DIRTT ENVIRONMENTAL SOLUTIONS LTD - Quarter Report: 2022 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended September 30, 2022


☐	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 (State or other jurisdiction of incorporation or organization)		N/A (IRS Employer Identification No.)

7303 30th Street S.E. Calgary, Alberta, Canada (Address of principal executive offices)		T2C 1N6 (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

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	☐	Smaller 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No

The registrant had 88,714,941 common shares outstanding as of November 1, 2022.

DIRTT ENVIRONMENTAL SOLUTIONS LTD.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2022

TABLE OF CONTENTS


		Page
Cautionary Statement Regarding Forward-Looking Statements		ii
PART I – FINANCIAL INFORMATION		4
Item 1. Financial Statements (Unaudited)		4
Interim Condensed Consolidated Balance Sheets		4
Interim Condensed Consolidated Statement of Operations and Comprehensive Loss		5
Interim Condensed Consolidated Statement of Changes in Shareholders’ Equity		6
Interim Condensed Consolidated Statement of Cash Flows		7
Notes to the Unaudited Interim Condensed Consolidated Financial Statements		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3. Quantitative and Qualitative Disclosures About Market Risk		36
Item 4. Controls and Procedures		36

PART II – OTHER INFORMATION		37

Item 1. Legal Proceedings		37
Item 1A. Risk Factors		37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		39
Item 3. Defaults Upon Senior Securities		39
Item 4. Mine Safety Disclosures		39
Item 5. Other Information		39
Item 6. Exhibits		40

Cautionary Statement Regarding Forward-Looking Statements

Certain statements contained in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2022 (this “Quarterly 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, as amended (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 Quarterly 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 Quarterly 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. 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 an 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 under the section titled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the U.S. Securities and Exchange Commission (the “SEC”) and applicable securities commissions or similar regulatory authorities in Canada on February 23, 2022 (the “Annual Report on Form 10-K”) as supplemented by our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2022 and June 30, 2022 filed with the SEC and applicable securities commissions or similar regulatory authorities in Canada on May 4, 2022 and July 27, 2022 respectively and in this Quarterly Report under “Part II, Item 1A. Risk Factors.” These factors include, but are not limited to, the following:

•

the impact of the COVID-19 pandemic and any strain variants or resurgences thereof on our business;

•

our ability to implement our strategic plan, including realizing on certain cost-optimization initiatives undertaken in 2022;

•

the effect of the cost saving initiatives the Company announced in February and July 2022;

•

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

•

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

•

the ability of our reconstituted board of directors ("Board of Directors") to successfully implement its transformation plan;

•

our ability to attract, train and retain qualified hourly labor on a timely basis to increase overall productive capacity in our manufacturing facilities to enable us to capture rising demand as the construction industry recovers from the COVID-19 pandemic;

•

our ability to achieve and manage growth effectively;

•

competition in the interior construction industry;

•

competitive behaviors by our co-founders and former executives;

•

the condition and changing trends of the overall construction industry;

•

our reliance on our network of construction partners ("Construction Partners"), which we have previously referred to as our Distribution Partners, 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;

•

inflation and material fluctuations of commodity prices, including raw materials and our ability to set prices for our products that satisfactorily adjust for inflation and fluctuations in commodity prices;

•

the effectiveness of our manufacturing processes and our success in implementing improvements to those processes;

•

the effectiveness of certain elements of our administrative systems and the need for investment in those systems;

•

shortages of supplies of certain key components and materials or disruption in supplies due to global events, including the COVID-19 pandemic;

•

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, including those relating to the COVID-19 pandemic;

•

our ability to generate sufficient revenue to achieve and sustain profitability and achieve positive cash flows;

•

our periodic fluctuations in results of operations and financial conditions;

•

volatility of our share price;

•

our ability to maintain our listing on Nasdaq;

•

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;

•

the availability and treatment of government subsidies (including any current or future requirements to repay or return such subsidies); and

•

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

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 Quarterly 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 place undue reliance 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.

iii

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

DIRTT Environmental Solutions Ltd.

Interim Condensed Consolidated Balance Sheets

(Unaudited – Stated in thousands of U.S. dollars)


	As at September 30,			As at December 31,
	2022			2021
ASSETS
Current Assets
Cash and cash equivalents		6,818			60,313
Restricted cash		3,611			3,095
Trade and accrued receivables, net of expected credit losses of $0.1 million at September 30, 2022 and at December 31, 2021		19,553			14,063
Other receivables		8,009			3,477
Inventory		23,295			18,457
Prepaids and other current assets		5,389			4,399
Total Current Assets		66,675			103,804
Property, plant and equipment, net		43,450			51,697
Capitalized software, net		4,634			7,395
Operating lease right-of-use assets, net		31,965			30,880
Other assets		5,192			5,663
Total Assets		151,916			199,439
LIABILITIES
Current Liabilities
Accounts payable and accrued liabilities		26,104			22,751
Other liabilities		1,787			2,379
Customer deposits and deferred revenue		3,027			2,420
Current portion of long-term debt and accrued interest		3,221			3,323
Current portion of lease liabilities		5,626			6,214
Total Current Liabilities		39,765			37,087
Long-term debt		61,997			67,319
Long-term lease liabilities		29,141			27,267
Total Liabilities		130,903			131,673
SHAREHOLDERS’ EQUITY
Common shares, unlimited authorized without par value, 88,266,915 issued and outstanding at September 30, 2022 and 85,345,433 at December 31, 2021		187,930			181,782
Additional paid-in capital		9,592			13,200
Accumulated other comprehensive loss		(16,143	)		(15,916	)
Accumulated deficit		(160,366	)		(111,300	)
Total Shareholders’ Equity		21,013			67,766
Total Liabilities and Shareholders’ Equity		151,916			199,439

The accompanying notes are an integral part of these interim condensed consolidated financial statements. The prior year comparatives have been revised in line with current year presentation - refer to Note 7.

DIRTT Environmental Solutions Ltd.

Interim Condensed Consolidated Statement of Operations

(Unaudited - Stated in thousands of U.S. dollars)


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022			2021			2022			2021
Product revenue		44,307			33,054			124,849			101,683
Service revenue		2,440			1,044			4,885			2,982
Total revenue		46,747			34,098			129,734			104,665

Product cost of sales		37,965			30,717			109,757			85,359
Costs of under-utilized capacity		-			-			-			1,756
Service cost of sales		1,774			931			3,406			2,506
Total cost of sales		39,739			31,648			113,163			89,621
Gross profit		7,008			2,450			16,571			15,044

Expenses
Sales and marketing		6,089			7,536			21,094			21,770
General and administrative		6,542			7,546			21,412			22,567
Operations support		2,321			2,374			7,347			6,884
Technology and development		1,695			2,146			5,714			6,005
Stock-based compensation		918			837			3,546			3,792
Reorganization		3,426			-			12,281			-
Total operating expenses		20,991			20,439			71,394			61,018

Operating loss		(13,983	)		(17,989	)		(54,823	)		(45,974	)
Government subsidies		7,141			2,935			7,765			10,434
Foreign exchange gain		1,356			526			1,870			286
Interest income		19			20			50			62
Interest expense		(1,276	)		(823	)		(3,935	)		(2,117	)
		7,240			2,658			5,750			8,665
Loss before tax		(6,743	)		(15,331	)		(49,073	)		(37,309	)
Income taxes
Current tax expense (recovery)		(16	)		-			(16	)		210
Deferred tax expense		-			88			-			137
		(16	)		88			(16	)		347
Net loss		(6,727	)		(15,419	)		(49,057	)		(37,656	)

Loss per share
Basic and diluted loss per share		(0.08	)		(0.18	)		(0.57	)		(0.44	)

Weighted average number of shares outstanding (in thousands)
Basic and Diluted		87,446			85,325			86,299			84,922

Interim Condensed Consolidated Statement of Comprehensive Loss


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022			2021			2022			2021
Loss for the period		(6,727	)		(15,419	)		(49,057	)		(37,656	)
Exchange differences on translation of foreign operations		(66	)		(855	)		(227	)		466
Comprehensive loss for the period		(6,793	)		(16,274	)		(49,284	)		(37,190	)

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

DIRTT Environmental Solutions Ltd.

Interim Condensed Consolidated Statement of Changes in Shareholders’ Equity

(Unaudited – Stated in thousands of U.S. dollars, except for share data)


								Accumulated
	Number of				Additional			other						Total
	Common		Common		paid-in			comprehensive			Accumulated			shareholders’
	shares		shares		capital			loss			deficit			equity
As at December 31, 2020		84,681,364		180,639		10,175			(17,018	)		(57,265	)		116,531
Stock-based compensation		-		-		796			-			-			796
Foreign currency translation adjustment		-		-		-			605			-			605
Net loss for the period		-		-		-			-			(12,499	)		(12,499	)
As at March 31, 2021		84,681,364		180,639		10,971			(16,413	)		(69,764	)		105,433
Stock-based compensation		-		-		1,285			-			-			1,285
Issued on vesting of RSUs		630,211		1,074		(1,074	)		-			-			-
RSUs and Share Awards withheld to settle employee tax obligations		-		-		(252	)		-			(342	)		(594	)
Foreign currency translation adjustment		-		-		-			716			-			716
Net loss for the period		-		-		-			-			(9,738	)		(9,738	)
As at June 30, 2021		85,311,575		181,713		10,930			(15,697	)		(79,844	)		97,102
Stock-based compensation		-		-		1,177			-			-			1,177
Issued on vesting of RSUs		22,980		49		(49	)		-			-			-
RSUs and Share Awards withheld to settle employee tax obligations		-		-		(35	)		-			(28	)		(63	)
Foreign currency translation adjustment		-		-		-			(855	)		-			(855	)
Net loss for the period		-		-		-			-			(15,419	)		(15,419	)
As at September 30, 2021		85,334,555		181,762		12,023			(16,552	)		(95,291	)		81,942

As at December 31, 2021		85,345,433		181,782		13,200			(15,916	)		(111,300	)		67,766
Stock-based compensation		-		-		1,339			-			-			1,339
Issued on vesting of RSUs and Share Awards		487,544		1,203		(1,203	)		-			-			-
RSUs and Share Awards withheld to settle employee tax obligations		-		-		(189	)		-			(9	)		(198	)
Foreign currency translation adjustment		-		-		-			433			-			433
Net loss for the period		-		-		-			-			(23,042	)		(23,042	)
As at March 31, 2022		85,832,977		182,985		13,147			(15,483	)		(134,351	)		46,298
Stock-based compensation		-		-		1,286			-			-			1,286
Issued on vesting of RSUs and Share Awards		1,155,851		3,268		(3,268	)		-			-			-
RSUs and Share Awards withheld to settle employee tax obligations		-		-		(536	)		-			-			(536	)
Foreign currency translation adjustment		-		-		-			(594	)		-			(594	)
Net loss for the period		-		-		-			-			(19,288	)		(19,288	)
As at June 30, 2022		86,988,828		186,253		10,629			(16,077	)		(153,639	)		27,166
Stock-based compensation		-		-		846			-			-			846
Issued on vesting of RSUs and Share Awards		874,266		1,587		(1,587	)		-			-			-
Issued for employee share purchase plan		403,821		90		-			-			-			90
RSUs and Share Awards withheld to settle employee tax obligations		-		-		(296	)		-			-			(296	)
Foreign currency translation adjustment		-		-		-			(66	)		-			(66	)
Net loss for the period		-		-		-			-			(6,727	)		(6,727	)
As at September 30, 2022		88,266,915		187,930		9,592			(16,143	)		(160,366	)		21,013

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

DIRTT Environmental Solutions Ltd.

Interim Condensed Consolidated Statement of Cash Flows

(Unaudited – Stated in thousands of U.S. dollars)


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022			2021			2022			2021
Cash flows from operating activities:
Net loss for the period		(6,727	)		(15,419	)		(49,057	)		(37,656	)
Adjustments:
Depreciation and amortization		4,236			3,815			12,202			10,638
Stock-based compensation, net of settlements		888			837			2,596			3,580
Foreign exchange gain		(1,365	)		(735	)		(2,147	)		(495	)
Accretion of convertible debentures		163			89			505			236
Loss (gain) on disposal of equipment		44			15			(121	)		15
Deferred income tax expense		-			88			-			137
Changes in operating assets and liabilities:
Trade and accrued receivables		(819	)		2,488			(5,814	)		(479	)
Other receivables		(7,419	)		1,616			(4,566	)		1,752
Inventory		1,052			(944	)		(6,052	)		(1,444	)
Prepaid and other assets, current and long term		(254	)		(1,858	)		(1,421	)		(1,709	)
Accounts payable and accrued liabilities		2,748			(2,330	)		5,921			(3,587	)
Other liabilities		(70	)		(1,581	)		(109	)		186
Customer deposits and deferred revenue		(3,078	)		1,112			641			2,429
Current portion of long-term debt and accrued interest		(44	)		601			(186	)		1,607
Lease liabilities		(22	)		15			99			918
Net cash flows used in operating activities		(10,667	)		(12,191	)		(47,509	)		(23,872	)
Cash flows from investing activities:
Purchase of property, plant and equipment, net of accounts payable changes		(360	)		(1,755	)		(2,247	)		(10,462	)
Capitalized software development expenditures		(385	)		(516	)		(1,286	)		(1,852	)
Other asset expenditures		(86	)		(60	)		(367	)		(387	)
Proceeds on sales of equipment		141			-			214			-
Recovery of software development expenditures		46			121			91			145
Net cash flows used in investing activities		(644	)		(2,210	)		(3,595	)		(12,556	)
Cash flows from financing activities:
Proceeds received on long-term debt		-			-			647			37,952
Repayment of long-term debt		(616	)		(457	)		(1,852	)		(1,217	)
Employee tax payments on vesting of RSUs		(296	)		(63	)		(597	)		(652	)
Net cash flows (used in) provided by financing activities		(912	)		(520	)		(1,802	)		36,083
Effect of foreign exchange on cash, cash equivalents and restricted cash		(293	)		(130	)		(73	)		581
Net (decrease) increase in cash, cash equivalents and restricted cash		(12,516	)		(15,051	)		(52,979	)		236
Cash, cash equivalents and restricted cash, beginning of period		22,945			61,133			63,408			45,846
Cash, cash equivalents and restricted cash, end of period		10,429			46,082			10,429			46,082
Supplemental disclosure of cash flow information:
Interest paid		(1,108	)		(1,231	)		(3,439	)		(1,360	)
Income taxes received		-			369			3,207			321

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the consolidated balance sheets.

							For the Nine Months Ended September 30,
							2022			2021
Cash and cash equivalents								6,818			43,288
Restricted cash								3,611			2,794
Total cash, cash equivalents and restricted cash								10,429			46,082

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

DIRTT Environmental Solutions Ltd.

Notes to the Unaudited Interim Condensed Consolidated Financial Statements

(Amounts in thousands of U.S. dollars unless otherwise stated)

1. GENERAL INFORMATION

DIRTT Environmental Solutions Ltd. and its subsidiary (“DIRTT”, the “Company”, “we” or “our”) is a global leader in industrialized construction. DIRTT's system of physical products and digital tools empowers organizations, together with construction and design leaders, to build high-performing, adaptable, interior environments. Operating in the workplace, healthcare, education, and public sector markets, DIRTT’s system provides total design freedom, and greater certainty in cost, schedule, and outcomes.

DIRTT’s proprietary design integration software, ICE® (“ICE” or “ICE software”), translates the vision of architects and designers into a 3D model that also acts as manufacturing information. ICE is also licensed to unrelated companies and Construction Partners of the Company.

DIRTT is incorporated under the laws of the province of Alberta, Canada, its headquarters is located at 7303 – 30th Street S.E., Calgary, AB, Canada T2C 1N6 and its registered office is located at 4500, 855 – 2nd Street S.W., Calgary, AB, Canada T2P 4K7. DIRTT’s common shares trade on the Toronto Stock Exchange under the symbol “DRT” and on The Nasdaq Global Select Market (“Nasdaq”) under the symbol “DRTT”.

2. BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial statements (the “Financial Statements”) have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X and, accordingly, the Financial Statements do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of the Company, the Financial Statements contain all adjustments necessary, consisting of only normal recurring adjustments, for a fair statement of its financial position as of September 30, 2022, and its results of operations and cash flows for the three and nine months ended September 30, 2022 and 2021. The condensed balance sheet at December 31, 2021, was derived from audited annual financial statements but does not contain all of the footnote disclosures from the annual financial statements. These Financial Statements should be read in conjunction with the audited consolidated financial statements as of December 31, 2021 and 2020 and for each of the three years in the period ended December 31, 2021 included in the Annual Report on Form 10-K of the Company as filed with the SEC and applicable securities commission or similar regulatory authorities in Canada. As described in Note 6, the Company adopted ASU 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance effective January 1, 2022. There was no impact of this standard on our disclosures or accounting for government assistance.

In these Financial Statements, unless otherwise indicated, all dollar amounts are expressed in United States (“U.S.”) dollars. DIRTT’s financial results are consolidated in Canadian dollars, the Company’s functional currency, and the Company has adopted the U.S. dollar as its reporting currency. All references to US$ or $ are to U.S. dollars and references to C$ are to Canadian dollars.

Principles of consolidation

The Financial Statements include the accounts of DIRTT and its subsidiary. All intercompany balances, income and expenses, unrealized gains and losses and dividends resulting from intercompany transactions have been eliminated on consolidation.

Basis of measurement

These Financial Statements have been prepared on the historical cost convention except for certain financial instruments and certain components of stock-based compensation that are measured at fair value. Historical cost is generally based on the fair value of the consideration given in exchange for assets. The Company’s quarterly tax provision is based upon an estimated annual effective tax rate.

Seasonality

Sales of the Company’s products are driven by consumer and industrial demand for interior construction solutions. The timing of customer’s construction projects can be influenced by a number of factors including the prevailing economic climate and weather.

3. LIQUIDITY

The Company has been negatively impacted by the effect of COVID-19 on the non-residential construction industry, costs incurred associated with the Company’s contested director elections, reorganization costs to reconstitute the executive team and align the Company’s cost structure with current sales activity, and significant inflation on raw materials costs, which have resulted in a significant usage of cash in recent periods which has been funded through Convertible Debentures and Leasing Facilities entered into in the prior year (refer to Note 9). As at September 30, 2022, the Company had $6.8 million of cash on hand and $9.0 million of available borrowings (December 31, 2021 - $60.3 million and $10.4 million of available borrowings).

We have implemented a number of restructuring initiatives to create a reduced cost structure moving forward (refer to Note 5) and have implemented multiple price increases during the year to mitigate the impact of inflation on raw material costs. While these actions, combined with an increasing project pipeline is promising, we continue to see unpredictability in our pace of orders. As a result, the Company has initiated certain strategic actions to improve our balance sheet in the short term. First, historically we have licensed the use of ICE software to certain strategic partners for use in their business, and DIRTT has provided licensing and developer software support for these counterparties. We are in the process of evaluating multiple initiatives related to the further use of ICE software by third parties. Second, we have certain properties that are currently owned that we are evaluating for potential sale and lease back arrangements. We do not intend to vacate these premises as they still serve a valuable aspect of our value proposition, but this type of arrangement would provide us with a one-time cash payment in the near term, in exchange for future rent payments. We expect these strategic initiatives to result in positive cash inflows in 2023. As these transactions are awaiting finalization, we are undertaking a Private Placement (defined in Note 15) of common shares, supported by significant shareholders and directors and officers of the Company to bridge any cash requirements between now and the completion and closing of the noted strategic transactions (refer to Note 15).

We have assessed the Company’s liquidity position as at September 30, 2022, using multiple scenarios taking into account our sales outlook for the next year, our existing cash balances and available credit facilities and the probability of executing the strategic transactions noted above. Based on this analysis we believe the Company has sufficient liquidity to support ongoing operations for the next twelve months. However, should anticipated profitable growth and increased labor headcount and manufacturing capacity not occur or should there be a delayed recovery of the North American construction activities from the pandemic, a sustained economic depression and its adverse impacts on customer demand or significant inflationary pressure on raw materials and transportation cost that we are unable to recover through price increases, the Company will need to identify alternative sources of financing, further reduce its cost structure, delay capital expenditures, evaluate potential asset sales and potentially curtail or cease certain operations. While the Company is confident that it will be able to raise additional capital when needed or under acceptable terms, there can be no absolute assurance it will be able to do so.

4. COVID-19

The impact of the COVID-19 pandemic on our future consolidated results of operations remains uncertain. The extent to which COVID-19 impacts our employees, operations, customers, suppliers and financial results depends on numerous evolving factors that we may not be able to accurately predict, including: the duration and scope of the pandemic (and whether there is a resurgence or multiple resurgences in the future, including the impact of new variants); government actions taken in response to the pandemic, including required shutdowns or vaccine or testing mandates; the availability, acceptance, distribution and continued effectiveness of vaccines; the impact on construction activity, including the effect on our customers’ demand for our ceiling and wall systems; supply chain disruptions; rising inflation; labor shortages; sustained remote or hybrid work models; our ability to manufacture and sell our products; and the ability of our customers to pay for our products. While many of our products support life-sustaining activities and essential construction, we and certain of our customers or suppliers may be impacted by national, federal, state and 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 vary in each of the jurisdictions in which we operate. We did not record any asset impairments, inventory charges or material bad debt reserves related to COVID-19 during the three and nine months ended September 30, 2022 and 2021, but future events may require such charges which could have a material adverse effect on our financial condition, liquidity or results of operations.

Government subsidies

In the United States, the Employee Retention Credit ("ERC") was established by Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") to provide an incentive for employers to keep their employees on their payroll during COVID-19 closures. The ERC is a refundable payroll tax credit based on qualified wages paid by an eligible employer between March 12, 2020, and October 1, 2021 for companies experiencing a significant decline in gross receipts during a calendar quarter or having operations fully or partially suspended during the quarter due to COVID-19. During the third quarter of 2022, the Company determined it was eligible for the ERC for the first three quarters of 2021 and has filed a claim for $7.3 million in payroll tax credits ($7.1 million net of expenses). As of September 30, 2022 these credits have not been received and are included in other receivables in the balance sheet.

As part of the Canadian federal government’s COVID-19 Economic Response Plan, the Canadian government established the Canadian Emergency Wage Subsidy (“CEWS”). The CEWS provided the Company with a taxable subsidy in respect of a specific portion of wages paid to Canadian employees during qualifying periods extending from March 15, 2020 to October 23, 2021 based on the percentage decline of certain of the Company’s Canadian sourced revenues during each qualifying period. The Company’s eligibility for the CEWS was subject to change for each qualifying period and was reviewed by the Company for each qualifying period, with amounts being received by the Company for various, but not each, qualifying period. Pursuant to amendments enacted as part of the 2021 Canadian federal budget, the Company is required to repay a portion of the CEWS amounts received for any qualifying period commencing after June 5, 2021 where the aggregate compensation for “specified executives” (within the meaning of the CEWS) during the 2021 calendar year exceeds the aggregate compensation for “specified executives” during the 2019 calendar year. Upon finalization of 2021 compensation to specified executives, approximately C$0.5 million ($0.4 million) of subsidies was repaid to the Canadian authorities in the second quarter of 2022. The repayment amount was fully provided for in the third quarter of 2021 in accounts payable and accrued liabilities and in the first quarter of 2022 the Company reversed a $0.6 million incremental provision related to this that is no longer necessary.

On November 19, 2020, the Canadian government also implemented the Canada Emergency Rent Subsidy (“CERS”). The CERS provided a taxable subsidy to cover eligible expenses for qualifying properties, subject to certain maximums, for qualifying periods extending from September 27, 2020 to October 23, 2021, with the amount of the subsidy available to the Company being based on the percentage decline of certain of the Company’s Canadian-sourced revenues in each qualifying period. The Company’s eligibility for the CERS was subject to change for each qualifying period and was reviewed by the Company for each qualifying period.

The last claim period under the CEWS and CERS programs ended on October 23, 2021. The Company is not eligible and did not receive any new Canadian government subsidies in the three or nine months ended September 30, 2022.

5. REORGANIZATION

During the nine month period ended September 30, 2022, the Company undertook a number of reorganization initiatives:

Closure of Phoenix Aluminum Manufacturing Facility (the “Phoenix Facility”)

On February 22, 2022, we commenced the process of closing our Phoenix Facility, shifting related manufacturing to both our Savannah and Calgary aluminum manufacturing facilities. The closure of the Phoenix Facility was substantially completed in the second quarter of 2022. The Company entered into a sublease arrangement during the second quarter of 2022, commencing July 1, 2022, which exceeds the contractual lease commitments under the Right of Use assets.

Workforce Reductions, Board and Management Changes

In February and July of 2022, we announced our intention to eliminate a portion of our salaried workforce including manufacturing and office positions along with other cost reduction initiatives. The Company’s Board of Directors was reconstituted following a contested proxy contest in April 2022 which was deemed a change of control under the Company’s insurance policy resulting in additional insurance expenditures. Further, the Company made changes to several executive officer roles during the nine months ended September 30, 2022, which resulted in incurring certain termination benefits and recruitment costs.

Temporary Suspension of Operations at Rock Hill, South Carolina (the "Rock Hill Facility")

On August 23, 2022, we announced the temporary suspension of operations at our Rock Hill Facility, shifting related manufacturing to our Calgary manufacturing facility.

Reorganization costs incurred:


	For the Three Months Ended			For the Nine Months Ended
	September 30, 2022			September 30, 2022
Termination benefits		2,843			6,870
Insurance costs on change of control		-			3,676
Phoenix Facility closure		-			853
Rock Hill temporary suspension of operations		144			144
Other costs		439			738
Total reorganization costs		3,426			12,281

	For the Three Months Ended			For the Nine Months Ended
	September 30, 2022			September 30, 2022
Opening reorganization costs in accounts payable and accrued liabilities		1,555			-
Reorganization expense		3,426			12,281
Reorganization costs paid		(3,228	)		(10,528	)
Reorganization costs in accounts payable and accrued liabilities at September 30, 2022		1,753			1,753

Of the $1.8 million payable, $1.5 million relates to termination benefits and $0.3 million relates to other reorganization costs.

Discontinuation of Reflect Product Line and Other Charges Incurred

In August 2022, the Company discontinued the Reflect and other product lines, resulting in a one time inventory write-down of $1.0 million, and an acceleration of amortization expense associated with ICE development for Reflect of $1.0 million in cost of sales.

Additionally, the Company accelerated the depreciation of certain items of property, plant and equipment associated with the closure of the Phoenix Facility resulting in an additional $1.1 million of depreciation and amortization incurred in the first quarter of 2022.

These costs were included in cost of sales:


	For the Three Months Ended		For the Nine Months Ended
	September 30, 2022		September 30, 2022
Accelerated depreciation and amortization associated with closure of the Phoenix Facility		-		1,054
Accelerated amortization associated with product line discontinuation		1,019		1,019
Provision for inventory of discontinued product lines		1,035		1,035
Incremental cost of sales		2,054		3,108

6. ADOPTION OF NEW AND REVISED ACCOUNTING STANDARDS

In 2021, the Financial Accounting Standards Board issued Accounting Standards Update No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance. The ASU provides guidance on required disclosures with respect to government assistance in a company’s notes to the annual financial statements. The amendments in the ASU are effective for periods beginning after December 15, 2021. The Company has adopted this standard effective January 1, 2022 and notes there is no significant impact of this standard on our accounting or disclosures for government assistance.

Although there are several other new accounting standards issued or proposed by the Financial Accounting Standards Board, which the Company has adopted or will adopt, as applicable, the Company does not believe any of these accounting pronouncements has had or will have a material impact on its Financial Statements.

7. TRADE AND ACCRUED RECEIVABLES AND OTHER RECEIVABLES

Accounts receivable are recorded at the invoiced amount, do not require collateral and do not bear interest. The Company estimates an allowance for credit losses using the lifetime expected credit loss at each measurement date taking into account historical credit loss experience as well as forward-looking information in order to establish rates for each class of financial receivable with similar risk characteristics. Adjustments to this estimate are recognized in the statement of operations.

In order to manage and assess our risk, management maintains credit policies that include regular review of credit limits of individual receivables and systematic monitoring of aging of trade receivables and the financial wellbeing of our customers. In addition, we acquired trade credit insurance effective April 1, 2020. At September 30, 2022, approximately 83% of our trade accounts receivable are insured, relating to accounts receivables from counterparties deemed creditworthy by the insurer and excluding accounts receivable from government entities, which have arisen since April 1, 2020 when the trade credit insurance became effective.

Our trade balances are spread over a broad Construction Partner base, which is geographically dispersed. For the three months ended September 30, 2022 and 2021, no Construction Partner accounted for greater than 10% of revenue. No Construction Partner accounted for greater than 10% of revenue for the nine months ended September 30, 2022 and one Construction Partner accounted for $13.5 million of revenue for the nine months ended September 30, 2021, which is greater than 10% of total revenue. In addition, and where possible, we collect a 50% deposit on sales, excluding government and certain other clients.

The Company’s aged receivables were as follows:


	As at
	September 30,			December 31,
	2022			2021
Current		17,021			13,572
Overdue		2,658			621
		19,679			14,193
Less: expected credit losses		(126	)		(130	)
		19,553			14,063

No adjustment to our expected credit losses of $0.1 million was required for the nine months ended September 30, 2022. Receivables are generally considered to be past due when over 60 days old unless there is a separate payment arrangement in place for the collection of the receivable.

For the period ended September 30, 2022, the Company classified Other Receivables separately from Trade and Accrued Receivables on the balance sheet, as reconciled below:


	As at,
	September 30,			December 31,
	2022			2021
Trade and accrued receivables		19,679			14,193
Allowance for doubtful accounts		(126	)		(130	)
Accounts receivable		19,553			14,063
Sales tax receivable		289			196
Income taxes receivable		2			3,194
Government subsidies		7,141			-
Other receivables		577			87
Other receivables (reclassified on the balance sheet)		8,009			3,477
Total Trade and other receivables, as previously presented		27,562			17,540

8. OTHER LIABILITIES


	As at,
	September 30, 2022		December 31, 2021
Warranty provisions(1)		1,275		1,451
DSU liability		329		785
Sublease deposits		138		-
Other provisions		45		143
Other liabilities		1,787		2,379

(1)

The following table presents a reconciliation of the warranty and other provisions balance:


	September 30, 2022			December 31, 2021
As at January 1		1,451			1,763
Adjustments to timber provision		-			(500	)
Additions to warranty provision		726			1,019
Payments related to warranties		(902	)		(831	)
		1,275			1,451

9. LONG-TERM DEBT


	Revolving Credit Facility		Leasing Facilities			Convertible Debentures			Total Debt
Balance on December 31, 2020		-		5,967			-			5,967
Issuances		-		9,805			55,107			64,912
Accretion of issue costs		-		-			352			352
Accrued interest		-		556			1,935			2,491
Interest payments		-		(556	)		(987	)		(1,543	)
Principal repayments		-		(1,808	)		-			(1,808	)
Exchange differences		-		(55	)		326			271
Balance at December 31, 2021		-		13,909			56,733			70,642
Current portion of long-term debt and accrued interest		-		2,386			937			3,323
Long-term debt		-		11,523			55,796			67,319

Balance on December 31, 2021		-		13,909			56,733			70,642
Issuances		-		647			-			647
Accretion of issue costs		-		-			505			505
Accrued interest		-		562			2,691			3,253
Interest payments		-		(562	)		(2,877	)		(3,439	)
Principal repayments		-		(1,852	)		-			(1,852	)
Exchange differences		-		(267	)		(4,271	)		(4,538	)
Balance at September 30, 2022		-		12,437			52,781			65,218
Current portion of long-term debt and accrued interest		-		2,520			701			3,221
Long-term debt		-		9,917			52,080			61,997

Revolving Credit Facility

On February 12, 2021, the Company entered into a loan agreement governing a C$25.0 million senior secured revolving credit facility with the Royal Bank of Canada (“RBC”), as lender (the “RBC Facility”). Under the RBC Facility, the Company is able to borrow up to a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of (i) 75% of the book value of eligible inventory and (ii) 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims (the “Borrowing Base”). At September 30, 2022, available borrowings are C$12.4 million ($9.0 million), of which no amounts have been drawn. Interest is calculated at the Canadian or U.S. prime rate plus 30 basis points or at the Canadian Dollar Offered Rate or LIBOR plus 155 basis points. Under the RBC Facility, if the “Aggregate Excess Availability”, defined as the Borrowing Base less any loan advances or letters of credit or guarantee and if undrawn including unrestricted cash, is less than C$5.0 million, the Company is subject to a fixed charge coverage ratio (“FCCR”) covenant of 1.10:1 on a trailing twelve-month basis until such time the borrowing availability net of unrestricted cash exceeds C$5.0 million for at least thirty consecutive calendar days. Additionally, if the FCCR has been below 1.10:1 for the three immediately preceding months, the Company is required to maintain a reserve account equal to the aggregate of one year of payments on outstanding loans on the Leasing Facilities (defined below). The Company did not meet the three-month FCCR requirement during the third quarter of 2022 which resulted in requiring the restriction of $3.6 million of cash. Should an event of default occur or the Aggregate Excess Availability be less than C$6.25 million for five consecutive business days, the Company would enter a cash dominion period whereby the Company’s bank accounts would be blocked by RBC and daily balances will set-off any borrowings and any remaining amounts made available to the Company.

Leasing Facilities

The Company has a C$5.0 million equipment leasing facility in Canada (the “Canada Leasing Facility”) and a $14.0 million equipment leasing facility in the United States (the “U.S. Leasing Facility” and, together with the Canada Leasing Facility, the “Leasing Facilities”) with RBC, and one of its affiliates, which are available for equipment expenditures and certain equipment expenditures already incurred. The Leasing Facilities, respectively, have seven and five-year terms and bear interest at 4.25% and 5.59%. The U.S. Leasing Facility is amortized over a six-year term and extendible at the Company’s option for an additional year.

During the three and nine months ended September 30, 2022, the Company received $nil (twelve months ended December 31, 2021: $9.8 million) of cash consideration under the U.S. Leasing Facility. The associated financial liabilities are shown on the consolidated balance sheet in current other liabilities and long-term debt. In April 2022 the Company received C$0.9 million ($0.7 million) under the Canada Leasing Facility.

Convertible Debentures

On January 25, 2021, the Company completed a C$35.0 million ($27.5 million) bought-deal financing of convertible unsecured subordinated debentures with a syndicate of underwriters (the “January Debentures”). On January 29, 2021, the Company issued a further C$5.25 million ($4.1 million) of the January Debentures under the terms of an overallotment option granted to the underwriters. The January Debentures will mature and be repayable on January 31, 2026 (the “January Debentures Maturity Date”) and will accrue interest at the rate of 6.00% per annum payable semi-annually in arrears on the last day of January and July of each year commencing on July 31, 2021 until the January Debentures Maturity Date. Interest and principal are payable in cash or shares at the option of the Company. The January Debentures will be convertible into common shares of DIRTT, at the option of the holder, at any time prior to the close of business on the business day prior to the earlier of the January Debentures Maturity Date and the date specified by the Company for redemption of the January Debentures at a conversion price of C$4.65 per common share, being a ratio of approximately 215.0538 common shares per C$1,000 principal amount of the January Debentures. Costs of the transaction were approximately C$2.7 million, including the underwriters’ commission.

On December 1, 2021, the Company completed a C$35.0 million ($27.4 million) bought-deal financing of convertible unsecured subordinated debentures with a syndicate of underwriters (the “December Debentures” and, together with the January Debentures, the “Debentures”). These December Debentures will mature and be repayable on December 31, 2026 (the “December Debentures Maturity Date”) and will accrue interest at the rate of 6.25% per annum payable semi-annually in arrears on the last day of June and December of each year commencing on June 30, 2022 until the December Debentures Maturity Date. Interest and principal are payable in cash or shares at the option of the Company. The December Debentures will be convertible into common shares of DIRTT, at the option of the holder, at any time prior to the close of business on the business day prior to the earlier of the December Debentures Maturity Date and the date specified by the Company for redemption of the December Debentures at a conversion price of C$4.20 per common share, being a ratio of approximately 238.0952 common shares per C$1,000 principal amount of the December Debentures. Costs of the transaction were approximately C$2.3 million, including the underwriters’ commission.

10. STOCK-BASED COMPENSATION

In May 2020, shareholders approved the DIRTT Environmental Solutions Ltd. Long-Term Incentive Plan (the “2020 LTIP”) at the annual and special meeting of shareholders. The 2020 LTIP gives the Company the ability to award options, share appreciation rights, restricted share units, restricted shares, dividend equivalent rights granted in connection with restricted share units, vested Share Awards (as defined below), and other share-based awards and cash awards to eligible employees, officers, consultants and directors of the Company and its affiliates. In accordance with the 2020 LTIP, the sum of (i) 5,850,000 common shares plus (ii) the number of common shares subject to stock options previously granted under the Company’s Amended and Restated Incentive Stock Option Plan (the “Stock Option Plan”) that, following May 22, 2020, expire or are cancelled or terminated without having been exercised in full have been reserved for issuance under the 2020 LTIP. Upon vesting of certain LTIP awards, the Company may withhold and sell shares as a means of meeting DIRTT’s tax withholding requirements in respect of the withholding tax remittances required in respect of award holders. To the extent the fair value of the withheld shares upon vesting exceeds the grant date fair value of the instrument, the excess amount is credited to retained earnings or deficit.

Under the terms of the 2020 LTIP, the change of 100% of the Board of Directors combined with the prior Board declining to endorse the incoming board constituted a change of a control as of April 26, 2022. As a result, all outstanding and unvested LTIP awards granted under the 2020 LTIP plan for any holder terminated without cause within one year of the change of control vest immediately upon termination.

The Company also maintains the DIRTT Environmental Solutions Ltd. Deferred Share Unit Plan for Non-Employee Directors pursuant to which deferred share units (“DSUs”) are granted to the Company’s non-employee directors. DSUs are settled solely in cash.

Prior to the approval of the 2020 LTIP, the Company granted awards of options under the Stock Option Plan and awards of performance share units (“PSUs”) under the DIRTT Environmental Solutions Ltd. Performance Share Unit Plan (the “PSU Plan”). Following the approval of the 2020 LTIP, no further awards were made under either the Stock Option Plan or the PSU Plan, but both remain in place to govern the terms of any awards that were granted pursuant to such plans and remain outstanding.

Stock-based compensation expense


	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
	2022		2021			2022		2021
Equity-settled awards		846		1,177			3,471		3,258
Cash-settled awards		72		(340	)		75		534
		918		837			3,546		3,792

The following summarizes RSUs (as defined below), Share Awards, PSUs, and DSUs activity during the periods:


	RSU Time-			RSU Performance-			Share
	Based			Based			Awards			PSU			DSU
	Number of			Number of			Number of			Number of			Number of
	units			units			units			units			units
Outstanding at December 31, 2020		2,414,066			200,000			-			197,471			363,664
Granted		1,919,102			878,601			-			-			88,880
Vested		(650,898	)		(2,294	)		-			(34,635	)		(55,802	)
Withheld to settle employee tax obligations		(174,103	)		(1,960	)		-			-			-
Forfeited		(237,910	)		(42,314	)		-			(5,636	)		-
Outstanding at September 30, 2021		3,270,257			1,032,033			-			157,200			396,742
Outstanding at December 31, 2021		3,216,536			1,021,739			-			157,200			361,577
Granted		2,303,287			863,279			162,682			-			890,832
Vested or settled		(2,019,550	)		(566,352	)		(94,528	)		-			(501,916	)
Withheld to settle employee tax obligations		(526,259	)		(242,460	)		(68,154	)		-			-
Forfeited		(734,855	)		(502,628	)		-			(157,200	)		-
Outstanding at September 30, 2022		2,239,159			573,578			-			-			750,493

Restricted share units (time-based vesting)

Restricted share units ("RSUs") that vest based on time have an aggregate time-based vesting period of three years and generally one-third of the RSUs vest every year over a three-year period from the date of grant. At the end of a three-year term, the RSUs will be settled by way of the provision of cash or shares to employees (or a combination thereof), at the discretion of the Company. The weighted average fair value of the RSUs granted was C$2.49 (2021 – C$3.14) which was determined using the closing price of the Company’s common shares on their respective grant dates.

Restricted share units (performance-based vesting)

During 2022 and 2021, restricted share units were granted to executives with service and performance-based conditions for vesting (the “PRSUs”). If the Company’s share price increases to certain values for 20 consecutive trading days, as outlined below, a percentage of the PRSUs will vest at the end of the three-year service period. PRSUs awarded in 2020 were forfeited in January 2022 upon the departure of an executive from the Company.

The grant date fair value of the 2022 and 2021 PRSUs were valued using the Monte Carlo valuation method and determined to have a weighted average grant date fair value of C$1.87 and C$3.27, respectively.

Based on share price performance since the date of grant, none of the 2022 PRSUs and 66.7% of the 2021 PRSUs will vest upon completion of the three-year service period.


	% of PRSUs Vesting
			33.3	%		66.7	%		100.0	%		150.0	%
2022 and 2021 PRSUs		$	3.00		$	4.00		$	5.00		$	7.00

Share awards

During the first quarter of 2022, certain executives were issued share awards in lieu of cash paid variable incentive compensation (“Share Awards”). These Share Awards vested upon grant. The fair value of the Share Awards granted was C$2.40 ($1.88), which was determined using the closing price of the Company’s common shares on the grant date.

During the third quarter of 2022, certain executives were provided a variable compensation plan for the achievement of certain financial targets payable partially in cash and partially in share awards. Based on the Company's performance to date relative to the financial targets, no share based awards have been recorded under this compensation plan for the quarter ended September 30, 2022. Under the plan, 1.2 million shares could have been awarded if the maximum targets were achieved based on the Company's share price at September 30, 2022.

Deferred share units

The fair value of the DSU liability and the corresponding expense is charged to profit or loss at the grant date. Subsequently, at each reporting date between the grant date and settlement date, the fair value of the liability is remeasured with any changes in fair value recognized in profit or loss for the year. DSUs outstanding at September 30, 2022 had a fair value of $0.3 million which is included in other liabilities on the balance sheet (December 31, 2021 – $0.8 million).

Options

The following summarizes options granted, exercised, forfeited and expired during the periods:


	Number of			Weighted average
	options			exercise price C$
Outstanding at December 31, 2020		4,774,328			6.52
Forfeited		(39,094	)		7.07
Outstanding at September 30, 2021		4,735,234			6.51
Outstanding at December 31, 2021		4,064,489			6.64
Forfeited		(2,530,120	)		6.40
Outstanding at September 30, 2022		1,534,369			7.03
Exercisable at September 30, 2022		1,534,369			7.03

Range of exercise prices outstanding at September 30, 2022:


	Options outstanding						Options exercisable
			Weighted		Weighted				Weighted		Weighted
			average		average				average		average
	Number		remaining		exercise		Number		remaining		exercise
Range of exercise prices	outstanding		life		price C$		exercisable		life		price C$
C$4.01 – C$5.00		15,025		2.14		4.12		15,025		2.14		4.12
C$6.01 – C$7.00		784,367		1.31		6.33		784,367		1.31		6.33
C$7.01 – C$8.00		734,977		1.63		7.84		734,977		1.63		7.84
Total		1,534,369						1,534,369

Dilutive Instruments

For the three and nine months ended September 30, 2022, 1.5 million options (2021 – 4.7 million), 2.8 million RSUs and PRSUs (2021 – 4.4 million) and 127.5 million shares, which would be issued if the principal amount of the Debentures were settled in our common shares at the quarter end share price (2021 – 10.3 million), were excluded from the diluted weighted average number of common shares calculation as their effect would have been anti-dilutive to the net loss per share.

11. REVENUE

In the following table, revenue is disaggregated by performance obligation and timing of revenue recognition. All revenue comes from contracts with customers. See Note 12 for the disaggregation of revenue by geographic region.


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2022		2021		2022		2021
Product		39,092		29,569		110,383		91,867
Transportation		5,022		3,294		13,878		9,277
License fees from Construction Partners		193		191		588		539
Total product revenue		44,307		33,054		124,849		101,683
Installation and other services		2,440		1,044		4,885		2,982
		46,747		34,098		129,734		104,665

DIRTT sells its products and services pursuant to fixed-price contracts, which generally have a term of one year or less. The transaction price used in determining the amount of revenue to recognize is based upon agreed contractual terms with the customer and is not subject to variability.


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2022		2021		2022		2021
At a point in time		44,114		32,863		124,261		101,144
Over time		2,633		1,235		5,473		3,521
		46,747		34,098		129,734		104,665

Revenue recognized at a point in time represents the majority of the Company’s sales and revenue is recognized when a customer obtains legal title to the product, which is when ownership of products is transferred to, or services are delivered to the contract counterparty. Revenue recognized over time is limited to installation and other services provided to customers and is recorded as performance obligations which are satisfied over the term of the contract.

Contract Liabilities


	As at
	September 30, 2022		December 31, 2021		December 31, 2020
Customer deposits		2,598		1,959		1,292
Deferred revenue		429		461		527
Contract liabilities		3,027		2,420		1,819

Contract liabilities primarily relate to deposits received from customers and deferred revenue from license subscriptions. The balance of contract liabilities was higher as at September 30, 2022 compared to December 31, 2021 mainly due to the timing of orders and payments. Contract liabilities as at December 31, 2021 and 2020 totaling $2.4 million and $1.7 million, respectively, were recognized as revenue during the nine months ended September 30, 2022 and 2021, respectively.

Sales by Industry

The Company periodically reviews the growth of product and transportation revenue by vertical market to evaluate the success of industry-specific sales initiatives. The nature of products sold to the various industries is consistent and therefore review is focused on sales performance.


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2022		2021		2022		2021
Commercial		31,796		20,805		85,458		55,981
Healthcare		3,638		5,017		15,693		25,680
Government		3,358		3,149		11,680		11,579
Education		5,322		3,892		11,430		7,904
License fees from Construction Partners		193		191		588		539
Total product and transportation revenue		44,307		33,054		124,849		101,683
Installation and other services		2,440		1,044		4,885		2,982
		46,747		34,098		129,734		104,665

12. SEGMENT REPORTING

The Company has one reportable and operating segment and operates in two principal geographic locations - Canada and the United States. Revenue continues to be derived almost exclusively from projects in North America and predominantly from the United States, with periodic international projects from North American Construction Partners. The Company’s revenue from operations from external customers, based on location of operations, and information about its non-current assets, is detailed below.

Revenue from external customers


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2022		2021		2022		2021
Canada		7,191		4,405		19,859		11,860
U.S.		39,556		29,693		109,875		92,805
		46,747		34,098		129,734		104,665

Non-current assets (1)


	As at
	September 30, 2022		December 31, 2021
Canada		29,931		34,912
U.S.		55,310		60,723
		85,241		95,635

(1)

Amounts include property, plant and equipment, capitalized software, operating lease right-of-use assets, and other assets.

13. INCOME TAXES

As at September 30, 2022, the Company had a valuation allowance of $28.1 million against deferred tax assets as the Company has experienced cumulative losses in recent years (December 31, 2021 – $17.3 million).

14. COMMITMENTS

As at September 30, 2022, the Company had outstanding purchase obligations of approximately $2.1 million related to inventory and property, plant and equipment purchases (December 31, 2021 – $3.7 million). As at September 30, 2022, the Company had undiscounted operating lease liabilities of $53.1 million (December 31, 2021 – $49.7 million).

15. SUBSEQUENT EVENTS

On November 14, 2022, the Company entered into irrevocable subscription agreements with its two largest shareholders, 22 NW Fund, LP (“22NW”) and 726 BC LLC and 726 BF LLC (together “726”) and all the directors and officers of the Company to issue up to 8.8 million shares for gross proceeds of approximately $3.0 million, based on the higher of the Nasdaq closing price on November 14, 2022, and the volume weighted average trading price of the common shares on the Toronto Stock Exchange for the 5 days following the announcement (the “Private Placement”). In addition, in connection with the Private Placement, the two shareholders, or their principals, have irrevocably committed to backstopping any rights offering occurring by the Company in the next twelve months in the aggregate amount of $2.0 million and the shortfall, if any, between the maximum anticipated gross proceeds under the Private Placement, being $3.0 million, and the actual gross proceeds received by the Company.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited interim condensed consolidated financial statements and related notes and other financial information appearing in this Quarterly Report. This discussion contains forward-looking statements reflecting our current expectations and estimates and assumptions concerning events and financial trends that may affect our future operating results or financial position. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those described under the headings “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements” appearing elsewhere in this Quarterly Report.

Summary of Financial Results

Key Third Quarter 2022 Highlights

•

Revenues were $46.7 million, an increase of $12.6 million or 37% from $34.1 million for the same period in 2021, and a $2.0 million or 5% increase from the second quarter of 2022.

•

In July 2022, the Company announced, and successfully implemented, a price increase of approximately 10% across most product lines. This price increase, along with the increases announced in November 2021 and June 2022, were made in response to rapid and continued inflationary pressures impacting nearly all of our material and labor input costs. Our third quarter product sales reflected approximately half of the price increases previously announced. We expect the price increases to be further realized in the fourth quarter of 2022.

•

Gross profit and gross profit margin for the third quarter of 2022 was $7.0 million or 15.0% of revenue, an increase of $0.7 million or 12% from $6.3 million in the second quarter of 2022, an increase of $4.6 million or 186% from $2.5 million or 7.2% of revenue for the same period of 2021. Cost of sales includes $1.0 million of accelerated amortization on software associated with the Reflect and other discontinued product lines, which were discontinued during the third quarter of 2022.

•

Adjusted Gross Profit (see “– Non-GAAP Financial Measures”) for the third quarter of 2022 was $10.1 million. This represents a $1.6 million (19.8%) increase over the second quarter of 2022 and a $5.4 million (112.5%) increase over the third quarter of 2021. Adjusted Gross Profit Margin (see “– Non-GAAP Financial Measures”) for the third quarter of 2022 was 21.7%, a 280 bps improvement over the second quarter 2022 and a 770 bps improvement over the third quarter 2021. Third quarter results include certain inventory write-downs of $1.0 million (2.1%, as a percent of total revenue), primarily related to the discontinuance of the Reflect and other product lines. The improved Adjusted Gross Profit and Adjusted Gross Profit Margin have been driven by a combination of improved demand for our products and commercial discipline. The Company benefited from a weakening Canadian dollar with an approximate benefit of $0.6 million on Canadian Dollar denominated manufacturing costs compared to the third quarter of 2021.

•

During the third quarter of 2022, we have continued to align our manufacturing footprint and salaried workforce with our current activity levels. In July 2022, we announced a further reduction of salaried positions and in August 2022, we announced the temporary closure of our Rock Hill Facility as the Calgary manufacturing facility has sufficient capacity to absorb production and meet expected demand for the near term. These changes are expected to result in approximately $5.0 million in annualized savings. One-time costs associated with the reorganization activities in the third quarter were $3.4 million but added back to Adjusted EBITDA.

•

Net loss for the third quarter of 2022 was $6.7 million compared to $15.4 million for the same period of 2021. The lower net loss is primarily the result of the higher gross profit margin explained above of $4.6 million, a $4.2 million increase in government subsidies, a $0.8 million increase in foreign exchange gain and a $2.9 million reduction in operating expenses offset by a $0.5 million increase in interest expense and $3.4 million of reorganization costs.

•

Adjusted EBITDA (see “– Non-GAAP Financial Measures”) for the third quarter of 2022 was a $5.4 million loss or (11.6)%, an improvement of $7.9 million from a $13.3 million loss or (39.1)% for the third quarter of 2021 and an improvement of $4.0 million from a $9.4 million loss or (21.1)% for the second quarter of 2022.

•

The Company used approximately $12.5 million of cash in the third quarter compared to $21.3 million and $19.1 million in the first and second quarter 2022, respectively. This included approximately $3.4 million in the quarter ($15.1 million year to date) of reorganization costs. Excluding these amounts, net of working capital, cash used would have been $9.1 million in the third quarter of 2022 compared to $16.2 million and $12.6 million in the first and second quarter of 2022, respectively.

•

On November 14, 2022, the Company entered into a Private Placement of 8.8 million shares to the two largest shareholders and all our directors and officers with expected proceeds of approximately $3.0 million, subject to certain pricing mechanisms, with an additional minimum aggregated value of $2.0 million committed to backstopping any rights offering occurring in the next twelve months.

•

The Company continues to evaluate certain non-dilutive, strategic cash initiatives expected to generate additional cash flows by early 2023.

Outlook

Third quarter 2022 revenues were in line with expectations and grew sequentially over the second quarter and the same period last year. As of October 1, 2022, our 12-month forward pipeline, which represents known projects and leads at various stages of maturation which our sales teams are working to convert into orders, increased by 10% to $395 million from $359 million at July 1, 2022. The increase is a function of the impact of our price increases, discussed above, and additional leads added to the pipeline. The pipeline comprises 63% commercial, 22% healthcare, 6% education and 9% government verticals The relative split between verticals remains consistent with pre-pandemic actual percentage results.

Overall, volumes have remained relatively consistent between the second and third quarters of 2022. While the increase in our sales pipeline is a positive indicator of the Company’s future revenue potential, we have been experiencing uneven demand flow in both lead and order conversion. Further, we have experienced higher than usual push out rates on orders, a trend that many other construction and product companies are seeing as well. We believe the primary factor has been jobsite readiness. Further, rising material input costs have forced many contractors to re-evaluate pricing and project profitability. These factors have all served to stretch construction schedules, and by extension, the timing at which our products are ordered. We believe these trends will normalize over time.

The Company’s current and immediate focus continues to be unlocking manufacturing capacity, improving revenues and profitability and accelerating the Company’s near-term progress towards cashflow breakeven and beyond, and managing liquidity. Under new leadership, the following actions have been, or are in the process of being, completed, and are discussed in more detail below:

•

Creating a more comprehensive, focused Project Enablement Team to provide first class support to our partners from quote to delivery.

•

Reestablishing bi-weekly communications and close collaboration with our Partner Advisory Council and monthly discussions with our entire partner network.

•

Identifying and taking steps to unlock manufacturing capacity through additions to our hourly workforce and implementation of manufacturing improvements.

•

Offering a suite of newly implemented incentives, including certain rebate and quick pay discount programs to our Construction Partners that are in good standing.

•

Evaluating several supply chain optimization projects that aim to improve Sales and Operational Planning and reduce slow moving and/or obsolete inventory items.

•

Tightly managing discretionary spend and overtime during periods of order volatility.

As a part of managing our working capital, we are working on managing our inventory levels, which built up during the year (primarily in aluminum extrusions). The increase in our inventory levels primarily reflects our difficulty in increasing order, and, therefore, actual production relative to expectations as previously described, but also reflects the increased cost of raw materials. As communicated in the second quarter, we have taken steps to moderate such supply and saw a drawdown of inventory by $2.0 million in the third quarter of 2022. As a result of the steps mentioned, we are to approaching monthly cashflow breakeven (see “–Liquidity and Capital Resources").

As revenues improve, including the effect of the price increases above, and the cost reduction initiatives take hold, we expect to continue to progress toward an improvement in net loss and Adjusted EBITDA breakeven in the fourth quarter of 2022. Unrestricted cash and net working capital at September 30, 2022 was $6.8 million and $26.9 million, compared to $19.7 million and $31.6 million at June 30, 2022, respectively, and $60.3 million and $66.7 million at December 31, 2021, respectively. The Company’s asset backed credit facility, which is based upon a percentage of accounts receivable and inventory, remains undrawn at September 30, 2022 with approximately C$12.4 million ($9.0 million) available. The Company continues to focus on revenue growth and cost initiatives to positively affect DIRTT’s balance sheet, cash flow and profitability and expects to see a trend of increasing monthly working capital by year end.

Non-GAAP Financial Measures

Note Regarding Use of Non-GAAP Financial Measures

Our condensed consolidated interim 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 Quarterly 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, reorganization expense and stock-based compensation. We remove the impact of all foreign exchange from Adjusted EBITDA. Foreign exchange gains and losses can vary significantly period-to-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 remove the impact of under-utilized capacity from gross profit, and 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. In addition, management bases certain forward-looking estimates and budgets on non-GAAP financial measures, primarily Adjusted EBITDA.

Government subsidies, depreciation and amortization, stock-based compensation expense, reorganization expense, foreign exchange gains and losses and impairment expenses 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 receipts and 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 receipts and 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 Quarterly Report, and a description of the calculation for each measure is included.


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	EBITDA adjusted to remove foreign exchange gains or losses; impairment expenses; reorganization expenses, stock-based compensation expense; government subsidies, 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.

Results of Operations

Three and Nine Months Ended September 30, 2022, Compared to Three and Nine Months Ended September 30, 2021


	For the Three Months Ended September 30,									For the Nine Months Ended September 30,
	2022			2021			% Change			2022			2021			% Change
	($ in thousands)									($ in thousands)
Revenue		46,747			34,098			37			129,734			104,665			24
Gross Profit(1)		7,008			2,450			186			16,571			15,044			10
Gross Profit Margin		15.0	%		7.2	%					12.8	%		14.4	%
Operating Expenses
Sales and Marketing		6,089			7,536			(19	)		21,094			21,770			(3	)
General and Administrative		6,542			7,546			(13	)		21,412			22,567			(5	)
Operations Support		2,321			2,374			(2	)		7,347			6,884			7
Technology and Development		1,695			2,146			(21	)		5,714			6,005			(5	)
Stock-Based Compensation		918			837			10			3,546			3,792			(6	)
Reorganization		3,426			-			100			12,281			-			100
Total Operating Expenses		20,991			20,439			3			71,394			61,018			17
Operating Loss		(13,983	)		(17,989	)		(22	)		(54,823	)		(45,974	)		19
Operating Margin		(29.9	)%		(52.8	)%					(42.3	)%		(43.9	)%
(1) Gross Profit for the three and nine month periods ended September 30, 2022 includes $1.0 million primarily related to the write off of inventory of discontinued product lines, and $1.0 million and $2.1 million, respectively of accelerated depreciation and amortization on software associated with discontinued product lines and the closure of the Phoenix Facility

Revenue

Revenue reflects sales to our Construction Partners for resale to their clients and, in limited circumstances, our direct sales to clients. Our revenue is generally affected by the timing of when orders are executed, particularly large orders, which can add variability to our financial results and shift revenue between quarters.

The following table sets forth the contribution to revenue of our DIRTT product and service offerings:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022		2021		% Change		2022		2021		% Change
	($ in thousands)						($ in thousands)
Product		39,092		29,569		32		110,383		91,867		20
Transportation		5,022		3,294		52		13,878		9,277		50
License fees from Construction Partners		193		191		1		588		539		9
Total product revenue		44,307		33,054		34		124,849		101,683		23
Installation and other services		2,440		1,044		134		4,885		2,982		64
		46,747		34,098		37		129,734		104,665		24

During the quarter ended September 30, 2022, revenue was $46.7 million, an increase of $12.6 million or 37% from the same period in 2021. This also reflects a $2.0 million or 5% increase in revenues from the second quarter of 2022. Revenue for the nine months ended September 30, 2022 was $129.7 million, an increase of $25.1 million or 24% from the nine months ended September 30, 2021. The first quarter of 2022 marked the transition of the COVID-19 pandemic to an endemic with the broad easing of health restrictions, including work-from-home mandates, across North America. While the resurgence in COVID-19 infections due to the Omicron variant at the beginning of the year temporarily sent many employees back to their home offices and delayed return dates, the Company and our Construction Partners experienced an uptick in planning activity and opportunity growth in our commercial vertical which began to translate into orders in March 2022 that has continued into the third quarter.

In response to significant increases in the costs of raw materials, shipping materials, labor and freight, effective November 16, 2021, DIRTT increased product and transportation prices on new projects by approximately 6.5%, with the benefits largely expected to be realized in 2022. On February 17, 2022, we implemented a further price increase of 5% that came into effect June 1, 2022. On June 21, 2022 an additional price increase of 10% was announced effective July 21, 2022. Our third quarter product sales reflected approximately 40% and 15% of these June and July price increases, respectively. We expect the price increases to be further realized in the fourth quarter of 2022. During the third quarter, DIRTT also terminated the 20% pilot price reduction program on its Reflect and Inspire product lines that it announced in February 2022 as a result of the combination of increased aluminum prices and the unanticipated impact that the increased demand placed on our productive capacity due to the immaturity of production processes related to these product lines. In August 2022, with consideration to the production process and profitability, we discontinued the Reflect product line.

Installation and other services revenue was $2.4 million and $4.9 million for the three and nine months ended September 30, 2022 respectively, compared to $1.0 million and $3.0 million in the same period of 2021. This revenue primarily reflects services performed by our ICE and design teams for third parties. Except in limited circumstances, our Construction Partners, rather than the Company, perform installation services, and accordingly, we are not anticipating significant growth in this revenue stream.

Our success is partly dependent on our ability to profitably develop our Construction Partner network to expand our market penetration and ensure best practices are shared across local markets. At September 30, 2022, we had 69 (December 31, 2021: 69) Construction Partners servicing multiple locations. During 2021 and the first quarter of 2022, we made several changes and upgrades to our Construction Partner network, expanding our relationships with new and existing partners and ending our relationships with others. In February 2022, we announced the establishment of a Partner Advisory Council to provide a greater link with Construction Partners and end clients who they service. The Partner Advisory Council will offer advice on sales and marketing effectiveness, product issues and new market needs, market conditions, competitive landscape, marketing support and other related areas of mutual interest.

We periodically analyze our revenue growth by vertical markets in the defined markets of commercial, healthcare, government and education. The following table presents our product and transportation revenue by vertical market:


	For the Three Months Ended September 30,							For the Nine Months Ended September 30,
	2022		2021		% Change			2022		2021		% Change
	($ in thousands)							($ in thousands)
Commercial		31,796		20,805		53			85,458		55,981		53
Healthcare		3,638		5,017		(27	)		15,693		25,680		(39	)
Government		3,358		3,149		7			11,680		11,579		1
Education		5,322		3,892		37			11,430		7,904		45
License fees from Construction Partners		193		191		1			588		539		9
Total product revenue		44,307		33,054		34			124,849		101,683		23
Service revenue		2,440		1,044		134			4,885		2,982		64
		46,747		34,098		37			129,734		104,665		24


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2022		2021		2022		2021
	(in %)				(in %)
Commercial		72		63		69		56
Healthcare		8		15		13		25
Government		8		10		9		11
Education		12		12		9		8
Total Product Revenue(1)		100		100		100		100

(1)

Excludes license fees from Construction Partners.

Commercial revenues increased by 53% in the three and nine month periods ended September 30, 2022 from the same prior year periods, reflecting improving market conditions as health restrictions and work-from-home requirements ease and include one large customer in the technology sector with revenue of $2.4 million and $7.9 million for the respective periods. Healthcare decreased by 27% and 39% in the three and nine months ended September 30, 2022, respectively, from the same periods in 2021. Such sales tend to be larger individual projects and are subject to timing due to a typically longer sales cycle, resulting in variability in sales levels. In 2021, we had one large healthcare project with revenue of $6.9 million which did not recur in 2022.

Education sales in the three and nine months ended September 30, 2022 increased by 37% and 45%, respectively, over the prior periods. At the beginning of the pandemic, education spending effectively paused with many institutions suspending in-person classes. There were no individually significant education projects and the increases represent higher volumes of projects due to the easing of health restrictions and many students returning to in-person learning. Government revenues in the three and nine months ended September 30, 2022 increased by 7% and 1%, respectively, over the prior year periods.

Revenue continues to be derived almost exclusively from projects in North America and predominantly from the United States. The following table presents our revenue dispersion by geography:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022		2021		% Change		2022		2021		% Change
	($ in thousands)						($ in thousands)
Canada		7,191		4,405		63		19,859		11,860		67
U.S.		39,556		29,693		33		109,875		92,805		18
		46,747		34,098		37		129,734		104,665		24

Historically, approximately 15-25% and 75-85% of revenues are derived from sales to Canada and the United States, respectively. In the quarter ended September 30, 2020, revenues from Canada fell to 9% of total sales while sales to the United States increased to 91%. The geographical split for the first three quarters of 2022 began to return to historical averages and reflects the easing of health restrictions in Canada which occurred later than in the United States.

Sales and Marketing Expenses

Sales and marketing expenses decreased by $1.4 million and $0.7 million to $6.1 million and $21.1 million for the three and nine months ended September 30, 2022, from $7.5 million and $21.8 million for the three and nine months ended September 30, 2021 respectively. The decrease was largely related to a decrease of $1.3 million and $2.2 million for the three and nine months ended September 30, 2022, respectively, in salaries and benefits costs. The decrease in the nine months ended September 30, 2022 was offset by a $1.5 million increase in travel, meals and entertainment expenses as business activity has increased and restrictions on travel have eased.

General and Administrative Expenses

General and administrative expenses decreased $1.0 million and $1.2 million to $6.5 million and $21.4 million for the three and nine months ended September 30, 2022 from $7.5 million and $22.6 million for the three and nine months ended September 30, 2021. The decrease in the three months ended September 30, 2022 was related to lower salaries and benefits costs associated with the planned headcount reductions as part of our cost savings initiatives and lower professional services costs. For the nine month period ended September 30, 2022, approximately $1.8 million of incremental professional fees associated with the contested election of directors was offset by lower salaries and benefits cost.

Operations Support Expenses

Operations support is comprised primarily of project managers, order entry and other professionals that facilitate the integration of our Construction Partner project execution and our manufacturing operations. Operations support expenses decreased by $0.1 million from $2.4 million to $2.3 million in the three months ended September 30, 2022 from the same period of 2021. The decrease was due to reduced travel costs in the quarter.

Operations support expenses increased $0.5 million from $6.9 million for the nine months ended September 30, 2021 to $7.3 million for the nine months ended September 30, 2022. The increase was due to a decrease in salaries and benefits capitalized to internal projects of $0.4 million with the completion of the Rock Hill Facility and the DIRTT Experience Centre ("DXC") in Dallas and an increase in salaries and benefits of $0.1 million for the nine month period ended September 30, 2022 compared to the previous year same period.

Technology and Development Expenses

Technology and development expenses relate to non-capitalizable costs associated with our product and software development teams and are primarily comprised of salaries and benefits of technical staff.

Technology and development expenses for the three and nine month period ended September 30, 2022 decreased by $0.5 million and $0.3 million, respectively, from the prior period costs to $1.7 million and $5.7 million. The decrease was related to reductions in salaries and benefits offset by lower capitalized costs due to fewer internal projects. For the nine months ended September 30, 2022, professional service fees also decreased by $0.2 million compared to the prior year period.

Stock-Based Compensation

Stock-based compensation expense for the three and nine months ended September 30, 2022 was $0.9 million and $3.5 million compared to $0.8 million and $3.8 million for the same periods in 2021. The movement in this expense was largely the impact of grants of RSUs to the Company's employees, including those in lieu of cash compensation to the Company’s former interim Chief Executive Officer in January 2022 and DSUs granted to the Board of Directors, lowered by the impact of fair value adjustments on cash settled awards as a result of our share price decreasing during the quarter and nine months ended September 30, 2022. The Board of Directors receives 100% of their remuneration in DSUs.

Reorganization

For the three and nine months ended September 30, 2022, we incurred $3.4 million and $12.3 million in reorganization costs, respectively. Reorganization costs for the quarter include termination benefits, and costs associated with the temporary suspension of the Rock Hill Facility. For the nine month period ended September 30, 2022, reorganization costs also include insurance costs incurred on change of control of the board, and costs associated with the closure of the Phoenix Facility.

We have undertaken several initiatives to align our manufacturing footprint with our current activity levels. This included the closure of the Phoenix Facility which was substantially completed in the second quarter of 2022, with related manufacturing to be undertaken by both our Savannah and Calgary aluminum facilities. Of the initial estimate of cost savings of approximately $2.4 million from this closure, we expect to realize annualized savings of approximately $1.0 million as $1.4 million of work force reductions were offset by additions in Calgary and Savannah due to increased demand. On August 23, 2022, we announced the temporary closure of our Rock Hill Facility, as the Calgary manufacturing facility has sufficient capacity to absorb production and meet expected demand for the near term.

Additionally, in February 2022, we announced a reduction of our salaried workforce including manufacturing and office positions which, along with other cost reduction initiatives, were expected to yield annualized savings of approximately $13.0 million. The reductions were followed by a further reduction of salaried positions, as announced in July 2022, and the temporary closure of our Rock Hill Facility, announced in August 2022, which are expected to result in approximately $5.0 million in annualized savings. Of these cost reduction initiatives, $14.0 million was implemented during the first three quarters of 2022, $3.0 million is expected to be implemented in the fourth quarter of 2022, and $1.0 million, comprised of certain manufacturing positions, has been deferred as we work to increase manufacturing headcount in light of increased demand.

Government Subsidies

During the quarter ended September 30, 2022, the Company determined it was eligible for the ERC in the United States established by Section 2301 of the CARES Act and has a filed a claim for $7.3 million payroll tax credits ($7.1 million net of expenses). The Company received subsidies of $3.4 and $7.5 million during the three and nine months ended September 30, 2021 under Canadian government programs CEWS and CERS. Upon finalization of 2021 compensation to specified executives, approximately C$0.5 million ($0.4 million) of previously-received subsidies were repaid to the Canadian authorities in the second quarter of 2022. The amount was fully provided for in the third quarter of 2021 and the Company reversed a $0.6 million incremental provision related to this that was no longer necessary in the first quarter of 2022. The last claim period under the CEWS and CERS programs expired on October 23, 2021.

Interest expense

Interest expense increased by $0.5 million from $0.8 million for the three months ended September 30, 2022 to $1.3 million compared to September 30, 2021 and by $1.8 million from $2.1 million in the nine months ended September 30, 2022 to $3.9 million compared to September 30, 2021. The increased interest expense is a result of the issuance of C$35.0 million ($27.4 million) of Debentures in December 2021 and draws on the Leasing Facilities.

Income Tax

The provision for income taxes comprises U.S. and Canadian federal, state and provincial taxes based on pre-tax income. The Company incurred a minimal income tax recovery during the three and nine months ended September 30, 2022, compared to a $0.1 million and $0.3 million expense for the same period of 2021. As at September 30, 2022 the Company had a valuation allowance of $28.1 million (December 31, 2021 $17.3 million) against deferred tax assets due to ongoing near term uncertainties on the business caused by the COVID-19 pandemic and the related decline in business activity which impacted our ability to generate sufficient taxable income in Canada and the United States to fully deduct historical losses. As at September 30, 2022, we had C$107.2 million of non-capital loss carry-forwards in Canada and $49.5 million in the United States. These loss carry-forwards will begin to expire in 2032.

Net Loss

Net loss decreased to $6.7 million or $0.08 net loss per share in the three months ended September 30, 2022 from a net loss of $15.4 million or $0.18 net loss per share for the quarter ended September 30, 2021. The decreased loss is primarily the result of a $4.6 million increase in gross profit, a $4.2 million increase in government subsidies and a $0.8 million increase in foreign exchange gain. These were offset by a $0.6 million increase in operating expenses (which includes $3.4 million of reorganization expenses), and a $0.5 million increase in interest expense.

Net loss increased to $49.1 million or $0.56 net loss per share for the nine months ended September 30, 2022 from a net loss of $37.7 million or $0.44 net loss per share for the nine months ended September 30, 2021. The increased loss is primarily the result of a $10.4 million increase in operating expenses (which includes $12.3 million of reorganization expenses and $1.8 million of incremental professional fees as described previously), a $1.8 million increase in interest expense and a $2.7 million decrease in government subsidies offset by an increase in gross margin of $1.5 million and an increase in foreign exchange gain of $1.6 million.

EBITDA and Adjusted EBITDA for the Three and Nine Months Ended September 30, 2022 and 2021

The following table presents a reconciliation for the third quarter and year to date results of 2022 and 2021 of EBITDA and Adjusted EBITDA to our net loss, which is the most directly comparable GAAP measure for the periods presented:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022			2021			2022			2021
	($ in thousands)						($ in thousands)
Net loss for the period		(6,727	)		(15,419	)		(49,057	)		(37,656	)
Add back (deduct):
Interest Expense		1,276			823			3,935			2,117
Interest Income		(19	)		(20	)		(50	)		(62	)
Income Tax expense (recovery)		(16	)		88			(16	)		347
Depreciation and Amortization		4,236			3,815			12,202			10,638
EBITDA		(1,250	)		(10,713	)		(32,986	)		(24,616	)
Foreign Exchange Gains		(1,356	)		(526	)		(1,870	)		(286	)
Stock-Based Compensation		918			837			3,546			3,792
Government Subsidies		(7,141	)		(2,935	)		(7,765	)		(10,434	)
Reorganization Expense		3,426			-			12,281			-
Adjusted EBITDA		(5,403	)		(13,337	)		(26,794	)		(31,544	)
Net Loss Margin(1)		(14.4	)%		(45.2	)%		(37.8	)%		(36.0	)%
Adjusted EBITDA Margin		(11.6	)%		(39.1	)%		(20.7	)%		(30.1	)%

(1)

Net loss divided by revenue.

For the three months ended September 30, 2022, Adjusted EBITDA and Adjusted EBITDA Margin increased by $7.9 million to a $5.4 million loss or (11.6)% from $13.3 million loss or (39.1)% in the same period of 2021. This primarily reflects a $5.4 million increase in Adjusted Gross Profit, $2.1 million decrease in salaries and benefits costs due to headcount reductions, $0.5 million reduction of professional fees and other cost reductions.

For the nine months ended September 30, 2022, Adjusted EBITDA and Adjusted EBITDA Margin increased by $4.8 million to a $26.8 million loss or (20.7)% from $31.5 million loss or (30.1)% in the same period of 2021. This primarily reflects a $2.2 million increase in Adjusted Gross Profit, a $5.1 million reduction in salaries and benefits costs due to headcount reductions (offset by a reduction in capitalized salaries of $1.1 million due to fewer internal projects), $1.8 million of costs of underutilized capacity in the first quarter of 2021 that did not recur in 2022, offset by $1.8 million of incremental professional fees as described previously and $1.5 million increase in travel and entertainment costs due to increased business activity and easing of travel restrictions.

Adjusted Gross Profit and Adjusted Gross Profit Margin for the Three and Nine Months Ended September 30, 2022 and 2021

The following table presents a reconciliation for the three and nine months ended September 30, 2022 and 2021 of Adjusted Gross Profit to our gross profit, which is the most directly comparable GAAP measure for the periods presented:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022			2021			2022			2021
	($ in thousands)						($ in thousands)
Gross profit		7,008			2,450			16,571			15,044
Gross profit margin		15.0	%		7.2	%		12.8	%		14.4	%
Add: Depreciation and amortization expense		3,132			2,321			8,792			6,383
Add: Costs of under-utilized capacity		-			-			-			1,756
Adjusted Gross Profit		10,140			4,771			25,363			23,183
Adjusted Gross Profit Margin		21.7	%		14.0	%		19.6	%		22.1	%

There have been significant and industry wide inflationary increases in the realized cost of materials, transportation, labor and packaging which have impacted DIRTT since the second half of 2021. In addition, in the second quarter and in response to a sustained increase in demand that began in the first quarter of 2022, the Company began efforts to increase its manufacturing labor headcount but experienced the ongoing effects of a tight labor market. This has made it more difficult than expected to attract and retain skilled labor, particularly at our Savannah manufacturing facility, and as a result the Company increased hourly rates by 6% on average to increase its overall competitiveness. To address these cost increases, the Company implemented a series of price increases starting with a 6.5% increase effective November 1, 2021, an additional 5% price increase effective June 1, 2022 and a further 10% price increase effective July 21, 2022 and continues to monitor raw material, labor and other costs to determine whether further action is necessary.

Gross profit and gross profit margin increased to $7.0 million or 15.0% for the three months ended September 30, 2022, from $2.5 million or 7.2% for the three months ended September 30, 2021. Adjusted Gross Profit and Adjusted Gross Profit Margin increased to $10.1 million or 21.7% for the three months ended September 30, 2022, from $4.8 million or 14.0% for the three months ended September 30, 2021. The 7.7% increase in Adjusted Gross Profit Margin was a result of improved labor efficiency which benefited gross profit by 4.9%, and the benefit of higher revenues on fixed costs which improved gross profit by 5.1%, offset by a $1.0 million charge, or 2.1% of gross profit, due to the write down of inventory related to Reflect and other discontinued product lines. Materials, transportation and other variable costs reduced gross profit by 0.6% as our price increases realized to date did not fully offset cost increases. We expect a higher realization of enacted price increases from the fourth quarter. Gross profit was impacted by a $1.0 million increase in depreciation and amortization in the quarter on account of accelerated depreciation on software associated with discontinued product lines. Gross profit for the third quarter benefited by approximately $0.6 million from the impact of the weakening Canadian dollar on U.S. dollar reported results, which is included in the above variances.

For the nine month period ended September 30, 2022, gross profit and gross profit margin increased to $16.6 million or 12.8% from $15.0 million or 14.4% for the nine month period ended September 30, 2021. Adjusted Gross Profit and Adjusted Gross Profit Margin decreased to $25.4 million or 19.6% for the nine months ended September 30, 2022, from $23.2 million or 22.1% for the nine months ended September 30, 2021. The 2.6% decrease in Adjusted Gross Profit was a result of higher materials, transportation, packaging and other variable costs which reduced gross profit by 4.4%. As previously discussed, price increases that were put in place over the last twelve months lagged cost increases. We expect the price increases to be further realized in the fourth quarter which will reduce variable costs as a percentage of revenues closer to historical levels. As a result of higher sales activities, gross profit benefited by 1.6% and 2.6% on utilization of labor and fixed costs, respectively. Labor costs increased $2.3 million for the year-to-date period as we incurred incremental costs during the second quarter associated with moving production to Calgary and Savannah on closure of the Phoenix Facility, rate increases, and adding capacity following an improvement in demand. Fixed costs increased $1.6 million due to cost inflations and the impact of adding the Rock Hill Facility in 2021 to the fixed cost base. In the current year we incurred a $0.8 million charge, or 0.6% of gross profit, due to the write down of inventory related to Reflect and other discontinued product lines. Prior year Adjusted Gross Profit benefited from the removal of $1.8 million, or 1.7% Adjusted Gross Profit impact, on under-utilized capacity not captured in product costs. Gross profit was impacted by $2.1 million of incremental depreciation and amortization on the acceleration of useful lives associated with discontinued product lines and the Phoenix Facility. Gross profit for the year to date benefited by approximately $0.9 million from the impact of the weakening Canadian dollar on U.S. dollar reported results, which is included in the above variances.

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 2021, we experienced the full impact of the slowdown in non-residential construction activity on our business. In anticipation of a recovery in demand for our products and services and to preserve our skilled workforce, we deliberately maintained manufacturing headcount, while implementing selective furlough days, in the first quarter of 2021 despite the shortfall in revenues relative to capacity. As a result, in the first quarter of 2021 we separately classified $1.8 million as costs related to our under-utilized capacity (1.2% of 2021 first quarter gross profit margin) in cost of sales. For the remaining quarters of 2021 and 2022, we did not have abnormal excess capacity as our workforce was better aligned with current production volumes.

Liquidity and Capital Resources

Cash and cash equivalents at September 30, 2022 totaled $6.8 million, a decrease of $53.5 million from December 31, 2021. The decrease in cash over the nine month period primarily reflects the impact of $47.5 million cash used in operations, of which $1.8 million related to one-time costs associated with the contested director election and $12.3 million of reorganization costs. In addition, capital expenditures totaled $3.6 million and scheduled Leasing Facilities repayments totaled $1.9 million. These outflows were offset by a C$0.9 million ($0.7 million) draw under the Canada Leasing Facility received in April 2022.

The impact of COVID-19 on the Company’s sales and operations has been severe, including a contraction of demand since the beginning of the pandemic and more recently, significant inflation on raw material costs. This has resulted in a significant usage of cash which we have financed through existing cash on hand and financings as described further below. Furthermore, we have implemented multiple initiatives to reduce our overall fixed cost base, including the closure of our Phoenix Facility in the second quarter of 2022, reduction in our hourly headcount in 2021 and salaried headcount reductions and other cost savings initiatives in February 2022 and July 2022. In August 2022 we announced the temporary suspension of operations at the Rock Hill Facility as we have sufficient capacity at our other facilities to manage current demand. This suspension of operations will reduce costs in the interim.

We have also implemented three price increases to mitigate the inflationary effect, comprised of 6.5% effective November 1, 2021, 5% effective June 1, 2022 and a further 10% effective July 21, 2022. We continue to monitor the cost of our raw materials and labor to determine whether further price increases are warranted. Since March 2022, however, the Company and its Construction Partners have experienced an increase in demand, particularly within its commercial and education verticals, with the broad lifting of health restrictions across North America. In response the Company began efforts to increase manufacturing headcount within its Calgary and Savannah facilities to enable it to meet both near-term demand and anticipated sustained increases. We have increased wage rates in both Canada and the United States to increase our competitiveness in what is proving to be a tight labor market, particularly in Savannah. We are also taking steps to decongest our manufacturing processes to return productivity to pre-pandemic levels. We have started to realize the benefits of the price increases, manufacturing headcount additions, training and debottlenecking in the latter part of the third quarter and expect to see further benefits in the fourth quarter.

The cost reductions and price increases discussed above positively benefited our third quarter results, and have reduced our rate of cash usage. We expect a greater impact of these actions to be realized in the fourth quarter and thereafter. While these actions, combined with an increasing project pipeline is promising, we continue to see unpredictability in our pace of orders.

Accordingly, we are taking several strategic actions to improve our balance sheet in the short term. First, we have determined our eligibility for the ERC for the first three quarters of 2021 and have filed a claim for $7.3 million in payroll tax credits ($7.1 million net of expenses). Second, we have certain properties that are currently owned that we are evaluating for sale and leasing back. We do not intend to vacate these premises as they still serve a valuable aspect of our value proposition, but we expect to receive a one-time cash payment, in exchange for future rent payments. Third, historically we have licensed the use of ICE software to certain strategic partners for use in their business, and DIRTT has provided licensing and developer software support for these counterparties. We are in the process of evaluating multiple initiatives related to the further use of ICE software by third parties. We expect these strategic initiatives to result in positive cash inflows in 2023.

To bridge any cash requirements between now and the completion and closing of these strategic transactions, the Company entered into irrevocable subscription agreements with its two largest shareholders, 22NW and 726 and all the directors and officers of the Company on November 14, 2022 to issue up to 8.8 million shares for gross proceeds of approximately $3.0 million, based on the higher of the Nasdaq closing price on November 14, 2022, and the volume weighted average trading price of the common shares on the Toronto Stock Exchange for the 5 days following the announcement. In addition, in connection with the Private Placement, the two shareholders, or their principals, have irrevocably committed to backstopping any rights offering occurring by the Company in the next twelve months in the aggregate amount of $2.0 million and the shortfall, if any, between the maximum anticipated gross proceeds under the Private Placement, being $3.0 million, and the actual gross proceeds received by the Company.

We believe completion of these strategic transactions and the Private Placement will improve our balance sheet and accordingly confidence in our business, benefiting our pipeline conversion which will enable us to cross the threshold of activity which will get us to cashflow breakeven.

We have assessed the Company’s liquidity using multiple downside and upside scenarios, taking into account these circumstances, our sales outlook for the next twelve months and actions in combination with existing cash balances, available credit facilities, the strategic transactions and Private Placement discussed previously, and potential equity or debt financing. Based upon this analysis, we believe the Company has sufficient liquidity to remain a going concern for at least the next 12 months. However, a number of factors, including our ability to satisfy the expected growth in pipeline demand and those discussed below, could adversely impact our liquidity over such period.

To the extent that existing cash and cash equivalents, available facilities and increased liquidity from the aforementioned strategic actions are not sufficient to fund future activities, we may seek to raise additional funds through equity or debt financings. If additional funds are raised through the incurrence of indebtedness, such indebtedness may have rights that are senior to holders of our Debentures and our equity securities or contain instruments that may be dilutive to our existing shareholders. Any additional equity or debt financing may be dilutive to our existing shareholders. While we are confident in our ability to access capital markets when needed or under acceptable terms, there can be no absolute assurance we will be able to do so.

During 2021, we completed financings to increase our liquidity in light of the highly uncertain economic conditions caused by the pandemic. In January 2021, we issued C$40.3 million of the January Debentures for net proceeds after costs of C$37.6 million ($29.5 million). The January Debentures accrue interest at a rate of 6.00% per annum and are convertible into common shares of DIRTT at an exercise price of C$4.65 per common share, or if not converted will mature and be repayable on the January Debenture Maturity Date. Interest and principal are payable in cash or shares at the option of the Company.

In February 2021, we entered into the RBC Facility, a C$25.0 million senior secured revolving credit facility with RBC. Under the RBC Facility, the “Borrowing Base” is a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of 75% of the book value of eligible inventory and 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims. Available borrowings under the RBC Facility at September 30, 2022 were C$12.4 million ($9.0 million).

In December 2021, we issued C$35.0 million of the December Debentures for net proceeds after costs of C$32.7 million ($25.6 million). The December Debentures accrue interest at a rate of 6.25% per annum and are convertible into common shares of DIRTT at an exercise price of C$4.20 per common share, or if not converted will mature and be repayable on the December Debenture Maturity Date. Interest and principal are payable in cash or shares at the option of the Company.

The Company has a C$5.0 million Canada Leasing Facility of which C$4.5 million ($3.4 million) has been drawn, and a $14.0 million U.S. Leasing Facility of which $13.3 million has been drawn with RBC and one of its affiliates. The Leasing Facilities are available for equipment expenditures and certain equipment expenditures already incurred.

The following table summarizes our consolidated cash flows for the periods indicated:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2022			2021			2022			2021
	($ in thousands)						($ in thousands)
Net cash flows (used in) provided by operating activities		(10,667	)		(12,191	)		(47,509	)		(23,872	)
Net cash flows used in investing activities		(644	)		(2,210	)		(3,595	)		(12,556	)
Net cash flows (used in) provided by financing activities		(912	)		(520	)		(1,802	)		36,083
Effect of foreign exchange on cash, cash equivalents and restricted cash		(293	)		(130	)		(73	)		581
Net (decrease) increase in cash, cash equivalents and restricted cash		(12,516	)		(15,051	)		(52,979	)		236
Cash, cash equivalents and restricted cash, beginning of period		22,945			61,133			63,408			45,846
Cash, cash equivalents and restricted cash, end of period		10,429			46,082			10,429			46,082

Operating Activities

Net cash flows used in operating activities were $10.7 million for the three months ended September 30, 2022 compared to $12.2 million in the three months ended September 30, 2021. Included in the $10.7 million used in operating activities in the third quarter of 2022 are $3.4 million of reorganization costs. Excluding these amounts, cashflows used in operations would have been $7.3 million in the third quarter of 2022 compared to $12.2 million cash provided by operations in the same period of 2021, with the decrease reflecting an increase of $5.4 million of Adjusted Gross Profit offset by working capital timing. Apart from the above noted items, working capital changes primarily reflect increased accounts payable due to higher activity and timing of payments, a decrease in inventory as we use the inventory built up in the first half of the year discussed below, and reduced deposits on orders from customers offset by the receivable related to the government subsidies.

Net cash flows used in operating activities were $47.5 million for the nine months ended September 30, 2022 compared to $23.9 million in the nine months ended September 30, 2021. Included in the $47.5 million used in operating activities in the nine months ended September 30, 2022 are $12.3 million of reorganization costs, $1.8 million of professional fees associated with the contested director election, and $6.1 million of increased inventory

where the Company took on incremental inventory from suppliers to mitigate against potential supply chain disruption, offset by the receipt of a $3.2 million income tax refund related to 2020. We have since taken steps to adjust our aluminum supply and expect to begin drawing down such inventory in the third and fourth quarter. Excluding these amounts, cashflow used in operations would have been $30.6 million in the nine months ended September 30, 2022 compared to $24.3 million cash used in operations in the same period of 2021, with the increase in cash used reflecting a decrease of government subsidies received and working capital timing. Apart from the above noted items, working capital changes primarily reflect government subsidies receivable offset by higher accounts payable due to higher activity and timing of payments.

Investing Activities

We invested $0.4 million and $2.2 million in property, plant and equipment during the three and nine months ended September 30, 2022, respectively, compared to $1.8 million and $10.5 million during the three and nine months ended September 30, 2021. The expenditure for the three months ended September 30, 2022 comprised of $0.1 million of manufacturing upgrades, $0.1 million of leasehold improvements and $0.1 million related to our website design. The expenditure for the nine months ended September 30, 2022 comprised of $1.0 million of working capital changes, $0.7 million of manufacturing upgrades, $0.2 million related to our website design and $0.3 million related to DXC refreshes and IT equipment. The decrease in investing activities is largely due to reduced spending as the Rock Hill Facility and Dallas DXC were completed in 2021.

We invested $0.4 million on capitalized software during the three months ended September 30, 2022, as compared to $0.5 million in the three months ended September 30, 2021 and $1.3 million for the nine months ended September 30, 2022 compared to $1.9 million for the comparative period.

Our 2022 capital expenditure program was comprised of approximately $2.5 million related to refreshes of DXCs, continued enhancement of our customer relationship management system and website redesign, approximately $2.5 million on software development and approximately $2.0 million on manufacturing and other capital upgrades of which actual expenditures have been less than budget.

Financing Activities

For the three and nine months ended September 30, 2022, $0.9 million and $1.8 million of cash was used in financing activities, comprising mainly of $0.6 million and $1.9 million of scheduled payments under the Leasing Facilities and $0.3 million and $0.6 million relating to taxes paid on RSU vestings for the three and nine month period ended September 30, 2022 respectively. During the second quarter, we received C$0.9 million ($0.7 million) under the Canada Leasing Facility. For the three and nine months ended September 30, 2021, $0.5 million of cash was used and $36.1 million of cash was provided by financing activities, respectively, mainly due to the proceeds received from the issuance of C$40.3 million of Debentures in January 2021 and the receipt of $8.4 million of cash consideration under the U.S. Leasing Facility.

We currently expect to fund anticipated future investments with available cash, including the proceeds from Debentures issued in 2021, and drawings on the RBC Facility. We also expect to pursue additional strategic actions to improve available cash, which includes filing an application for ERC for the first three quarters of 2021 for $7.1 million, net of expenses, evaluating properties we own for sale and lease back, evaluating multiple initiatives related to the use of our ICE software and the Private Placement of common shares. Refer to “–Liquidity and Capital Resources" for further details. We do not expect to make any further draws under the Leasing Facilities. Apart from cash flow from operations, issuing equity and debt has been our primary source of capital to date. Additional debt or equity financing may be pursued in the future as we deem appropriate. We may also use debt or pursue equity financing depending on the price of our common shares at the time, interest rates, and nature of the investment opportunity and economic climate. No assurance can be given that any of these actions will be successful, will be sufficient for our needs.

Credit Facility

On February 12, 2021, the Company entered into the RBC Facility. Under the RBC Facility, the Borrowing Base is up to a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of 75% of the book value of eligible inventory and 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims. At September 30, 2022, available borrowings

are C$12.4 million ($9.0 million), of which no amounts have been drawn. Interest is calculated at the Canadian or U.S. prime rate plus 30 basis points or at the Canadian Dollar Offered Rate or LIBOR plus 155 basis points. Under the RBC Facility, if the Aggregate Excess Availability is less than C$5.0 million, the Company is subject to a FCCR covenant of 1.10:1 on a trailing twelve-month basis until such time the borrowing availability net of unrestricted cash exceeds C$5.0 million for at least thirty consecutive calendar days. Additionally, if the FCCR has been below 1.10:1 for the three immediately preceding months, the Company is required to maintain a reserve account equal to the aggregate of one year of payments on outstanding loans on the Leasing Facilities. The Company did not meet the three-month FCCR requirement during the third quarter of 2022, which resulted in requiring the restriction of $3.6 million of cash. Should an event of default occur, or the Aggregate Excess Availability be less than C$6.25 million for five consecutive business days, the Company would enter a cash dominion period whereby the Company’s bank accounts would be blocked by RBC and daily balances will set-off any borrowings and any remaining amounts made available to the Company.

During 2020, the Company entered into the Leasing Facilities, consisting of the C$5.0 million Canada Leasing Facility and the $14.0 million U.S. Leasing Facility with RBC, which are available for equipment expenditures and certain equipment expenditures already incurred. The Leasing Facilities, respectively, have seven and five-year terms and bear interest at 4.25% and 5.59%. The U.S. Leasing Facility is amortized over a six-year term and is extendible at the Company’s option for an additional year.

The Company has drawn $13.3 million of cash consideration under the U.S. Leasing Facility and commenced the lease term in 2020 for the equipment at the Rock Hill Facility. The Company has drawn C$4.5 million ($3.4 million) of cash consideration under the Canada Leasing Facility and commenced the lease term for the Canadian equipment expenditures during 2020. C$0.9 million ($0.7 million) of the Canada Leasing Facility was drawn in the three months ended June 30, 2022.

We are restricted from paying dividends unless Payment Conditions (as defined in the RBC Facility) are met, including having a net borrowing availability of at least C$10 million over the proceeding 30-day period, and having a trailing twelve-month fixed charge coverage ratio above 1.10:1 and certain other conditions. The RBC Facility is currently secured by substantially all of our real property located in Canada and the United States.

Contractual Obligations

There have been no material changes in our contractual obligations during the three months ended September 30, 2022, as compared to those disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations” in our Annual Report on Form 10-K, other than additional commitments related to the extension of our headquarters lease in Calgary. See Note 14, “Commitments” to our interim condensed consolidated financial statements in this Quarterly Report for additional information.

Significant Accounting Policies and Estimates

There have been no material changes in our significant accounting policies during the three months ended September 30, 2022, as compared to those disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Significant Accounting Policies and Estimates” in our Annual Report on Form 10-K. For information regarding significant accounting policies and estimates, please refer to Item 7 and Item 8 in our Annual Report on Form 10-K. As disclosed in Note 6, “Adoption of New and Revised Accounting Standards” to our condensed consolidated interim financial statements appearing in this Quarterly Report, we adopted Accounting Standards Update No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance. The ASU provides guidance on required disclosures with respect to government assistance in a company’s notes to the annual financial statements. The amendments in the ASU are effective for periods beginning after December 15, 2021. The Company has adopted this standard effective January 1, 2022 and notes there is no impact of this standard on our accounting or disclosures of government assistance.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements, please refer to Note 6, “Adoption of New and Revised Accounting Standards” to our condensed consolidated interim financial statements and “–Significant Accounting Policies and Estimates” appearing in this Quarterly Report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our market risk exposures since our disclosures in our Annual Report on Form 10-K. For information regarding our exposure to certain market risks, please refer to Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” in our Annual Report on Form 10-K.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is accumulated and communicated to management, including our principal executive officers and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

As required by Rule 13a-15 under the Exchange Act, our principal executive officers and principal financial officer carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2022. Based upon their evaluation, our principal executive officers and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

We are pursuing multiple lawsuits against our former founders, Mogens Smed and Barrie Loberg, their new company Falkbuilt Ltd., and other related individual and corporate defendants for violations of fiduciary duties and noncompetition and non-solicitation covenants contained in their executive employment agreements, and the misappropriation of our confidential and proprietary information in violation of numerous Canadian and U.S. state, and federal laws pertaining to the protection of our trade secrets and proprietary information and the prevention of false advertising and deceptive trade practices. There have been no material developments in the legal proceedings previously disclosed in our Annual Report on Form 10-K, as supplemented by our Quarterly Report on Form 10-Q for the quarters ended March 31, 2022 and June 30, 2022, filed with the SEC and applicable securities commissions or similar regulatory authorities in Canada on May 4, 2022 and July 27, 2022 respectively.

Item 1A. Risk Factors

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors and other cautionary statements described under the heading “Risk Factors” included in our Annual Report on Form 10-K, as supplemented by our Quarterly Report on Form 10-Q for the quarter ended March 31, 2022 and June 30, 2022, filed with the SEC and applicable securities commissions or similar regulatory authorities in Canada on May 4, 2022 and July 27, 2022, which could materially affect our businesses, financial condition, or results of operations. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and results of operations.

Our share price has been and may continue to be volatile, which could cause the value of your investment to decline. If we fail to comply with the continuing listing standards of Nasdaq, our securities could be delisted.

Our common shares are currently listed on the Toronto Stock Exchange 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 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.

Further, if the closing bid price of our common shares is below the $1.00 Nasdaq minimum requirement for 30 consecutive business days, we may become subject to delisting proceedings. On September 7, 2022, we received a letter from Nasdaq that we have not been in compliance with the minimum bid price requirement set forth in Nasdaq Listing Rule 5450(a)(1) for a period of 30 consecutive business days. In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we are provided a compliance period of 180 calendar days from the date of the notice to regain compliance with the minimum closing bid price requirement. If we do not regain compliance during the compliance period, we may be afforded a second 180 calendar day period to regain compliance if, among other things, we meet certain listing requirements of, and elect to transfer to, the Nasdaq Capital Market. We can achieve compliance with the minimum bid price requirement if, during either compliance period, the closing bid price per share of our common shares is at least $1.00 for a minimum of ten consecutive business days. We intend to monitor the closing bid price of our common shares and assess potential actions to regain compliance, but there is no assurance that we will be able to regain compliance, including under the specified timeframes.

Any delisting of our securities could have an adverse effect on the market price of, and the efficiency of the trading market for, our securities, not only in terms of the number of shares that can be bought and sold at a given price, but also through delays in the timing of transactions and less coverage of us by securities analysts, if any. Also, if in the future we were to determine that we need to seek additional equity capital, having been delisted or being subject to delisting proceedings could have an adverse effect on our ability to raise capital in the public or private markets.

We are under the leadership of a reconstituted Board of Directors who plan to implement a variety of operational, organizational, cultural and other changes to our business, and we may not be able to achieve some or all of the anticipated benefits of this transformation plan. We are also undergoing changes at a senior management level, including the appointment of a new Chief Executive Officer in June 2022.

Our Board of Directors was entirely reconstituted at our annual and special meeting of shareholders held on April 26, 2022 and, following that meeting, Geoffrey Krause and Jeffrey Calkins were appointed Interim Co-Chief Executive Officers. In June 2022, Jeffrey Calkins and Jennifer Warawa departed the company and a new Chief Executive Officer, Benjamin Urban was appointed. Messrs. Urban and Noll were also appointed to our Board of Directors in June 2022. On July 27, 2022, the Company announced additional leadership changes, including the departures of Charles Kraus, Senior Vice President and General Counsel and Colin Blehm, Vice President Product Development, and the promotion of Trevor Didluck to Vice President Product Development. Nandini Somayaji has been promoted to Senior Vice President Talent, General Counsel & Corporate Secretary. On August 5, 2022, Mary Garden departed the Board of Directors. Geoffrey Krause, DIRTT’s former Chief Financial Officer retired from the Company, effective September 30, 2022 and Bradley Little was appointed as the incoming Chief Financial Officer effective August 23, 2022. On August 29, 2022, Richard Hunter was appointed as DIRTT's new Chief Operating Officer. On October 20, 2022, Jeff Dopheide as appointed as Chief Revenue Officer, effective November 15, 2022. As a result of these events, the timely integration of senior management will be critical in the successful implementation of the Board of Directors' plans. There can be no assurance that we will be able to successfully implement the plan or otherwise realize the anticipated benefits of the plan, and we may encounter short-term disruptions of certain aspects of our business as elements of the plan are implemented.

In addition to overseeing the changes to DIRTT’s leadership described above, since its election, the reconstituted Board of Directors has undertaken an extensive review of DIRTT’s operations, a process which is still ongoing (see Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Outlook”, above), and are in the process of implementing a variety of operational, organizational, cultural and other changes to our business, including plans to meet pipeline demand and expand revenues. We may not be successful in achieving some or all of the anticipated benefits of these plans, which may have an adverse effect on our results from operations and financial condition. Specifically, we are addressing the following issues:

•

Ability to increase manufacturing capacity to service current pipeline:

As at October 1, 2022, DIRTT’s 12-month forward pipeline, which represents known projects and leads at various stages of maturation which our sales teams are working to convert into orders, increased by 10% to $395 million from $359 million as at July 1, 2022 and 24% from $318 million as at April 1, 2022. Servicing of this pipeline and capturing the underlying revenue growth is dependent upon the Company's ability to ramp up production capabilities on a timely basis. The Board of Directors and DIRTT’s management team have prioritized removing constraints in DIRTT’s manufacturing processes and are pursuing a number of initiatives including increased hourly labor, improved hourly labor retention and streamlined manufacturing processes. DIRTT may not be successful in implementing such initiatives and may be negatively impacted by the competitive nature of attracting personnel and other current market conditions. DIRTT may not be able meet such demand and capture the underlying revenue growth which could adversely affect the Company’s results of operations and financial condition.

•

Discounting and raw material cost inflation impacts on profitability:

DIRTT's gross margins and resulting profitability have been negatively affected by the impacts of material cost inflation and the use of increased discounting to drive higher demand. DIRTT has taken steps to improve gross margin by reducing discounts and increasing prices, including a 5% price increase at June 1, 2022 and a further 10% price increase at July 21, 2022. If we are unable to realize the effects of reduced discounting or price increases, if inflationary increases continue without corresponding increases in our pricing or if such reduced discounting and price increases cause a material impact on demand, DIRTT’s results of operations and financial condition could be adversely impacted.

•

The effectiveness of certain elements of DIRTT’s administrative systems:

DIRTT has identified the need to upgrade its inventory management and cost accounting systems. Other information technology may require investment in the future. However, the success, in whole or in part, of this investment cannot be guaranteed.

We have negative cash flow from operating activities

We had negative cash flow from operating activities for the three and nine month period ended September 30, 2022. Continued negative operating cash flow may compromise our ability to make interest and principal payments on the convertible unsecured subordinated debentures issued on January 25, 2021 and December 1, 2021 (collectively, the “Debentures”) on a timely basis, or at all, our ability to execute our strategic plan and confidence in our business. Until we are able to generate positive cash flow from operating activities, our ability to finance our operations will be dependent on our cash reserves and available credit facilities and, if required, our ability to obtain additional external financing. Although we anticipate we will have positive cash flow from operating activities in future periods, we cannot guarantee that such future cash flow will be sufficient or that a prolonged recovery from the COVID-19 pandemic, or other changes to our circumstances, will not necessitate additional financial resources to fund our operating activities. In response to our negative cash flow from operations, we have undertaken several strategic actions and a Private Placement to improve our balance sheet in the short term, see “–Liquidity and Capital Resources". Although we anticipate these actions will strengthen our balance sheet and liquidity position, we cannot guarantee that such future cash flow will be sufficient or that a prolonged recovery from the COVID-19 pandemic, or other changes to our circumstances, will not necessitate additional financial resources to fund our operating activities.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

Not Applicable.

Item 6. Exhibits

EXHIBIT INDEX


Exhibit No.		Description

3.1		Restated Articles of Amalgamation of DIRTT Environmental Solutions Ltd. (incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form 10, File No. 001-39061, filed on September 20, 2019).
3.2		Amended and Restated Bylaw No. 1 of DIRTT Environmental Solutions Ltd. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, File No. 001-39061, filed on May 22, 2020).
4.1		Base Indenture, dated January 25, 2021, by and among DIRTT Environmental Solutions Ltd., Computershare Trust Company of Canada and Computershare Trust Company, National Association as Trustees (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, File No. 001-39061, filed on January 29, 2021).
4.2		Supplemental Indenture, dated January 25, 2021, by and among the Company, Computershare Trust Company of Canada and Computershare Trust Company, National Association as Trustees (incorporated by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K, File No. 001-39061, filed on January 29, 2021).
4.3		Second Supplemental Indenture, dated December 1, 2021, by and among the Company, Computershare Trust Company of Canada and Computershare Trust Company, National Association as Trustees (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, File No. 001-39061, filed on December 1, 2021).
10.1		DIRTT Environmental Solutions Ltd. Employee Share Purchase Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q File No. 001-39061, filed on May 4, 2022).
10.2*+		Executive Employment Agreement, dated August 12, 2022, by and between DIRTT Environmental Solutions Inc. and Richard Hunter
10.3*+		Executive Employment Agreement, dated August 17, 2022, by and between DIRTT Environmental Solutions Inc. and Bradley Little
10.4*+		Executive Employment Agreement, dated December 24, 2019, by and between DIRTT Environmental Solutions Ltd and Nandini Somayaji
10.5*+		Executive Employment Agreement, dated October 19, 2022, by and between DIRTT Environmental Solutions Inc and Jeff Dopheide
10.6*		Indemnity Agreement, dated August 12, 2022, between DIRTT Environmental Solutions Ltd and Richard Hunter, together with a schedule identifying other substantially identical agreements between the Company and each of the other persons identified on the schedule
31.1*		Certification of the Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of the Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**		Certification of the Principal Executive Officer required by 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**		Certification of the Principal Financial Officer required by 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*		Inline XBRL Instance Document
101.SCH*		Inline XBRL Taxonomy Extension Schema Document
101.CAL*		Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		Inline XBRL Taxonomy Extension Presentation Linkbase Document
104		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

* Filed herewith

** Furnished herewith

+ Compensatory plan or agreement

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	DIRTT ENVIRONMENTAL SOLUTIONS LTD.

	By:	/s/ Bradley S. Little
		Bradley S. Little
		Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer)

Date: November 14, 2022