DIRTT Environmental Solutions Ltd. - Interim / Quarterly Report 2022

The Management's Discussion and Analysis of Financial Condition and Results of Operations for DIRTT Environmental Solutions Ltd. ("MD&A") is also included in the Form 10Q for the period ended June 30, 2022 filed on SEDAR on July 27, 2022 in its entirety ("Form 10-Q"). Capitalized terms without definition in this MD&A are as defined elsewhere in the Form 10-Q. All references to US$ or $ are to U.S. dollars and references to C$ are to Canadian dollars.

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

Revenues for the quarter ended June 30, 2022 were $44.7 million, an increase of $3.6 million or 9% from $41.1 million for the three months ended June 30, 2021. Revenues increased $12.4 million or 18% to $83.0 million for the six months ended June 30, 2022 from $70.6 million for the same period ended June 30, 2021.While the resurgence of COVID-19 infections due to the Omicron variant at the beginning of the year temporarily sent many employees back to their home offices and delayed return dates, DIRTT and its Construction Partners experienced an uptick in planning activity and opportunities for growth which began to translate into orders in March 2022 primarily in the commercial vertical space. The delivery of some second quarter orders were delayed into the third quarter due mainly to the impacts of a tight labor market on attraction and retention of manufacturing employees as the Company works to increase its labor capacity and productivity in light of improving demand. The full impact of the COVID-19 pandemic was incurred in the first quarter of 2021 when the impact of the contraction in construction activity was experienced and with most of our pre-pandemic projects in process completed in 2020.
Gross profit and gross profit margin for the quarter ended June 30, 2022 was $6.3 million or 14.0% of revenue, a decrease of $2.9 million or 32% from $9.2 million or 22.4% of revenue for the quarter ended June 30, 2021. Gross profit and gross profit margin for the six months ended June 30, 2022 was $9.6 million or 11.5% of revenue compared to $12.6 million of 17.8% of revenue for the same period in 2021. The decrease in gross profit margin largely reflects the continued impact of significant inflationary increases in the realized cost of materials, transportation and packaging in excess of realized price increases and incremental fixed costs of our manufacturing facility in Rock Hill, South Carolina (the “South Carolina Facility”), as well as pressures on labor rates, partially offset by an improved fixed cost leverage as compared to the prior periods as a result of higher activity. The second quarter included labor costs and inefficiency associated with adding and training manufacturing employees in Calgary and Savannah following the closure of the Phoenix Facility. The Company also benefited from a weakening Canadian Dollar this quarter with a $0.8 million benefit on Canadian dollardenominated manufacturing costs. Gross profit for the six months ended June 30, 2022 also included $1.1 million of accelerated depreciation and amortization arising from a change in useful life of assets, which arose in the first quarter of the year.
The Company implemented an approximate 6.5% overall increase in our product and transportation prices effective on new orders subsequent to November 15, 2021 to offset increased materials, transportation and packaging costs. The impact of these changes was partially realized in the three and six months ended June 30, 2022 and is expected to be further realized in the second half of 2022. Due to the continued inflationary pressures on material and labor costs, the Company implemented a further 5% price increase effective June 1, 2022 as well as an additional 10% price increase effective July 21, 2022 and eliminated the 20% pilot price reductions, implemented in February, on the Reflect and Inspire product lines.
Adjusted Gross Profit and Adjusted Gross Profit Margin (see “– Non-GAAP Financial Measures”) for the quarter ended June 30, 2022 was $8.5 million or 18.9%, respectively, a decrease from $11.3 million or 27.4%, respectively, for the quarter ended June 30, 2021. Adjusted Gross Profit and Adjusted Gross Profit Margin (see “– Non-GAAP Financial Measures”) for the six months ended June 30, 2022 was $15.2 million or 18.3%, respectively, a decrease from $18.4 million or 26.1%, respectively, for the six months ended June 30, 2021, due to the reasons described above. For the six month period ended June 30, 2021, $1.8 million of overhead costs were excluded from Adjusted Gross Profit, as these costs were on account of operating at lower than normal capacity levels in the first quarter of 2021 and were accordingly charged directly and separately to cost of sales rather than as a cost attributable to production.

Operating expenses in the second quarter of 2022 increased by $4.2 million to $25.6 million from $21.3 million in the same period of 2021. This increase is largely due to $5.2 million of reorganization costs, $1.0 million of higher travel and entertainment costs due to increased business activity and the easing of travel restrictions and $0.3 million of incremental professional fees associated with the contested director elections, offset by lower salaries and wages, stock based compensation and depreciation and amortization. For the six months ended June 30, 2022, operating expenses increased by $9.8 million to $50.4 million from $40.6 million in the same period of 2021. This increase is largely due to $8.9 million in reorganization costs, $1.8 million of incremental professional fees associated with the contested director elections and $1.5 million increase in travel, meals and entertainment costs due to increased business activity and the easing of COVID-19 restrictions, offset by decreases in salaries and benefits associated with cost reduction measures. The Company also benefited from a weakening Canadian Dollar in the second quarter of 2022 with a $0.6 million benefit on Canadian dollar- denominated operating costs.
Net loss for the three months ended June 30, 2022 was $19.3 million compared to $9.7 million for the three months ended June 30, 2021. The higher net loss is primarily the result of the lower gross profit margin explained above, $4.2 million increase in operating expenses, a $3.4 million reduction in government subsidies, and a $0.5 million increase in interest expense offset by a $1.3 million increase in foreign exchange gain.
Net loss for the six months ended June 30, 2022 was $42.3 million compared to $22.2 million for the six months ended June 30, 2021. The higher net loss is primarily the result of the lower gross profit margin explained above, $9.8 million increase in operating expenses, a $6.9 million reduction in government subsidies and a $1.4 million increase in interest expense offset by a $0.8 million increase in foreign exchange gain.
On February 22, 2022, we announced a plan to close the Phoenix Facility, shifting related manufacturing to both our Savannah and Calgary aluminum facilities. The closure of the Phoenix Facility was substantially completed in the second quarter of 2022. Of the initial estimate of cost savings of approximately $2.4 million from this closure, we expect to realize annualized savings of approximately $1.0 million as $1.4 million of work force reductions were offset by additions in Calgary and Savannah due to increased demand. No amounts were realized in the second quarter. Additionally, we eliminated approximately 14% of the expected 18% reduction of our salaried workforce including manufacturing and office positions which, along with other cost reduction initiatives, are expected to yield annualized savings of approximately $13.0 million. Of these cost reduction initiatives, $9.0 million was implemented during the first and second quarters of 2022, $3.0 million will be implemented in the second half of 2022, and $1.0 million, comprised of certain manufacturing positions, has been deferred as we work to increase manufacturing headcount in light of increased demand. One-time costs associated with these reductions and other costs savings measures were previously estimated to be $4.4 million for the second quarter, and $8.1 million for the year. For the three and six months ended June 30, 2022, we incurred $5.2 million and $8.9 million in reorganization costs, respectively. Actual costs for the quarter ended June 30, 2022 are higher due to additional termination benefits arising in June 2022 with the departure of two executives.
Adjusted EBITDA (see “– Non-GAAP Financial Measures”) for the quarter ended June 30, 2022 was a $9.4 million loss or (21.1)%, a decline of $2.6 million from a $6.8 million loss or (16.6)% for the quarter ended June 30, 2021. Adjusted EBITDA (see “– Non-GAAP Financial Measures”) for the six months ended June 30, 2022 was a $21.4 million loss or (25.8%), a decline of $3.2 million from a $18.2 million loss or (25.8)% for the six months ended June 30, 2021. Reductions for the quarter and year-to-date periods were due to the above noted reasons. For the three and six months ended June 30, 2022, reorganization costs of $5.2 million and $8.9 million respectively, were added back in the calculation of Adjusted EBITDA.

Outlook

On April 26, 2022, at the Company’s 2022 annual and special meeting of shareholders, shareholders of the Company elected to replace the then-existing board of directors with seven new individuals, all of whom were nominated by 22 NW Fund, LP and other participants named in the definitive proxy statement filed on January 7, 2022, as amended. Following the election and appointment, the Board of Directors terminated the employment of Todd Lillibridge as Interim Chief Executive Officer and appointed Geoffrey Krause and Jeffrey Calkins as Interim Co-Chief Executive Officers, in each case effective as of April 26, 2022.

The Board of Directors in cooperation with management immediately commenced an in-depth review of the Company’s commercial and manufacturing operations, financial performance and outlook as well as accelerated its search for a permanent Chief Executive Officer. That review identified risks to DIRTT that are now being addressed (see “Item 1A. Risk Factors” below). As a result of this review, on June 3, 2022, the Company announced the departure

of Jennifer Warawa as Chief Commercial Officer and Jeffrey Calkins as Chief Operating Officer and Interim CoChief Executive Officer. The Company has commenced a search for a permanent Chief Operating Officer.

On June 22, 2022, the Company announced the appointment of Benjamin Urban as DIRTT’s new Chief Executive Officer, effective June 27, 2022 and along with Mr. Urban, the appointment of Shaun Noll to the Board of Directors. With the addition of Messrs. Urban and Noll, the Board of Directors is now comprised of nine highly qualified individuals.

On July 27, 2022, the Company announced additional leadership changes, including the departures of Charles Kraus, Senior Vice President and General Counsel and Colin Blehm, Vice President Product Development, and the promotion of Trevor Didluck to Vice President Product Development. Nandini Somayaji has been promoted to Senior Vice President Talent, General Counsel & Corporate Secretary. Geoffrey Krause, DIRTT’s current Chief Financial Officer, announced his intention to retire from the Company, effective September 30, 2022. A search for a suitable replacement has commenced.

Second quarter 2022 revenues were $44.7 million, an increase of 16.8% and 8.8% over the first quarter of 2022 and the second quarter of 2021, respectively, and within the guidance range of between $43 million and $47 million. As at July 1, 2022, our 12-month forward pipeline, which represents known projects and leads at various stages of maturation which our sales teams are working to convert into orders, increased by 13% to $359 million from $318 million at April 1, 2022, comprised of 65% commercial, 16% healthcare, 8% education and 11% government verticals. The relative split between verticals remains consistent with pre-pandemic actual percentage results. It is important to note that these figures do not reflect the impact of the 10% price increase nor termination of the Reflect and Inspire pilot price reduction. These pricing changes are expected to increase the Company’s gross margins; however, the net positive or negative impacts on the 12-month forward pipeline are not yet known. Although the current 12-month forward pipeline is a positive indicator of the Company’s future revenue potential, in the context of continued global macroeconomic uncertainty and possible recession risks, our fiscal year 2022 revenue guidance remains unchanged at $175 to $185 million. The midpoint of our 2022 guidance represents an approximate 22% increase over actual 2021 revenue of $147.6 million.

With demand for DIRTT’s product continuing to increase, the Company’s current and immediate focus is to unlock manufacturing capacity, improve revenues and profitability and accelerate the Company’s near-term progress towards cashflow breakeven and beyond. Under new leadership, the following actions have been taken and discussed in more detail below:

Identifying and taking steps to unlock manufacturing capacity through additions to our hourly workforce and implementation of manufacturing improvements for Reflect and Inspire product lines, which comprise approximately 10% of DIRTT product revenue;
Implementing an additional 10% price increase effective July 21, 2022 to mitigate the impact of ongoing inflationary pressures on raw material and labor costs;
Increasing governance over discounting and other similar activities;
Executing on $5.0 million of incremental annualized cost reductions through elimination of 36 salaried positions, including the aforementioned leadership changes;
Launching a new website, branding and associated sales collateral to generate increased awareness and demand; and
Continuing close collaboration with our Construction Partners through the Partner Advisory Council.

In the second quarter, we increased our overall manufacturing headcount in Calgary by 9%, following the closure of the Phoenix Facility, where we have commenced a night shift for certain operations. We are experiencing the effects of a tight labor market, which has made it more difficult than expected to attract and retain skilled labor. This has been particularly the case at our Savannah facility. As a result of these challenges, some of our orders were pushed to the third quarter from June 2022 while we worked to ramp up our hourly work force. To increase our competitiveness, we have raised hourly wages in both Calgary and Savannah, established headcount targets and factored in attrition rates in hiring and retention strategies. We are continuing to add to our work force in anticipation of higher activity in the third and fourth quarters to avoid manufacturing capacity constraints that we experienced in the second quarter of 2022. We also commenced operational improvements on our Reflect and Inspire product lines to increase overall productive capacity and improve lead times, with such improvements expected to be complete by

August 2022. Finally, we completed the closure of our Phoenix Facility in June 2022 and sublet the associated factory space in July 2022 at a premium to the prior rent commitment.

In June 2022, in addition to a 5% price increase effective June 1, 2022, the Company announced a further 10% increase in prices on its products effective July 21, 2022 to further address the impact of ongoing inflationary pressure on raw material and labor costs. DIRTT also terminated the 20% pilot price reduction program on its Reflect and Inspire product lines, which comprise approximately 10% of product revenue for the six months ended June 30, 2022, that it announced in February 2022. This program termination is a result of the combination of increased aluminum prices and the unanticipated impact that the increased demand placed on our productive capacity due to the immaturity of production processes related to these product lines.

Through the course of the pandemic, the Company increased its use of discounting in an attempt to drive higher revenues, with approximately 10.5% of discounts on total revenue in the second quarter of 2022 compared to 8.7% in the same period of 2020. A pricing oversight committee was established in the second quarter to provide increased scrutiny of discounting behaviors and pricing decision making, with the goal of significantly reducing the amount of discounting provided on a go forward basis.

Under the leadership of its new Chief Executive Officer, the Company took further steps in July 2022 to flatten its organization to increase its overall effectiveness and to optimize its fixed salaried cost base in light of current activity levels and strategic needs. This resulted in annualized cost savings of $5.0 million and the elimination of 36 salaried positions, including the leadership changes described earlier. Key objectives of this process include breaking down interdepartmental silos, increasing cross functional communication and joint accountabilities, improving overall productivity across the organization and enhancing DIRTT’s overall approach to Construction Partner recruitment, onboarding, management and accountability. We are making additional investments in the ICE team and investing to support the long-term success of our Partners. These changes include but are not limited to:

Reintegration of supply chain, quality and safety under plant management and elimination of non-core positions;
Reallocation of resources to increase order engineering throughput and capacity;
Flattening of overall organization and removal of unnecessary layers;
Reorganization of Construction Partner development function under new leadership; and
Redefining approach to strategic account and market segment management.

While revenues were in line with expectations and grew sequentially over the first quarter and the same period last year, the Company used approximately $19.1 million of cash in the second quarter compared to $21.3 million in the first quarter 2022. This included approximately $6.0 million in the quarter ($11.1 million year to date) of one-time reorganization and contested director election costs and DSU payments. Excluding these amounts, net of working capital, cash used would have been $13.7 million in the second quarter of 2022 compared to $18.3 million in the first quarter of 2022. From a working capital management perspective, we continued to experience a buildup in inventory, primarily in aluminum extrusions, reflecting our difficulty in increasing productive capacity relative to expectations as described above. Inventory increased by $3.7 million and $3.2 million in the first and second quarter of 2022, respectively. We have taken steps to moderate such supply and expect to begin to reduce our inventory levels in the third and fourth quarters. As a result of the steps mentioned, we expect cash usage to improve as 2022 progresses and to approach monthly cashflow breakeven in the fourth quarter of 2022 (see “–Liquidity and Capital Resources").

As revenues improve, including the effect of the price increases above, and the cost reduction initiatives take hold, we expect to continue to progress toward an improvement in net loss and Adjusted EBITDA breakeven in the fourth quarter of 2022. Unrestricted cash and net working capital at June 30, 2022 was $19.7 million and $31.6 million, compared to $38.9 million and $49.3 million at March 31, 2022, respectively, and $60.3 million and $66.7 million at December 31, 2021, respectively. The Company’s asset backed credit facility, which is based upon a percentage of accounts receivable and inventory, remains undrawn at June 30, 2022 with approximately $11.3 million available . The Company continues to focus on revenue growth and cost initiatives to positively affect DIRTT’s balance sheet, cash flow and profitability and expects to see a trend of increasing monthly working capital by year end.

Non-GAAP Financial Measures

Note Regarding Use of Non-GAAP Financial Measures

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

As a result, we also provide financial information in this Quarterly Report that is not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. Management uses these non-GAAP financial measures in its review and evaluation of the financial performance of the Company. We believe that these non-GAAP financial measures also provide additional insight to investors and securities analysts as supplemental information to our GAAP results and as a basis to compare our financial performance period-over-period and to compare our financial performance with that of other companies. We believe that these non-GAAP financial measures facilitate comparisons of our core operating results from period to period and to other companies by removing the effects of our capital structure (net interest income on cash deposits, interest expense on outstanding debt and debt facilities, or foreign exchange movements), asset base (depreciation and amortization), the impact of under-utilized capacity on gross profit, tax consequences, reorganization expense and stock-based compensation. We remove the impact of all foreign exchange from Adjusted EBITDA. Foreign exchange gains and losses can vary significantly period-to-period due to the impact of changes in the U.S. and Canadian dollar exchange rates on foreign currency denominated monetary items on the balance sheet and are not reflective of the underlying operations of the Company. We remove the impact of under-utilized capacity from gross profit, and fixed production overheads are allocated to inventory on the basis of normal capacity of the production facilities. In periods where production levels are abnormally low, unallocated overheads are recognized as an expense in the period in which they are incurred. In addition, management bases certain forward-looking estimates and budgets on non-GAAP financial measures, primarily Adjusted EBITDA.

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

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

Adjusted Gross Profit Gross profit before deductions for costs of under-utilized capacity, depreciation and amortization Adjusted Gross Profit Margin Adjusted Gross Profit divided by revenue EBITDA Net income before interest, taxes, depreciation and amortization

EBITDA Net income before interest, taxes, depreciation and amortization Adjusted EBITDA EBITDA adjusted to remove foreign exchange gains or losses; impairment expenses; reorganization expenses, stock-based compensation expense; government subsidies, and any other non-core gains or losses

Adjusted EBITDA Margin

Adjusted EBITDA divided by revenue

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

Results of Operations

Three and Six Months Ended June 30, 2022, Compared to Three and Six Months Ended June 30, 2021

	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands) 44,701 41,102 9 6,276 9,224 (32) 14.0 % 22.4 % 7,777 7,564 3 6,877 7,780 (12) 2,528 2,213 14 1,879 1,924 (2) 1,326 1,861 (29 ) 5,163 - 100	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands) 44,701 41,102 9 6,276 9,224 (32) 14.0 % 22.4 % 7,777 7,564 3 6,877 7,780 (12) 2,528 2,213 14 1,879 1,924 (2) 1,326 1,861 (29 ) 5,163 - 100	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands) 44,701 41,102 9 6,276 9,224 (32) 14.0 % 22.4 % 7,777 7,564 3 6,877 7,780 (12) 2,528 2,213 14 1,879 1,924 (2) 1,326 1,861 (29 ) 5,163 - 100	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands) 82,987 70,567 18 9,563 12,594 (24 ) 11.5 % 17.8 % 15,005 14,234 5 14,870 15,021 (1 ) 5,026 4,510 11 4,019 3,859 4 2,628 2,955 (11 ) 8,855 - 100	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands) 82,987 70,567 18 9,563 12,594 (24 ) 11.5 % 17.8 % 15,005 14,234 5 14,870 15,021 (1 ) 5,026 4,510 11 4,019 3,859 4 2,628 2,955 (11 ) 8,855 - 100	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands) 82,987 70,567 18 9,563 12,594 (24 ) 11.5 % 17.8 % 15,005 14,234 5 14,870 15,021 (1 ) 5,026 4,510 11 4,019 3,859 4 2,628 2,955 (11 ) 8,855 - 100
	2022 2021 ($ in thousands) 44,701 41,102 6,276 9,224 14.0 % 22.4 % 7,777 7,564 6,877 7,780 2,528 2,213 1,879 1,924 1,326 1,861 5,163 -			2022 82,987 9,563 11.5 % 15,005 14,870 5,026 4,019 2,628 8,855	2021 ($ in thousands) 70,567 12,594 17.8 % 14,234 15,021 4,510 3,859 2,955 -
Revenue	44,701
Gross Profit	6,276
Gross Profit Margin	14.0 %
Operating Expenses
Sales and Marketing	7,777
General and Administrative	6,877
Operations Support	2,528
Technology and Development	1,879
Stock-Based Compensation	1,326
Reorganization	5,163
Total Operating Expenses	25,550	21,342 (12,118)	20 59	50,403 (40,840)	40,579 (27,985)	24 46
Operating Loss	(19,274)
Operating Margin	(43.1 )%	(29.5 )%		(49.2 )%	(39.7 )%

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 June 30, 2022 2021 % Change ($ in thousands)	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)
	2022 2021 ($ in thousands)			2022 2021 ($ in thousands)
Product	38,098	36,462	4	71,291	62,298	14
Transportation	4,795	3,484	38	8,856	5,983	48
License fees from Construction
	198	141	40	395	348	14
Partners

Total product revenue	43,091	40,087	7	80,542	68,629	17
Installation and other services	1,610	1,015	59	2,445	1,938	26
	44,701	41,102	9	82,987	70,567	18

Our sales activity and associated revenues continue to be impacted by the severe economic and social impact of the COVID-19 pandemic since March 2020, including a major contraction in construction activity levels in North America due to work-from-home requirements, lock-down measures and other regulatory responses implemented by governments and public health officials.

During the quarter ended June 30, 2022, revenue was $44.7 million, an increase of $3.6 million or 9% from the same period in 2021. Revenue for the six months ended June 30, 2022 was $83.0 million an increase of 12.4 million

or 18% from the six months ended June 30, 2021. The first quarter of 2022 marked the transition of the COVID-19 pandemic to an endemic with the broad easing of health restrictions, including work-from-home mandates, across North America. While the resurgence in COVID-19 infections due to the Omicron variant at the beginning of the year temporarily sent many employees back to their home offices and delayed return dates, the Company and our Construction Partners experienced an uptick in planning activity and opportunity growth in our commercial vertical which began to translate into orders in March 2022 that has continued into the second quarter. In response, the Company began efforts to increase its manufacturing labor headcount to enable it to capture the increase in demand but experienced the ongoing effects of a tight labor market. This has made it more difficult than expected to attract and retain skilled labor particularly, the case at our Savannah facility. As a result of these challenges in combination with the time to fully onboard new hires up to productive status, some orders had to be pushed to the third quarter from June 2022 while we worked to ramp up our hourly workforce.

We remain uncertain as to the ongoing impact of the pandemic, including effects of resurgent infection rates due to variants, on future projects that are either in the planning or conceptual stage. It is likely that future projects will experience similar delays as the COVID-19 pandemic runs its course and as DIRTT works through the aforementioned hiring and training challenges. See Item 1A. “Risk Factors”.

In response to significant increases in the costs of raw materials, shipping materials, labor and freight, effective November 16, 2021, DIRTT increased product and transportation prices on new projects by approximately 6.5%, with the benefits largely expected to be realized in 2022. On February 17, 2022, we implemented a further price increase of 5% that came into effect June 1, 2022. Based on experience to date, these increases were not sufficient to offset the significant inflationary impacts on raw materials. Accordingly, on June 21, 2022 an additional price increase of 10% was announced effective July 21, 2022. The benefits of this additional increase are largely expected to be realized in the second half of 2022. DIRTT also terminated the 20% pilot price reduction program on its Reflect and Inspire product lines that it announced in February 2022 as a result of the combination of increased aluminum prices and the unanticipated impact that the increased demand placed on our productive capacity due to the immaturity of production processes related to these product lines.

Installation and other services revenue was $1.6 million and $2.4 million for the three and six months ended June 30, 2022 respectively, compared to $1.0 million and $1.9 million in the same period of 2021. 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 June 30, 2022, we had 69 (December 31, 2021: 69) Construction Partners servicing multiple locations. During 2021 and the first quarter of 2022, we made several changes and upgrades to our Construction Partner network, expanding our relationships with new and existing partners and ending our relationships with others. In February 2022, we announced the establishment of a Partner Advisory Council to provide a greater link with Construction Partners and end clients who they service. The Partner Advisory Council will offer advice on sales and marketing effectiveness, product issues and new market needs, market conditions, competitive landscape, marketing support and other related areas of mutual interest.

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

	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)
	2022 2021 ($ in thousands)			2022 2021 ($ in thousands)
Commercial	29,618	19,032	56	53,662	35,176	53
Healthcare	5,091	14,176	(64)	12,055	20,663	(42)
Government	5,041	4,249	19	8,322	8,430	(1 )
Education	3,143 198 43,091	2,489 141 40,087	26 40 7	6,108 395 80,542	4,012 348 68,629	52 14 17
License fees from Construction	198
Partners
Total product revenue
Service revenue	1,610	1,015	59	2,445	1,938	26
	44,701	41,102	9	82,987	70,567	18

	For the Three Months Ended June 30, 2022 2021 (in %)	For the Three Months Ended June 30, 2022 2021 (in %)	For the Six Months Ended June 30, 2022 2021 (in %)	For the Six Months Ended June 30, 2022 2021 (in %)
Commercial	69	47	67	52
Healthcare	12	36	15	30
Government	12	11	10	12
Education	7	6	8	6
Total Product Revenue(1)	100	100	100	100

(1) Excludes license fees from Construction Partners.

Commercial revenues increased by 56% and 53% in the three and six month periods ended June 30, 2022 from the same prior year periods, reflecting improving market conditions as health restrictions and work-from-home requirements ease and include one large customer in the technology sector with revenue of $2.3 million and $5.6 million for the respective periods. Healthcare decreased by 64% and 42% in the three and six months ended June 30, 2022, respectively, from the same periods in 2021. Such sales tend to be larger individual projects and are subject to timing due to a typically longer sales cycle, resulting in variability in sales levels. In 2021, we had one large healthcare project with revenue of $6.9 million in the second quarter which did not recur in 2022.

Education sales in the three and six months ended June 30, 2022 increased by 26% and 52%, respectively, over the prior periods. At the beginning of the pandemic, education spending effectively paused with many institutions suspending in-person classes. There were no individually significant education projects and the increases represent higher volumes of projects due to the easing of health restrictions and many students returning to in-person learning. Government revenues in the three months ended June 30, 2022 increased by 19% and decreased by 1% for the six month period then ended over the prior year periods.

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

	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Three Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)	For the Six Months Ended June 30, 2022 2021 % Change ($ in thousands)
	2022 2021 ($ in thousands)			2022 2021 ($ in thousands)
Canada	7,417	4,461	66	12,668	7,456	70
U.S.	37,284	36,641	2	70,319	63,111	11
	44,701	41,102	9	82,987	70,567	18

Historically, approximately 15-25% and 75-85% of revenues are derived from sales to Canada and the United States, respectively. In the quarter ended June 30, 2020, revenues from Canada fell to 10% of total sales while sales

to the United States increased to 90%. The geographical split for the quarter ended June 30, 2022 began to return to historical averages and reflects the easing of health restrictions in Canada which was later than the United States.

Sales and Marketing Expenses

Sales and marketing expenses increased by $0.2 million and $0.8 million to $7.8 million and $15.0 million for the three and six months ended June 30, 2022, from $7.6 million and $14.2 million for the three and six months ended June 30, 2021 respectively. The increase was largely related to an increase of $0.9 million and $1.3 million for the three and six months ended June 30, 2022, respectively, in travel, meals and entertainment expenses as business activity has increased and restrictions on travel have eased, offset by lower salary and benefit expenses due to planned headcount reductions as part of the cost savings initiatives.

General and Administrative Expenses

General and administrative expenses decreased $0.9 million to $6.9 million and $0.1 million to $14.9 million for the three and six months ended June 30, 2022 from $7.8 million and $15.0 million for the three and six months ended June 30, 2021. In the three months ended June 30, 2022, approximately $0.3 million of professional fees associated with the contested election of directors was more than offset by lower salaries and benefits costs. For the six month period ended June 30, 2022, approximately $1.8 million of incremental professional fees associated with the contested election of directors was offset by lower salaries and benefits cost. Reductions in salaries and benefits includes planned headcount reductions as part of cost savings initiatives as well as the impact of the Chief Executive Officer vacancy in the periods.

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 increased by $0.3 million and $0.5 million from $2.2 million and $4.5 million for the three and six months ended June 30, 2021, respectively, to $2.5 million and $5.0 million for the three and six months ended June 30, 2022. The increase was due to lower costs capitalized to internal projects with the completion of the South Carolina Facility and the DIRTT Experience Centre ("DXC") in Dallas and an increase in salaries and benefits of $0.2 million and $0.3 million for the three and six month period ended June 30, 2022 compared to the previous year same period.

Technology and Development Expenses

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

Technology and development expenses for the three and six month period ended June 30, 2022 were consistent with prior period costs as $0.2 million and $0.5 million of lower capitalized costs due to fewer internal projects, respectively, were offset by reductions in salaries and benefits expense.

Stock-Based Compensation

Stock-based compensation expense for the three and six months ended June 30, 2022 was $1.3 million and $2.6 million compared to $1.9 million and $3.0 million for the same periods in 2021. The movement in this expense was largely the impact of grants of RSUs to the Company's employees, including those in lieu of cash compensation to the Company’s former interim Chief Executive Officer in January 2022 and DSUs granted to the Board of Directors, lowered by the impact of fair value adjustments on cash settled awards as a result of our share price decreasing during the quarter and six months ended June 30, 2022. The Board of Directors receives 100% of their remuneration in DSUs.

Reorganization

On February 22, 2022, we announced a plan to close the Phoenix Facility, shifting related manufacturing to both our Savannah and Calgary aluminum facilities. The closure of the Phoenix Facility was substantially completed in the second quarter of 2022. Of the initial estimate of cost savings of approximately $2.4 million from this closure, we expect to realize annualized savings of approximately $1.0 million as $1.4 million of work force reductions were offset by additions in Calgary and Savannah due to increased demand. No amounts were realized in the second quarter. Additionally, we eliminated approximately 14% of the expected 18% reduction of our salaried workforce including manufacturing and office positions, which, along with other cost reduction initiatives, are expected to yield annualized

savings of approximately $13.0 million. Of these cost reduction initiatives, $9.0 million was implemented during the first and second quarters of 2022, $3.0 million will be implemented in the second half of 2022, and $1.0 million, comprised of certain manufacturing positions, has been deferred as we work to increase manufacturing headcount in light of increased demand. One-time costs associated with these reductions and other costs savings measures were previously estimated to be $4.4 million for the second quarter, and $8.1 million for the year. For the three and six months ended June 30, 2022, we incurred $5.2 million and $8.9 million in reorganization costs, respectively. Actual costs for the quarter ended June 30, 2022 are higher due to additional termination benefits arising in June 2022 with the departure of two executives.

Government Subsidies

The Company was not eligible and did not receive any new government subsidies in the three and six months ended June 30, 2022 compared to $3.4 and $7.5 million of subsidies received during the three and six months ended June 30, 2021. Upon finalization of 2021 compensation to specified executives, approximately C$0.5 million ($0.4 million) of previously-received subsidies were repaid to the Canadian authorities in the second quarter of 2022. The amount was fully provided for in the third quarter of 2021 and the Company reversed a $0.6 million incremental provision related to this that was no longer necessary in the first quarter of 2022. The last claim period under the CEWS and CERS programs expired on October 23, 2021.

The Company is currently evaluating its eligibility for the Employer Retention Tax Credit in the United States, which, if eligible, could provide additional subsidies to the Company.

Interest expense

Interest expense increased by $0.5 million from $0.8 million for the three months ended June 30, 2022 to $1.3 million compared to June 30, 2021 and by $1.4 million from $1.3 million in the six months ended June 30, 2022 to $2.7 million compared to June 30, 2021. The increased interest expense is a result of the issuance of C$35.0 million ($27.4 million) of Debentures in December 2021 and draws on the Leasing Facilities.

Income Tax

The provision for income taxes is comprised of U.S. and Canadian federal, state and provincial taxes based on pre-tax income. The Company incurred no income tax expense or recovery during the three and six months ended June 30, 2022, compared to a $0.2 million and $0.3 million expense for the same period of 2021. As at June 30, 2022 the Company had a valuation allowance of $27.0 million (December 31, 2021 $17.3 million) against deferred tax assets due to ongoing near term uncertainties on the business caused by the COVID-19 pandemic and the related decline in business activity which impacted our ability to generate sufficient taxable income in Canada and the United States to fully deduct historical losses. As at June 30, 2022, we had C$89.8 million of non-capital loss carry-forwards in Canada and $60.4 million in the United States. These loss carry-forwards will begin to expire in 2032.

Net Loss

Net loss increased to $19.3 million or $0.22 net loss per share in the three months ended June 30, 2022 from a net loss of $9.7 million or $0.11 net loss per share for the quarter ended June 30, 2021. The increased loss is primarily the result of a $2.9 million decrease in gross profit, a $4.2 million increase in operating expenses (which includes $5.2 million of reorganization expenses and $0.3 million of incremental professional fees described previously), a $0.5 million increase in interest expense and a $3.4 million decrease in government subsidies offset by a $1.3 million increase in foreign exchange gain.

Net loss increased to $42.3 million or $0.49 net loss per share in the first half of 2022 from a net loss of $22.2 million or $0.26 net loss per share for the six months ended June 30, 2021. The increased loss is primarily the result of a $3.0 million decrease in gross profit, a $9.8 million increase in operating expenses (which includes $8.9 million of reorganization expenses and $1.8 million of incremental professional fees as described previously), a $1.4 million increase in interest expense and a $6.9 million decrease in government subsidies offset by a foreign exchange gain of $0.8 million.

EBITDA and Adjusted EBITDA for the Three and Six Months Ended June 30, 2022 and 2021

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

	For the Three Months Ended June 30, 2022 2021 ($ in thousands)	For the Three Months Ended June 30, 2022 2021 ($ in thousands)	For the Six Months Ended June 30, 2022 2021 ($ in thousands)	For the Six Months Ended June 30, 2022 2021 ($ in thousands)
Net loss for the period	(19,288 )	(9,738 )	(42,330 )	(22,237 )
Add back (deduct):
Interest Expense	1,329	794	2,659	1,294
Interest Income	(20)	(23)	(31)	(42)
Income Tax Expense	-	220	-	259
DepreciationandAmortization	3,344	3,421	7,966	6,823
EBITDA	(14,635 )	(5,326 )	(31,736 )	(13,903 )
Foreign Exchange (Gains) Losses	(1,246)	60	(514)	240
Stock-Based Compensation	1,326	1,861	2,628	2,955
Government Subsidies	(49)	(3,431)	(624)	(7,499)
Reorganization Expense	5,163	-	8,855	-
Adjusted EBITDA	(9,441)	(6,836)	(21,391)	(18,207)
Net Loss Margin(1)	(43.1 )%	(23.7 )%	(51.0 )%	(31.5 )%
Adjusted EBITDA Margin	(21.1)%	(16.6)%	(25.8)%	(25.8)%

(1) Net loss divided by revenue.

For the three months ended June 30, 2022, Adjusted EBITDA and Adjusted EBITDA Margin decreased by $2.6 million to a $9.4 million loss or (21.1)% from $6.8 million loss or (16.6)% in the same period of 2021. This primarily reflects a $2.8 million decrease in Adjusted Gross Profit, $1.0 million increase in travel and entertainment costs, $0.3 million of incremental professional fees as described previously and, $0.3 million reduction in capitalized costs due to fewer internal projects, offset by $1.4 million of lower salaries and benefits costs due to headcount reductions and other cost savings.

For the six months ended June 30, 2022, Adjusted EBITDA and Adjusted EBITDA Margin decreased by $3.2 million to a $21.4 million loss or (25.8)% from $18.2 million loss or (25.8)% in the same period of 2021. This primarily reflects a $3.2 million decrease in Adjusted Gross Profit, $1.8 million of incremental professional fees as described previously, $1.5 million increase in travel and entertainment costs, and $0.7 million reduction in capitalized costs due to fewer internal projects, offset by $1.8 million of costs of underused capacity in the first quarter of 2021 which did not re-occur and $2.6 million lower salaries and benefits costs due to headcount reductions.

Adjusted Gross Profit and Adjusted Gross Profit Margin for the Three and Six Months Ended June 30, 2022 and 2021

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

	For the Three Months Ended June 30, 2022 2021 ($ in thousands)	For the Three Months Ended June 30, 2022 2021 ($ in thousands)	For the Six Months	For the Six Months
Gross profit	6,276	9,224	9,563	12,594
Gross profit margin	14.0%	22.4%	11.5%	17.8%
Add: Depreciation and amortization expense	2,188	2,033	5,660	4,062
Add: Costs ofunder-utilized capacity	-	-	-	1,756
Adjusted Gross Profit	8,464	11,257	15,223	18,412
Adjusted Gross Profit Margin	18.9%	27.4%	18.3%	26.1%

Gross profit and gross profit margin decreased to $6.3 million or 14.0% for the three months ended June 30, 2022, from $9.2 million or 22.4% for the three months ended June 30, 2021. Adjusted Gross Profit and Adjusted Gross Profit Margin decreased to $8.5 million or 18.9% for the three months ended June 30, 2022, from $11.3 million or 27.4% for the three months ended June 30, 2021.

For the six month period ended June 30, 2022, gross profit and gross profit margin decreased to $9.6 million or 11.5% from $12.6 million or 17.8% for the six month period ended June 30, 2021. Adjusted Gross Profit and Adjusted Gross Profit Margin decreased to $15.2 million or 18.3% for the six months ended June 30, 2022, from $18.4 million or 26.1% for the six months ended June 30, 2021.

The decrease in gross profit margin largely reflects significant and industry wide inflationary increases in the realized cost of materials, transportation, labor and packaging. In addition, in the second quarter and in response to a sustained increase in demand that began in the first quarter of 2022, the Company began efforts to increase its manufacturing labor headcount but experienced the ongoing effects of a tight labor market. This has made it more difficult than expected to attract and retain skilled labor, particularly at our Savannah facility, and as a result the Company increased hourly rates by 6% on average to increase its overall competitiveness.

To address these cost increases, the Company implemented a series of price increases, including a 6.5% increase effective November 1, 2021 and an additional 5% price increase effective June 1, 2022. As these increases were not sufficient to offset the continuing inflationary pressure, the Company announced a further 10% price increase effective July 21, 2022 and will continue to monitor raw material, labor and other costs to determine whether further action is necessary.

For the three month period ended June 30, 2022, gross profit margin decreased by 8.4% from the same period in 2021 as material, transportation and packaging costs increased by approximately 5.4% as a percentage of revenue and a negative labor efficiency of 2.3% was realized due to higher labor rates and increased inefficiencies resulting from training and onboarding of new employees. In addition, the Company had previously announced intentions to extend its scheduling lead times, while removing deposit requirements, and accordingly reduce standby production labor capacity by up to 20%. Following further discussions with our Construction Partners, including the importance of short lead times, we reversed this decision in the second quarter of 2022. Other cost increases negatively impacted the gross profit by 1.1% partially offset by marginal fixed cost leverage on account of the 9% increase in revenue compared to the same period last year.

For the six month period ended June 30, 2022, gross profit margin decreased by 6.3% from the same period in 2021 as material, transportation and packaging costs increased by approximately 6.7% as a percentage of revenue. Other cost increases negatively impacted the gross profit by 1.4% and gross profit was reduced by approximately 1% due to incremental South Carolina Facility fixed costs. Additional depreciation and amortization due to revision to the useful lives of assets, including the Phoenix Facility, contributed $1.1 million or 1.1% of the gross margin. This increased cost impact was offset by 2.8% of improved fixed cost leverage on account of the $12.4 million or 18% increase in revenue compared to the same period in 2021.

During the fourth quarter of 2019, we determined that we were carrying abnormal excess capacity in our manufacturing facilities as a result of the slowdown in sales and determined certain production overheads should be directly expensed in cost of sales, representing production overheads that were not attributable to production. In the first quarter of 2021, we experienced the full impact of the slowdown in non-residential construction activity on our business. In anticipation of a recovery in demand for our products and services and to preserve our skilled workforce, we deliberately maintained manufacturing headcount, while implementing selective furlough days, in the first quarter of 2021 despite the shortfall in revenues relative to capacity. As a result, in the first quarter of 2021 we separately classified $1.8 million as costs related to our under-utilized capacity (1.2% of 2021 first quarter gross profit margin) in cost of sales. For the remaining quarters of 2021 and 2022, we did not have abnormal excess capacity as our workforce was better aligned with current production volumes.

Liquidity and Capital Resources

Cash and cash equivalents at June 30, 2022 totaled $19.7 million, a decrease of $40.5 million from December 31, 2021. The decrease in cash over the six month period primarily reflects the impact of $36.8 million cash used in

operations, of which $1.8 million related to one-time costs associated with the contested director election and $8.9 million of reorganization costs. In addition, capital expenditures totaled $3.0 million and scheduled Leasing Facilities repayments totaled $1.2 million. These outflows were offset by a C$0.9 million ($0.7 million) draw under the Canada Leasing Facility received in April 2022.

The impact of COVID-19 on the Company’s sales and operations has been severe, including a contraction of demand since the beginning of the pandemic and more recently, significant inflation on raw material costs. This has resulted in a significant usage of cash which we have financed through existing cash on hand and financings as described further below. Furthermore, we have implemented multiple initiatives to reduce our overall fixed cost base, including the closure of our Phoenix Facility in the second quarter of 2022, reduction in our hourly headcount in 2021 and salaried headcount reductions and other cost savings initiatives in February 2022 and July 2022. We have also implemented three price increases to mitigate the inflationary effect, comprised of 6.5% effective November 1, 2021, 5% effective June 1, 2022 and a further 10% effective July 21, 2022. We continue to monitor the cost of our raw materials and labor to determine whether further price increases are warranted. Since March 2022, however, the Company and its Construction Partners have experienced a significant increase in demand, particularly within its commercial and education verticals, with the broad lifting of health restrictions across North America. In response the Company began efforts to increase manufacturing headcount within its Calgary and Savannah facilities to enable it to meet both near-term demand and anticipated sustained increases. We have increased wage rates in both Canada and the United States to increase our competitiveness in what is proving to be a tight labor market, particularly in Savannah. We are also taking steps to decongest our manufacturing processes to return productivity to pre-pandemic levels. We believe the benefits of the price increases, manufacturing headcount additions, training and debottlenecking will begin to be realized in the middle of the third quarter 2022, continuing throughout the balance of the year.

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

Should the recovery of the North American construction activities from the pandemic be delayed, a sustained economic depression and its adverse impacts on customer demand occur, significant inflationary pressure on raw materials and transportation costs continue that we are unable to recover through price increases or should we be unable to economically increase manufacturing labor headcount and related capacity, this could continue to adversely affect our liquidity. To the extent that existing cash and cash equivalents and increased liquidity from the aforementioned 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.

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

In February 2021, we entered into the RBC Facility, a C$25.0 million senior secured revolving credit facility with RBC. Under the RBC Facility, the “Borrowing Base” is a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of 75% of the book value of eligible inventory and 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims. Available borrowings under the RBC Facility at June 30, 2022 were C$14.5 million or $11.3 million.

In December 2021, we issued C$35.0 million of the December Debentures for net proceeds after costs of C$32.7 million ($25.6 million). The December Debentures accrue interest at a rate of 6.25% per annum and are convertible into common shares of DIRTT at an exercise price of C$4.20 per common share, or if not converted will mature and

be repayable on the December Debenture Maturity Date. Interest and principal are payable in cash or shares at the option of the Company.

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

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

	For the Three Months Ended June 30, 2022 2021 ($ in thousands)	For the Three Months Ended June 30, 2022 2021 ($ in thousands)	For the Six Months Ended June 30, 2022 2021 ($ in thousands)	For the Six Months Ended June 30, 2022 2021 ($ in thousands)
Net cash flows (used in) provided by operating activities	(17,800 )	86	(36,842 )	(12,008 )
Net cash flows used in investing activities	(1,331)	(6,430)	(2,951)	(10,019)
Net cash flows (used in) provided by financing activities	(63 )	7,266	(890 )	36,603
Effect of foreign exchange on cash, cash equivalents and restricted cash	54	408	220	711
Net (decrease) increase in cash, cash equivalents and
	(19,140 )	1,330	(40,463 )	15,287
restricted cash

Cash, cash equivalents and restricted cash, beginning of period	42,085	59,803	63,408	45,846
Cash, cash equivalents and restricted cash, end of
	22,945	61,133	22,945	61,133
period

Operating Activities

Net cash flows used in operating activities were $17.8 million for the three months ended June 30, 2022 compared to $0.1 million cash flows provided by operating activities in the three months ended June 30, 2021. Included in the $17.8 million used in operating activities in the second quarter of 2022 are $5.2 million of reorganization costs, $0.3 million of professional fees associated with the contested director election, and $3.7 million of increased inventory where the Company took on incremental reserves to mitigate against potential supply chain disruption, offset by the receipt of a $3.2 million income tax refund related to 2020. We have since taken steps to adjust our aluminum supply and expect to begin drawing down such inventory in the third and fourth quarter. Excluding these amounts, cashflow from operations would have been $11.8 million in the second quarter of 2022 compared to $0.1 million cash provided by operations in the same period of 2021, with the decrease reflecting $3.4 million of government subsidies that did not re-occur in 2022, $2.8 million of lower Adjusted Gross Profit, higher interest payments and working capital timing. Apart from the above noted items, working capital changes primarily reflect the timing of insurance renewals and increased accounts payable due to higher activity and timing of payments.

Net cash flows used in operating activities were $36.8 million for the six months ended June 30, 2022 compared to $12.0 million in the six months ended June 30, 2021. Included in the $36.8 million used in operating activities in the first half of 2022 are $8.9 million of reorganization costs, $1.8 million of professional fees associated with the contested director election, and $7.1 million of increased inventory where the Company took on incremental inventory from suppliers to mitigate against potential supply chain disruption, offset by the receipt of a $3.2 million income tax refund related to 2020. We have since taken steps to adjust our aluminum supply and expect to begin drawing down such inventory in the third and fourth quarter. Excluding these amounts, cashflow from operations would have been $22.2 million in the first half of 2022 compared to $12.0 million cash used in operations in the same period of 2021, with the decrease reflecting $7.5 million of government subsidies that did not re-occur in 2022, $1.4 million lower Adjusted Gross Profit before underutilized capacity, higher interest payments and working capital timing. Apart from the above noted items, working capital changes primarily reflect the timing of insurance renewals and increased accounts receivable, accounts payable and customer deposits due to higher activity and timing of payments.

Investing Activities

We invested $0.9 million and $1.9 million in property, plant and equipment during the three and six months ended June 30, 2022, respectively, compared to $5.8 million and $8.7 million during the three and six months ended

June 30, 2021. This expenditure for the three months ended June 30, 2022 comprised of $0.1 million of working capital changes, $0.5 million of manufacturing upgrades, $0.1 million related to our website redesign, $0.1 million of leasehold improvements and $0.1 million of DXC refreshes. The expenditure for the six months ended June 30, 2022 comprised of $1.0 million of working capital changes, $0.6 million of manufacturing upgrades, $0.2 million related to our website design and $0.1 million related to DXC refreshes and IT equipment.

We invested $0.4 million on capitalized software during the three months ended June 30, 2022, as compared to $0.6 million in the three months ended June 30, 2021 and $0.9 million for the six months ended June 30, 2022 compared to $1.3 million for the comparative period.

Our 2022 capital expenditure program comprises approximately $2.5 million related to refreshes of DXCs, continued enhancement of our customer relationship management system and website redesign, approximately $2.5 million on software development and approximately $2.0 million on manufacturing and other capital upgrades. The decrease in cash flows used in investing activities is largely due to reduced spending as the South Carolina Facility and Dallas DXC were completed in 2021.

Financing Activities

For the three and six months ended June 30, 2022, $0.1 million and $0.9 million of cash was used in financing activities, comprising mainly of $0.6 million and $1.2 million of scheduled payments under the Leasing Facilities for the three and six month period ended June 20, 2022. During the second quarter, we received C$0.9 million ($0.7 million) under the Canada Leasing Facility. For the three and six months ended June 30, 2021, $7.3 million and $36.6 million of cash was provided by financing activities, respectively, mainly due to the proceeds received from the issuance of C$40.3 million of Debentures in January 2021 and the receipt of $8.4 million of cash consideration under the U.S. Leasing Facility.

We currently expect to fund anticipated future investments with available cash, including the proceeds from Debentures issued in 2021, and drawings on our Credit Facility. We do not expect to make any significant further draws under the Leasing Facilities. Apart from cash flow from operations, issuing equity and debt has been our primary source of capital to date. Additional debt or equity financing may be pursued in the future as we deem appropriate. We may also use debt or pursue equity financing depending on the price of our common shares at the time, interest rates, and nature of the investment opportunity and economic climate.

Credit Facility

On February 12, 2021, the Company entered into the RBC Facility. Under the RBC Facility, the Borrowing Base is up to a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of 75% of the book value of eligible inventory and 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims. At June 30, 2022, available borrowings are C$14.5 million ($11.3 million), of which no amounts have been drawn. Interest is calculated at the Canadian or U.S. prime rate plus 30 basis points or at the Canadian Dollar Offered Rate or LIBOR plus 155 basis points. Under the RBC Facility, if the Aggregate Excess Availability is less than C$5.0 million, the Company is subject to a FCCR covenant of 1.10:1 on a trailing twelve-month basis. Additionally, if the FCCR has been below 1.10:1 for the three immediately preceding months, the Company is required to maintain a reserve account equal to the aggregate of one year of payments on outstanding loans on the Leasing Facilities. The Company did not meet the three-month FCCR requirement during the second quarter of 2022, which resulted in requiring the restriction of $3.2 million of cash. Should an event of default occur, or the Aggregate Excess Availability be less than C$6.25 million for five consecutive business days, the Company would enter a cash dominion period whereby the Company’s bank accounts would be blocked by RBC and daily balances will set-off any borrowings and any remaining amounts made available to the Company.

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

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

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

Contractual Obligations

There have been no material changes in our contractual obligations during the three months ended June 30, 2022, as compared to those disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations” in our Annual Report on Form 10-K, other than the forthcoming additional commitments related to the extension of our headquarters lease in Calgary. See Note 13, “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 June 30, 2022, as compared to those disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Significant Accounting Policies and Estimates” in our Annual Report on Form 10-K. For information regarding significant accounting policies and estimates, please refer to Item 7 and Item 8 in our Annual Report on Form 10-K. As disclosed in Note 5, “Adoption of New and Revised Accounting Standards” to our condensed consolidated interim financial statements appearing in this Quarterly Report, we adopted Accounting Standards Update No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance. The ASU provides guidance on required disclosures with respect to government assistance in a company’s notes to the annual financial statements. The amendments in the ASU are effective for periods beginning after December 15, 2021. The Company has adopted this standard effective January 1, 2022 and notes there is no impact of this standard on our accounting or disclosures of government assistance.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements, please refer to Note 5, “Adoption of New and Revised Accounting Standards” to our condensed consolidated interim financial statements and “–Significant Accounting Policies and Estimates” appearing in this Quarterly Report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

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

Changes in Internal Control Over Financial Reporting

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

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

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

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

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

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

• Ability to increase manufacturing capacity to service current pipeline:

As at July 1, 2022, DIRTT’s 12-month forward pipeline, which represents known projects and leads at various stages of maturation which our sales teams are working to convert into orders, increased by 13% to $359 million from $318 million as at April 1, 2022. Servicing of this pipeline and capturing the underlying revenue growth is dependent upon the Company's ability to ramp up production capabilities on a timely basis. The Board of Directors and DIRTT’s management team have prioritized removing constraints in DIRTT’s manufacturing processes and are pursuing a number of initiatives including increased hourly labor, improved hourly labor

retention and streamlined manufacturing processes. DIRTT may not be successful in implementing such initiatives and may be negatively impacted by the competitive nature of attracting personnel and other current market conditions. DIRTT may not be able meet such demand and capture the underlying revenue growth which could adversely affect the Company’s results of operations and financial condition.

Discounting and raw material cost inflation impacts on profitability:

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

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

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

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

None.

Item 3. Defaults Upon Senior Securities