DIRTT Environmental Solutions Ltd. - Interim / Quarterly Report 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 September 30, 2023 filed on SEDAR+ on November 9, 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, including AWI which owns a 50% interest in the rights, title and interests in all the intellectual property rights in a portion of the ICE Software that is used by AWI.

Key Third Quarter Highlights

Revenue for the quarter ended September 30, 2023 was $49.5 million, an increase of $2.8 million or 6% from $46.7 million for the same period in 2022, and a $4.8 million or 11% increase from the second quarter of 2023. Compared to the same period in 2022, the increase in revenue was primarily driven by an increase in pricing, as well as volume growth in Healthcare and Government sectors. Compared to the first and second quarter of 2023, third quarter activity was higher, in line with seasonal demand patterns and timing of project schedules.
Gross profit and gross profit margin for the quarter ended September 30, 2023 was $17.1 million or 34.4% of revenue, an increase of $10.1 million or 144% from $7.0 million or 15.0% of revenue for the quarter ended September 30, 2022. Adjusted Gross Profit (see “– Non-GAAP Financial Measures”) for the three months ended September 30, 2023 was $18.3 million. This represents an $8.2 million or 80% increase over the comparative period in 2022 and a $2.1 million or 13% increase from the second quarter of 2023. Adjusted Gross Profit Margin (see “– Non-GAAP Financial Measures”) for the third quarter of 2023 was 36.9%, a 1,520 bps improvement over the comparative period and a 70 bps improvement from the second quarter of 2023. The increase in Adjusted Gross Profit and Adjusted Gross Profit Margin compared to the previous and comparative quarters is due to having better leverage over fixed costs through price increases and reduced fixed costs.
Net loss for the third quarter of 2023 was $6.3 million compared to a $6.7 million net loss for the same period of 2022. The lower net loss is primarily the result of the higher gross profit margin of $10.1 million (as explained above), a $2.2 million increase in operating expenses including the $8.0 impairment charge on the Rock Hill Facility, offset by a $3.1 million reduction in reorganization costs, a $0.1 million increase in interest income and $0.1 million decrease in interest expense, offset by a $0.5 million decrease in foreign exchange gain and a $7.1 million government subsidy in 2022 that did not recur.
During the third quarter of 2023, we announced the permanent closure of the Rock Hill Facility. This facility had been temporarily suspended since August 2022. With annual production capacity at DIRTT facilities in Savannah, Georgia and Calgary, Alberta, of approximately $400 million in annual revenue, the closure is part of DIRTT’s ongoing focus on realigning the organization, increasing efficiency, and improving profitability. Non-cash impairment charges related to Rock Hill Facility equipment of $8.0 million has been recorded in the three months ended September 30, 2023.
Adjusted EBITDA (see “– Non-GAAP Financial Measures”) for the third quarter of 2023 was $5.3 million or 10.6%, an improvement of $10.7 million from a $5.4 million loss or (11.6)% for the third quarter of

This improvement was driven by the price increases and improved product mix, as well as the cost reduction measures taken by the Company over the past twenty four months.
Approximately $1.9 million of cash was generated by operating activities in the third quarter of 2023 compared to $10.7 million of cash used in the third quarter of 2022, with cash increasing $0.6 million overall in the third quarter of 2023. Our cash flow has improved compared to earlier quarters due to improved gross margin, our cost reduction initiatives, strategic actions and careful working capital management.

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

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

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

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

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

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

Outlook

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

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

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

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

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

Non-GAAP Financial Measures

Note Regarding Use of Non-GAAP Financial Measures

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

As a result, we also provide financial information in this Quarterly Report that is not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. Management uses these non-GAAP financial measures in its review and evaluation of the financial performance of the Company. We believe that these non-GAAP financial measures also provide additional insight to investors and securities analysts as supplemental information to our GAAP results and as a basis to compare our financial performance period-over-period and to compare our financial performance with that of other companies. We believe that these non-GAAP financial measures facilitate comparisons of our core operating results from period to period and to other companies by removing the effects of our capital structure (net interest income on cash deposits, interest expense on outstanding debt and debt facilities, or foreign exchange movements), asset base (depreciation and amortization), the impact of under-utilized capacity on gross profit, tax consequences, reorganization expense, 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.

Government subsidies, depreciation and amortization, stock-based compensation expense, reorganization expense, foreign exchange gains and losses and impairment charges are excluded from our non-GAAP financial measures because management considers them to be outside of the Company’s core operating results, even though some of those receipts and expenses may recur, and because management believes that each of these items can distort

the trends associated with the Company’s ongoing performance. We believe that excluding these receipts and expenses provides investors and management with greater visibility to the underlying performance of the business operations, enhances consistency and comparativeness with results in prior periods that do not, or future periods that may not, include such items, and facilitates comparison with the results of other companies in our industry.

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

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

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

Results of Operations

Three and Nine Months Ended September 30, 2023, Compared to the Three and Nine Months Ended September 30, 2022

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,
	2023 2022		% Change	2023 2022		% Change
	($ in thousands)			($ in thousands)
Revenue	49,537	46,747	6	130,998	129,734	1
Gross Profit(1)	17,065	7,008	144	40,304	16,571	143
Gross Profit Margin	34.4 %	15.0 %		30.8 %	12.8 %
Operating Expenses
Sales and Marketing	6,161	6,089	1	18,302	21,094	(13 )
General and Administrative	4,669	6,542	(29 )	16,003	21,412	(25 )
Operations Support	1,752	2,321	(25 )	5,564	7,347	(24 )
Technology and Development	1,239	1,695	(27 )	4,055	5,714	(29 )
Stock-Based Compensation	1,069	918	16	2,543	3,546	(28 )
Reorganization	321	3,426	(91 )	2,857	12,281	(77 )
Impairment charge on Rock Hill	7,952	-	100	7,952	-	100
Facility
Related Party Expense	-	-	NA	1,524	-	100
Total Operating Expenses	23,163	20,991	10	58,800	71,394	(18 )
Operating Loss	(6,098 )	(13,983 )	(56 )	(18,496 )	(54,823 )	(66 )
Operating Margin	(12.3 )%	(29.9 )%		(14.1 )%	(42.3 )%
Government subsidies	-	7,141	(100 )	236	7,765	(97 )
Gain on sale of software and	-	-	NA	6,145	-	100
patents
Foreign exchange (loss) gain	822	1,356	(39 )	(59 )	1,870	(103 )
Interest income	161	19	747	271	50	442
Interest expense	(1,196 )	(1,276 )	(6 )	(3,636 )	(3,935 )	(8 )
	(213 )	7,240	103	2,957	5,750	(49 )
Net loss before tax	(6,311 )	(6,743 )	6	(15,539 )	(49,073 )	68
Current and deferred income tax	-	(16 )	100	-	(16 )	100
recovery
	-	(16 )	100	-	(16 )	100
Net loss	(6,311 )	(6,727 )	6	(15,539 )	(49,057 )	68
(1) For the three and nine months ended September 30, 2022, $1.0 million primarily related to the write off of inventory of discounted product lines, and $1.0 million and $2.1 million, respectively of accelerated depreciation and amortization on software associated with discontinued product lines and the closure of the Phoenix Facility.

Revenue

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

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

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,
	2023 2022		% Change	2023 2022		% Change
	($ in thousands)			($ in thousands)
Product	43,132	39,092	10	113,323	110,383	3
Transportation	4,767	5,022	(5 )	13,169	13,878	(5 )
License fees from	196
		193	2	613	588	4
Construction Partners

Total product revenue	48,095	44,307	9	127,105	124,849	2
Installation and other services	1,442	2,440	(41 )	3,893	4,885	(20 )
	49,537	46,747	6	130,998	129,734	1

Beginning in 2020, we experienced significant increases in nearly all of our material input costs, including raw materials, shipping materials, labor, and freight. This led to significant gross margin compression in 2021 and 2022. Effective November 16, 2021, DIRTT increased product and transportation prices on new projects by approximately

6.5%. On February 17, 2022, we implemented a further price increase of 5% that came into effect June 1, 2022. On June 21, 2022 an additional price increase of 10% was announced effective July 21, 2022. These increases have improved revenue and profitability through better recovery of the material input costs previously discussed.

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

Installation and other services revenue was $1.4 million for the quarter ended September 30, 2023 compared to $2.4 million in the quarter ended September 30, 2022, and $3.9 million in the nine months ended September 30, 2023 compared to $4.9 million in the same period of 2022. This revenue primarily reflects services performed by our ICE and design teams for third parties. Except in limited circumstances, our Construction Partners, rather than the Company, perform installation services, and accordingly, we are not anticipating significant growth in this revenue stream.

Our success is partly dependent on our ability to profitably develop our Construction Partner network to expand our market penetration and ensure best practices are shared across local markets. At September 30, 2023, we had 71 (September 30, 2022: 69; December 31, 2022: 67) Construction Partners servicing multiple locations. During the nine months ended September 30, 2023, we announced the expansion of seven of our DIRTT Construction Partners into new markets as we expand the reach of DIRTT products in North America.

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

The following table presents our product and transportation revenue by vertical market:

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,
	2023 2022		% Change	2023 2022		% Change
	($ in thousands)			($ in thousands)
Commercial	31,272	31,796	(2 )	82,154	85,458	(4 )
Healthcare	8,483	3,638	133	25,111	15,693	60
Government	4,606	3,358	37	10,581	11,680	(9 )
Education	3,538	5,322	(34 )	8,646	11,430	(24 )
License fees from	196	193	2	613	588	4
Construction Partners
Total product revenue	48,095	44,307	9	127,105	124,849	2
Service revenue	1,442	2,440	(41 )	3,893	4,885	(20 )
	49,537	46,747	6	130,998	129,734	1

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,

	2023 2022		2023	2022
	(in %)		(in	%)
Commercial	65	72	65	69
Healthcare	18	8	20	13
Government	10	8	8	9
Education	7	12	7	9
Total Product Revenue(1)	100	100	100	100

(1) Excludes license fees from Construction Partners.

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

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

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

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,
	2023 2022		% Change	2023 2022		% Change
	($ in thousands)			($ in thousands)
Canada	5,665	7,191	(21 )	14,577	19,859	(27 )
U.S.	43,872	39,556	11	116,421	109,875	6
	49,537	46,747	6	130,998	129,734	1

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

Sales and Marketing Expenses

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

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

General and Administrative Expenses

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

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

Operations Support Expenses

Operations support is comprised primarily of project managers, order entry and other professionals that facilitate the integration of our Construction Partner project execution and our manufacturing operations. Operations support expenses decreased by $0.6 million from $2.3 million for the three months ended September 30, 2022 to $1.8 million for the three months ended September 30, 2023. The decrease was primarily due to a $0.4 million decrease in salaries and benefits costs associated with the planned headcount reductions as part of our cost reduction initiatives. Operations support expenses decreased $1.8 million for the nine months ended September 30, 2023 to $5.6 million from $7.3 million in the same period of 2022 mostly related to a $1.6 million decrease in salaries and benefits costs.

Technology and Development Expenses

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

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

Stock-Based Compensation

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

Reorganization

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

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

Impairment charge on Rock Hill Facility

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

Related Party Expense

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

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

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

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

Government Subsidies

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

Pursuant to amendments enacted as part of the 2021 Canadian federal budget, the Company was required to repay a portion of the Canadian Emergency Wage Subsidy ("CEWS") amounts received for any qualifying period commencing after June 5, 2021 where the aggregate compensation for “specified executives” (within the meaning of the CEWS) during the 2021 calendar year exceeds the aggregate compensation for “specified executives” during the 2019 calendar year. Upon finalization of 2021 compensation to specified executives, approximately C$0.5 million ($0.4 million) of subsidies was expected to be returned to the Canadian authorities in the second quarter of 2022. The amount was fully provided for in the third quarter of 2021 and in the first quarter of 2022 and the Company reversed a $0.6 million incremental provision related to this that was no longer necessary.

Gain on sale of software and patents

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

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

Interest Expense

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

Income Tax

The provision for income taxes comprises U.S. and Canadian federal, state and provincial taxes based on pretax income. As at September 30, 2023 the Company had a valuation allowance of $33.4 million (December 31, 2022: $29.8 million) against deferred tax assets due to ongoing near term uncertainties on the business caused by the COVID19 pandemic and the related decline in business activity which impacted our ability to generate sufficient taxable income in Canada and the United States to fully deduct historical losses. As at September 30, 2023, we had C$110.9

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

Net Loss

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

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

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

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

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,

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

(1) Net loss divided by revenue.

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

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

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

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

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

The following table presents a reconciliation for the three and nine months ended September 30, 2023 and 2022 of Adjusted Gross Profit to our gross profit, which is the most directly comparable GAAP measure for the periods presented:

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,

	2023 2022		2023 2022
	($ in thousands)		($ in thousands)
Gross profit	17,065	7,008	40,304	16,571
Gross profit margin	34.4 %	15.0 %	30.8 %	12.8 %
Add: Depreciation and amortization expense	1,231	3,132	4,656	8,792
Adjusted Gross Profit	18,296	10,140	44,960	25,363
Adjusted Gross Profit Margin	36.9 %	21.7 %	34.3 %	19.6 %

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

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

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

Liquidity and Capital Resources

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

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

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

Over the past twelve months, we have executed upon several initiatives to improve liquidity. First, in May 2023, we entered into an agreement with AWI resulting in the receipt of $10.9 million of cash. Second, during March 2023, we entered into an agreement to sublease our Dallas “DXC” to one of our Construction Partners in that region. Under the sublease agreement, the subtenant has assumed responsibility for the monthly rent, utilities, maintenance, taxes and other costs as of April 1, 2023, through December 31, 2024, providing us annualized savings of approximately $1 million. We are continuing to evaluate other properties for sale and leaseback or sublease opportunities, including our Rock Hill Facility and expect these strategic initiatives to result in positive cash inflows in 2023 and 2024. Third, we completed a Private Placement (as defined herein) of common shares in November 2022, with certain significant shareholders and directors and officers of the Company to bridge cash requirements before the completion and closing of the noted strategic transactions. The Company entered into irrevocable subscription agreements with its two largest shareholders, 22NW and 726 and all the directors and officers of the Company on November 14, 2022 to issue 8.7 million shares for gross consideration of $2.8 million (the "Private Placement"). The Private Placement closed on November 30, 2022. In addition, in connection with the Private Placement, 22NW and 726, or their principals, have irrevocably committed to backstopping any rights offering occurring by the Company within twelve months of closing the Private Placement in the aggregate amount of $2.0 million.

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

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

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

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

In January 2021, we issued C$40.3 million of the January Debentures for net proceeds after costs of C$37.6 million ($29.5 million). The January Debentures accrue interest at a rate of 6.00% per annum and are convertible into common shares of DIRTT at an exercise price of C$4.65 per common share, or if not converted will mature and be repayable on the January Debenture Maturity Date. Interest and principal are payable in cash or shares at the option of the Company. As at September 30, 2023, C$18.9 million of the January Debentures are held by a related party,

22NW. 22NW holds approximately 22.1% of our issued and outstanding common stock as of October 25, 2023. Aron English, manager of 22NW Fund GP, LLC, the general partner of 22NW, is a director of the Company.

In February 2021, we entered into the RBC Facility, a C$25.0 million senior secured revolving credit facility with RBC. Under the RBC Facility, the “Borrowing Base” is a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of 75% of the book value of eligible inventory and 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims. On February 9, 2023, the Company extended the RBC Facility. The Extended RBC Facility has a borrowing base of C$15 million and a one year term. Available borrowings under the Extended RBC Facility at September 30, 2023 were C$14.6 million ($10.8 million).

On December 1, 2021, we issued C$35.0 million of the December Debentures for net proceeds after costs of C$32.7 million ($25.6 million). The December Debentures accrue interest at a rate of 6.25% per annum and are convertible into common shares of DIRTT at an exercise price of C$4.20 per common share, or if not converted will mature and be repayable on the December Debenture Maturity Date. Interest and principal are payable in cash or shares at the option of the Company. As at September 30, 2023, C$13.6 million of the December Debentures are held by a related party, 22NW.

The Company has a C$5.0 million Canada Leasing Facility of which C$4.4 million ($3.3 million) has been drawn, and a $14.0 million U.S. Leasing Facility of which $13.3 million has been drawn with RBC and one of its affiliates. The Leasing Facilities are available for equipment expenditures and certain equipment expenditures already incurred. In connection with the Company’s decision to close the Rock Hill Facility, we intend to settle the liability related to the U.S. Leasing Facility of $8.2 million in the next twelve months. With the settlement of this liability, we expect approximately $2.6 million to be released from restricted cash. On October 31, 2023, the Company paid off $1.0 million of the U.S. Leasing Facility.

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

	For the Three Months Ended September 30,	For the Three Months Ended September 30,	For the Nine Months Ended September 30,	For the Nine Months Ended September 30,

	2023 2022		2023 2022
	($ in thousands)		($ in thousands)
Net cash flows provided by (used in) operating
	1,919	(10,667 )	4,687	(47,509 )
activities

Net cash flows provided by (used in) investing
	(658 )	(644 )	7,089	(3,595 )
activities

Net cash flows used in financing activities	(551 )	(912 )	(3,412 )	(1,802 )
Effect of foreign exchange on cash, cash
	(117 )	(293 )	(166 )	(73 )
equivalents andrestricted cash

Net increase (decrease) in cash, cash
	593	(12,516 )	8,198	(52,979 )
equivalents and restricted cash

Cash, cash equivalents and restricted cash,
	21,844	22,945	14,239	63,408
beginning of period

Cash, cash equivalents and restricted cash, end
	22,437	10,429	22,437	10,429
of period

Operating Activities

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

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

Investing Activities

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

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

Financing Activities

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

We currently expect to fund anticipated future investments with available cash and drawings on the Extended RBC Facility. To date, our strategic actions have generated cash through proceeds from the Private Placement in November 2022, the receipt of $7.3 million of government subsidy through the ERC application during the nine months ended September 30, 2023 and proceeds of $10.9 million received in the second quarter of 2023 through the AWI transaction. We continue to evaluate properties we own for sale and lease back and opportunities to sub lease available spaces. Apart from cash flow from operations, issuing equity and debt has been our primary source of capital to date. Additional debt or equity financing, may be pursued in the future as we deem appropriate. We may also use debt or pursue equity financing depending on the price of our common shares at the time, interest rates, and nature of the investment opportunity and economic climate. No assurance can be given that any of these actions will be successful and will be sufficient for our needs.

Credit Facility

On February 12, 2021, the Company entered into the RBC Facility. Under the RBC Facility, the Borrowing Base is up to a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of 75% of the book value of eligible inventory and 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims. Interest is calculated at the Canadian or U.S. prime rate plus 30 basis points or at the Canadian Dollar Offered Rate or LIBOR plus 155 basis points. Under the RBC Facility, if the Aggregate Excess Availability is less than C$5.0 million, the Company is subject to a FCCR covenant of 1.10:1 on a trailing twelve-month basis. Additionally, if the FCCR has been below 1.10:1 for the three immediately preceding months, the Company is required to maintain a reserve account equal to the aggregate of one year of payments on outstanding loans on the Leasing Facilities. Should an event of default occur, or the Aggregate Excess Availability be less than C$6.25 million for five consecutive business days, the Company would enter a cash dominion period whereby the Company’s bank accounts would be blocked by RBC and daily balances will set-off any borrowings and any remaining amounts made available to the Company.

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

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

The Company has drawn $13.3 million of cash consideration under the U.S. Leasing Facility and commenced the lease term in 2020 for the equipment at the South Carolina Facility. The Company has drawn C$4.4 million ($3.3 million) of cash consideration under the Canada Leasing Facility and commenced the lease term for the Canadian equipment expenditures during 2020. In connection with the Company’s decision to close the Rock Hill Facility, we intend to settle the liability related to the U.S. Leasing Facility of $8.2 million in the next twelve months. With the settlement of this liability, we expect approximately $2.6 million to be released from restricted cash. On October 31, 2023, the Company paid off $1.0 million of the U.S. Leasing Facility.

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

Contractual Obligations

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

additional commitments related to the extension of one of our factory leases in Calgary for an additional ten years beyond the original term;
our entry into the Debt Settlement Agreement with the 22NW Group; and
the modification of our Rock Hill Facility lease.

See Note 15, “Commitments” to our interim condensed consolidated financial statements in this Quarterly Report for additional information.

Significant Accounting Policies and Estimates

There have been no material changes in our significant accounting policies during the three months ended September 30, 2023, as compared to those disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Significant Accounting Policies and Estimates” in our Annual Report on Form 10-K. For information regarding significant accounting policies and estimates, please refer to Item 7 and Item 8 in our Annual Report on Form 10-K. As disclosed in Note 3, “Adoption of New and Revised Accounting Standards” to our condensed consolidated interim financial statements appearing in this Quarterly Report, there were no new accounting standards adopted during the three months ended September 30, 2023. We have disclosed the accounting policy applied for the assets held for sale related to the Rock Hill Facility.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements, please refer to Note 3, “Adoption of New and Revised Accounting Standards” to our condensed consolidated interim financial statements and “–Significant Accounting Policies and Estimates” appearing in this Quarterly Report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our market risk exposures since our disclosures in our Annual Report on Form 10-K. For information regarding our exposure to certain market risks, please refer to Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” in our Annual Report on Form 10-K. The Company’s cash and cash equivalents are predominantly all with one AA rated financial institution.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

As required by Rule 13a-15 under the Exchange Act, our principal executive officers and principal financial officer carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2023. Based upon their evaluation, our principal executive officers and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

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

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

In the Canadian Non-Compete Case, on February 14, 2023, the Court of King’s Bench of Alberta granted DIRTT's application to schedule the hearing of its summary judgment application and dismissed Falkbuilt’s 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 was also promptly denied. Fallkbuilt also petitioned the Supreme Court to accept review, even after losing the stay motion, that petition was also denied in early October.

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

Item 1A. Risk Factors

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

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

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

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

None.

Item 3. Defaults Upon Senior Securities