, the more striking example of our achievement this quarter was the unveiling of ICEreality which brings augmented reality or mixed reality to the interior construction world.

In addition, our product development team continues to innovate especially with respect to healthcare by integrating new and improved technologies in our solutions. We also continue to invest in advancements on the residential front, and one thing we are very excited about although it is early is furthering our capabilities with respect to residential environments that adapt as people lives change and they age. The last thing I want to touch on before turning the call over to Derek is our strategic partnerships with other innovative companies. We previously discussed our partnership with Corning and Willow and we continue to collaborate with them on many fronts and they have been a great partner to work with. We also have other strategic partnerships though such as our partnership with Identity Ink a company with innovative architectural graphic treatments. And we are constantly working with our suppliers and other stakeholders on new product initiatives and are in discussions with multiple companies to collaborate with new sustainable materials, new technologies and leading-edge design ideas. I want to conclude by saying we are a company committed to constant innovation and we will continue to invest so that we can further disrupt the interior construction industry. We continue to expand our portfolio of intellectual property and as previously discussed on earnings calls; we are completely committed to defending our intellectual property rights. Our growth as evidenced by the first quarter may not always be linear but taking a slightly longer term approach and reviewing it on an annual or trailing 12-month basis highlights our longer-term potential.

I’ll now turn the call over to Derek for the financial review.

Derek Payne

Thanks Scott and good morning everyone. As Scott indicated, we are pleased to report our second quarter results highlighted by our record adjusted gross margin percentage demonstrating the leverage in our modern particularly with higher revenue levels and favorable operating conditions. As can be expected in the second quarter each year, these results also reflect our annual investment on our single largest and most important annual marketing and training event DIRTT Connext. Turning to the specific numbers, revenue increased by CAD8.4 million or 15.9% to CAD61.3 million for the quarter compared with the same quarter in 2015. Revenue is driven by strength across many of our vertical sectors but highlighted by our first large-scale residential project which contributed CAD4.3 million in revenue in the period. On a geographical basis, revenue in our US and international markets was up 24.7% to 92% of total revenue which more than offset sluggish results in the Canadian market which declined by CAD2.7 million to 8% of total revenue in the period. On a trailing 12-month basis, revenue grew CAD30.1 million or 14% to CAD244.2 million. Adjusted gross profit as a percentage of revenue of 46.1% represents a record quarterly result for DIRTT. In addition to solid revenue levels in the period, these record operating results were driven by very favorable manufacturing conditions including a diverse product mix and balanced month-to-month volumes. This allowed for optimal factory loading resulting in efficient utilization of factory labor and other manufacturing efficiencies.

Adjusted SG&A increased by CAD3.7 million or 19% in the second quarter as compared with the same period in 2015. On a percentage of revenue basis, adjusted SG&A increased 100 basis points to 38.5% from 37.5% in 2015. The most significant factors influencing this change can be attributed directly to sales related and business development efforts, reflecting our ongoing investment in growth. The largest such investment in the period is our annual sales, marketing and training event DIRTT Connext with a total cost of CAD3.4 million in the current year. This represents an increase of CAD1.1 million over the prior year and is a direct result of a record 513 distribution partners and their keep team members attending this year's event. Other increases in adjusted SG&A in the quarter included salaries and commissions which increased CAD0.5 million, professional fees of CAD0.4 million for various corporate matters, rent expense of CAD0.3 million on our expanded facilities and other operating costs of CAD0.7 million due to increased business activity. The higher US dollar to Canadian dollar exchange rate also contributed to the increased adjusted SG&A cost in the period. As some of these expenditures including the majority of cost associated with DIRTT Connext are denominated in US dollars.

For the six-month period ended June 30, adjusted SG&A increased by CAD5.6 million or 15% as compared with the same period in the prior year. On a percentage of revenue basis, adjusted SG&A increased 250 basis points from 34% to 36.5% in the current six month period. The reason for the increase are largely the same as those just discussed in the most recent quarterly period including DIRTT Connext, compensation cost on our expanded sales force and general business development cost increasing over the same year-ago period. Adjusted EBITDA increased by CAD2.1 million or 88.7% in the second quarter versus the same period in 2015. On a percentage of revenue basis, adjusted EBITDA improved to 7.2% versus 4.4% in 2015. The increase in the current year was mainly due to higher adjusted gross profit driven by increasing revenue and our record adjusted gross profit percentage. These amounts were partially offset by the higher adjusted SG&A cost I just discussed as well as CAD0.2 million increase in the foreign exchange loss in the quarter.

On a year-to-date basis, adjusted EBITDA declined by CAD2.1 million or 18.6% versus the first half of 2015. Improvements in adjusted gross profit of CAD6.3 million were more than offset by increased adjusted SG&A costs of CAD5.6 million as well as an increase in the foreign exchange loss of CAD2.8 million. This additional foreign exchange loss was largely the result of the reversing trend in the US dollar. The first six months of 2015 saw an appreciation in the US dollar of CAD0.09 versus a decline in the value of the US dollar of CAD0.09 over the same period in 2016. As monetary assets and liabilities, primarily our US dollar cash holdings are revalued at the end of each reporting period, foreign exchange gains of CAD1.5 million in the first six months of 2015 were replaced by losses of CAD1.3 million in the first six months of the current year. Turning briefly to the balance sheet, at quarter end, we had CAD93.9 million in cash and cash equivalents compared with CAD91.4 million at December 31, 2015. Capital additions of CAD7.5 million incurred in the quarter were partially funded by US$4.2 million draw on our new US$10 million capital financing facility that was secured as part of our back renewal in March. In addition to the remaining balance of this capital financing facility, we also have access to undrawn US$18 million revolving operating facility. This in addition to cash on hand provides us with significant liquidity that will allow us to invest on our ICE software, new product solutions and manufacturing capabilities that create long-term value.

That concludes our prepared remarks for today. I would like to thank you for your time and attention and to remind you that this webcast will be archived on DIRTT’s website dirtt.net. Operator, we are now ready for questions.

Question-And-Answer Session

Operator

[Operator Instructions] your first question comes from David Quezada from Raymond James. Your line is open.

David Quezada

I guess my first question, I know in the release you mentioned increased headcount on the sales and marketing side, wondering if you can provide us any other details on that and just kind of when you expect those new hires will eventually translate into maybe a bump to sales at some point here?

Scott Jenkins

Sure, so it’s Scott speaking David. So the new hires, I want to split them for the listeners on the call and our investors into two groups. So we've added both direct salespeople in geographic markets that will support our distribution partners. So I want to just point out how scalable these people can be in terms of - because they are actually supporting our distribution partners growth in their local markets and we've also added industry specialists, so industry specialists are people we’ve tripled our education team, we've doubled our healthcare team and we've also doubled our construction focused team who reach out and speak directly with general contractors. So they go into markets and support the direct sales reps and also the distribution partners in terms of the specific industries, whether its industry or healthcare which we obviously see as our key growth verticals.

The industry specialists in particular to answer your question more directly can hit the ground and be support of almost immediately because these people that we've added to the DIRTT team they bring in some cases two of individuals more than two decades worth of experience and relationship in that specific industry. So, we think they are tremendous adds. With respect to the direct sales team members, it usually takes a couple of quarters and usually 12 months for them fully to really be contributing solid opportunities into the sales pipeline. I've been happy to say or to see though that we've actually seen some earlier success and I think that speaks to our training, the full participation of all of our new team members in DIRTT Connext in Chicago and also just in terms of our technology and the capabilities of ICE. So hopefully that answers your question a little bit.

David Quezada

That's very helpful thank you. And I guess kind of related to that, the DP Movers Program, just wondering if there is any other details that you can share there, maybe early commentary on how that's going and I don't know if you have any kind of targets from that program that you can share?

Scott Jenkins

So anecdotally, so I guess first of all by the next quarterly conference call, we will be able to provide investors I think with some more data in terms of sales growth. Anecdotally, the sales growth of our top tier partners and then the second tier partners for the Movers and they’re working in conjunction and learning from each other is exceeding our overall growth rate. Anecdotally, also in specific markets I think about our partners in Denver, I think about our partner in New York, I think about San Diego, I think about our partners - our new partners not even part of the program but they’re doing a hell of a job in Kansas. We are seeing tremendous growth rates locally. So the investment in the DIRTT Movers Program is paying dividends and we think in the second half of the year it will only accelerate. So we will provide a little more guidance on this as we can compare to our existing overall partner base going forward. I don’t know Derek if you'd like to add anything to that.

Derek Payne

The DIRTT Movers Program has been tremendously successful, it's still early, but we want to highlight for investors the investment we’re making, but also I guess it's probably an opportunity with this question to just highlight the investment those partners in particular are making back in the DIRTT business and again, I want to thank them for that.

Operator

Your next question comes from Neil Linsdell from Industrial Alliance. Your line is open.

Neil Linsdell

Just to get on the sales force headcount as you’re talking about that growing, can you talk between the industry specialists and the sales and marketing professionals, the actual number of people you are talking about?

Scott Jenkins

So in terms of the actual number it now exceeds 100 in the percentage, so, what we included in our prepared comments this morning versus the press release, the press release compares June 30 headcount number at June 30, 2015 versus June 30, 2016. In the prepared comments this morning, we've also included the additional team members from July, so up until this week, to give a little more up-to-date number, which is a headcount increase of just over 20%, it’s actually 21.4% I believe. So we're talking an increase of about I think its 17 or 18 individuals and we are now over 100.

Neil Linsdell

And the number of industry specialists in which specific industries are?

Scott Jenkins

So we now have three industry specialists in education, two in healthcare, two in construction, one in US government and then a couple of peripheral support people.

Neil Linsdell

And further distribution partners, I know so this is completely separate from the actual distribution partners given the fact that you had more attendance in Chicago this year, are the distribution partners increasing their staffing as well?

Scott Jenkins

Yes, we have seen that. We don't want to give a specific number in terms of their staff, because we are receiving the information sporadically, we don't have a clear cut off like we would have obviously on our own payroll, headcount and team members. But we've seen significant increase in the distribution partners DIRTT related team members so that’s DIRTT Champions, their salespeople, DIRTT project managers and DIRTT designers.

Neil Linsdell

Okay.

Scott Jenkins

That's an important question, because for listeners, our distribution partners, the teams that they are dedicating towards the DIRTT business and really towards interior construction, we’re seeing our partners set up separate teams, add, this is where they are making their investment, but this is investment on their payroll, on their income statement, on their balance sheet when they open a new Green learning Centre.

Neil Linsdell

All right. And with the international expansion that we’re talking about, can you provide more details, you mentioned London, you mentioned Singapore, as far as the timeline, short-term, long-term, what the milestones are going to be as these -- as your international expansion kind of takes hold and how far out you’re planning and you're looking three year, you’re looking at five years?

Scott Jenkins

Sure, three years would be good in terms of an overall. So let me take a quick step back on this question. So our first international expansion and where we've seen a lot of success, but in 2015, was somewhat flat lined just due to timing. It was of course our partnership with NMG, who is our partner who handles the Middle East. NMG has invested significant resources, both in Dubai and Saudi Arabia with Green Learning Centers, but also every year annually in January, during the Arab Health trade show, which is one of the world's largest healthcare focused shows and they spend significant amounts of money, time, effort, bringing in clients, showcasing the latest DIRTT solutions.

We have seen healthy sales momentum from them, which we are very happy. So that's healthcare focused Middle East. That ties into the rational for our London Green Learning Centre. It really was and is meant to be an opportunity for us to showcase, bring clients into London, it's an easy place for our guests and our clients out of the Middle East to travel to less visa restrictions, most of the countries, they don’t a visa to enter the UK, the Middle East and just time zone issues as well. So that's number one. So we’re seeing healthy, healthy momentum in the Middle East, largely healthcare focused and that's in concert with our partnership with NMG.

Within the UK, so we’re hoping to open our Green Learning Centre this fall, it's actually been delayed somewhat, the building that the Green Learning Centre is going into in London is under -- the entire building is being renovated, so that's behind schedule, nothing to do with DIRTT, but we're at the mercy of other constructions schedules, which is actually an interesting testament to the capabilities we have and the difference between us and traditional construction. We also are hopeful though without London GLC, independent of challenges of the overall UK market, London is a very expensive city to build, they are very keen on sustainability, reducing ways through the construction process, flexibility to high rent areas. So we hope to make some inroads.

I mentioned briefly the small project south of Paris, where we’re going to be showcasing integration technology, obviously, a lot of Willow Glass and other products from our strategic partner, Corning and their offices. That's being handled out of the London office with our team in the UK. So, expectation, timing, a couple of years, milestones on the UK would be to secure kind of our first commercial project in the next year, maybe first few projects. There is a pipeline now developing, but to have it generating some meaningful revenue within the next three years. So that’s UK and the Middle East.

Now, as we move to Singapore, so Singapore. Subsequent to quarter end, we completed the first phase installation in partnership actually, we're sharing space with a large investment fund, unrelated to DIRTT and then we’re going to, the second phase will be largely healthcare focused. There are some large healthcare projects, which we are discussing with both the government and the health ministry over there. The government of Singapore has been very supportive, very keen on supporting DIRTT and prefabricated construction solutions, also very keen in using our ICE technology and where that can be expanded too.

So again, a milestone will be similar to London, in my mind, would be our first commercial project or first few next year and then adding significant or meaningful revenues within the next three years.

Neil Linsdell

Okay, great. And just lastly, you mentioned the strategic partnership with Corning, obviously we all hear about the Willow Glass a lot. But I know there is a lot of fiber-optic cable, say, in your Chicago GLC when you're looking at all the solutions, when you're integrating with the lighting and in the walls in the floors, can you talk about the extent of the Corning relationship and both within the product groups and perhaps geographically, how much traction or how much benefit you could get out of that over the next couple of years?

Scott Jenkins

Well, let me answer the last part of that first. In terms of how much traction we could get, I'm not sure, it's still early days. Our relationship with Corning has been, it's very collaborative, they've been very good to work with. They have some interesting, obviously some other interesting innovative technologies, both as you mentioned on fiber-optic, we are moving forward with our DIRTT network solutions, we call it passive optical networks where we've already seen some successful commercial projects, where we think we can significantly reduce both the costs in data, so that would be DIRTT passive optical network solutions, DIRTT network solutions versus conventional cabling and data solutions.

We've already seen a couple of case studies, we hope to publish a case study on our website shortly for our large commercial client, a publicly traded restaurant channel in the United States, where they saved a tremendous amount of money. So we think that's compelling and we are obviously in conversation with Corning in terms of their solutions and integrating that with ours. So I’m very excited about that, again, early days.

In terms of other initiatives, sales and marketing, we continue to discuss ways we can collaborate with them. Again, it’s early. But I think a great example is this small project, I'm very excited about it and just south of just or just outside of Paris for their European Technology Center, I think it's an opportunity for us to showcase our mutual solutions to a lot of existing relationships that they already have.

Neil Linsdell

Okay, great color. Thank you.

Operator

Your next question comes from Elizabeth Johnston from Laurentian Bank Securities. Your line is open.

Elizabeth Johnston

Good morning. Just my first question, in terms of outlook for growth in Canada and the US, and Canada in particular, we’ve seen a fair amount of variance quarter-to-quarter and in the first half of this year, it’s actually tracking lower than the first half last year. Can you talk a little bit about where you're seeing that from, specifically from energy related markets and if so, would you expect that to level off or perhaps improve going to the back half of this year?

Scott Jenkins

So, this is an important question as well. So we’re very excited obviously with the growth in our key US market, which now represents over 90% of our sales, sales growth of over 24% quarter-over-quarter and that's probably where we’re seeing the most momentum. I think Canada is a little bit a tale of two geographies, Western Canada and the energy industry in particular. So, Calgary, of course, which is head office for us, home-based, if you will where we’ve seen tremendous success right from day one, because we have a large footprint, brand recognition, and traditionally, the energy sector has been an early adopter of prefabricated construction solutions and has been really supportive of DIRTT.

So the falloff in the energy industry obviously affected our results in 2015, even though we showed strong growth, we think it could have been stronger and in Q1. We think that has largely leveled off now. It is a much smaller percentage of our business. We’ve shown the benefits of our diversification strategy into healthcare, education, other commercial sectors, now even our first successful commercial project for residential in Barrow, Alaska. So we do think it’s leveled off. Interestingly, without specific contract discussions on this call, we actually potentially going into 2017, will see a bit of an uptick from the energy sector as we have verbally secured a couple of interesting projects that are meaningful to us, not large enough to be publicly disclosed, but they are meaningful going forward, timing still to be determined.

Now, moving to the second kind of geography, more Eastern Canada, in Eastern Canada, we’re seeing some good success, especially in Southern Ontario. Our Montréal team, we've actually expanded our Montréal team recently on the sales side. We've had some cache projects over the last year. There is just a little bit of volatility due to timing of some of these projects. We have some upcoming projects in Canada, because it's a much smaller percentage of our overall sales, it can be affected, I’ll give you an example, if we secure a $3 million project in Montréal or Toronto or Markham or Winsor or London, Ontario, that can move our Canadian revenue up by a meaningful percentage and in the next quarter, if that project is not there, whereas the US, it’s such a larger base, obviously it's a wider representation. Hopefully, that sort of gives you some color there.

Elizabeth Johnston

Okay. Yes. For sure. And just on the topic you disclosed about the large contracts in the US, the energy related contracts that you don't expect to have going forward, can you give any additional commentary on that?

Scott Jenkins

Yes. It's just -- again, we can't provide any guidance on when and if the remainder of that project that was really 2014 and then the first quarter of 2015, given the energy sector, who knows, we’re not predictors of oil prices, energy prices or spending from these companies, so we just like to guide that we are not certain about the remainder of that contract. I think more importantly though, it's more important for investors and listeners to this call to recognize energy is significantly less than 10% of our business. We have some good -- we are seeing a couple of green shoots, if you will, in terms of some clients in that sector, some other additional clients, but it’s not meaningful to us. We’re focused on education, healthcare, diversifying our business internationally and I think this quarter shows that we’re back on strong footing and we’re seeing momentum going forward.

Elizabeth Johnston

Okay, great. And since you mentioned it, in terms of healthcare, can you give us a percentage of revenue that health represents at this point, either year to date or in the quarter?

Scott Jenkins

I'm going to ask, Derek, I mean, he is just going to make sure we get you the exact number here.

Derek Payne

Yeah. So year to date, healthcare was 15% of our business and in the second quarter, 13%.

Scott Jenkins

So it's now becoming a meaningful percentage. The one comment I will also make on healthcare is it is a longer sales cycle. We know that. We've now been in this industry for about seven years, but we’re now developing an excellent roster of name brand recognizable clients, both in United States and Canada, and when we do a project for a healthcare provider, whether it’s medical office building, clinics, training, laboratories, or full patient care, a lot of projects are full patient care. So it really is us versus conventional construction. We’re able to demonstrate our speed, our quality, flexibility for the future, and many of those clients are starting to have discussions with us about becoming repeat clients. So I guess my comment anecdotally is, once we develop that relationship, it can pay dividends going forward.

Elizabeth Johnston

Okay, great. Thanks. And just in terms of continuing on with our discussion with verticals and in terms of residential, I think in the past, you had mentioned that you didn’t expect and I think you don't still expect a meaningful contribution from that segment, although you did have the contracts this quarter. Would you say for the balance of the year that it would represent less than 10% of sales or could you even make some kind of comment there?

Scott Jenkins

Yes. I think we might even be able to say even less than that Elizabeth is, residential for us, there are some exciting initiatives. We hope to have some future announcements in the near to mid-term, but without anything specific, the project in Barrow, Alaska, very excited about it, it's generating a lot of interest, especially for other developers, builders who have projects in maybe more remote locations, but want high-quality solutions. So we’re excited about it, we can use it as a case study, but it actually maybe can be even a little earlier that we expected. So our expectation for residential is more into 2017 and 2018.

Elizabeth Johnston

Okay, great. Thanks. And you made a comment in the MD&A about volume being flat year-over-year, if you could just clarify that comment for me, does that mean that the same number of projects or any additional information would be helpful there?

Scott Jenkins

So I think that comment and maybe we weren't clear, so apologies. This is important, the volumes in the quarter, month-to-month were very consistent, we maybe should've said consistent. So that’s a bit of a wording error on our part. When we see consistent volumes and throughput through the manufacturing facilities, that is another positive factor on adjusted gross profit. Derek can add something.

Derek Payne

Sorry, Elizabeth. That was wording. So we talked about the things that drive our margin, revenue levels, margins increasing on increased revenue levels, we talked about product mix having an impact, but then as well manufacturing throughput. A quarter where the monthly revenue levels are consistent on a month-to-month, it just helps. Tracy and her team from an overall efficiency standpoint and we saw all of those factors in this quarter, which resulted in record operating margins.

Elizabeth Johnston

Yes. So versus last year, within the same quarter last year?

Scott Jenkins

Yes, from April, May and June, the three months, it was a little more volatile, which puts a little more pressure on our manufacturing.

Elizabeth Johnston

And looking forward as we’re starting Q3, are you still seeing consistent level of volume or the same level or any comment there?

Scott Jenkins

We are seeing consistent and we're seeing some good momentum, as we’re starting it. We've put it both in the press release and our comments today, Q3 is starting up strong for us and it looks very consistent.

Derek Payne

Elizabeth, as you know, our visibility in our business is limited because of our short lead times, but the forward-looking information that we gave regarding pardon me, third quarter, was that it was off to a good start and keeping up with the results we just released.

Elizabeth Johnston

Thank you. That's all my questions.

Operator

Your next question comes from Steve Hong from National Bank Financial. Your line is open.

Steve Hong

Hi. This is Steven Hong filling on behalf of Rupert. I just have a question in terms of DIRTT Connext. I know that DIRTT experienced approximately like 55% increase this year, wondering if that could be ongoing run rate or kind of things that you guys are going to see for next year?

Scott Jenkins

That's a difficult question to answer in terms of attendance for next year, so we would be predicting our distribution partner investment in sending their teams for DIRTT Connext in Chicago. That being said, what we have seen, I’ll give another data point, maybe, which we didn't touch on is we know that when we bring customers, architects, designers, contractors, developers to Calgary, to Savannah, to Phoenix, any of our plants where we can spend a day, especially Calgary, we can immerse them in the DIRTT culture, they can meet various members of our team, they can see why we believe we’re so different and we’re disrupting construction. We know that we see a significant success and we have very good percentage of close rates on contracts and getting the project. We've also seen, in addition to DIRTT Connext from our partners and from potential clients, architecture designers, GCs, et cetera an increase, a significant increase in tours and visits to Calgary, Savannah and Phoenix. When forward, it is difficult to predict, especially three months, six months, nine months and now into Chicago next year, but it will be a focus of ours to increase attendance at DIRTT Connext in June in 2017.

Steve Hong

Okay, that's good. And finally, I was looking to see if DIRTT is looking to monetize [indiscernible] technology or if you guys are really looking to having a specific timeline for that?

Scott Jenkins

So the augmented reality or ICE reality, as we call it, mix reality, which is alive mix reality and augmented reality file and again I want to invite everybody on this call to please visit dirt.net to see the video of various announcement and the unveiling to really get a sense of what it is. It will be critical for us going forward and our distribution partners to allow a fully immersive live creative, collaborative experience for our clients and potential clients. So that's number one how we're going to monetize it is through our distribution, it is enabling our partners, clients, architects and designers, DIRTT sales team members with technology that does not exist in the construction industry period. We have filed some intellectual property filings on this as well. So that is number one.

In terms of other monetization, I’m not sure, there is always ongoing discussions internally, it's early days, but obviously that would be a tremendous value proposition longer term for our shareholders.

Derek Payne

Yeah. I’ll just add, so the rollout to our wider distribution network will be dependent on hardware manufacturers. So not unlike virtual reality, for those who have been with us for some time, we unveiled Virtual reality three years ago in Chicago and we've actually been doing virtual reality demonstrations in our GLC here in Calgary for well over two years. They had said, the hardware now is just starting to become commercially available and we are now in a position where that technology will start to be rolled out to our partner network. We may see the same, we may experience the same thing with VI’s reality where we have some continuing development on our end, but the ultimate rollout to our partner network will be somewhat dependent on availability of hardware.

Steve Hong

All right. That's all I have. Thank you.

Operator

[Operator Instructions] Your next question comes from Gabriel Leung from Beacon Securities. Your line is open.

Gabriel Leung

Sorry, good morning. Thanks for taking my question. First off, I think earlier, you had mentioned that you’re running at about 118 in terms of sales and industry exports right now, is there a target for you on that front, on the headcount side by the end of the year?

Scott Jenkins

There isn’t a specific target. We added the commentary for the July editions and there is a few more that will be in August. We are now, I think then from that point going forward will be opportunistic. The one benefit with our technology, our developing brand recognition, in both United States and Canada, we've had some excellent press coverage over the last little while is we are able to attract and retain some excellent talent. So we’re always going to be open and opportunistic on that side. Passed or after two, three, I don't see significant adds in our sales and marketing team, but I want to remain flexible there. So I guess it's a difficult question to answer, Gab.

Gabriel Leung

Thanks for the color. And I think last quarter, you provided a little bit of color around, excuse me, what your, I guess, qualified pipeline was looking like going in to the quarter, do you have any sort of similar metrics as we go into Q3?

Scott Jenkins

So for this quarter, we want to let people know that the 12 month sales pipeline has increased versus the prior quarter. So we are seeing growth. I think we are going to shy away from giving specific numbers, because the timing of those projects in terms of how we monitor, Derek already commented today that our visibility is getting better into the next quarter, but our sales, sorry, our lead times in terms of our manufacturing are actually starting to get shorter, which is very important in terms of accelerating our competitive advantage and it’s really one of our greatest competitive advantages. Unfortunately is that we produce things, so fast. So in terms of actual contract backlog, we've told investors before, it’s a difficult metric for us. Those numbers are increasing from what we last reported, so we’ll leave it at that and hope that's okay.

Gabriel Leung

And maybe on a similar note, as you look into Canada, given what you're seeing in terms of a near or maybe mid-term pipeline, how are you budgeting for that division, I mean, thinking about Canada as a $5 million a quarter business or is this sort of, in your mind, more like a 10 million a quarter business, more in line with what you guys are doing sort of last year. What are your thoughts around that?

Scott Jenkins

So for Q3 and Q4, it's a little difficult, obviously there is volatility. But in terms of some recent contract wins, I think we are going to be quite commenting in more like a 10 million a quarter business as we move into 2017.

Gabriel Leung

Okay. That's great, that's extremely helpful. Thanks a lot.

Operator

And we have no further questions at this time.

Scott Jenkins

Excellent. Well, I want to thank everybody listening today or those who will be listening via the website and download. That concludes our call today and we want to thank everybody for their time and attention and we look forward to updating you all again next quarter. Thank you.

Operator

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

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