DIRTT Environmental Solutions Ltd. — Interim / Quarterly Report 2023

Aug 2, 2023

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 10-Q for the period ended June 30, 2023 filed on SEDAR+ on August 2, 2023 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

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. As of May 9, 2023, 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.

Key Second Quarter Highlights

• Revenues for the quarter ended June 30, 2023 were $44.8 million, an increase of $0.1 million or 0.1% from $44.7 million for the same period in 2022, and a $8.0 million or 22% increase from the first quarter of 2023. Compared to the same period in 2022, the increase in revenue is driven by an increase in pricing, but offset by a decrease in total order volume. Compared to the first quarter of 2023, second quarter activity is higher, in line with seasonal demand patterns and timing of project schedules.

• Gross profit and gross profit margin for the quarter ended June 30, 2023 was $14.6 million or 32.5% of revenue, an increase of $8.3 million or 132% from $6.3 million or 14.0% of revenue for the quarter ended June 30, 2022 and an increase of $5.9 million or 68% from $8.7 million or 23.7% of revenue for the first quarter of 2023. Adjusted Gross Profit (see “– Non-GAAP Financial Measures”) for the three months ended June 30, 2023 was $16.2 million. This represents a $7.7 million or 91% increase over the comparative period in 2022 and $5.7 million or 55% from the first quarter of 2023. Adjusted Gross Profit Margin (see “– Non-GAAP Financial Measures”) for the second quarter of 2023 was 36.2%, a 1,723 bps improvement over the comparative period and 772 bps improvement from the first 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. General inflation in services and labor costs have been offset by the favorable impact from the weakening Canadian dollar during the quarter.

• During the second quarter of 2023, we eliminated approximately 4% of our salaried workforce office positions which we expect to yield annualized savings of approximately $2.6 million. One-time costs associated with these reductions during the quarter totaled $0.7 million and is included in reorganization expenses.

• On May 9, 2023, we entered into the Co-Ownership Agreement and Partial Patent Assignment Agreement with AWI. We concurrently entered into the ARMSA with AWI, under which AWI has also prepaid certain development services to be provided by DIRTT. Through these arrangements we received $10.9 million of cash and recognized a gain on the sale of software and patents of $6.1 million during the quarter ended June 30, 2023.

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• Net income for the second quarter of 2023 was $2.2 million compared to a $19.3 million net loss for the same period of 2022. The higher income is primarily the result of the higher gross profit margin of $8.3 million (as explained above), a $8.7 million reduction in operating expenses including a $3.7 million reduction in reorganization costs, a $6.1 million one-time gain on sale of software and patents, a $0.1 million increase in interest income and $0.1 million decrease in interest expense, offset by a $1.9 million increase in foreign exchange loss.

• Adjusted EBITDA (see “– Non-GAAP Financial Measures”) for the second quarter of 2023 was $1.9 million or 4.1%, an improvement of $11.3 million from a $9.4 million loss or (21.1)% for the second quarter of 2022. This improvement was driven by the price increases and improved product mix discussed above, as well as the cost reduction measures taken by the Company over the previous year. The gain on sale of software and patents to AWI was excluded from Adjusted EBITDA as this is considered nonrecurring and not indicative of ongoing Company performance.

• Approximately $3.8 million of cash was provided by operating activities in the second quarter of 2023 compared to $17.8 million of cash used in the second quarter of 2022. Our cashflow has improved compared to earlier quarters due to improved gross margin, our cost reduction initiatives and strategic actions and careful working capital management. This quarter, our cashflow also benefited from the receipt of $2.6 million from the ERC government subsidy.

In the first quarter of 2023, we changed our methodology for calculating and disclosing our forward twelve month pipeline as the macroeconomic environment has been impacting our ability to close and convert qualified leads on a timely basis. Accordingly, 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 recessionary impacts on construction projects.

We have also increased the scrutiny on the expected timing of orders that are expected to be delivered between six and twelve months in the future. This has resulted in a decrease in our forward twelve-month pipeline, illustrated in the table below.

			As at
	July 1, 2023	January 1, 2023	% Change		July 1, 2022	% Change
Twelve Month Forward Pipeline ($ 000s)
Commercial	145,750	141,293		3 %	158,306		(8 %)
Healthcare	35,124	55,719		(37 %)	48,093		(27 %)
Government	29,724	32,313		(8 %)	30,718		(3 %)
Education	9,260	17,201		(46 %)	19,017		(51 %)
	219,858	246,526		(11 %)	256,134		(14 %)
Leads (#)	872	721		21 %	417		109 %

Our current twelve month forward pipeline has a higher mix of projects that are further along in the order cycle, and thus we believe our current presentation is a better reflection of future revenue. It should be noted that our total pipeline, including those orders expected to place beyond twelve months, has remained flat year over year.

Our qualified leads being pursued with expected projects in the next twelve months was 872 as of July 1, 2023, as compared to 721 at January 1, 2023 and 417 as of July 1, 2022. The Company has increased its qualified leads as a result of the implementation of our customer relationship management system, as well as improved communication and collaboration to our commercial organization.

Despite this new pipeline presentation, we have not changed our view on near to mid-term growth for the Company, discussed below within the “Outlook” section.

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Outlook

Through the first six months of 2023 we have seen 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 larger projects that were planned for the first two quarters of 2023 being deferred or canceled.

In response, and as discussed in our previous 10-Q filing, 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.

In some aspects, the aforementioned macroeconomic uncertainty has subsided. Various inflation metrics have improved over the three months ended June 30, 2023 and certain recession indicators have eased. We have seen improved demand for our products, beginning in mid-April. From May 1 to June 30, 2023, the Company generated $33.3 million in total revenue and an associated $3.5 million in Adjusted EBITDA, with Adjusted Gross Profit during the same period of 39.2%. Further, we have been awarded several large projects during the second quarter of 2023, including Bechtel and Visa, which began to order during the second quarter of 2023, with Apache expected to order during the second half of 2023. These projects are expected to deliver an aggregate of $10 to $15 million in revenue during 2023.

Total revenue for the second quarter of 2023 increased by approximately $8.0 million, or 22% from the first quarter of 2023. We expect a sequential increase in revenue in the third quarter of 2023 over the second quarter of 2023, though not to the same extent.

For fiscal 2023, we continue to project low to mid-single digit growth in total revenue over 2022, a trend we expect to continue into 2024 based on our current twelve month forward pipeline.

We have meaningfully reduced our cost footprint and lowered our estimated revenue breakeven point. In tandem with the improved gross profit percentages and the cash initiatives discussed above, we believe we are positioned to weather the current macroeconomic conditions, while continuing to invest in our technology and commercial organizations. 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 healthy gross profit and Adjusted EBITDA margins.

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, onetime 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.

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

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

Adjusted Gross Profit Gross profit before deductions for costs of under-utilized capacity, depreciation and amortization Adjusted Gross Profit Margin Adjusted Gross Profit divided by revenue EBITDA Net income before interest, taxes, depreciation and amortization Adjusted EBITDA EBITDA adjusted to remove foreign exchange gains or losses; impairment expenses; reorganization expenses; stock-based compensation expense; government subsidies; one-time, nonrecurring 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.

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Results of Operations

Three and Six Months Ended June 30, 2023, Compared to the Three and Six Months Ended June 30, 2022

	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,
	2023 2022		% Change	2023 2022		% Change
	($ in thousands)			($ in thousands)
Revenue	44,753	44,701	0	81,461	82,987	(2 )
Gross Profit(1)	14,557	6,276	132	23,239	9,563	143
Gross Profit Margin	32.5 %	14.0 %		28.5 %	11.5 %
Operating Expenses
Sales and Marketing	6,626	7,777	(15 )	12,141	15,005	(19 )
General and Administrative	5,501	6,877	(20 )	11,334	14,870	(24 )
Operations Support	1,822	2,528	(28 )	3,812	5,026	(24 )
Technology and Development	1,277	1,879	(32 )	2,816	4,019	(30 )
Stock-Based Compensation	678	1,326	(49 )	1,474	2,628	(44 )
Reorganization	1,465	5,163	(72 )	2,536	8,855	(71 )
Related PartyExpense(recovery)	(532 )	-	100	1,524	-	100
Total Operating Expenses	16,837	25,550	(34 )	35,637	50,403	(29 )
Operating Loss	(2,280 )	(19,274 )	(88 )	(12,398 )	(40,840 )	(70 )
Operating Margin	(5.1 )%	(43.1 )%		(15.2 )%	(49.2 )%
Government subsidies	88	49	80	236	624	(62 )
Gain on sale of software and	6,145	-	NA	6,145	-	NA
patents
Foreign exchange (loss) gain	(620 )	1,246	(150 )	(881 )	514	(271 )
Interest income	106	20	430	110	31	255
Interest expense	(1,233 )	(1,329 )	(7 )	(2,440 )	(2,659 )	(8 )
	4,486	(14 )	32,143	3,170	(1,490 )	(313 )
Net income (loss) before tax	2,206	(19,288 )	111	(9,228 )	(42,330 )	78
Current and deferred income tax	-	-	NA	-	-	NA
expense(recovery)
	-	-	NA	-	-	NA
Net income (loss)	2,206	(19,288 )	111	(9,228 )	(42,330 )	78

(1) Gross Profit for the six months ended June 30, 2022, includes $1.1 million 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 June 30,	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,
	2023	2022 % Change		2023 2022 % Change
		($ in thousands)		($ in thousands)
Product	38,710	38,098	2	70,191	71,291	(2 )
Transportation	4,614	4,795	(4 )	8,402	8,856	(5 )
License fees from Construction
	210	198	6	417	395	6
Partners
Total product revenue	43,534	43,091	1	79,010	80,542	(2 )
Installationand otherservices	1,219	1,610	(24 )	2,451	2,445	0
	44,753	44,701	0	81,461	82,987	(2 )

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

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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 six months ended June 30, 2023, was $81.5 million, a decrease of $1.5 million compared to $83.0 million in the comparative period of 2022. The first six 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 June 30, 2023, revenue was $44.8 million, an increase of $0.1 million compared to the comparative period of 2022 of $44.7 million.

Installation and other services revenue was $1.2 million for the quarter ended June 30, 2023 compared to $1.6 million in the quarter ended June 30, 2022 and $2.5 million in the six months ended June 30, 2023 compared to $2.4 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 June 30, 2023, we had 68 (March 31, 2023: 67; December 31, 2022: 67) Construction Partners servicing multiple locations. In March 2023, we announced the expansion of six 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 June 30,	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,
	2023	2022 % Change		2023 2022 % Change
		($ in thousands)		($ in thousands)
Commercial	26,378	29,618	(11 )	50,882	53,662	(5 )
Healthcare	10,457	5,091	105	16,628	12,055	38
Government	3,268	5,041	(35 )	5,975	8,322	(28 )
Education	3,221	3,143	2	5,108	6,108	(16 )
License fees from Construction	210	198	6	417	395	6
Partners
Total product revenue	43,534	43,091	1	79,010	80,542	(2 )
Servicerevenue	1,219	1,610	(24 )	2,451	2,445	0
	44,753	44,701	0	81,461	82,987	(2 )

	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,
	2023 2022		2023 2022
	(in %)		(in %)
Commercial	61	69	65	67
Healthcare	24	12	21	15
Government	8	12	8	10
Education	7	7	6	8
Total Product Revenue(1)	100	100	100	100

(1) Excludes license fees from Construction Partners.

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Commercial revenues decreased by 11% from the prior year period. Revenues in the second quarter of 2022 were higher as customers placed orders and accelerated deliveries prior to the 10% price increase that was implemented in July 2022. Healthcare revenues increased by 105% in the second quarter of 2023 from the same period of 2022. The quarter ended June 30, 2023 includes two large healthcare customers totaling $5.6 million. 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 second quarter of 2023 decreased by 35% from the prior period. Similar to healthcare, government revenues tend to be larger individual projects. Education sales in the second quarter of 2023 were consistent with the prior year period at $3.2 million. Both healthcare and education sectors included a higher magnitude of smaller projects in the second quarter of 2023 than in the second quarter of 2022.

For the six months ended June 30, 2023 commercial revenues decreased by 5% from the prior year period. Healthcare revenues increased by 38% in the first half of 2023 from the same period of 2022. Government revenues decreased by 28% from the prior year period. Education sales in the first half of 2023 were down 16% from 2022. Both the healthcare and education sectors included a higher magnitude of smaller projects in 2023 than 2022. During 2023, we have experienced an increase in quotes for healthcare and education related projects, but these tend to have longer project lifecycles than commercial projects.

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,	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,
	2023	2022 % Change		2023 2022 % Change
		($ in thousands)		($ in thousands)
Canada	4,000	7,417	(46 )	8,912	12,668	(30 )
U.S.	40,753	37,284	9	72,549	70,319	3
	44,753	44,701	0	81,461	82,987	(2 )

Historically, approximately 15-25% and 75-85% of revenues are derived from sales to Canada and the United States, respectively.

Sales and Marketing Expenses

Sales and marketing expenses decreased by $1.2 million to $6.6 million for the three months ended June 30, 2023, from $7.8 million for the three months ended June 30, 2022 and $2.9 million to $12.1 million for the six months ended June 30, 2023 from $15.0 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. We expect to increase the investment in this function during 2023 in order to support organic revenue growth. We incurred $0.4 million in costs associated with Connext, our annual open house event in Chicago, Illinois, which coincided with a major commercial interior show in North America, NeoCon.

General and Administrative Expenses

General and administrative expenses decreased by $1.4 million to $5.5 million for the three months ended June 30, 2023 from $6.9 million for the three months ended June 30, 2022. The decrease was primarily related to a decrease in professional services of $1.3 million, which included $0.3 million related to the costs of the contested director elections, and an additional $0.1 million decrease in communications costs associated with our cost savings initiatives.

For the six months ended June 30, 2023, general and administrative expenses decreased $3.5 million to $11.3 million from $14.9 million driven by a $3.1 million reduction in professional services which included $1.8 million related to the costs of the contested director elections, a $0.2 million reduction in office and communication costs and a $0.4 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 $0.7 million from $2.5 million for the three months ended June 30, 2022 to $1.8 million for the three months ended June 30, 2023. The decrease was primarily due to a $0.6 million decrease in salaries and benefits costs associated with the planned headcount reductions as part of our cost savings initiatives. Operations support expenses decreased $1.2 million for the six months ended June 30, 2023 to $2.8 million from $4.0 million in the same period of 2022 mostly related to a $1.2 million decrease in salaries and benefits costs.

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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 $0.6 million to $1.3 million for the three months ended June 30, 2023, compared to $1.9 million for the three months ended June 30, 2022, primarily related to decreased salaries and benefits costs associated with the planned headcount reductions as part of our cost savings initiatives. For the six months ended June 30, 2023, technology and development costs decreased by $1.2 million to $2.8 million from $4.0 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 six months ended June 30, 2023 was $0.7 million and $1.5 million, respectively, compared to $1.3 million and $2.6 million in the same periods of 2022. The decrease 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, lowered by the impact of fair value adjustments on cash settled awards as a result of our share price decreasing during the quarter ended June 30, 2023.

Reorganization

Reorganization expenses for the quarter of $1.5 million decreased from $5.2 million in the prior period. Current quarter costs relate primarily to termination costs associated with actions taken to streamline our back office and operational support functions, as discussed herein and in our quarterly report on Form 10-Q for the period ended March 31, 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 $2.5 million for the six months ended June 30, 2023 from $8.9 million for the same period of 2022. Six month costs in 2023 relate primarily to termination costs discussed above while the costs in 2022 relate to expenditures in closing the Phoenix Facility and costs associated with workforce reductions and changes in management.

Related Party Expense (Recovery)

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 own approximately 19.5% of issued and outstanding common shares. 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").

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. Under the Debt Settlement Agreement, a cash payment shall not be made to settle the Debt unless permitted under the terms of the Extended RBC Facility.

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 shareholders.

At the Annual General Meeting 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.

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Government Subsidies

The Company was not eligible and did not receive any new government subsidies in the quarter ended June 30, 2023. The Company received $0.2 million of interest with the collection of the ERC during the six months ended June 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 quarter ended June 30, 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 profit and loss. 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 June 30, 2022 to $1.2 million in the quarter ended June 30, 2023 and by $0.2 million for the six months ended June 30, 2023 to $2.4 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 pretax income. As at June 30, 2023 the Company had a valuation allowance of $31.9 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 June 30, 2023, we had C$106.9 million of noncapital loss carry-forwards in Canada and $60.5 million in the United States. These loss carry-forwards will begin to expire in 2032.

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Net Income (Loss)

Net income increased to $2.2 million or $0.01 per share in the three months ended June 30, 2023 from a net loss of $19.3 million or $0.22 net loss per share for the three months ended June 30, 2022. The decreased loss is primarily the result of an $8.3 million increase in gross profit, a $8.7 million decrease in operating expenses, including a $3.7 million decrease in reorganization expenses, a one-time gain of $6.1 million on the sale of software and patents, a $0.1 million decrease in interest expense and a $0.1 million increase in interest income, offset by a $1.9 million increase in foreign exchange loss.

Net loss decreased to $9.2 million or $0.09 net loss per share in the six months ended June 30, 2023 from a net loss of $42.3 million or $0.49 net loss per share for the six months ended June 30, 2022. The decreased loss is primarily the result of an $13.7 million increase in gross profit, a $14.8 million decrease in operating expenses (including a $6.3 million decrease in reorganization expenses, and a decrease of $1.8 million of incremental professional fees as described previously), a one-time gain of $6.1 million on the sale of software and patents, a $0.2 million decrease in interest expense, a $0.1 million increase in interest income, offset by a $1.4 million increase in foreign exchange loss and a $0.4 million decrease in government subsidies.

EBITDA and Adjusted EBITDA for the Three and Six Months Ended June 30, 2023 and 2022

The following table presents a reconciliation for the results of the three and six months ended June 30, 2023 and 2022 of EBITDA and Adjusted EBITDA to our net income (loss), which is the most directly comparable GAAP measure for the periods presented:

measure for the periods presented:
	For the Three Months Ended June 30,		For the Six Months Ended June 30,
	2023	2022	2023	2022
	($ in thousands)		($ in thousands)
Net income (loss) for the period	2,206	(19,288 )	(9,228 )	(42,330 )
Add back (deduct):
Interest expense	1,233	1,329	2,440	2,659
Interest income	(106 )	(20 )	(110 )	(31 )
Depreciationand amortization	2,524	3,344	5,199	7,966
EBITDA	5,857	(14,635 )	(1,699 )	(31,736 )
Foreign exchange (gain) loss	620	(1,246 )	881	(514 )
Stock-based compensation	678	1,326	1,474	2,628
Government subsidies	(88 )	(49 )	(236 )	(624 )
Related party expense (recovery)(2)	(532 )	-	1,524	-
Reorganization expense	1,465	5,163	2,536	8,855
Gainonsale ofsoftware and patents(3)	(6,145 )	-	(6,145 )	-
Adjusted EBITDA	1,855	(9,441 )	(1,665 )	(21,391 )
Net Income (Loss) Margin(1)	4.9 %	(43.1 )%	(11.3 )%	(51.0 )%
Adjusted EBITDA Margin	4.1 %	(21.1 )%	(2.0 )%	(26.3 **)% **

(1) Net income (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 17 of the consolidated interim financial statements).

(3) The Gain on sale of software and patents in a non-recurring transaction that is not core to our business and is excluded from the Adjusted EBITDA calculation (Refer to Note 7 of the consolidated interim financial statements).

For the three months ended June 30, 2023, Adjusted EBITDA and Adjusted EBITDA Margin increased by $11.3 million to $1.9 million or 4.1% from a $9.4 million loss or (21.1)% in the same period of 2022. This primarily reflects an $8.3 million increase in Adjusted Gross Profit, a decrease of $1.5 million of incremental professional fees as described previously, a $1.6 million decrease in salaries and benefits costs, a $0.5 million decrease in office, building and communication costs, and a $0.4 million decrease in travel and entertainment costs in the quarter.

For the six months ended June 30, 2023, Adjusted EBITDA and Adjusted EBITDA Margin increased by $19.7 million to a $1.7 million loss or (2.0)% from a $21.4 million loss or (26.3)% in the same period of 2022. This primarily reflects a $11.4 million increase in Adjusted Gross Profit, a decrease of $3.1 million of professional fees, a $4.0 million

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decrease in salaries and benefits costs, a $0.6 million decrease in travel and entertainment costs, a $0.4 million decrease in marketing costs and a $0.4 million decrease in other costs.

Adjusted Gross Profit and Adjusted Gross Profit Margin for the Three and Six Months Ended June 30, 2023 and 2022

The following table presents a reconciliation for the three and six months ended June 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 June 30,	For the Three Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,
	2023 2022		2023 2022
	($ in thousands)		($ in thousands)
Gross profit	14,557	6,276	23,239	9,563
Gross profit margin	32.5 %	14.0 %	28.5 %	11.5 %
Add:Depreciationand amortizationexpense	1,643	2,188	3,425	5,660
Adjusted Gross Profit	16,200	8,464	26,664	15,223
Adjusted Gross Profit Margin	36.2 %	18.9 %	32.7 %	18.3 %

For the quarter ended June 30, 2023, gross profit and gross profit margin increased to $14.6 million or 32.5% from $6.3 million or 14.0% for the prior period. Adjusted Gross Profit and Adjusted Gross Profit Margin increased 91% to $16.2 million or 36.2% for the three months ended June 30, 2023, from $8.5 million or 18.9% for the three months ended June 30, 2022.

For the six months ended June 30, 2023, gross profit and gross profit margin increased to $23.2 million or 28.5% from $9.6 million or 11.5% for the prior period. Adjusted Gross Profit and Adjusted Gross Profit Margin increased 75% to $26.7 million or 32.7% for the six months ended June 30, 2023, from $15.2 million or 18.3% for the six months ended June 30, 2022. Gross profit for the six months ended June 30, 2022 included $1.1 million of accelerated depreciation and amortization arising from 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 $1.9 million and $3.3 million and fixed costs decreased $1.0 million and $1.9 million, respectively, for the quarter and six months ended June 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 related to the Rock Hill Facility incurred since suspension of operations of $0.4 million and $0.9 million for the three and six months ended June 30, 2023 are included in cost of sales.

Liquidity and Capital Resources

As at June 30, 2023, the Company had $18.9 million of cash on hand and C$12.3 million ($9.2 million) of available borrowings (December 31, 2022 - $10.8 million and C$7.2 million ($5.3 million) of available borrowings). Through the first six months of fiscal 2023, the Company generated $2.8 million in cash flows provided from operations, compared to a cash usage of $36.8 million over the first six 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. 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 six months ended June 30, 2023, was $23.2 million, or 28.5%. This represents a meaningful improvement from the same period of 2022, which only generated gross profit of $9.6 million, or 11.5%, despite having 2% lower revenue during fiscal 2023.

Over the past three quarters, we have executed upon several initiatives. 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

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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, providing us annualized savings of approximately $1 million. We are continuing to evaluate other properties 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. Over the past year, 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 147 employees, or approximately 15% from January 2022 through June 2023. The reduced overhead has served to offset the impact from the macroeconomic headwinds experienced over the past year.

We have assessed the Company’s liquidity as at June 30, 2023 taking into account our sales outlook for the next twelve months 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 the macroeconomic factors discussed above could adversely impact our liquidity over such period.

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

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

In February 2021, we entered into the RBC Facility, a C$25.0 million senior secured revolving credit facility with RBC. Under the RBC Facility, the “Borrowing Base” is a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of 75% of the book value of eligible inventory and 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims. 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 June 30, 2023 were C$12.3 million ($9.2 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.

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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.

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

	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Three Months Ended June 30,	For the Six Months Ended June 30,	For the Six Months Ended June 30,
	2023	2022		2023 2022
	($ in thousands)			($ in thousands)
Net cash flows provided by (used in) operating
	3,756		(17,800 )	2,768	(36,842 )
activities
Net cash flows provided by (used in) investing
	8,730		(1,331 )	7,747	(2,951 )
activities
Net cash flows used in financing activities	(2,193 )		(63 )	(2,861 )	(890 )
Effect of foreign exchange on cash, cash
	(13 )		54	(49 )	220
equivalents and restricted cash
Net increase (decrease) in cash, cash
	10,280		(19,140 )	7,605	(40,463 )
equivalents and restricted cash
Cash, cash equivalents and restricted cash,
	11,564		42,085	14,239	63,408
beginningofperiod
Cash, cash equivalents and restricted cash, end
	21,844		22,945	21,844	22,945
of period

Operating Activities

Net cash flows provided by operating activities were $3.8 million for the three months ended June 30, 2023 compared to $17.8 million used in the same period of 2022. The improvement in cash flow used in operations is largely due to the $11.3 million increase in Adjusted EBITDA, a $3.7 million decrease in reorganization expenses, and a $4.4 million net decrease in working capital comprising a $1.8 million decrease in routine working capital and a $2.6 million decrease in other receivables relating to the ERC claim.

Net cash flows provided by operating activities were $2.8 million for the six months ended June 30, 2023 compared to $36.8 million used in the same period of 2022. The improved cash flow from operations was driven by the $19.7 million increase in Adjusted EBITDA, a $6.3 million decrease in reorganization expenses, and a $13.6 million net decrease in working capital comprising $6.3 million decrease in routine working capital and a $7.3 million decrease in other receivables relating to the ERC claim. In the first half of 2023, we have continued to draw down on our inventory supply built up in the first half of 2022.

Investing Activities

Cash flow provided by investing activities during the three and six months ended June 30, 2023 benefited from $10.0 million of proceeds from the AWI transaction during the second quarter of 2023.

We invested $0.7 million and $1.0 million in property, plant and equipment during the three and six months ended June 30, 2023, respectively compared to $0.9 million and $1.9 million, respectively, during the three and six months ended June 30, 2022. This expenditure consisted of $0.2 million of information technology, $0.3 million of DXC refreshes and $0.5 million of manufacturing upgrades for the six months ended June 30, 2023. We invested $0.6 million and $1.1 million on capitalized software during the three and six months ended June 30, 2023, respectively, compared to $0.4 million and $0.9 million for the three and six months ended June 30, 2022.

Financing Activities

For the three and six months ended June 30, 2023, $2.2 million and $2.9 million of cash, respectively, was used in financing activities compared to $0.1 million and $0.9 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 three months ended June 30, 2023, an additional $1.6 million principal repayment was made against the Canadian leasing facilities. 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 six months ended June 30, 2022, we incurred $0.1 million and $0.3 million of spend on employee tax payments on vesting of RSUs compared to $nil and $0.03 million in the same period of 2023.

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We currently expect to fund anticipated future investments with available cash, our strategic actions described in this report, 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 six months ended June 30, 2023 and proceeds of $10.9 million received in the three months ended June 30, 2023 through the AWI transaction. We continue to evaluate properties we own for sale and lease back. 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 June 30, 2023, available borrowings are C$12.3 million ($9.2 million), 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 second 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.

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, 2023, 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. See Note 16, “Commitments” to our interim condensed consolidated financial statements in this Quarterly Report for additional information.

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Significant Accounting Policies and Estimates

There have been no material changes in our significant accounting policies during the three months ended June 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 June 30, 2023.

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 June 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 June 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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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 crossapplication 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 and also promptly denied. DIRTT intends to seek an immediate status conference in Utah now that the case has been returned to the Utah District Court.

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.

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.

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

Our common shares are currently listed on the Toronto Stock Exchange (“TSX”) under the symbol “DRT” and on Nasdaq under the symbol “DRTT.” The price of our common shares has in the past fluctuated significantly, and may fluctuate significantly in the future, depending upon a number of factors, many of which are beyond our control and may adversely affect the market price of our common shares. These factors include: (i) variations in quarterly results of operations; (ii) deviations in our earnings from publicly disclosed forward-looking guidance; (iii) changes in earnings estimates by analysts; (iv) our announcements or our competitors’ announcements of significant contracts, acquisitions, strategic partnerships or joint ventures; (v) general conditions in the offsite construction and manufacturing industries; (vi) sales of our common shares by our significant shareholders; (vii) fluctuations in stock market price and volume; and (viii) other general economic conditions.

In the past, following periods of volatility in the trading price of a company’s securities, securities class action litigation has been brought against that company. If our share price is volatile, we may become the target of securities litigation in both the United States and Canada. Securities litigation could result in substantial costs and divert management’s attention and resources from our business and could have an adverse effect on our business, financial condition and results of operations.

Further, because the closing bid price of our common shares was below the $1.00 Nasdaq minimum requirement for 30 consecutive business days, we became subject to de-listing proceedings. On September 7, 2022, we received a letter from Nasdaq that we had not been in compliance with the minimum bid price requirement set forth in Nasdaq Listing Rule 5450(a)(1) for a period of 30 consecutive business days (the “Bid Price Rule”). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we were provided a compliance period of 180 calendar days from the date of the notice to regain compliance with the minimum closing bid price requirement.

On March 7, 2023, Nasdaq notified us in writing that while we had not regained compliance with the Bid Price Rule, we were eligible for an additional 180 calendar day period, or until September 5, 2023, to regain compliance with the Bid Price Rule. Nasdaq’s determination was based on us having met the continued listing requirement for market value of publicly held shares and all other applicable requirements for initial listing on The Nasdaq Capital Market, with the exception of the Bid Price Rule, and on our written notice to Nasdaq of our intention to cure the deficiency during the second compliance period, including by effecting a reverse stock split, if necessary. If at any time during this additional time period the closing bid price of our common shares is at least $1.00 per share for a minimum of 10 consecutive business days, Nasdaq will provide written confirmation of compliance and the matter will be closed.

If we do not regain compliance by September 5, 2023, Nasdaq will provide written notice that our common shares will be delisted, at which point we may appeal Nasdaq’s determination to a Hearings Panel. There can be no assurance that, in the event we do not regain compliance within the requisite time period and if we chose to appeal the delisting determination by Nasdaq to the Hearings Panel, that such appeal would be successful.

We intend to continue to monitor the closing bid price of our common shares, but we do not intend to initiate a reverse stock split or take other additional actions to regain compliance with the Bid Price Rule. Accordingly, DIRTT common shares may be delisted from Nasdaq. If such delisting occurs, DIRTT shares will continue to trade on the TSX in Canada and OTC in the US.

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

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Our core intellectual property in the ICE Code is jointly owned with a third party, which may fail to comply with its contractual obligations to protect and enforce our intellectual property rights.

AWI owns a 50% interest in the rights, title and interests in all the Applicable ICE Code, including a 50% interest in the patent rights that relate to the Applicable ICE Code. As part of AWI’s purchase of the Applicable ICE Code, AWI must comply with contractual obligations designed to protect the Applicable ICE Code from infringement, misappropriation, misuse or exposure to unauthorized third parties. However, despite our efforts to monitor AWI’s actions, we may not become aware of AWI’s failure to comply with its obligations or we may not have adequate time to address such failure before there are adverse impacts to our business. Additionally, even if we attempt to require AWI to comply with its obligations to enforce our intellectual property rights, AWI may refuse or may not take adequate steps to do so. AWI’s failure to protect or maintain the proprietary nature of the Applicable ICE Code could adversely affect our ability to sell original products and materially and adversely affect our business, financial condition and results of operations.

AWI may fail to meet certain security and non-disclosure obligations designed to prevent our competitors or other unauthorized third parties from accessing the Applicable ICE Code. Despite our efforts to enforce our rights and monitor any inadequacies, we may not have access to AWI’s internal security or business practices. Additionally, we may not be successful in preventing AWI from exposing the source code of the Applicable ICE Code to such third parties or in protecting our intellectual property rights in the Applicable ICE Code. Any unauthorized access to the Applicable ICE Code in AWI’s possession could substantially and adversely affect our business and competitive advantage and management may have to expend significant time and resources to address unauthorized access and disclosure, all of which could have a material adverse effect on our business, financial condition and results of operations.

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

On June 2, 2023, the Company issued 3,899,745 common shares to the 22NW Group pursuant to the Debt Settlement Agreement and the Share Issuance Agreement at a deemed price of $0.40 per common share. The issuance of common shares pursuant to the Share Issuance Agreement was subject to approval by the Company’s shareholders, and the Company’s shareholders subsequently approved such issuance at the Company’s 2023 annual meeting of shareholders held on May 30, 2023. The common shares were offered and sold in reliance upon an exemption from registration provided under Section 4(a)(2) of the Securities Act of 1933 and under National Instrument 45-106 – Prospectus Exemptions .

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

Not Applicable.

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