DIRTT ENVIRONMENTAL SOLUTIONS LTD - Quarter Report: 2023 September (Form 10-Q)

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, 2023


☐	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: None

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 104,789,358 common shares outstanding as of October 31, 2023.

DIRTT ENVIRONMENTAL SOLUTIONS LTD.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2023

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		7
Interim Condensed Consolidated Statement of Cash Flows		8
Notes to the Unaudited Interim Condensed Consolidated Financial Statements		9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3. Quantitative and Qualitative Disclosures About Market Risk		36
Item 4. Controls and Procedures		37

PART II – OTHER INFORMATION		38

Item 1. Legal Proceedings		38
Item 1A. Risk Factors		39
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, 2023 (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,” “continue,” 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 contained in, or expressed or implied by such statements. Due to the risks, uncertainties and assumptions inherent in forward-looking information, you should not place undue reliance on forward-looking statements. Factors that could have a material adverse effect on our business, financial condition, results of operations and growth prospects can be found in the section titled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the U.S. Securities and Exchange Commission (the “SEC”) and applicable securities commissions or similar regulatory authorities in Canada on February 22, 2023 (the “Annual Report on Form 10-K”), and in our subsequently filed Quarterly Reports on Form 10-Q and in this Quarterly Report under “Part II, Item 1A. Risk Factors.” These factors include, but are not limited to, the following:

•

general economic and business conditions in the jurisdictions in which we operate, including inflation;

•

our ability to implement our strategic plan, including realization of benefits from certain cost-optimization initiatives undertaken in 2022 and initiatives being taken in 2023 and the ability of our board of directors ("Board of Directors") to successfully implement its transformation plan;

•

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;

•

volatility of our share price;

•

the availability of capital or financing on acceptable terms, or at all, 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;

•

our history of negative cash flow from operating activities;

•

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

•

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 in the construction industry;

•

our ability to achieve and manage growth effectively;

•

competition in the interior construction industry;

•

competitive behaviors by our former co-founders and executives;

•

the condition and changing trends of the overall construction industry;

•

our reliance on our network of construction partners ("Construction 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;

•

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;

•

global economic, political and social conditions affecting financial markets, such as the war in Ukraine and the Israel-Hamas war;

•

our exposure to currency exchange rates, tax rates, interest 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;

•

the impact of increasing attention to environmental, social and governance (ESG) matters on our business;

•

periodic fluctuations in our results of operations and financial conditions;

•

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 expressed 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,
	2023			2022
ASSETS
Current Assets
Cash and cash equivalents		19,460			10,821
Restricted cash		2,977			3,418
Trade and accrued receivables, net of expected credit losses of $0.1 million at September 30, 2023 and at December 31, 2022		20,516			13,930
Other receivables		852			7,880
Inventory		17,368			22,251
Prepaids and other current assets		4,015			3,825
Assets held for sale		2,317			-
Total Current Assets		67,505			62,125
Property, plant and equipment, net		26,324			41,522
Capitalized software, net		2,168			4,406
Operating lease right-of-use assets, net		30,561			30,490
Other assets		3,776			5,110
Total Assets		130,334			143,653
LIABILITIES
Current Liabilities
Accounts payable and accrued liabilities		18,761			19,881
Other liabilities		2,021			2,056
Customer deposits and deferred revenue		6,743			4,866
Current portion of long-term debt and accrued interest		8,961			3,306
Current portion of lease liabilities		5,284			5,889
Total Current Liabilities		41,770			35,998
Long-term debt		53,901			62,129
Long-term lease liabilities		28,751			27,534
Total Liabilities		124,422			125,661
SHAREHOLDERS’ EQUITY
Common shares, unlimited authorized without par value, 104,789,358 issued and outstanding at September 30, 2023 and 97,882,844 at December 31, 2022		195,747			191,347
Additional paid-in capital		7,933			9,023
Accumulated other comprehensive loss		(15,957	)		(16,106	)
Accumulated deficit		(181,811	)		(166,272	)
Total Shareholders’ Equity		5,912			17,992
Total Liabilities and Shareholders’ Equity		130,334			143,653

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

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,
	2023			2022			2023			2022
Product revenue		48,095			44,307			127,105			124,849
Service revenue		1,442			2,440			3,893			4,885
Total revenue		49,537			46,747			130,998			129,734

Product cost of sales		31,622			37,965			88,529			109,757
Service cost of sales		850			1,774			2,165			3,406
Total cost of sales		32,472			39,739			90,694			113,163
Gross profit		17,065			7,008			40,304			16,571

Expenses
Sales and marketing		6,161			6,089			18,302			21,094
General and administrative		4,669			6,542			16,003			21,412
Operations support		1,752			2,321			5,564			7,347
Technology and development		1,239			1,695			4,055			5,714
Stock-based compensation		1,069			918			2,543			3,546
Reorganization		321			3,426			2,857			12,281
Impairment charge on Rock Hill Facility		7,952			-			7,952			-
Related party expense		-			-			1,524			-
Total operating expenses		23,163			20,991			58,800			71,394

Operating loss		(6,098	)		(13,983	)		(18,496	)		(54,823	)
Government subsidies		-			7,141			236			7,765
Gain on sale of software and patents		-			-			6,145			-
Foreign exchange (loss) gain		822			1,356			(59	)		1,870
Interest income		161			19			271			50
Interest expense		(1,196	)		(1,276	)		(3,636	)		(3,935	)
		(213	)		7,240			2,957			5,750
Net loss before tax		(6,311	)		(6,743	)		(15,539	)		(49,073	)
Income taxes
Current and deferred income tax recovery		-			(16	)		-			(16	)
		-			(16	)		-			(16	)
Net loss		(6,311	)		(6,727	)		(15,539	)		(49,057	)

Net loss per share
Net loss per share - basic and diluted		(0.06	)		(0.08	)		(0.15	)		(0.57	)

Weighted average number of shares outstanding (in thousands)
Basic and diluted		104,449			87,446			101,036			86,229

Interim Condensed Consolidated Statement of Comprehensive Loss


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2023			2022			2023			2022
Loss for the period		(6,311	)		(6,727	)		(15,539	)		(49,057	)
Exchange differences on translation of foreign operations		(45	)		(66	)		149			(227	)
Comprehensive loss for the period		(6,356	)		(6,793	)		(15,390	)		(49,284	)

Total revenue for the nine months ended September 30, 2023 includes $0.3 million earned from related parties. All related party income was earned in the first quarter of 2023.

Interest expense for the three and nine month ended September 30, 2023 includes $0.4 million owing to a related party (refer to Note 16).

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, 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

As at December 31, 2022		97,882,844		191,347		9,023			(16,106	)		(166,272	)		17,992
Stock-based compensation		-		-		452			-			-			452
Issued on vesting of RSUs and Share Awards		659,473		1,256		(1,256	)		-			-			-
RSUs withheld to settle employee tax obligations		-		-		(26	)		-			-			(26	)
Issued for employee share purchase plan		322,408		128		-			-			-			128
Foreign currency translation adjustment		-		-		-			273			-			273
Net loss for the period		-		-		-			-			(11,434	)		(11,434	)
As at March 31, 2023		98,864,725		192,731		8,193			(15,833	)		(177,706	)		7,385
Stock-based compensation		-		-		625			-			-			625
Issued on vesting of RSUs and Share Awards		1,108,213		1,243		(1,243	)		-			-			-
Issued for employee share purchase plan		572,253		122		-			-			-			122
Issued to settle related party debt		3,899,745		1,524		-			-			-			1,524
Foreign currency translation adjustment		-		-		-			(79	)		-			(79	)
Net income for the period		-		-		-			-			2,206			2,206
As at June 30, 2023		104,444,936		195,620		7,575			(15,912	)		(175,500	)		11,783
Stock-based compensation		-		-		360			-			-			360
Issued on vesting of RSUs and Share Awards		1,011		2		(2	)		-			-			-
Issued for employee share purchase plan		343,411		125		-			-			-			125
Foreign currency translation adjustment		-		-		-			(45	)		-			(45	)
Net loss for the period		-		-		-			-			(6,311	)		(6,311	)
As at September 30, 2023		104,789,358		195,747		7,933			(15,957	)		(181,811	)		5,912

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,
	2023			2022			2023			2022
Cash flows from operating activities:
Net loss for the period		(6,311	)		(6,727	)		(15,539	)		(49,057	)
Adjustments:
Depreciation and amortization		2,017			4,236			7,216			12,202
Impairment charge on Rock Hill Facility		7,952			-			7,952			-
Stock-based compensation, net of settlements		1,069			888			2,543			2,596
Foreign exchange loss (gain)		(577	)		(1,365	)		563			(2,147	)
Gain on sale of software and patents		-			-			(6,145	)		-
Loss (gain) on disposal of equipment		97			44			97			(121	)
Accretion of convertible debentures		172			163			515			505
Changes in operating assets and liabilities:
Trade and accrued receivables		(5,130	)		(819	)		(6,639	)		(5,814	)
Other receivables		(163	)		(7,419	)		7,029			(4,566	)
Inventory		1,749			1,052			4,902			(6,052	)
Prepaid and other assets, current and long term		477			(254	)		(41	)		(1,421	)
Accounts payable and accrued liabilities		(77	)		2,748			475			5,921
Other liabilities		(212	)		(70	)		(421	)		(109	)
Customer deposits and deferred revenue		737			(3,078	)		1,702			641
Current portion of long-term debt and accrued interest		(49	)		(44	)		(64	)		(186	)
Lease liabilities		168			(22	)		542			99
Net cash flows provided by (used in) operating activities		1,919			(10,667	)		4,687			(47,509	)
Cash flows from investing activities:
Purchase of property, plant and equipment, net of accounts payable changes		(255	)		(360	)		(1,304	)		(2,247	)
Capitalized software development expenditures		(425	)		(385	)		(1,530	)		(1,286	)
Other asset expenditures		(41	)		(86	)		(186	)		(367	)
Recovery of software development expenditures		49			46			131			91
Proceeds on sale of software and patents		-			-			9,964			-
Proceeds on sale of equipment		14			141			14			214
Net cash flows provided by (used in) investing activities		(658	)		(644	)		7,089			(3,595	)
Cash flows from financing activities:
Proceeds received on long-term debt		-			-			-			647
Repayment of long-term debt		(551	)		(616	)		(3,386	)		(1,852	)
Employee tax payments on vesting of RSUs		-			(296	)		(26	)		(597	)
Net cash flows used in financing activities		(551	)		(912	)		(3,412	)		(1,802	)
Effect of foreign exchange on cash, cash equivalents and restricted cash		(117	)		(293	)		(166	)		(73	)
Net increase (decrease) in cash, cash equivalents and restricted cash		593			(12,516	)		8,198			(52,979	)
Cash, cash equivalents and restricted cash, beginning of period		21,844			22,945			14,239			63,408
Cash, cash equivalents and restricted cash, end of period		22,437			10,429			22,437			10,429
Supplemental disclosure of cash flow information:
Interest paid		(1,038	)		(1,108	)		(3,077	)		(3,439	)
Income taxes (paid) received		-			-			(10	)		3,207

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the consolidated balance sheets.
							As at September 30,
							2023			2022
Cash and cash equivalents								19,460			6,818
Restricted cash								2,977			3,611
Total cash, cash equivalents and restricted cash								22,437			10,429

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 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. As of May 9, 2023, Armstrong World Industries, Inc. ("AWI") owns a 50% interest in the rights, title and interests in all the intellectual property rights in a portion of the ICE Software that is used by AWI.

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”. Effective October 12, 2023, DIRTT’s common shares ceased to trade on the Nasdaq Capital Market. DIRTT’s common shares are quoted on the OTC Markets on the “OTC Pink Tier” under the symbol “DRTTF.”

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, 2023, and its results of operations and cash flows for the three and nine months ended September 30, 2023 and 2022. The condensed balance sheet at December 31, 2022, 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, 2022 and 2021 and for each of the three years in the period ended December 31, 2022 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 3, no new accounting standards were adopted by the Company during the quarter.

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 Environmental Solutions Ltd. 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, assets held for sale 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. ADOPTION OF NEW AND REVISED ACCOUNTING STANDARDS

The Company has not adopted any new accounting standards effective January 1, 2023. Accounting guidance for assets held for sale was applicable to the Company this quarter and the policy applied has been disclosed below. Although there are several 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.

Assets held for sale

The Company classifies an asset group (“asset”) as held for sale in the period that (i) it has approved and committed to a plan to sell the asset, (ii) the asset is available for immediate sale in its present condition, (iii) an active program to locate a buyer and other actions required to sell the asset have been initiated, (iv) the sale of the asset is probable and transfer of the asset is expected to qualify for recognition as a completed sale within one year (subject to certain events or circumstances), (v) the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value, and (vi) it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. The Company initially and subsequently measures a long-lived asset that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the consolidated statement of operations in the period in which the held for sale criteria are met. Conversely, gains are generally not recognized on the sale of a long-lived asset until the date of sale. Upon designation as an asset held for sale, the Company stops recording depreciation or amortization expense on the asset. The Company assesses the fair value of assets held for sale less any costs to sell at each reporting period until the asset is no longer classified as held for sale. Adjustments made to the fair value are recorded in the consolidated statement of operations in the period it is measured. Refer to Note 6.

4. LIQUIDITY

As at September 30, 2023, the Company had $19.5 million of cash on hand and C$14.6 million ($10.8 million) of available borrowings (December 31, 2022 – $10.8 million and C$7.2 million ($5.3 million) of available borrowings). Through the first nine months of fiscal year 2023, the Company generated $4.7 million in cash flows from operations, compared to a cash usage of $47.5 million over the first nine months of fiscal year 2022. The Company benefited from the receipt of $7.3 million of government subsidies during the first nine months of 2023 compared to $nil in the nine months ended September 30, 2022 (refer to Note 5).

We have implemented multiple price increases during the past two years to mitigate the impact of inflation on raw materials. These actions have resulted in a meaningful improvement in our gross profit margins and higher net profit and have served to reduce our cash usage to operate the business. Gross profit for the nine months ended September 30, 2023 was $40.3 million, or 30.8%, compared to the same period of 2022, which generated gross profit of $16.6 million, or 12.8%.

Over the past four quarters, we have also executed upon several cash initiatives. First, in May 2023, we entered into an agreement with AWI (refer to Note 7) resulting in the receipt of $10.9 million of cash. Second, during March 2023, we entered into an agreement to sublease our Dallas DIRTT Experience Center (“DXC”) to one of our Construction Partners in that region. Under the sublease agreement, the subtenant has assumed responsibility for the monthly rent, utilities, maintenance, taxes and other costs as of April 1, 2023, through December 31, 2024, which will provide us annualized savings of approximately $1 million. We are continuing to evaluate other properties for sale and leaseback or sublease opportunities and expect these strategic initiatives to result in positive cash inflows in 2023

and 2024. Third, we completed a Private Placement (as defined herein) of common shares in November 2022, with certain significant shareholders and directors and officers of the Company, to bridge cash requirements before the completion and closing of the noted strategic transactions.

While we are encouraged by our improved profitability and cash flow, we have continued to evaluate our fixed cost structure and overhead in light of macroeconomic uncertainty. We have implemented multiple restructuring initiatives (refer to Note 6) designed to align our cost structure with current expected levels of demand. In addition, the Company has reduced headcount by 154 employees, or approximately 16% from January 2022 through September 2023.

We have assessed the Company’s liquidity position as at September 30, 2023 taking into account our sales outlook for the next year, our existing cash balances and available credit facilities and expected early settlements related to our Rock Hill Facility equipment lease (refer to Note 10). Based on this analysis, we believe the Company has sufficient liquidity to support ongoing operations for the next twelve months.

5. 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 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 filed a claim for $7.3 million in payroll tax credits ($7.1 million net of expenses). As of September 30, 2023, the $7.3 million claim (plus an additional $0.2 million of interest) has been received in full.

6. REORGANIZATION AND ASSETS HELD FOR SALE

During the year ended December 31, 2022, and continuing into 2023, 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 manufacturing facilities. During the first quarter of 2022, the Company incurred $1.0 million of accelerated depreciation, recorded in cost of sales, associated with the closure of the Phoenix Facility. The closure of the Phoenix Facility was substantially completed in the second quarter of 2022. The Company entered into a sublease arrangement for part of the Phoenix Facility 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 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 year ended December 31, 2022. During the nine months ended September 30, 2023, we continued to review costs resulting in the elimination of additional salaried positions in the second and third quarters of 2023. These actions resulted in the Company incurring certain one-time termination costs.

Temporary Suspension of Operations and Subsequent Closure 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. Costs associated with this idle facility, included in cost of sales, were $0.4 million and $1.4 million for the three month and nine month period ended September 30, 2023, respectively.

On September 27, 2023, we decided to permanently close the Rock Hill Facility. As a result of this decision, we incurred $8.0 million of impairment charges associated with the manufacturing equipment located at the Rock Hill Facility. We expect to incur $0.5 million of costs in dismantling and decommissioning the Rock Hill Facility assets. The Company will continue to maintain the building lease and is pursuing a sublease arrangement.

For the three and nine months ended September 30, 2023, reorganization costs incurred relate to the above mentioned initiatives:


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2023		2022		2023		2022
Termination benefits		168		2,843		2,138		6,870
Insurance costs on change of control		-		-		-		3,676
Phoenix Facility closure		24		-		96		853
Rock Hill Facility temporary suspension and closure of operations		129		144		129		144
Other costs		-		439		494		738
Total reorganization costs		321		3,426		2,857		12,281


Reorganization costs in accounts payable and accrued liabilities at January 1, 2022	-
Reorganization expense	13,461
Reorganization costs paid	(11,184	)
Reorganization costs in accounts payable and accrued liabilities at December 31, 2022	2,277
Reorganization expense	2,857
Reorganization costs paid	(3,977	)
Reorganization costs in accounts payable and accrued liabilities at September 30, 2023	1,157

The $1.1 million payable relates to termination benefits (December 2022 – $2.1 million).

Assets classified as held for sale as at September 30, 2023 of $2.3 million consist of manufacturing equipment previously used in the Rock Hill Facility. Prior to the decision to permanently close the Rock Hill Facility, the assets were classified as property, plant and equipment.

7. GAIN ON SALE OF SOFTWARE AND PATENTS

On May 9, 2023, we entered into a Co-Ownership Agreement (the “Co-Ownership Agreement”) and Partial Patent Assignment Agreement with AWI. The agreements provided for a cash payment from AWI to the Company of $10.0 million, subject to certain routine closing conditions, in exchange for the partial assignment to AWI and resulting co-ownership of a 50% interest in the rights, title and interests in certain intellectual property rights in a portion of the ICE software that is used by AWI (the “Applicable ICE Code”), including a 50% interest in the patent rights that relate to the Applicable ICE Code. Under the Co-Ownership Agreement, we also agreed to provide AWI a transfer of knowledge concerning the source code of the Applicable ICE Code. In exchange for completing the knowledge transfer, we will receive an additional cash payment of $1.0 million, which is expected to be received by early 2024. The Co-Ownership Agreement provides that we and AWI have separate exclusive fields of use and restrictive covenants with respect to the Applicable ICE Code and related intellectual property, which survive until either party elects to separate from its relationship with the other and for five years thereafter. We concurrently entered into an Amended and Restated Master Services Agreement (the “ARMSA”) with AWI, under which AWI has also prepaid certain development services to be provided by DIRTT. The ARMSA will automatically terminate if the Co-Ownership Agreement is terminated or expires, and may also be terminated if either party breaches the exclusive fields of use or restrictive covenants in the Co-Ownership Agreement.

The $10.0 million of proceeds on the sale of the 50% interest in the Applicable ICE code, pursuant to the Co-Ownership Agreement, was received during the second quarter of 2023. In accordance with US GAAP, the proceeds were first applied to the net book value of the related cost of software of $2.9 million and patents (other assets) of $0.9 million and the residual amount of $6.1 million was recognized as a gain in the consolidated statement of operations. Further, $0.9 million was received during the second quarter as a prepayment under the ARMSA, which was recognized into revenue as the performance obligation is met. Part of the proceeds of this transaction were used to

settle one of our equipment leases of $1.6 million and resulted in the release of $0.4 million of restricted cash (refer to Note 10). A final prepayment of $0.9 million under the ARMSA was received in October 2023.

8. TRADE AND ACCRUED RECEIVABLES

Accounts receivable are recorded at the invoiced amount, do not require collateral and typically 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 consolidated 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 well-being of our customers. In addition, we acquired trade credit insurance effective April 1, 2020. At September 30, 2023, approximately 80% 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.

Our trade balances are spread over a broad Construction Partner base, which is geographically dispersed. For the three and nine months ended September 30, 2023, one Construction Partner accounted for greater than 10% of revenue (one Construction Partner for the nine months ended September 30, 2022). 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,
	2023			2022
Current		16,974			12,381
Overdue		3,642			1,675
		20,616			14,056
Less: expected credit losses		(100	)		(126	)
		20,516			13,930

No adjustment to our expected credit losses of $0.1 million was required for the three or nine months ended September 30, 2023. 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.

9. OTHER LIABILITIES


	As at,
	September 30, 2023		December 31, 2022
Warranty provisions (1)		867		1,278
DSU liability		971		594
Sublease deposits		183		139
Other provisions		-		45
Other liabilities		2,021		2,056

(1)

The following table presents a reconciliation of the warranty balance:


	As at,
	September 30, 2023			December 31, 2022
As at January 1		1,278			1,451
Additions to warranty provision		845			1,134
Payments related to warranties		(1,056	)		(1,307	)
Adjustments to warranty provision		(200	)		-
		867			1,278

10. LONG-TERM DEBT


	Revolving Credit Facility		Leasing Facilities			Convertible Debentures			Total Debt
Balance on January 1, 2022		-		13,909			56,733			70,642
Issuances		-		647			-			647
Accretion of issue costs		-		-			676			676
Accrued interest		-		735			3,539			4,274
Interest payments		-		(735	)		(3,688	)		(4,423	)
Principal repayments		-		(2,470	)		-			(2,470	)
Exchange differences		-		(274	)		(3,637	)		(3,911	)
Balance at December 31, 2022		-		11,812			53,623			65,435
Current portion of long-term debt and accrued interest		-		2,561			745			3,306
Long-term debt		-		9,251			52,878			62,129

Balance on December 31, 2022		-		11,812			53,623			65,435
Accretion of issue costs		-		-			515			515
Accrued interest		-		447			2,566			3,013
Interest payments		-		(447	)		(2,630	)		(3,077	)
Principal repayments		-		(3,386	)		-			(3,386	)
Exchange differences		-		241			121			362
Balance at September 30, 2023		-		8,667			54,195			62,862
Current portion of long-term debt and accrued interest		-		8,250			711			8,961
Long-term debt		-		417			53,484			53,901

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”). 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. 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). 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 offset any borrowings and any remaining amounts made available to the Company.

On February 9, 2023, the Company extended the RBC Facility (the “Extended RBC Facility”). The Extended RBC Facility has a borrowing base of C$15 million and a one year term. Interest is calculated as at the Canadian or U.S. prime rate plus 75 basis points or the Canadian Dollar Offered Rate or Term Secured Overnight Financing Rate ("SOFR") plus 200 basis points plus the Term SOFR Adjustment (as defined in the amended loan agreement governing the Extended RBC Facility). Under the Extended RBC Facility, if the trailing twelve month FCCR is not above 1.25 for three consecutive months, a cash balance equivalent to one-year's worth of Leasing Facilities payments must be maintained. At September 30, 2023, available borrowings are C$14.6 million ($10.8 million) (December 31, 2022 – $10.8 million and C$7.2 million ($5.3 million) of available borrowings), calculated in the same manner as the RBC facility described above, of which no amounts have been drawn. The Company did not meet the three-month FCCR requirement during the third quarter of 2023, which resulted in requiring the restriction of $3.0 million of cash ($3.4 million as at December 31, 2022).

Leasing Facilities

The Company has a C$5.0 million equipment leasing facility in Canada (the “Canada Leasing Facility”) of which C$4.4 million ($3.3 million) has been drawn and C$3.8 million ($2.8 million) has been repaid, 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”) of which $13.3 million has been drawn and $5.2 million has been repaid, each with RBC, and one of its affiliates, which are available for equipment expenditures and certain equipment expenditures already incurred. The Canadian Leasing Facility and the U.S. Leasing Facility, respectively, have seven and five-year terms and bear interest at 4.25% and 5.59%. Refer to Note 6 on the decision to permanently close the Rock Hill Facility. As part of this decision the Company intends to early settle the U.S. Leasing Facility in the next twelve months. The $8.2 million balance of the U.S. Leasing Facility has therefore been classified under current liabilities as at September 30, 2023. On October 31, 2023, the Company paid off $1.0 million of the U.S. Leasing Facility.

The Company did not make any draws on the Leasing Facilities during the three and nine months ended September 30, 2023. During the three and nine months ended September 30, 2022, the Company received C$0.9 million ($0.7 million) under the Canada Leasing Facility. The associated financial liabilities are shown on the consolidated balance sheet in the current portion of long-term debt and accrued interest and long-term debt.

As part of RBC's consent to the AWI transaction (refer to Note 7), one of the Canadian lease agreements of $1.6 million was fully settled using AWI proceeds. This resulted in the release of $0.4 million of restricted cash associated with the one year of payments on this lease, as described above.

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. As at September 30, 2023, C$18.9 million of the January Debentures are held by a related party (refer to Note 16).

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 September 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. As at September 30, 2023, C$13.6 million of the December Debentures are held by a related party (refer to Note 16).

11. STOCK-BASED COMPENSATION

In May 2020, shareholders approved the DIRTT Environmental Solutions Long Term Incentive Plan (the “2020 LTIP”). The 2020 LTIP replaced the predecessor incentive plans, being the Performance Share Unit Plan (“PSU Plan”) and the Amended and Restated Stock Option Plan (“Stock Option Plan”). Following the approval of the 2020 LTIP, no further awards will be 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.

In May 2023, shareholders approved the DIRTT Environmental Solutions Ltd. Amended and Restated Long-Term Incentive Plan (the “2023 LTIP”) at the annual and special meeting of shareholders. The 2023 LTIP gives the

Company the ability to award options, share appreciation rights, restricted share units, deferred share units, restricted shares, dividend equivalent rights, 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 2023 LTIP, the sum of (i) 12,350,000 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 30, 2023, expire or are cancelled or terminated without having been exercised in full, have been reserved for issuance under the 2023 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.

Deferred share units (“DSUs”) have historically been granted to non-employee directors under the Deferred Share Unit Plan for Non-Employee Directors (as amended and restated, the “DSU Plan”) and settleable only in cash. The 2023 LTIP gives the Company the ability to settle DSUs in either cash or common shares, while consolidating future share-based awards under a single plan. The terms of the DSU Plan are otherwise materially unchanged as incorporated into the 2023 LTIP. Effective May 30, 2023, no new awards will be made under the DSU Plan, but awards previously granted under the DSU Plan will continue to be governed by the DSU Plan. DSUs are settled following cessation of services with the Company.

Stock-based compensation expense


	For The Three Months Ended September 30,				For the Nine Months Ended September 30,
	2023		2022		2023		2022
Equity-settled awards		594		846		2,106		3,471
Cash-settled awards		475		72		437		75
		1,069		918		2,543		3,546

The following summarizes RSUs, 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, 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
Outstanding at December 31, 2022		1,885,337			343,919			-			-			1,165,319
Granted		3,549,500			-			522,883			2,584,161			1,646,420
Vested or settled		(987,054	)		(258,760	)		(522,883	)		-			(220,590	)
Withheld to settle employee tax obligations		(64,230	)		-			-			-			-
Forfeited or expired		(600,345	)		-			-			(738,553	)		-
Outstanding at September 30, 2023		3,783,208			85,159			-			1,845,608			2,591,149

Restricted share units (time-based vesting)

Restricted share units 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 (“RSUs”). 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 in 2022 and 2023 was C$2.37 and C$0.46, respectively, 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.

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.

In the first quarter of 2023, 36,254 Share Awards were issued to a consultant as compensation for services rendered. During the second quarter of 2023, certain executives were issued Share Awards in lieu of cash paid variable incentive compensation. These Share Awards vested upon grant. The fair value of the Share Awards granted was C$0.49 ($0.34), which was determined using the closing price of the Company’s common shares on the grant date.

Performance share units

During the second quarter of 2023, certain executives were issued a strategic equity grant through Performance share units (“PSUs”). The performance period of the PSUs is from January 1, 2023 to December 31, 2026 with a cliff vesting term for December 31, 2026. 2,584,161 PSUs were granted and depending on the level of performance, the PSUs will vest 100%, 160% or 190% up to a maximum of 4,909,907 PSUs. Settlement will be made in the form of shares issued from treasury. The performance measures are a combination of Revenue and Earnings Before Interest, Taxes, Depreciation and Amortization and both targets have to be achieved. As of September 30, 2023, the fair value of these PSUs have been deemed to be nil based on the likelihood of achieving the targets compared to current results. During the third quarter of 2023, 738,553 PSUs with a $nil value were forfeited as a result of an executive departure and 1,845,608 PSUs with a $nil value are outstanding at September 30, 2023.

Deferred share units

Granted under the DSU Plan

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 period. DSUs outstanding at September 30, 2023 had a fair value of $0.6 million which is included in other liabilities on the balance sheet (December 31, 2022 – $0.6 million).

Granted under the 2023 LITP

DSUs granted after May 30, 2023 (the "New DSUs") will be settled by way of the provision of cash or shares (or a combination thereof) to the Directors, at the discretion of the Company. The Company intends to settle these DSUs through issuances of common shares. The weighted average fair value of the DSUs granted in 2023 was C$0.44 ($0.33), which was determined using the closing price of the Company’s common shares on the grant date. New DSUs outstanding at September 30, 2023 had a fair value of $0.4 million which is included in other liabilities on the balance sheet (December 31, 2022 – $nil).

Options

The following summarizes options forfeited and expired during the periods:


	Number of			Weighted average
	options			exercise price C$
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
Outstanding at December 31, 2022		1,480,069			7.03
Forfeited		(989,066	)		6.97
Expired		(263,725	)		6.46
Outstanding and Exercisable at September 30, 2023		227,278			7.95

No options were granted during the three months and nine months ended September 30, 2023.

Range of exercise prices outstanding and exercisable at September 30, 2023:


	Options outstanding						Options exercisable
			Weighted		Weighted				Weighted		Weighted
	Number of		average		average				average		average
	options		remaining		exercise		Number		remaining		exercise
Range of exercise prices			life		price C$		exercisable		life		price C$
C$6.01 – C$7.00		16,350		0.97	$	6.12		16,350		0.97	$	6.12
C$7.01 – C$7.84		210,928		0.63	$	7.84		210,928		0.63	$	7.84
Total		227,278						227,278

Dilutive Instruments

For the three and nine months ended September 30, 2023, 0.2 million options (2022 – 1.5 million) 3.9 million RSUs and PRSUs (2022 – 2.8 million), 1.2 million New DSUs (2022 – nil), 2.6 million PSUs (2022 – nil), 1.1 million shares relating to equity-settled Variable Pay Plan (“VPP”) (2022 – nil), and 134.4 million (2022 – 127.5 million) shares would be issued if the principal amount of the Debentures were settled in our common shares at the quarter end price and were included in the diluted EPS calculation.

12. 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 13 for the disaggregation of revenue by geographic region.


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2023		2022		2023		2022
Product		43,132		39,092		113,323		110,383
Transportation		4,767		5,022		13,169		13,878
License fees from Construction Partners		196		193		613		588
Total product revenue		48,095		44,307		127,105		124,849
Installation and other services		1,442		2,440		3,893		4,885
		49,537		46,747		130,998		129,734

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 from fixed-price contracts is based upon agreed contractual terms with each customer and is not subject to variability.


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2023		2022		2023		2022
At a point in time		47,899		44,114		126,492		124,261
Over time		1,638		2,633		4,506		5,473
		49,537		46,747		130,998		129,734

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

Contract Liabilities


	As at
	September 30, 2023		December 31, 2022		December 31, 2021
Customer deposits		6,396		4,458		1,959
Deferred revenue		347		408		461
Contract liabilities		6,743		4,866		2,420

Contract liabilities primarily relate to deposits received from customers and maintenance revenue from license subscriptions. The balance of contract liabilities was higher as at September 30, 2023 compared to December 31, 2022 mainly due to the timing of orders and payments. Contract liabilities as at December 31, 2022 and 2021, respectively, totaling $4.8 million and $2.4 million were recognized as revenue during the nine months ended September 30, 2023 and 2022, 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,
	2023		2022		2023		2022
Commercial		31,272		31,796		82,154		85,458
Healthcare		8,483		3,638		25,111		15,693
Government		4,606		3,358		10,581		11,680
Education		3,538		5,322		8,646		11,430
License fees from Construction Partners		196		193		613		588
Total product and transportation revenue		48,095		44,307		127,105		124,849
Installation and other services		1,442		2,440		3,893		4,885
		49,537		46,747		130,998		129,734

13. 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. 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,
	2023		2022		2023		2022
Canada		5,665		7,191		14,577		19,859
U.S.		43,872		39,556		116,421		109,875
		49,537		46,747		130,998		129,734

Non-current assets


	As at
	September 30, 2023		December 31, 2022
Canada		30,396		28,251
U.S.		32,433		53,277
		62,829		81,528

14. INCOME TAXES

As at September 30, 2023, the Company had a valuation allowance of $33.4 million against deferred tax assets as the Company has experienced cumulative losses in recent years (December 31, 2022 – $29.8 million).

15. COMMITMENTS

As at September 30, 2023, the Company had outstanding purchase obligations of approximately $4.2 million related to inventory and property, plant and equipment purchases (December 31, 2022 – $2.2 million). As at September 30, 2023, the Company had undiscounted operating lease liabilities of $46.0 million (December 31, 2022 – $48.7 million). The decrease in undiscounted operating lease liabilities from June 30, 2023 ($61.2 million) was related to a modification on the Rock Hill Facility lease liability, as DIRTT no longer assumes the two 5-year extension options will be exercised (refer to Note 6).

16. RELATED PARTY TRANSACTIONS

On March 15, 2023, the Company entered into a Debt Settlement Agreement (the "Debt Settlement Agreement") with 22NW Fund, LP ("22NW") and Aron English, 22NW's principal and a director of DIRTT, (together, the "22NW Group") who, collectively, beneficially owned approximately 19.5% of the Company's issued and outstanding common shares at such time. Pursuant to the Debt Settlement Agreement, the Company agreed to reimburse the 22NW Group for the costs incurred by the 22NW Group in connection with the contested director election at the annual and special meeting of shareholders of the Company held on April 26, 2022, being approximately $1.6 million (the "Debt").

Pursuant to the Debt Settlement Agreement, the Company agreed to repay the Debt by either, or a combination of (i) a payment in cash by the Company to the 22NW Group, and/or (ii) the issuance of equity securities of the Company to the 22NW Group.

In connection with the Debt Settlement Agreement, on March 15, 2023, the Company entered into a share issuance agreement with the 22NW Group, pursuant to which the Company agreed to repay the Debt with the issuance to the 22NW Group of 3,899,745 common shares at a deemed price of $0.40 per common share, subject to approval by the Company’s shareholders.

At the annual general and special meeting of shareholders held on May 30, 2023, shareholders voted to approve the issuance of common shares to 22NW Group, and on June 2, 2023, the Company issued 3,899,745 common shares to 22NW Group as repayment for the Debt. Upon settlement, the debt was revalued at the higher of the deemed price of $0.40 per common share and the May 30, 2023 market price of $0.38 per common share resulting in a recovery from the balance recorded at March 31, 2023 which had been valued at a price of $0.53 per common share.

Other related party transactions for the three and nine months ended September 30, 2023, relate to the sale of DIRTT products and services to the 22NW Group for $nil and $0.3 million, respectively (2022 – $nil). The sale to 22NW Group was based on price lists in force and terms that are available to all employees.

As at September 30, 2023, C$18.9 million and C$13.6 million of the January Debentures and December Debentures, respectively, are held by 22NW Group. Interest accrued on the debentures for the three months ended September 30, 2023 is $0.4 million (2022 – $nil). Interest is earned on terms applicable to all Debenture holders.

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

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, including AWI which owns a 50% interest in the rights, title and interests in all the intellectual property rights in a portion of the ICE Software that is used by AWI.

Key Third Quarter Highlights

•

Revenue for the quarter ended September 30, 2023 was $49.5 million, an increase of $2.8 million or 6% from $46.7 million for the same period in 2022, and a $4.8 million or 11% increase from the second quarter of 2023. Compared to the same period in 2022, the increase in revenue was primarily driven by an increase in pricing, as well as volume growth in Healthcare and Government sectors. Compared to the first and second quarter of 2023, third quarter activity was higher, in line with seasonal demand patterns and timing of project schedules.

•

Gross profit and gross profit margin for the quarter ended September 30, 2023 was $17.1 million or 34.4% of revenue, an increase of $10.1 million or 144% from $7.0 million or 15.0% of revenue for the quarter ended September 30, 2022. Adjusted Gross Profit (see “– Non-GAAP Financial Measures”) for the three months ended September 30, 2023 was $18.3 million. This represents an $8.2 million or 80% increase over the comparative period in 2022 and a $2.1 million or 13% increase from the second quarter of 2023. Adjusted Gross Profit Margin (see “– Non-GAAP Financial Measures”) for the third quarter of 2023 was 36.9%, a 1,520 bps improvement over the comparative period and a 70 bps improvement from the second quarter of 2023. The increase in Adjusted Gross Profit and Adjusted Gross Profit Margin compared to the previous and comparative quarters is due to having better leverage over fixed costs through price increases and reduced fixed costs.

•

Net loss for the third quarter of 2023 was $6.3 million compared to a $6.7 million net loss for the same period of 2022. The lower net loss is primarily the result of the higher gross profit margin of $10.1 million (as explained above), a $2.2 million increase in operating expenses including the $8.0 impairment charge on the Rock Hill Facility, offset by a $3.1 million reduction in reorganization costs, a $0.1 million increase in interest income and $0.1 million decrease in interest expense, offset by a $0.5 million decrease in foreign exchange gain and a $7.1 million government subsidy in 2022 that did not recur.

•

During the third quarter of 2023, we announced the permanent closure of the Rock Hill Facility. This facility had been temporarily suspended since August 2022. With annual production capacity at DIRTT facilities in Savannah, Georgia and Calgary, Alberta, of approximately $400 million in annual revenue, the closure is part of DIRTT’s ongoing focus on realigning the organization, increasing efficiency, and improving profitability. Non-cash impairment charges related to Rock Hill Facility equipment of $8.0 million has been recorded in the three months ended September 30, 2023.

•

Adjusted EBITDA (see “– Non-GAAP Financial Measures”) for the third quarter of 2023 was $5.3 million or 10.6%, an improvement of $10.7 million from a $5.4 million loss or (11.6)% for the third quarter of

2022. This improvement was driven by the price increases and improved product mix, as well as the cost reduction measures taken by the Company over the past twenty four months.

•

Approximately $1.9 million of cash was generated by operating activities in the third quarter of 2023 compared to $10.7 million of cash used in the third quarter of 2022, with cash increasing $0.6 million overall in the third quarter of 2023. Our cash flow has improved compared to earlier quarters due to improved gross margin, our cost reduction initiatives, strategic actions and careful working capital management.

In the first quarter of 2023, we changed our methodology for calculating and disclosing our forward twelve month pipeline. We are now disclosing qualified leads, defined as quantity of projects being pursued, and our pipeline, defined as working with an engaged client on assessment of DIRTT as a prefabricated interior solution provider. We have begun using these new measures as they better measure expected near term performance given our operating environment has been prone to change due to macroeconomic factors such as worksite labor availability, interest rate changes, and potential recessionary impacts on construction projects.

As of October 1, 2023, our twelve month forward pipeline is projecting a 9% growth year on year and a 15% growth from January 1, 2023, illustrated in the table below.


	As at
	October 1, 2023		January 1, 2023		% Change			October 1, 2022		% Change
Twelve Month Forward Pipeline ($ 000s)
Commercial		192,773		141,293		36	%		146,306		32	%
Healthcare		39,230		55,719		(30	%)		67,008		(41	%)
Government		34,866		32,313		8	%		28,526		22	%
Education		16,235		17,201		(6	%)		17,524		(7	%)
		283,104		246,526		15	%		259,364		9	%
Leads (#)		999		721		39	%		678		47	%

Our Commercial segment has benefited from our positioning in Texas and Alberta and exposure to the energy sector. Our healthcare segment pipeline has returned to growth from the previous quarter after delivering several large healthcare projects. Due to the extended sales cycle of healthcare projects our twelve month pipeline experiences higher volatility than our other segments. Our full pipeline for healthcare projects continues to experience growth.

We are cautious on the timing of our Government and Education pipeline in the forward twelve months due to the uncertainty and risk of a potential U.S. federal government shutdown. We continue to increase our penetration in K-12 education and grow a higher education presence in our Central and Southern regions.

We are constantly scrutinizing our pipeline and believe that our commercial initiatives are reflected in the increased pipeline size and lead activity.

Outlook

Through the first six months of 2023, we experienced continued volatility in economic conditions, especially in regions with concentrated sales to the technology and banking sectors. These conditions included layoffs in the technology sector, reduction in short-term needs for office space, and increasing interest rates impacting borrowings, resulting in certain projects that were planned earlier in the year being deferred or canceled. We note that we are exiting our seasonally strongest quarter and are entering our typically weaker winter period.

In response and as discussed in our previous quarterly reports on Form 10-Q, we identified and took action to reduce annualized overhead costs by $5.0 million during the first quarter of 2023. Further, on May 8, 2023, the Company reduced its salaried workforce, resulting in annualized savings of $2.6 million. One-time costs associated with these reductions, incurred in the second quarter of 2023, were approximately $0.7 million.

The trend of economic uncertainty has continued into the third quarter of 2023. The conversation on “return to work” continues as some companies are mandating a hybrid “return to work” policy. Various inflation metrics have improved over the three months ended September 30, 2023, although there is no guarantee they will continue to do so.

We believe that wider macroeconomic conditions indicate we are in an uncertain late cycle environment with the near-term potential for deteriorating macroeconomic conditions. The increase in long term interest rates can potentially reduce demand for capital intensive projects in our Commercial, Healthcare, and Education segments. The AIA/Deltek Architecture Billings Index fell into contraction across all geographies in September. Regardless, we continue to focus on what is within our control: supporting our current partners, increasing penetration in targeted geographies, onboarding new Construction Partners, and new strategic partnerships. While we are benefiting from price stability in our input costs as well as a strengthening U.S. dollar, recent unrest in the Middle East may adversely impact our gross margins, and could further impact our pipeline, should energy prices return to 2022 levels.

We have made hard choices and meaningfully reduced our cost footprint and made great progress lowering our estimated revenue breakeven point. We will continue to evaluate our cost structure and respond to the inflationary impacts to labor, materials and services in an efficient manner consistent with our goal to maintain future healthy gross profit and Adjusted EBITDA margins while improving our future liquidity.

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, one-time non-recurring charges or gains (such as gain on sale of software and patents), 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 charges 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 charges; reorganization expenses; stock-based compensation expense; government subsidies; one-time, non-recurring charges and gains; 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, 2023, Compared to the Three and Nine Months Ended September 30, 2022


	For the Three Months Ended September 30,									For the Nine Months Ended September 30,
	2023			2022			% Change			2023			2022			% Change
	($ in thousands)									($ in thousands)
Revenue		49,537			46,747			6			130,998			129,734			1
Gross Profit(1)		17,065			7,008			144			40,304			16,571			143
Gross Profit Margin		34.4	%		15.0	%					30.8	%		12.8	%
Operating Expenses
Sales and Marketing		6,161			6,089			1			18,302			21,094			(13	)
General and Administrative		4,669			6,542			(29	)		16,003			21,412			(25	)
Operations Support		1,752			2,321			(25	)		5,564			7,347			(24	)
Technology and Development		1,239			1,695			(27	)		4,055			5,714			(29	)
Stock-Based Compensation		1,069			918			16			2,543			3,546			(28	)
Reorganization		321			3,426			(91	)		2,857			12,281			(77	)
Impairment charge on Rock Hill Facility		7,952			-			100			7,952			-			100
Related Party Expense		-			-		NA				1,524			-			100
Total Operating Expenses		23,163			20,991			10			58,800			71,394			(18	)
Operating Loss		(6,098	)		(13,983	)		(56	)		(18,496	)		(54,823	)		(66	)
Operating Margin		(12.3	)%		(29.9	)%					(14.1	)%		(42.3	)%
Government subsidies		-			7,141			(100	)		236			7,765			(97	)
Gain on sale of software and patents		-			-		NA				6,145			-			100
Foreign exchange (loss) gain		822			1,356			(39	)		(59	)		1,870			(103	)
Interest income		161			19			747			271			50			442
Interest expense		(1,196	)		(1,276	)		(6	)		(3,636	)		(3,935	)		(8	)
		(213	)		7,240			103			2,957			5,750			(49	)
Net loss before tax		(6,311	)		(6,743	)		6			(15,539	)		(49,073	)		68
Current and deferred income tax recovery		-			(16	)		100			-			(16	)		100
		-			(16	)		100			-			(16	)		100
Net loss		(6,311	)		(6,727	)		6			(15,539	)		(49,057	)		68
(1) For the three and nine months ended September 30, 2022, $1.0 million primarily related to the write off of inventory of discounted 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,
	2023		2022		% Change			2023		2022		% Change
	($ in thousands)							($ in thousands)
Product		43,132		39,092		10			113,323		110,383		3
Transportation		4,767		5,022		(5	)		13,169		13,878		(5	)
License fees from Construction Partners		196		193		2			613		588		4
Total product revenue		48,095		44,307		9			127,105		124,849		2
Installation and other services		1,442		2,440		(41	)		3,893		4,885		(20	)
		49,537		46,747		6			130,998		129,734		1

Beginning in 2020, we experienced significant increases in nearly all of our material input costs, including raw materials, shipping materials, labor, and freight. This led to significant gross margin compression in 2021 and 2022. Effective November 16, 2021, DIRTT increased product and transportation prices on new projects by approximately 6.5%. 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. These increases have improved revenue and profitability through better recovery of the material input costs previously discussed.

Revenue for the nine months ended September 30, 2023, was $131.0 million, an increase of $1.3 million compared to $129.7 million in the comparative period of 2022. The first nine months of 2023 were impacted by macroeconomic conditions, including layoffs in the tech sector and rising interest rates, both of which have had an impact on our pipeline. For example, one large project with a customer in the technology sector that was originally scheduled for the first quarter of 2023 was deferred indefinitely. During the quarter ended September 30, 2023, revenue was $49.5 million, an increase of $2.8 million compared to the comparative period of 2022 of $46.7 million.

Installation and other services revenue was $1.4 million for the quarter ended September 30, 2023 compared to $2.4 million in the quarter ended September 30, 2022, and $3.9 million in the nine months ended September 30, 2023 compared to $4.9 million in the same period of 2022. 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, 2023, we had 71 (September 30, 2022: 69; December 31, 2022: 67) Construction Partners servicing multiple locations. During the nine months ended September 30, 2023, we announced the expansion of seven of our DIRTT Construction Partners into new markets as we expand the reach of DIRTT products in North America.

We periodically analyze our revenue growth by vertical markets in the defined markets of commercial, healthcare, government and education. While the commercial sector has been challenged by the macroeconomic factors discussed previously, we are seeing increased growth in our healthcare sector, as an increase in new construction starts and the heightened need for adaptability and flexibility in the years after COVID-19 have increased the demand for our products. We continue to see growth opportunities in the government and education sectors and have restructured our sales leadership function, prioritizing oversight of these verticals.

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,
	2023		2022		% Change			2023		2022		% Change
	($ in thousands)							($ in thousands)
Commercial		31,272		31,796		(2	)		82,154		85,458		(4	)
Healthcare		8,483		3,638		133			25,111		15,693		60
Government		4,606		3,358		37			10,581		11,680		(9	)
Education		3,538		5,322		(34	)		8,646		11,430		(24	)
License fees from Construction Partners		196		193		2			613		588		4
Total product revenue		48,095		44,307		9			127,105		124,849		2
Service revenue		1,442		2,440		(41	)		3,893		4,885		(20	)
		49,537		46,747		6			130,998		129,734		1


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2023		2022		2023		2022
	(in %)				(in %)
Commercial		65		72		65		69
Healthcare		18		8		20		13
Government		10		8		8		9
Education		7		12		7		9
Total Product Revenue(1)		100		100		100		100

(1) Excludes license fees from Construction Partners.

Commercial revenues decreased by 2% from the prior year period. Healthcare revenues increased by 133% in the third quarter of 2023 from the same period of 2022. The quarter ended September 30, 2023 includes $2.1 million of revenue from a large healthcare customer. 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. Government revenues in the third quarter of 2023 increased by 37% from the prior year period. Similar to healthcare, government revenues tend to be larger individual projects. Education sales in the third quarter of 2023 decreased 34% from the same period of 2022. The education sector included a higher magnitude of smaller projects in the third quarter of 2023 than in the third quarter of 2022.

For the nine months ended September 30, 2023 commercial revenues decreased by 4% from the prior year period. Healthcare revenues increased by 60% in the first nine months of 2023 from the same period of 2022. Government revenues decreased by 9% from the prior year period. Education sales for the nine months ended September 30, 2023 were down 24% from 2022. Both the healthcare and education sectors included a higher magnitude of smaller projects in 2023 than 2022.

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,
	2023		2022		% Change			2023		2022		% Change
	($ in thousands)							($ in thousands)
Canada		5,665		7,191		(21	)		14,577		19,859		(27	)
U.S.		43,872		39,556		11			116,421		109,875		6
		49,537		46,747		6			130,998		129,734		1

Historically, approximately 15-25% and 75-85% of revenues are derived from sales to Canada and the United States, respectively. The third quarter of 2023 included a higher volume of sales to customers in the United States compared to Canada resulting in 11% of sales to Canada with the rest in the United States.

Sales and Marketing Expenses

Sales and marketing expenses increased by $0.1 million to $6.2 million for the three months ended September 30, 2023, from $6.1 million for the three months ended September 30, 2022. The increase was driven by higher commissions costs offset by lower travel and entertainment costs, marketing costs, and building expenses.

Sales and marketing expenses decreased by $2.8 million to $18.3 million for the nine months ended September 30, 2023 from $21.1 million from the same period of 2022. The decreases were largely related to a realignment of back office support and territory coverage and cost structure with current demand levels.

General and Administrative Expenses

General and administrative expenses decreased by $1.9 million to $4.7 million for the three months ended September 30, 2023 from $6.5 million for the three months ended September 30, 2022. The decrease was primarily related to a decrease in professional services costs of $1.0 million, a $0.2 million decrease in office costs, a $0.2 million decrease in communications costs and a $0.5 million decrease in salaries and benefits costs associated with the planned headcount reductions as part of our cost reduction initiatives.

For the nine months ended September 30, 2023, general and administrative expenses decreased by $5.4 million to $16.0 million from $21.4 million driven by a $4.1 million reduction in professional services costs, which included $1.8 million related to the costs of the contested director elections, a $0.6 million reduction in office and communication costs and a $0.7 million reduction in depreciation.

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 $0.6 million from $2.3 million for the three months ended September 30, 2022 to $1.8 million for the three months ended September 30, 2023. The decrease was primarily due to a $0.4 million decrease in salaries and benefits costs associated with the planned headcount reductions as part of our cost reduction initiatives. Operations support expenses decreased $1.8 million for the nine months ended September 30, 2023 to $5.6 million from $7.3 million in the same period of 2022 mostly related to a $1.6 million decrease in salaries and benefits costs.

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 decreased by $0.5 million to $1.2 million for the three months ended September 30, 2023, compared to $1.7 million for the three months ended September 30, 2022, primarily related to decreased salaries and benefits costs associated with the planned headcount reductions as part of our cost reduction initiatives. For the nine months ended September 30, 2023, technology and development costs decreased by $1.7 million to $4.1 million from $5.7 million in the same period of 2022 related to a decrease in salaries and benefits costs and an increase in capitalized software development costs.

Stock-Based Compensation

Stock-based compensation expense for the three and nine months ended September 30, 2023 was $1.1 million and $2.5 million, respectively, compared to $0.9 million and $3.5 million in the same periods of 2022. The movement in this expense was largely due to grants of RSUs and share awards which occurred in the first quarter of 2022 but in 2023 were granted in the second quarter. Grants for RSUs in lieu of cash compensation to the Company’s interim Chief Executive Officer in 2022 were not repeated in 2023. DSUs were granted to the Board of Directors, but was offset by the impact of fair value adjustments on cash settled awards as a result of our share price decreasing during the nine months ended September 30, 2023.

Reorganization

Reorganization expenses for the quarter of $0.3 million decreased from $3.4 million in the prior period. Current quarter costs relate primarily to movement of inventory from the Rock Hill Facility and termination costs associated with actions taken to streamline our back office and operational support functions, as discussed herein and in our quarterly reports on Form 10-Q for the periods ended March 31, 2023 and June 30, 2023, which are expected to contribute $2.6 million in annualized savings. Second quarter of 2022 reorganization costs were driven by the closure of Phoenix Facility and the one-time costs associated with a reduction of salaried workforce and two executives.

Reorganization costs decreased to $2.9 million for the nine months ended September 30, 2023 from $12.3 million for the same period of 2022. Nine month costs in 2023 relate primarily to termination costs and costs to move materials from Rock Hill to Calgary, while the costs in 2022 relate to expenditures in closing the Phoenix Facility and costs associated with workforce reductions and changes in management.

Impairment charge on Rock Hill Facility

On September 27, 2023, the Company decided to permanently close the Rock Hill Facility in South Carolina. The Company reassessed the useful lives of the manufacturing equipment resulting in an $8.0 million impairment charge in the three and nine months ended September 30, 2023 ($nil for the three and nine months ended September 30, 2022) to reduce the assets to their fair value less costs to sell certain assets being held for sale.

Related Party Expense

On March 15, 2023, the Company entered into a Debt Settlement Agreement (the "Debt Settlement Agreement") with 22NW Fund, LP ("22NW") and Aron English, 22NW's principal and a director of DIRTT, (together, the "22NW Group") who, collectively, beneficially owned approximately 19.5% of the Company’s issued and outstanding common shares at such time. Pursuant to the Debt Settlement Agreement, the Company agreed to reimburse the 22NW Group for the costs incurred by the 22NW Group in connection with the contested director election at the annual and special meeting of shareholders of the Company held on April 26, 2022, being $1.6 million (the "Debt").

At the annual general and special meeting of shareholders held on May 30, 2023 shareholders voted to approve the issuance of common shares, and on June 2, 2023, the Company issued 3,899,745 common shares to 22NW Group as repayment for the Debt. Upon settlement, the debt was revalued at the higher of the deemed price of $0.40 per common share and the May 30, 2023 market price of $0.38 per common share resulting in a recovery from the balance recorded at March 31, 2023 which had been valued at a price of $0.53 per common share.

Government Subsidies

The Company was not eligible and did not receive any new government subsidies in the quarter ended September 30, 2023. The Company received $0.2 million of interest with the collection of the ERC during the nine months ended September 30, 2023.

Pursuant to amendments enacted as part of the 2021 Canadian federal budget, the Company was required to repay a portion of the Canadian Emergency Wage Subsidy ("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 expected to be returned to the Canadian authorities in the second quarter of 2022. The amount was fully provided for in the third quarter of 2021 and in the first quarter of 2022 and the Company reversed a $0.6 million incremental provision related to this that was no longer necessary.

Gain on sale of software and patents

On May 9, 2023, we entered into the Co-Ownership Agreement and Partial Patent Assignment Agreement with AWI. The agreements provide for a cash payment from AWI to the Company of $10.0 million, subject to certain routine closing conditions, in exchange for the partial assignment to AWI and resulting co-ownership of a 50% interest in the rights, title and interests in certain intellectual property rights in a portion of the ICE software that is used by AWI (the “Applicable ICE Code”), including a 50% interest in the patent rights that relate to the Applicable ICE Code. We also agreed under the Co-Ownership Agreement to provide AWI a transfer of knowledge concerning the source code of the Applicable ICE Code. In exchange for completing the knowledge transfer, we will receive an additional cash payment of $1.0 million, which is expected to be received by early 2024. The Co-Ownership Agreement provides that we and AWI have separate exclusive fields of use and restrictive covenants with respect to the Applicable ICE Code and related intellectual property which survive until either party elects to separate from its relationship with the other and for five years thereafter. We concurrently entered into the ARMSA with AWI, under which AWI has also prepaid for certain development services to be provided by DIRTT. The ARMSA will automatically terminate if the Co-Ownership Agreement is terminated or expires, and may also be terminated if either party breaches the exclusive fields of use or restrictive covenants in the Co-Ownership Agreement.

The $10.0 million of proceeds from the Co-Ownership Agreement was received during the second quarter of 2023. In accordance with US GAAP, the proceeds were first applied to the net book value of the related cost of software and patents (other assets) and the residual amount of $6.1 million was recognized as a gain in the consolidated statement of operations. Further, $0.9 million was received during the quarter ended June 30, 2023 as prepayment under the ARMSA. Part of the proceeds of this transaction were used to settle one of our equipment leases of $1.6 million and resulted in the release of $0.4 million of restricted cash.

Interest Expense

Interest expense decreased by $0.1 million from $1.3 million in the quarter ended September 30, 2022 to $1.2 million in the quarter ended September 30, 2023 and by $0.3 million for the nine months ended September 30, 2023 to $3.6 million due to foreign exchange impacts and the decrease in equipment lease balances due to principal repayments.

Income Tax

The provision for income taxes comprises U.S. and Canadian federal, state and provincial taxes based on pre-tax income. As at September 30, 2023 the Company had a valuation allowance of $33.4 million (December 31, 2022: $29.8 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, 2023, we had C$110.9

million of non-capital loss carry-forwards in Canada and $55.7 million in the United States. These loss carry-forwards will begin to expire in 2032.

Net Loss

Net loss decreased to a $6.3 million loss or $0.06 net loss per share in the three months ended September 30, 2023 from a net loss of $6.7 million or a $0.08 net loss per share for the three months ended September 30, 2022. The lower net loss is primarily the result of the higher gross profit margin of $10.1 million, a $2.2 million increase in operating expenses (including an $8.0 million impairment charge on the closure of the Rock Hill Facility, offset by a $3.1 million reduction in reorganization costs), a $0.1 million increase in interest income and $0.1 million decrease in interest expense, offset by a $0.5 million decrease in foreign exchange gain and a $7.1 million government subsidy in 2022 that did not recur.

Net loss decreased to $15.5 million or $0.15 net loss per share in the nine months ended September 30, 2023 from a net loss of $49.1 million or $0.57 net loss per share for the nine months ended September 30, 2022. The decreased loss is primarily the result of a $23.7 million increase in gross profit, a $12.6 million decrease in operating expenses (including a $9.4 million decrease in reorganization expenses, and a decrease of $1.8 million of incremental professional fees offset by an $8.0 million impairment charge on the Rock Hill Facility, as described previously), a one-time gain of $6.1 million on the sale of software and patents, a $0.3 million decrease in interest expense, a $0.2 million increase in interest income, offset by a $1.9 million increase in foreign exchange loss and a $7.5 million decrease in government subsidies.

EBITDA and Adjusted EBITDA for the Three and Nine Months Ended September 30, 2023 and 2022

The following table presents a reconciliation for the results of the three and nine months ended September 30, 2023 and 2022 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,
	2023			2022			2023			2022
	($ in thousands)						($ in thousands)
Net loss for the period		(6,311	)		(6,727	)		(15,539	)		(49,057	)
Add back (deduct):
Interest expense		1,196			1,276			3,636			3,935
Interest income		(161	)		(19	)		(271	)		(50	)
Income tax recovery		-			(16	)		-			(16	)
Depreciation and amortization		2,017			4,236			7,216			12,202
EBITDA		(3,259	)		(1,250	)		(4,958	)		(32,986	)
Foreign exchange (gain) loss		(822	)		(1,356	)		59			(1,870	)
Stock-based compensation		1,069			918			2,543			3,546
Government subsidies		-			(7,141	)		(236	)		(7,765	)
Related party expense (2)		-			-			1,524			-
Reorganization expense		321			3,426			2,857			12,281
Gain on sale of software and patents(3)		-			-			(6,145	)		-
Impairment charge on Rock Hill Facility (3)		7,952			-			7,952			-
Adjusted EBITDA		5,261			(5,403	)		3,596			(26,794	)
Net Loss Margin(1)		(12.7	)%		(14.4	)%		(11.9	)%		(37.8	)%
Adjusted EBITDA Margin		10.6	%		(11.6	)%		2.7	%		(20.7	)%

(1) Net loss divided by revenue.

(2) The related party transaction is a non-recurring transaction that is not core to our business and is excluded from the Adjusted EBITDA calculation (Refer to Note 16 of the consolidated interim financial statements).

(3) The gain on sale of software and patents is a non-recurring transaction and the impairment charge on Rock Hill Facility are not core to our business and are excluded from the Adjusted EBITDA calculation (Refer to Note 7 and Note 6, respectively, of the consolidated interim financial statements).

For the three months ended September 30, 2023, Adjusted EBITDA and Adjusted EBITDA Margin increased by $10.7 million to $5.3 million or 10.6% from a $5.4 million loss or (11.6)% in the same period of 2022. This primarily reflects an $8.2 million increase in Adjusted Gross Profit, a decrease of $1.0 million of professional fees, a $1.1 million decrease in salaries and benefits costs, a $0.6 million decrease in office, building and communication costs, and a $0.3 million decrease in travel and entertainment costs in the quarter, offset by a $0.5 million increase in commissions.

For the nine months ended September 30, 2023, Adjusted EBITDA and Adjusted EBITDA Margin increased by $30.4 million to $3.6 million or 2.7% from a $26.8 million loss or (20.7)% in the same period of 2022. This primarily reflects a $19.6 million increase in Adjusted Gross Profit, a decrease of $4.1 million of professional fees, a $5.1 million decrease in salaries and benefits costs, a $0.8 million decrease in travel and entertainment costs, a $0.6 million decrease in marketing costs and a $1.2 million decrease in building, office and communications costs.

Adjusted Gross Profit and Adjusted Gross Profit Margin for the Three and Nine Months Ended September 30, 2023 and 2022

The following table presents a reconciliation for the three and nine months ended September 30, 2023 and 2022 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,
	2023			2022			2023			2022
	($ in thousands)						($ in thousands)
Gross profit		17,065			7,008			40,304			16,571
Gross profit margin		34.4	%		15.0	%		30.8	%		12.8	%
Add: Depreciation and amortization expense		1,231			3,132			4,656			8,792
Adjusted Gross Profit		18,296			10,140			44,960			25,363
Adjusted Gross Profit Margin		36.9	%		21.7	%		34.3	%		19.6	%

For the quarter ended September 30, 2023, gross profit and gross profit margin increased to $17.1 million or 34.4% from $7.0 million or 15.0% for the prior period. Adjusted Gross Profit and Adjusted Gross Profit Margin increased 80% to $18.3 million or 36.9% for the three months ended September 30, 2023, from $10.1 million or 21.7% for the three months ended September 30, 2022.

For the nine months ended September 30, 2023, gross profit and gross profit margin increased to $40.3 million or 30.8% from $16.6 million or 12.8% for the prior period. Adjusted Gross Profit and Adjusted Gross Profit Margin increased 77% to $45.0 million or 34.3% for the nine months ended September 30, 2023, from $25.4 million or 19.6% for the nine months ended September 30, 2022. Gross profit for the nine months ended September 30, 2022 included $1.1 million of accelerated depreciation and amortization arising from the change in useful lives of the Phoenix Facility's equipment.

The improvement in Adjusted Gross Profit was a result of improved product mix, a reduction in fixed costs, management of labor hours throughout the period and the impact of the price increases to offset the inflationary impacts on material costs. Labor decreased $0.7 million and $4.0 million and fixed costs decreased $1.1 million and $2.9 million, respectively, for the quarter and nine months ended September 30, 2023 as we closed our Phoenix Facility during the second quarter of 2022 and temporarily suspended operations in our Rock Hill Facility in the third quarter of 2022, as well as cost reduction initiatives taken impacting our overheads. Idle facility costs incurred to the suspension of operations at the Rock Hill Facility of $0.4 million and $1.4 million for the three and nine months ended September 30, 2023, respectively, and are included in cost of sales.

Liquidity and Capital Resources

As at September 30, 2023, the Company had $19.5 million of cash on hand and C$14.6 million ($10.8 million) of available borrowings, compared to $10.8 million of cash on hand and C$7.2 million ($5.3 million) of available borrowings as at December 31, 2022. Through the first nine months of fiscal 2023, the Company generated $4.7

million in cash flow from operations, compared to a cash usage of $47.5 million over the first nine months of fiscal 2022. The Company benefited from the receipt of $7.3 million of government subsidies during the first half of 2023.

We have implemented multiple price increases to mitigate the impact of inflation on raw materials and improve liquidity during the past two years. These actions have resulted in a meaningful improvement in our gross profit margins and higher net profit and have served to stabilize our cash usage to operate the business. Gross profit for the nine months ended September 30, 2023 was $40.3 million, or 30.8% compared to the same period of 2022, which generated gross profit of $16.6 million, or 12.8%.

Over the past twelve months, we have executed upon several initiatives to improve liquidity. First, in May 2023, we entered into an agreement with AWI resulting in the receipt of $10.9 million of cash. Second, during March 2023, we entered into an agreement to sublease our Dallas “DXC” to one of our Construction Partners in that region. Under the sublease agreement, the subtenant has assumed responsibility for the monthly rent, utilities, maintenance, taxes and other costs as of April 1, 2023, through December 31, 2024, providing us annualized savings of approximately $1 million. We are continuing to evaluate other properties for sale and leaseback or sublease opportunities, including our Rock Hill Facility and expect these strategic initiatives to result in positive cash inflows in 2023 and 2024. Third, we completed a Private Placement (as defined herein) of common shares in November 2022, with certain significant shareholders and directors and officers of the Company to bridge cash requirements before the completion and closing of the noted 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 8.7 million shares for gross consideration of $2.8 million (the "Private Placement"). The Private Placement closed on November 30, 2022. In addition, in connection with the Private Placement, 22NW and 726, or their principals, have irrevocably committed to backstopping any rights offering occurring by the Company within twelve months of closing the Private Placement in the aggregate amount of $2.0 million.

While we are encouraged by the improved profitability and cash flow, we have continued to evaluate our fixed cost structure and overhead in light of recent macroeconomic uncertainty. We have implemented multiple restructuring initiatives designed to align our cost structure with current expected levels of demand. In addition, the Company has reduced headcount by 154 employees, or approximately 16% from January 2022 through September 2023. The reduced overhead has served to offset the impact from the macroeconomic headwinds experienced over the past year.

Furthermore, the Company is evaluating a rights offering to raise additional capital, as described in the registration statement on Form S-1, filed on October 26, 2023 (File No. 333-275172) (the “S-1”) with the SEC (the “Rights Offering”), the proceeds of which, if pursued, are expected to be used for general corporate purposes, which may include investments in our business, funding potential future cash needs or operating losses, funding working capital and capital expenditure needs, or reductions to our outstanding indebtedness.

We have assessed the Company’s liquidity as at September 30, 2023 taking into account our sales outlook for the next twelve months, our existing cash balances and available credit facilities and expected early settlements related to our Rock Hill Facility equipment lease. Based upon this analysis, we believe the Company has sufficient liquidity to remain a going concern for at least the next twelve months. However, a number of factors, including the macroeconomic factors discussed above could adversely impact our liquidity over such period.

To the extent that existing cash and cash equivalents and available facilities 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 believe we can access capital markets when needed or under acceptable terms, there can be no assurance we will be able to do so.

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. As at September 30, 2023, C$18.9 million of the January Debentures are held by a related party,

22NW. 22NW holds approximately 22.1% of our issued and outstanding common stock as of October 25, 2023. Aron English, manager of 22NW Fund GP, LLC, the general partner of 22NW, is a director 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. On February 9, 2023, the Company extended the RBC Facility. The Extended RBC Facility has a borrowing base of C$15 million and a one year term. Available borrowings under the Extended RBC Facility at September 30, 2023 were C$14.6 million ($10.8 million).

On December 1, 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. As at September 30, 2023, C$13.6 million of the December Debentures are held by a related party, 22NW.

The Company has a C$5.0 million Canada Leasing Facility of which C$4.4 million ($3.3 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. In connection with the Company’s decision to close the Rock Hill Facility, we intend to settle the liability related to the U.S. Leasing Facility of $8.2 million in the next twelve months. With the settlement of this liability, we expect approximately $2.6 million to be released from restricted cash. On October 31, 2023, the Company paid off $1.0 million of the U.S. Leasing Facility.

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,
	2023			2022			2023			2022
	($ in thousands)						($ in thousands)
Net cash flows provided by (used in) operating activities		1,919			(10,667	)		4,687			(47,509	)
Net cash flows provided by (used in) investing activities		(658	)		(644	)		7,089			(3,595	)
Net cash flows used in financing activities		(551	)		(912	)		(3,412	)		(1,802	)
Effect of foreign exchange on cash, cash equivalents and restricted cash		(117	)		(293	)		(166	)		(73	)
Net increase (decrease) in cash, cash equivalents and restricted cash		593			(12,516	)		8,198			(52,979	)
Cash, cash equivalents and restricted cash, beginning of period		21,844			22,945			14,239			63,408
Cash, cash equivalents and restricted cash, end of period		22,437			10,429			22,437			10,429

Operating Activities

Net cash flows provided by operating activities were $1.9 million for the three months ended September 30, 2023 compared to $10.7 million used in the same period of 2022. The improvement in cash flows used in operations is largely due to the $10.7 million increase in Adjusted EBITDA and a $3.1 million decrease in reorganization expenses offset by a $1.7 million increase in working capital excluding the $7.1 million receivable for government subsidies impacting the third quarter of 2022.

Net cash flows provided by operating activities were $4.7 million for the nine months ended September 30, 2023 compared to $47.5 million used in the same period of 2022. The improved cash flows from operations was driven by the $30.4 million increase in Adjusted EBITDA, a $9.4 million decrease in reorganization expenses, and a $19.0 million net decrease in working capital comprising $11.7 million decrease in routine working capital and a $7.3 million decrease in other receivables relating to the ERC claim. Through September 30, 2023, we have continued to draw down on our inventory supply built up in the first half of 2022.

Investing Activities

Cash flows provided by investing activities during the nine months ended September 30, 2023 benefited from $10.0 million of proceeds from the AWI transaction during the second quarter of 2023.

We invested $0.3 million and $1.3 million in property, plant and equipment during the three and nine months ended September 30, 2023, respectively compared to $0.4 million and $2.2 million, respectively, during the three and nine months ended September 30, 2022. This expenditure consisted of $0.3 million of information technology, $0.4 million of DXC refreshes and $0.6 million of manufacturing upgrades for the nine months ended September 30, 2023. We invested $0.4 million and $1.5 million on capitalized software during the three and nine months ended September 30, 2023, respectively, compared to $0.4 million and $1.3 million for the three and nine months ended September 30, 2022.

Financing Activities

For the three and nine months ended September 30, 2023, $0.6 million and $3.4 million of cash, respectively, was used in financing activities compared to $0.9 million and $1.8 million in the same periods of 2022. The cash used comprised mainly of $0.6 million of scheduled payments under the Leasing Facilities for both periods. During the second quarter of 2023, an additional $1.6 million principal repayment was made against the Canadian Leasing Facility. This payment was required by RBC as part of their consent for the AWI transaction and resulted in the full settlement of one of the Canadian leasing agreements. In the three and nine months ended September 30, 2022, we incurred $0.3 million and $0.6 million of spend on employee tax payments on vesting of RSUs compared to $nil and $0.03 million in the same period of 2023.

We currently expect to fund anticipated future investments with available cash and drawings on the Extended RBC Facility. To date, our strategic actions have generated cash through proceeds from the Private Placement in November 2022, the receipt of $7.3 million of government subsidy through the ERC application during the nine months ended September 30, 2023 and proceeds of $10.9 million received in the second quarter of 2023 through the AWI transaction. We continue to evaluate properties we own for sale and lease back and opportunities to sub lease available spaces. 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 and 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. 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. 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. 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.

On February 9, 2023, the Company extended the RBC Facility. The Extended RBC Facility has a borrowing base of C$15 million and a one year term. Interest is calculated at the Canadian or U.S. prime rate plus 75 basis points or at the Canadian Dollar Offered Rate or Term Secured Overnight Financing Rate ("SOFR") plus 200 basis points plus the Term SOFR Adjustment. Under the Extended RBC Facility, if the trailing twelve month FCCR is above 1.25 for three consecutive months, a cash balance equivalent to one-year's worth of Leasing Facilities payments must be maintained. At September 30, 2023, available borrowings are C$14.6 million ($10.8 million) (December 31, 2022 – $10.8 million and C$7.2 million ($5.3 million) of available borrowings), calculated in the same manner described above, of which no amounts have been drawn. The Company did not meet the three-month FCCR requirement during the third quarter of 2023, which resulted in requiring the restriction of $3.0 million of cash.

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 South Carolina Facility. The Company has drawn C$4.4 million ($3.3 million) of cash consideration under the Canada Leasing Facility and commenced the lease term for the Canadian equipment expenditures during 2020. In connection with the Company’s decision to close the Rock Hill Facility, we intend to settle the liability related to the U.S. Leasing Facility of $8.2 million in the next twelve months. With the settlement of this liability, we expect approximately $2.6 million to be released from restricted cash. On October 31, 2023, the Company paid off $1.0 million of the U.S. Leasing Facility.

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

Since our disclosure in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations” in our Annual Report on Form 10-K the following material contractual changes have occurred:

•

additional commitments related to the extension of one of our factory leases in Calgary for an additional ten years beyond the original term;

•

our entry into the Debt Settlement Agreement with the 22NW Group; and

•

the modification of our Rock Hill Facility lease.

See Note 15, “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, 2023, 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 3, “Adoption of New and Revised Accounting Standards” to our condensed consolidated interim financial statements appearing in this Quarterly Report, there were no new accounting standards adopted during the three months ended September 30, 2023. We have disclosed the accounting policy applied for the assets held for sale related to the Rock Hill Facility.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements, please refer to Note 3, “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. The Company’s cash and cash equivalents are predominantly all with one AA rated financial institution.

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, 2023. 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, 2023, 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

DIRTT is pursuing multiple lawsuits against its former founders, Mogens Smed and Barrie Loberg, as well as Falkbuilt Ltd. and Falkbuilt, Inc. (collectively, “Falkbuilt”) and related individuals and corporations. DIRTT alleges breaches of fiduciary duties and non-competition and non-solicitation covenants, and the misappropriation of its confidential and proprietary information (in violation of numerous U.S. state and federal laws pertaining to the protection of trade secrets and proprietary information and the prevention of false advertising and deceptive trade practices). Except as described below, there have been no material developments in the legal proceedings previously disclosed in our Annual Report on Form 10-K.

DIRTT’s litigation against Falkbuilt, Messrs. Smed and Loberg, and their associates is comprised of three main lawsuits: (i) an action in the Alberta Court of King’s Bench commenced on May 9, 2019 against Falkbuilt, Messrs. Smed and Loberg, and several other former DIRTT employees alleging breaches of restrictive covenants, fiduciary duties, and duties of loyalty, fidelity and confidentiality, and the misappropriation of DIRTT’s confidential information (the “Canadian Non-Compete Case”); (ii) an action in the U.S. District Court for the Northern District of Utah instituted on December 11, 2019 against Falkbuilt, Smed, and other individual and corporate defendants alleging misappropriation of DIRTT’s confidential information, trade secrets, business intelligence and customer information (the “Utah Misappropriation Case”); and (iii) an action in the U.S. District Court for the Northern District of Texas instituted on June 24, 2021 alleging that Falkbuilt has unlawfully used DIRTT’s confidential information in the United States and intentionally caused confusion in the United States in an attempt to steal customers, opportunities, and business intelligence, with the aim of establishing a competing business in the United States market (the “Texas Unfair Competition Case”). DIRTT intends to pursue the cases vigorously.

In the Canadian Non-Compete Case, on February 14, 2023, the Court of King’s Bench of Alberta granted DIRTT's application to schedule the hearing of its summary judgment application and dismissed Falkbuilt’s cross-application to strike the summary judgment application. On April 5, 2023, the parties appeared before the Associate Chief Justice of the Court of King’s Bench of Alberta for a Case Management Conference. In the Conference, the Associate Chief Justice offered the parties an expedited six-week trial on both liability and damage issues, as an alternative to DIRTT proceeding with its summary judgment application, on the condition that the parties could reach an agreement on the terms of the alternative process. The parties have not reached consensus regarding the terms of an expedited six-week trial, however, DIRTT remains fully cooperative with the Court of King’s Bench. In the meantime, DIRTT plans to aggressively pursue its summary judgment application.

In the Utah Misappropriation Case, on April 11, 2023, the United States Court of Appeals for the Tenth Circuit reversed the U.S. District Court for the Northern District of Utah’s decision that Utah was an inconvenient forum for DIRTT’s claims against Falkbuilt and others for the misappropriation of confidential information, trade secrets, business intelligence and customer information. The Utah Court had previously, and erroneously, found that DIRTT’s United States-based claims should be litigated in Canada. The Court of Appeals remanded the matter back to the Utah District Court. Falkbuilt filed motions to stay the Tenth Circuit decision pending its petition for a Writ of Certiorari to the Supreme Court of the United States. The Court of Appeals promptly denied the motion to stay. A similar motion subsequently filed with the Supreme Court of the United States on the same basis was also promptly denied. Fallkbuilt also petitioned the Supreme Court to accept review, even after losing the stay motion, that petition was also denied in early October.

The Texas Unfair Competition Case was dismissed, without prejudice, in reliance upon the now-reversed decision in the Utah Misappropriation Case, described above. DIRTT appealed that decision, and the United States Court of Appeals for the Fifth Circuit stayed the appeal pending the Tenth Circuit ruling at Falkbuilt's request. After prevailing in the Tenth Circuit, DIRTT asked Falkbuilt if it would, consistent with its prior representations, agree to remand the appeal to the Texas Court for disposition to Utah. Falkbuilt refused and DIRTT filed a Motion to Remand. The Court denied the Motion for Remand without prejudice and asked for full briefing. Argument is currently scheduled for December 7th, 2023 in New Orleans. The Court will either order the claims transferred to Utah or, if it affirms the lower court, those claims would proceed, inconveniently, in Canada. We believe it is very unlikely they would proceed in Texas as neither DIRTT or Falkbuilt currently desires that outcome.

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, 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 common shares are quoted on the OTC’s Pink® Open Market, and there may be a limited trading market in our common shares in the United States. As a result of the limited trading market, investors may experience limited liquidity, and may experience limited ability to sell shares in the open market.

Our common shares are quoted on the OTC’s Pink® Open Market under the symbol “DRTTF.” There may be a limited trading market in our common shares in the United States. As a result of the limited trading market of our common shares, investors in our common shares may experience limited demand for their shares of common shares, which may limit their ability to sell their shares in the open market.

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 4.1 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*		Executive Employment Agreement, dated August 2, 2023, by and between DIRTT Environmental Solutions Inc. and Fareeha Khan
10.2*		Indemnity Agreement, dated August 2, 2023, between DIRTT Environmental Solutions Ltd and Fareeha Khan
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

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/ Fareeha Khan
		Fareeha Khan
		Chief Financial Officer (Duly Authorized Officer, Principal Financial Officer and Principal Accounting Officer)

Date: November 9, 2023