DIRTT ENVIRONMENTAL SOLUTIONS LTD

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

1. GENERAL INFORMATION

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

DIRTT’s proprietary design integration software, ICE® (“ICE” or “ICE software”), translates the vision of architects and designers into a 3D model that also acts as manufacturing information. ICE is also licensed to unrelated companies and Construction Partners of the Company. As of May 9, 2023, Armstrong World Industries, Inc. (“AWI”) owns a 50% interest in the rights, titles and interest in certain intellectual property rights in a portion of the ICE Software that is used by AWI.

DIRTT is incorporated under the laws of the province of Alberta, Canada, its headquarters is located at 7303 – 30th Street S.E., Calgary, AB, Canada T2C 1N6 and its registered office is located at 4500, 855 – 2nd Street S.W., Calgary, AB, Canada T2P 4K7. DIRTT’s common shares trade on the Toronto Stock Exchange under the symbol “DRT”. Effective October 12, 2023, DIRTT’s common shares ceased to trade on The Nasdaq Capital Markets. DIRTT’s common shares are quoted on the OTC Markets on the “OTC Pink Tier” under the symbol “DRTTF”.

2. SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

These consolidated financial statements (“Financial Statements”), including comparative figures, have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

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

Principles of consolidation

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

Basis of measurement

These Financial Statements have been prepared on the historical cost convention except for certain financial instruments, assets held for sale and stock-based compensation that are measured at fair value, as explained in the accounting policies below. Historical cost is generally based on the fair value of the consideration given in exchange for assets.

Use of estimates

The preparation of the Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingent liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Such estimates primarily relate to unsettled transactions and events as of the date of the Financial Statements. Estimates are based on historical data and experience, as well as various other factors that management considers reasonable under the circumstances. Actual outcomes can differ from these estimates.

Significant estimates and assumptions made by management include:

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Estimates of ability and timeliness of customer payments of trade receivables;

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Estimates of useful lives of depreciable assets as well as the fair value of long-term assets and future cash flows used for impairment calculations;

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Determining the fair value less costs to sell of the assets held for sale;

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Estimates of future taxable earnings used to assess the realizable value of deferred tax assets and the ability to recognize a deferred tax asset;

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Tax interpretations, regulations and legislation in the various jurisdictions in which the Company and its subsidiary operate;

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Estimates of the fair value of stock awards, including whether the performance criteria will be met and measurement of the ultimate payout amount; and

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Estimates of liabilities associated with the potential and amount of warranty, legal claims and other contingencies.

Segments

Management has determined that DIRTT hasone operating segment. The Company’s chief executive officer, who is DIRTT’s chief operating decision maker, reviews financial information on a consolidated and aggregate basis, together with certain operating metrics principally, to make decisions about how to allocate resources and to measure the Company’s performance.

Foreign currency translation

DIRTT Environmental Solutions Ltd. is a Canadian company and its functional currency is the Canadian dollar. DIRTT’s wholly owned subsidiary is domiciled in the United States and its functional currency is the U.S. dollar.

Assets and liabilities denominated in foreign currencies, other than those held through foreign subsidiaries, are translated into the transacting company’s functional currency at the year-end exchange rate for monetary items, and at the historical exchange rates for non-monetary items. Foreign currency revenues and expenses are translated at the exchange rates in effect on the dates of the related transactions. Foreign exchange gains and losses, other than those arising from the translation of the Company’s net investments in its foreign subsidiary, are included in income.

The accounts of the Company’s U.S. dollar subsidiary is translated into Canadian dollars, and the Financial Statements are translated into U.S. dollars for financial statement presentation. Assets and liabilities are translated using year-end exchange rates, and revenues, expenses, gains and losses are translated using average monthly exchange rates. Foreign exchange gains and losses arising from the translation of the Company’s assets and liabilities are included in “comprehensive loss for the year”.

Cash and cash equivalents and restricted cash

Cash and cash equivalents include cash on hand held at banks and cash equivalents, which are defined as highly liquid investments with original maturities of three months or less. Restricted cash is a reserve account not available for immediate or general business use and is required when certain requirements are not met under the terms of the Company’s senior secured credit facility (as defined in Note 14).

Trade and other receivables, net of expected credit losses

Accounts receivable are recorded at the invoiced amount, do not require collateral and do not bear interest. The Company estimates its allowance for doubtful accounts using the current expected credit loss (“CECL”) methodology, which is designed to capture the Company’s current estimate of all expected credit losses.

Inventory

Inventory is comprised of raw materials and work in progress. The Company does not typically carry a significant amount of finished goods inventory. Inventory is valued at the lower of weighted average cost and net realizable value. Net realizable value is based on an item’s usability in the manufacturing of the Company’s products. The Company records an allowance for obsolescence when the net realizable value of inventory items declines below weighted average cost. Net realizable value is determined based on current market prices for inventory less the estimated cost to sell. Work in progress is valued at an estimate of cost, including attributable overheads, based on stage of completion.

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 separately recognized as an expense in the period in which they are incurred.

Assets held for sale

The Company classifies an asset group (“asset”) as held for sale in the period that (i) it has approved and committed to a plan to sell the asset, (ii) the asset is available for immediate sale in its present condition, (iii) an active program to locate a buyer and other actions required to sell the asset have been initiated, (iv) the sale of the asset is probable and transfer of the asset is expected to qualify for recognition as a completed sale within one year (subject to certain events or circumstances), (v) the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value, and (vi) it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. The Company initially and subsequently measures a long-lived asset that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the consolidated statement of operations and comprehensive loss in the period in which the held for sale criteria are met. Upon designation as an asset held for sale, the Company stops recording depreciation expense on the asset.

The Company assesses the fair value of assets held for sale less any costs to sell at each reporting period until the asset is no longer classified as held for sale.

Leases

The Company categorizes leases at their inception as either operating or finance leases. Leases where the Company assumes substantially all of the rewards or ownership and leases where ownership is transferred at the end of the lease term, or by way of a bargain purchase option, are classified as finance leases. Upon initial recognition, the leased asset is measured at an amount equal to the lower of its fair value and the present value of the minimum lease payments. Lease payments are apportioned between finance charges and reduction of the lease liability, so as to achieve a constant rate of interest on the balance of the liability. Finance charges are recognized in the statement of operations.

The Company’s Leasing Facilities (as defined in Note 8) are accounted for as finance leases as ownership of the equipment is expected to return to the Company at the end of the lease term. These transactions are not accounted for as a sale of the underlying equipment as the Company continues to control the equipment.

For leases categorized as operating, the Company determines if an arrangement is a lease or contains a lease element at inception. The arrangement is a lease if it conveys the right to the Company to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. Operating leases are separately disclosed as operating lease right-of-use (“ROU”) assets, with a corresponding lease liability split between current and long-term components on the balance sheet. Operating leases with an initial term of 12 months or less are not included on the balance sheet.

The Company recognizes lease expense for these leases on a straight-line basis over the lease term. ROU assets represent the right to use an underlying asset for the lease term and operating lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term.

Property, plant and equipment

Property, plant and equipment are recorded at cost, including direct costs, attributable indirect costs and carrying costs, less accumulated depreciation and any accumulated impairment losses. Expenditures for repairs and maintenance are expensed as incurred, while renewals and betterments are capitalized.

Depreciation is charged to the consolidated statement of operations on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives of the Company’s property, plant and equipment are as follows:

When assets are disposed of or retired, the cost and accumulated depreciation and impairment losses are removed from the respective accounts and any resulting gain or loss is reflected in operating expenses.

Capitalized software costs

The Company capitalizes costs related to internally developed software during the application development stage when (i) the preliminary project stage is completed, (ii) management has authorized further funding for the completion of the project, and (iii) it is probable that the project will be completed and performed as intended. Capitalized costs include costs of personnel and related expenses for employees and third parties directly attributable to the projects. Capitalization of these costs ceases once the project is substantially complete and the software is ready for its intended purpose. Costs incurred for significant upgrades and enhancements are also capitalized. Costs related to preliminary project activities and post implementation activities, including training, maintenance and minor modifications or enhancements are expensed as incurred. Capitalized software costs are amortized on a straight-line basis over the estimated useful life of the developed asset, which is generally three tofive years. Management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of the assets.

Software development is considered internal-use as it is used to design and sell the DIRTT products and is not included in the end client’s product. Revenues received from Construction Partners for ICE Software are recognized as revenues as they are considered an element of the product sale. Any incidental third-party revenues received for the ICE Software are credited against capitalized software costs. The Company follows this accounting policy for cloud computing arrangements that are considered a service contract, however, these projects are capitalized to prepaids and other assets on the balance sheet and are expensed as an operating cost, as opposed to amortization, over the expected term of the software service contract.

Impairment of long-lived assets

Management evaluates the recoverability of the Company’s property, plant and equipment, capitalized software costs and ROU assets when events or changes in circumstances indicate a potential impairment exists. Events and changes in circumstances considered by the Company in determining whether the carrying value of long-lived assets may not be recoverable include, but are not limited to, significant changes in performance relative to expected operating results, significant changes in the use of the assets, significant negative industry or economic trends, and changes in the Company’s business strategy. Impairment testing is performed at an asset level that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (an “asset group”). In determining if impairment exists, the Company estimates the undiscounted cash flows to be generated from the use and ultimate disposition of the asset group. If impairment is indicated based on a comparison of the assets’ carrying values and the undiscounted cash flows, the impairment loss is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets.

Convertible Debentures

The Company accounts for convertible debentures as liabilities. Embedded features included in the convertible debentures that require bifurcation are accounted for separately. Costs incurred directly related to the issuance of convertible debentures are presented as a direct deduction against the carrying amount of the convertible debentures and are amortized to interest expense using the effective interest method.

Income taxes

Income tax expense is comprised of current and deferred tax. Income tax is recognized in the consolidated statement of operations and comprehensive loss except to the extent it relates to items recognized directly in equity.

Current tax

Current tax expense is based on the results for the year, adjusted for items that are not taxable or not deductible. Current tax is calculated using tax rates and laws that were enacted at the end of the reporting period. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation. Provisions are established where appropriate on the basis of amounts expected to be paid to the tax authorities.

Deferred tax

Deferred tax is recognized, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated balance sheet. Deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates and laws that will be in effect when the differences are expected to reverse.

The effect of a change in income tax rates on deferred income tax assets and liabilities is recognized in income in the period during which the change occurs.

When appropriate, the Company records a valuation allowance against deferred tax assets to reflect that these tax assets may not be realized. In determining whether a valuation allowance is appropriate, the Company considers whether it is more likely than not that all or some portion of the Company’s deferred tax assets will not be realized, based on management’s judgment using available evidence about future events.

At times, tax benefits claims may be challenged by a tax authority. Tax benefits are recognized only for tax positions that are more likely than not sustainable upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely to be realized upon settlement. A liability for “unrecognized tax benefits” is recorded for any tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards.

Revenue recognition

The Company accounts for revenue in accordance with topic 606, Revenue from Contracts with Customers, (“ASC 606”) and Subtopic 340-40, Other Assets and Deferred Costs – Contracts with Customers. Under ASC 606, an entity recognizes revenue in a manner that reflects the transfer of promised goods or services to customers in an amount which the entity expects to be entitled in exchange for those goods or services.

The Company recognizes revenue upon transfer of control of promised goods or services to customers at the transaction price, an amount that reflects the consideration the Company expects to receive in exchange for those goods or services. Transaction price is calculated as selling price net of variable consideration which may include estimates for sales incentives related to current period product revenue. Revenue is measured at the fair value of the consideration received or receivable, after discounts, rebates and sales taxes or income taxes and duties.

Product sales

The Company recognizes revenue upon transfer of control of products to the customer, which typically occurs upon shipment. The Company’s main performance obligation to customers is the delivery of products in accordance with purchase orders. Each purchase order defines the transaction price for the products purchased under the arrangement. Construction Partners typically sell DIRTT product to end clients and issue purchase orders to the Company to manufacture the product. Construction Partners utilize ICE licenses to sell DIRTT products. The ICE licenses sold to Construction Partners are not considered a separate performance obligation as they are not distinct, and ICE license revenue is recognized in conjunction with product sales. The Construction Partner ICE Software revenue is recognized over the license period.

The Company’s standard sales terms are Free On Board (“FOB”) shipping point, which comprise the majority of sales. The Company usually requires a 50% progress payment on receipt of certain orders, excluding certain government orders or in some special contractual situations. Customer deposits received are recognized as a liability on the balance sheet until revenue recognition criteria is met. At the point of shipment, the customer is generally required to pay the balance of the sales price within 30 days. The Company’s sales arrangements do not have any material financing components. In addition, the Company’s customer arrangements do not produce contract assets that are material to its consolidated financial statements.

The Company provides sales commissions to internal and external sales representatives which are earned in the period in which revenue is recognized.

The Company accounts for product transportation revenue and costs as fulfillment activities and presents the associated costs in costs of goods sold in the period in which the Company sells its product.

Contracts containing multiple performance obligations

The Company offers certain arrangements whereby a customer can purchase products and installation together, which are generally capable of being distinct and accounted for as separate performance obligations. Where multiple performance obligations exist, the Company determines revenue recognition by (1) identifying the contract with the customer, (2) identifying the performance obligation in the contract, (3) determining the transaction price, (4) allocating the transaction price to the performance obligations based on the relative standalone selling prices, typically based on cost plus a reasonable margin, and (5) recognizing revenue as the performance obligations are satisfied.

Installation and other services

The Company provides installation and other services for certain customers as a distinct performance obligation. Revenue from installation services is recognized over time as the service is performed.

Principal vs Agent Considerations

The Company evaluates the presentation of revenue on a gross vs. net basis based on whether it acts as a principal by controlling the product or service sales to customers. In certain instances, the Company facilitates contracting of certain sales on behalf of Construction Partners. The Company records these revenues on a gross basis when the Company is obligated to fulfill the service and has the risk associated with service delivery. The Company records these revenues on a net basis when the Construction Partner has the obligation to fulfill the services and has the risk associated with service delivery.

Construction Partner rebates

Rebates to Construction Partners (“Partner Rebates”) are accrued for and recognized as a reduction of revenue at the date of the sale to the customer. Partner Rebates include amounts collected directly by the Company owed to Construction Partners in accordance with their Construction Partner agreements, being the difference between the price to the end customer and the Construction Partners’ price. Other sales discounts are deducted immediately from sales invoices.

Contract balances

Timing of revenue recognition may differ from the timing of invoicing to customers. The Company records an unbilled receivable when revenue is recognized prior to invoicing. As the Company’s contracts are less than one year in duration, the Company has elected to apply the practical expedients to expense costs related to costs to obtain contracts and not disclose unfulfilled performance obligations. As deferred revenue and customer deposits are typically recognized during the year, the Company does not account for financing elements.

Warranties

The Company provides a warranty on all products sold to its clients and Construction Partner’s clients. Warranties are not sold separately to customers. Provisions for the expected cost of warranty obligations are recognized based on an analysis of historical costs for warranty claims relative to current activity levels and adjusted for factors based on management’s assessment that increase or decrease the provision. Warranty provision is recognized in cost of goods sold. Warranty claims have historically not been material and do not constitute a separate performance obligation.

Stock-based compensation

The Company follows the fair value-based approach to account for options, share awards and restricted share units (“RSUs”). Compensation expense and an increase in “Additional paid-in capital” are recognized for options and RSUs over their vesting period based on their estimated fair values on the grant date, as determined using the Black-Scholes option pricing model for the majority of options and the market value of the Company’s common shares on the grant date for share awards and RSUs. Certain executive stock options and RSUs have performance conditions and are valued using a Monte Carlo model.

On exercise of stock options and RSUs, the recorded fair value of the option or RSU is removed from “Additional paid-in capital” and credited to “Share capital”. For options, any consideration paid by employees is credited to “Share capital” when the option is exercised. The Company’s stock options and RSUs are not shares of the Company and have no rights to vote, receive dividends, or any other rights as a shareholder of the Company.

Stock-based compensation expense is also recognized for performance share units (“PSUs”) and deferred share units (“DSUs”) using the fair value method. Compensation expense is recognized over the vesting period and the corresponding amount is recorded as a liability on the balance sheet.

The Company measures the DSUs granted under the 2023 LTIP (the “New DSUs”) using the closing price of the Company’s common shares on the grant date as the present intention is to settle the New DSUs in equity. This is recognized as an increase to stock-based compensation and the corresponding liability on the balance sheet.

Technology and development expenditures

Technology and development expenses are comprised primarily of salaries and benefits associated with the Company’s product and software development personnel which do not qualify for capitalization. These costs are expensed as incurred and exclude certain information and technology costs used in operations which are classified as general and administrative costs.

Government subsidies

The Company accounts for government subsidies on an accrual basis when the conditions for eligibility are met. The Company has adopted an accounting policy to present government subsidies as other income. The nature, significant terms and conditions of government subsidies are disclosed in the Financial Statements.

Earnings per share (“EPS”)

Basic earnings per share is calculated using the weighted average number of common shares outstanding during the year and adjusted for any change in capital structure events triggering retroactive changes to weighted average number of common shares outstanding. Diluted earnings per share is calculated using the treasury stock method for determining the dilutive impact of stock options, RSUs, and New DSUs. The Company follows the “if converted” method for accounting for the impact of convertible debentures on net (loss) per share, whereby interest charges applicable to the convertible debentures are added to the numerator and the convertible debentures are assumed to have been converted at the beginning of the period (or time of issuance, if later), and the resulting common shares are added to the denominator.

Fair value of financial instruments

ASC 820, “Fair Value Measurements,” requires entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the consolidated balance sheet, for which it is practicable to estimate fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

The Company’s fair value analysis is based on the degree to which the fair value is observable and grouped into categories accordingly:

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Level 1 financial instruments are those which can be derived from quoted market prices (unadjusted) in active markets for similar financial assets or liabilities.

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Level 2 financial instruments are those which can be derived from inputs that are observable for the asset or liability, either directly (i.e., as prices) or indirectly (i.e., derived from prices). Level 2 financial instruments include current and long-term debt. The carrying amounts of these instruments approximates fair value due to limited changes to interest rates and the Company’s credit rating since issuance.

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Level 3 financial instruments are those derived from valuation techniques that include inputs for the financial asset or liability which are not based on observable market data (unobservable inputs). The Company does not have any Level 3 financial instruments.

The carrying amounts of cash and cash equivalents and restricted cash; trade and accrued receivables, other receivables; accounts payable and accrued liabilities; other liabilities; and customer deposits approximate fair value due to their short-term nature.

3. ADOPTION OF NEW ACCOUNTING STANDARDS AND RECENT PRONOUNCEMENTS ISSUED

In November 2023, the Financial Accounting Standards Board ("FASB") issued ASU No. 2023-07"Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures (ASU 2023-07), which requires an enhanced disclosure of significant segment expenses on an annual and interim basis. This guidance will be effective for the annual periods beginning the year ended December 31, 2024, and for interim periods beginning January 1, 2025. Early adoption is permitted. The Company has chosen to early adopt. Upon adoption, the guidance is applied retrospectively to all prior periods presented in the financial statements.

On December 14, 2023, the Financial Accounting Standards Board issued Accounting Standards Update No. 2023-09, “Improvements to Income Tax Disclosures” (the “ASU”) further disaggregated information on an entity’s tax rate reconciliation and income taxes paid. The amendments in this ASU are effective for fiscal years beginning after December 15, 2024, on a prospective basis with an option of retrospective application. The Company will continue to evaluate the impact of the adoption of this standard.

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

4. LIQUIDITY

As at December 31, 2023, the Company had $24.7 million of cash on hand and C$13.6 million ($10.3 million) of available borrowings (2022 – $10.8 million and C$7.2 million ($5.3 million) of available borrowings). Through the year ended December 31, 2023, the Company generated $14.8 million in cash flows from operations, compared to a cash usage of $44.3 million over fiscal year 2022. The Company benefited from the receipt of $7.3 million of government subsidies during 2023, compared to $nil for the year ended December 31, 2022 (refer to Note 5).

We have implemented multiple price increases during the past two years to mitigate the impact of inflation on raw materials and improve liquidity. These actions have resulted in a meaningful improvement in our gross profit margins and have served to reduce our cash usage to operate the business. Gross profit for the year ended December 31, 2023, was $59.5 million or 32.7% of revenue, compared to the same period in 2022, which generated gross profit of $28.2 million or 16.4% of revenue.

Over the same period, we have also executed upon several initiatives. First, in May 2023, we entered into an agreement with AWI (refer to Note 7) resulting in the receipt of $12.8 million of cash during 2023. Second, in March 2023, we entered into an agreement to sublease our Dallas DIRTT Experience Center (“DXC”) to one of our Construction Partners in that region. Under the sublease agreement, the subtenant has assumed responsibility for the monthly rent, utilities, maintenance, taxes and other costs as of April 1, 2023, through December 31, 2024, which will provide us annualized savings of approximately $1 million. We are continuing to evaluate other properties for sale and leaseback or sublease opportunities and expect these strategic initiatives to result in positive cash inflows in 2024. Third, we completed a private placement of common shares in November 2022 for aggregate proceeds of $2.8 million (the "Private Placement"), 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 BC LLC and 726 BF (together “726” (which subsequently transferred its holdings to WWT)) 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 closed on November 30, 2022 (refer to Note 22).

On November 21, 2023, we announced the Rights Offering to common shareholders for aggregate gross proceeds of C$30.0 million (the “Rights Offering”). The Rights Offering closed on January 9, 2024 (refer to Note 23).

While we are encouraged by our improved profitability and cash flow, we have continued to evaluate our fixed cost structure and overhead in light of macroeconomic uncertainty. We have implemented multiple reorganization initiatives (refer to Note 6) designed to align our cost structure with current expected levels of demand. In addition, the Company has reduced headcount by approximately 10% from January 2022 through December 2023.

We have assessed the Company’s liquidity position as at December 31, 2023, taking into account our sales outlook for the next twelve-months, our existing cash balances and available credit facilities. Based on this analysis, we believe the Company has sufficient liquidity to support ongoing operations for at least the next twelve months.

5. GOVERNMENT SUBSIDIES

In the United States, the Employee Retention Credit (“ERC”) was established by Section 2301 of the Coronavirus Aid, Relief, and Economic Security Act to provide an incentive for employers to keep their employees on their payroll during COVID-19 closures. The ERC is a refundable payroll tax credit based on qualified wages paid by an eligible employer between March 12, 2020, and October 1, 2021, for companies experiencing a significant decline in gross receipts during a calendar quarter or having operations fully or partially suspended during the quarter due to COVID-19. During the third quarter of 2022, the Company determined it was eligible for the ERC for the first three quarters of 2021 and filed a claim for $7.3 million in payroll tax credits ($7.1 million net of expenses). As at December 31, 2023, the $7.3 million of these claimed credits (plus an additional $0.2 million of interest) have been received.

6. REORGANIZATION AND ASSETS HELD FOR SALE

Over the past two years, the Company has undertaken a number of reorganization initiatives:

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

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

Workforce Reductions, Board and Management Changes

In February and July of 2022, we announced our intention to eliminate a portion of our salaried workforce, including manufacturing and office positions, along with other cost reduction initiatives. The Company’s Board of Directors was reconstituted following a proxy contest in April 2022, which was deemed a change of control under the Company’s insurance policy resulting in additional insurance expenditures. Further, the Company made changes to several executive officer roles during the year ended December 31, 2022. During the year ended December 31, 2023, we continued to review costs, resulting in the elimination of additional salaried positions in the second and third quarters of 2023. These actions resulted in the Company incurring certain one-time termination costs.

Temporary Suspension of Operations and Subsequent Closure at the Rock Hill Facility

On August 23, 2022, we announced the temporary suspension of operations at our Rock Hill Facility, shifting related manufacturing to our Calgary manufacturing facility. Costs associated with this idle facility, included in costs of sales, were $2.0 million (2022 - $0.5 million).

On September 27, 2023, we announced our intention to permanently close the Rock Hill Facility. We plan to move certain assets to our other facilities and dispose of remaining assets. The assets to be disposed of have been reclassified and measured as assets held for sale (see table below). As a result of this decision, we incurred $8.7 million of impairment charges associated with the transfer of assets from held for use to held for sale. We also expect to incur$0.2 million of costs in dismantling and decommissioning the Rock Hill Facility assets. The Company will continue to maintain the Rock Hill Facility building lease and is pursuing a sublease arrangement. Based on prevailing market prices in the area, no impairment indicators exist for the Right of Use asset of $6.7 million and the related leasehold improvements of $2.7 million.

Reorganization costs incurred related to the above-mentioned initiatives:

Of the $0.6 million payable, $0.5 million relates to termination benefits and $0.1 million relates to other reorganization costs (2022 - of the $2.3 million payable, $2.1 million relates to termination benefits and $0.2 million relates to other reorganization costs).

Assets held for sale

Assets classified as held for sale as at December 31, 2023, of $1.6 million consist of manufacturing equipment previously used in the Rock Hill Facility (refer to Note 11). As part of the decision to permanently close the Rock Hill Facility, $10.3 million of assets were assessed against the assets held for sale criteria and reclassified from property, plant and equipment to assets held for sale in the third quarter of 2023. The assets are measured at the lower of the net book value versus the fair value less cost to sell resulting in an impairment charge of $8.7 million. In the fourth quarter, the fair value was remeasured and an adjustment of $(0.8) million was recorded. It is expected that these assets will be sold within the next twelve months.

To move the assets or dispose of the assets at the Rock Hill Facility, the Company fully settled the principal balance of the U.S. leasing facility in the fourth quarter of 2023. Principal payments of $7.8 million and interest penalties of $0.4 million were incurred (refer to Note 14). As a result of this settlement, $2.6 million of restricted cash was released to the Company in the fourth quarter of 2023.

Discontinuation of Reflect Product Line and Other Charges Incurred

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

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

These costs were included in cost of sales:

7. GAIN ON SALE OF SOFTWARE

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

The $11.0 million of proceeds on the sale of the 50% interest in the Applicable ICE code, pursuant to the AWI Agreement, was received during the year ended December 31, 2023. In accordance with GAAP, the proceeds were first applied to the net book value of the related cost of software of $2.9 million and patents (other assets) of $0.9 million. The residual amount of $7.1 million was recognized as a gain in the consolidated statement of operations. Further, $1.8 million was received as a prepayment under the ARMSA, which is recognized into revenue as the performance obligation is met. During the year ended December 31, 2023, $1.6 million of the $1.8 million payment was recognized into revenue and $0.2 million remains a customer deposit to be recognized as revenue in the first quarter of 2024. Part of the proceeds of this transaction was used to settle one of our equipment leases of $1.6 million and resulted in the release of $0.4 million of restricted cash (refer to Note 14).

8. LEASES

The Company leases office and factory space under various operating leases. As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The Company gives consideration to instruments with similar characteristics when calculating its incremental borrowing rate. The Company’s operating leases have remaining lease terms of 1 year to 14 years. Lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option.

The weighted average remaining lease term and weighted average discount rate at December 31, 2023, wasnine years (2022 -thirteen years) and 6.3% (2022 –4.9%), respectively.

The Company entered into a sublease arrangement for part of the Phoenix Facility during the second quarter of 2022, commencing July 1, 2022. Additionally, the Company entered into a sublease agreement for the Dallas DXC to one of our Construction Partners in that region, in which the subtenant has assumed responsibility for all monthly rent, utilities, maintenance, taxes and other costs as of April 1, 2023, through December 31, 2024.

The following table includes ROU assets included on the balance sheet at December 31, 2023 and 2022:

The components of the lease cost for the years ended December 31, 2023 and 2022 were as follows:

The following table includes lease liabilities included on the balance sheet at December 31, 2023 and 2022:

In February 2023, the Company modified an existing agreement for a Calgary manufacturing facility to extend the leasing term for an additional five years. An extension option period of five years was also determined to be more likely than not to occur. Undiscounted cash flows associated with this modification are $16.3 million. The rent obligations have been discounted at a rate of 8.58% to determine the lease liability.

In May 2023, the Company modified an existing agreement through early termination for the Seattle DXC. This amendment caused the derecognition of the lease, albeit DIRTT maintaining guarantor status for the remainder of the original lease term which terminates in August 2027. Undiscounted cash flows associated with this modification were $0.5 million.

On September 27, 2023, we announced our intention to permanently close the Rock Hill Facility (refer to Note 6). As a result of this decision, DIRTT no longer assumes the two five-year extension options under the related property lease will be exercised.

Undiscounted cash flows associated with this modification were $13.7 million. The rent obligations have been discounted at a rate of 6.77% to determine the lease liability.

The following table includes maturities of operating lease liabilities at December 31, 2023:

9. TRADE AND ACCRUED RECEIVABLES AND OTHER RECEIVABLES

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

In order to manage and assess our risk, management maintains credit policies that include regular review of credit limits of individual receivables and systematic monitoring of aging of trade receivables and the financial wellbeing of our customers. In addition, we acquired trade credit insurance effective April 1, 2020. At December 31, 2023, approximately 93% of our trade accounts receivable are insured, relating to accounts receivables from counterparties deemed creditworthy by the insurer and excluding accounts receivable from government entities. In addition, and where possible, we collect a 50% deposit on sales, excluding government and certain other clients.

Our trade balances are spread over a broad Construction Partner base, which is geographically dispersed. For the year ended December 31, 2023, one Construction Partner accounted for greater than 10% of revenue, compared to 2022 in which no Construction Partner accounted for greater than 10% of revenue.

No change to our expected credit loss was required during the year ended December 31, 2023, or December 31, 2022. Receivables are generally considered to be past due when over 60 days old, unless there is a separate payment arrangement in place for the collection of the receivable.

10. INVENTORY

As of December 31, 2023, the Company had $1.7 million (2022 - $1.2 million) provided for inventory that is not expected to be used in future production and the associated expense was recorded to cost of goods sold. During 2023, the Company wrote off $1.0 million of inventory against the provision (2022 - $0.5 million) and increased the allowance for obsolescence by $0.4 million (2022 - $0.9 million). In addition, the Company recorded direct write offs against inventory of $0.5 million (2022 - $0.3 million). Production overheads capitalized in work in progress were $0.2 million at Dece mber 31, 2023 (2022 - $0.2 million).

Additional costs included in cost of goods sold

During 2021, the Company experienced periods where it was operating below normal capacity levels. During that period, overheads included in inventory were not increased and $1.8 million was included in cost of sales. In 2022, we temporarily suspended operations at the Rock Hill Facility. On September 27, 2023, we announced our intention to permanently close the Rock Hill Facility. As of December 31, 2023, the Company leases the Rock Hill Facility and is actively pursuing sublease arrangements. Idle facility costs being incurred at the Rock Hill Facility are included in cost of sales.

Change in presentation in Consolidated Statement of Operations

11. PROPERTY, PLANT AND EQUIPMENT, NET

As at December 31, 2023, the Company had $0.2 million of assets in progress of completion which were excluded from assets subject to depreciation (2022 – $0.1 million).

During the year ended December 31, 2022, depreciation expense included $1.1 million of incremental depreciation on the acceleration of useful lives associated with the closing of the Phoenix Facility. The year ended December 31, 2023, did not include any significant amounts related to accelerated depreciation (refer to Note 6).

On September 27, 2023, the Company announced its intention to permanently close the Rock Hill Facility in South Carolina. $10.3 million of manufacturing equipment at Rock Hill was transferred to assets held for sale (refer to Note 6).

As at December 31, 2023, the Company determined that there were no impairment indicators warranting an impairment test.

During the year ended December 31, 2022, the Company has incurred negative cash flows from operations and accordingly management determined that this was an indicator of impairment for property, plant and equipment assets. The Company estimated the undiscounted cash flows to be generated from the use and ultimate disposition of the property, plant and equipment assets. To estimate the undiscounted cash flows of the reporting unit, the Company applied the income approach. Sales and cost projections were based on assumptions driven by current economic conditions. The Company considered various scenarios and probability-weighted the likelihood of each scenario in determining the reporting unit’s fair value. The average compounded annual growth rate of revenues was 5%-10%. Other key assumptions used in the quantitative assessment of the reporting unit’s undiscounted cashflows was terminal growth rate of 2%. The Company estimated the undiscounted cash flows to be generated from the use and ultimate disposition of the property, plant and equipment assets. The results of the test indicated that the undiscounted cash flows exceeded the carrying values of property, plant and equipment, therefore, no impairment charge was required at December 31, 2022.

12. CAPITALIZED SOFTWARE, NET

The disposal of capitalized software in 2023 with a net book value of $2.9 million, relates to the AWI transaction (refer to Note 7).

Estimated amortization expense on capitalized software is $0.8 million in 2024, $0.8 million in 2025, $0.5 million in 2026, $0.3 million in 2027, and $0.1 million in 2028.

During the year ended December 31, 2022, amortization expense was impacted by $1.0 million of incremental amortization on the acceleration of useful lives associated with discontinued product lines (refer to Note 6). Amortization expense for the year ended December 31, 2023, wasnot impacted by any incremental amortization of this kind.

13. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES AND OTHER LIABILITIES

(1)

In 2023, $2.6 million of rebates were earned (2022 - $4.8 million) and $4.4 million were paid (2022 -$3.7 million).

(2)

In 2022, $3.4 million of trade accruals were previously included in the Accrued liabilities balance.

Other liabilities

(1)

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

14. LONG-TERM DEBT

Revolving Credit Facility

On February 12, 2021, the Company entered into a loan agreement governing a C$25.0 million senior secured revolving credit facility with the Royal Bank of Canada (“RBC”), as lender (the “RBC Facility”). Under the RBC Facility, the Company is able to borrow up to a maximum of 90% of investment grade or insured accounts receivable plus 85% of eligible accounts receivable plus the lesser of (i) 75% of the book value of eligible inventory and (ii) 85% of the net orderly liquidation value of eligible inventory less any reserves for potential prior ranking claims (the “Borrowing Base”). Interest was calculated at the Canadian or U.S. prime rate plus 30 basis points or at the Canadian Dollar Offered Rate or LIBOR plus 155 basis points. Under the RBC Facility, if the “Aggregate Excess Availability”, (defined as the Borrowing Base less any loan advances or letters of credit or guarantee and if undrawn including unrestricted cash), is less than C$5.0 million, the Company was subject to a fixed charge coverage ratio (“FCCR”) covenant of 1.10:1 on a trailing twelve-month basis. Additionally, if the FCCR has been below 1.10:1 for the three immediately preceding months, the Company is required to maintain a reserve account equal to the aggregate of one year of payments on outstanding loans on the Leasing Facilities (defined below). Should an event of default occur or the Aggregate Excess Availability be less than C$6.25 million forfive consecutive business days, the Company would enter a cash dominion period whereby the Company’s bank accounts would be blocked by RBC and daily balances will offset any borrowings and any remaining amounts made available to the Company.

On February 9, 2023, the Company extended the RBC Facility (the “Extended RBC Facility”). The Extended RBC Facility has a maximum borrowing base of C$15 million and a one-year term. Interest is calculated as at the Canadian or U.S. prime rate plus 75 basis points or the Canadian Dollar Offered Rate or Term Secured Overnight Financing Rate (“SOFR”) plus 200 basis points plus the Term SOFR Adjustment (as defined in the amended loan agreement governing the Extended RBC Facility). Under the Extended RBC Facility, if the trailing twelve-month FCCR is not above 1.25 for three consecutive months, a cash balance equivalent to one year’s worth of Leasing Facilities payments must be maintained. Effective October 2023, inventory was scoped out of the Borrowing Base. At December 31, 2023, available borrowings are C$13.6 million ($10.3 million) (2022 – C$7.2 million ($5.3 million) of available borrowings), calculated in the same manner as the RBC Facility described above, of which no amounts have been drawn. The Company did not meet the three-month FCCR requirement during the year end 2023, which resulted in the restriction of $0.4 million of cash (2022 - $3.4 million).

On February 9, 2024, the Company extended the Extended RBC Facility (the “Second Extended RBC Facility”). The Second Extended RBC Facility is subject to the borrowing base calculation to a maximum of C$15 million and a one-year term. Interest is calculated as at the Canadian or U.S. prime rate plus 75 basis points or at the Canadian Dollar Offered Rate or Adjusted Term CORRA or Term SOFR plus the Term SOFR Adjustment, in each case plus 200 basis points.

Leasing Facilities

The Company has a C$5.0 million equipment leasing facility in Canada (the “Canada Leasing Facility”) of which C$4.4 million ($3.4 million) has been drawn and C$3.8 million ($2.9 million) has been repaid, and a $14.0 million equipment leasing facility in the United States of which $13.3 million has been drawn and repaid (the “U.S. Leasing Facility” and, together with the Canada Leasing Facility, the “Leasing Facilities”) with RBC. The Canada Leasing Facility has a seven-year term and bears interest at 4.25%.

The Company did not make any draws on the Leasing Facilities during 2023. During the year ended December 31, 2022, the Company received C$0.9 million ($0.7 million) under the Canada Leasing Facility. The associated financial liabilities are shown on the consolidated balance sheet in the current portion of long-term debt and accrued interest and long-term debt.

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

Refer to Note 6 on the decision to permanently close the Rock Hill Facility. As part of this decision, the Company fully settled the $7.8 million principal balance of the U.S. Leasing Facility in the fourth quarter of 2023. The U.S. Leasing Facility is no longer available to be drawn on. With the settlement of this liability, $2.6 million was released from restricted cash.

Convertible Debentures

On January 25, 2021, the Company completed a C$35.0 million ($27.5 million) bought-deal financing of convertible unsecured subordinated debentures with a syndicate of underwriters (the “January Debentures”). On January 29, 2021, the Company issued a further C$5.25 million ($4.1 million) of the January Debentures under the terms of an overallotment option granted to the underwriters. The January Debentures will mature and be repayable on January 31, 2026 (the “January Debentures Maturity Date”) and will accrue interest at the rate of 6.00% per annum payable semi-annually in arrears on the last day of January and July of each year commencing on July 31, 2021, until the January Debentures Maturity Date. Interest and principal are payable in cash or shares at the option of the Company. Costs of the transaction were approximately C$2.7 million, including the underwriters’ commission. The January Debentures will be convertible into common shares of DIRTT, at the option of the holder, at any time prior to the close of business on the business day prior to the earlier of the January Debentures Maturity Date and the date specified by the Company for redemption of the January Debentures at a conversion price of C$4.65 per common share, being a ratio of approximately 215.0538 common shares per C$1,000 principal amount of the January Debentures. Subsequent to the Rights Offering (refer to Note 23), the conversion price is now C$4.03 per common share representing a conversion rate of approximately 248.1390 common shares per C$1,000 principal amount of the January Debentures. As at December 31, 2023, C$18.9 million of the January Debentures are held by a related party (refer to Note 22).

On December 1, 2021, the Company completed a C$35.0 million ($27.4 million) bought-deal financing of convertible unsecured subordinated debentures with a syndicate of underwriters (the “December Debentures” and, together with the January Debentures, the “Debentures”). These December Debentures will mature and be repayable on December 31, 2026 (the “December Debentures Maturity Date”) and will accrue interest at the rate of 6.25% per annum payable semi-annually in arrears on the last day of June and December of each year commencing on June 30, 2022, until the December Debentures Maturity Date. Interest and principal are payable in cash or shares at the option of the Company. Costs of the transaction were approximately C$2.3 million, including the underwriters’ commission. The December Debentures will be convertible into common shares of DIRTT, at the option of the holder, at any time prior to the close of business on the business day prior to the earlier of the December Debentures Maturity Date and the date specified by the Company for redemption of the December Debentures at a conversion price of C$4.20 per common share, being a ratio of approximately 238.0952 common shares per C$1,000 principal amount of the December Debentures. Subsequent to the Rights Offering (refer to Note 23), the conversion price is now C$3.64 per common share representing a conversion rate of approximately 274.7253 common shares per C$1,000 principal amount of the December Debentures. As at December 31, 2023, C$13.6 million of the December Debentures are held by a related party (refer to Note 22).

15. INCOME TAXES

Reconciliation of income taxes

The following reconciles income taxes calculated at the Canadian statutory rate with the actual income tax expense. The Canadian statutory rate includes federal and provincial income taxes. This rate was used because Canada is the domicile of the parent entity of the Company.

The provision for income taxes is comprised of federal, state, provincial and foreign taxes based on pre-tax income. In the United States, the CARES Act of 2020 allows, among other provisions, for the recovery of taxes paid over the preceding five years from current year losses.

The Company’s U.S. subsidiary’s result was taxable income for the year ended December 31, 2023. The Company utilized prior year operating losses against this income; however, U.S. tax law does not allow for the full offset of losses against current year taxable income to reduce tax payable to zero. This resulted in current tax payable of $0.3 million in 2023.

Deferred tax assets and liabilities

Significant components of the Company’s deferred tax assets and liabilities as at December 31, 2023 and 2022 were as follows:

Summary of temporary difference movements during the year:

For the year ended December 31, 2023, the Company recorded valuation allowances of $4.2 million against deferred tax assets (“DTAs”) incurred during the year. A valuation allowance is recognized to the extent that it is more likely than not that the deferred tax assets will not be realized (2022 – $13.6 million).

On an annual basis, the Company and its subsidiary file tax returns in Canada and various foreign jurisdictions. In Canada, the Company’s federal and provincial tax returns for the years 2019 to 2022 remain subject to examination by taxation authorities. In the United States, both the federal and state tax returns filed for the years 2018 to 2022 remain subject to examination by the taxation authorities.

Tax loss carryforwards and other tax pools

The significant components of the Company’s net future income tax deductions in these consolidated financial statements are summarized as follows:

16. STOCK-BASED COMPENSATION

In May 2020, shareholders approved the DIRTT Environmental Solutions Ltd. Long-Term Incentive Plan (the “2020 LTIP”). The 2020 LTIP replaced the predecessor incentive plans, being the Performance Share Unit Plan (“PSU Plan”) and the Amended and Restated Stock Option Plan (“Stock Option Plan”). Following the approval of the 2020 LTIP, no further awards will be made under either the Stock Option Plan or the PSU Plan, but both remain in place to govern the terms of any awards that were granted pursuant to such plans and remain outstanding.

In May 2023, shareholders approved the DIRTT Environmental Solutions Ltd. Amended and Restated Long-Term Incentive Plan (the “2023 LTIP”) at the annual and special meeting of shareholders. The 2023 LTIP gives the Company the ability to award options, share appreciation rights, restricted share units, deferred share units, restricted shares, dividend equivalent rights, and other share-based awards and cash awards to eligible employees, officers, consultants and directors of the Company and its affiliates. In accordance with the 2023 LTIP, the sum of (i)12,350,000 common shares plus (ii) the number of common shares subject to stock options previously granted under the Stock Option Plan that, following May 30, 2023, expire or are cancelled or terminated without having been exercised in full, have been reserved for issuance under the 2023 LTIP. Upon vesting of certain LTIP awards, the Company may withhold and sell shares as a means of meeting DIRTT’s tax withholding requirements in respect of the withholding tax remittances required in respect of award holders. To the extent the fair value of the withheld shares upon vesting exceeds the grant date fair value of the instrument, the excess amount is credited to retained earnings or deficit.

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

Stock-based compensation expense

The following summarizes RSUs, Share Awards, PSUs, and DSUs activity during the periods:

Restricted share units (time-based vesting)

Restricted share units that vest based on time have an aggregate time-based vesting period ofthree years and generally one-third of the RSUs vest every year over a three-year period from the date of grant (the “RSUs”). At the end of a three-year term, the associated RSUs will be settled by way of the provision of cash or shares to employees (or a combination thereof), at the discretion of the Company. The weighted average fair value of the RSUs granted in 2023 was C$0.46 (2022 – C$2.37), which was determined using the closing price of the Company’s common shares on their respective grant dates. During 2023,150,000 RSUs were granted to each of the chief executive officer, chief operations officer and chief financial officer which vest in one year.

Restricted share units (performance-based vesting)

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

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

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

Share awards

During the first quarter of 2022, certain executives were issued share awards in lieu of cash paid variable incentive compensation (“Share Awards”). These Share Awards vested upon grant. The fair value of the Share Awards granted was C$2.40 ($1.88), which was determined using the closing price of the Company’s common shares on the grant date. In the fourth quarter of 2022,59,488 Share Awards were issued to employees as a component of their compensation.

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

Performance share units

During the second quarter of 2023, certain executives were issued a strategic equity grant through Performance Share Units (“PSUs”). The performance period of the PSUs is from January 1, 2023, to December 31, 2026, with a cliff vesting term for December 31, 2026.2,584,161 PSUs were granted and depending on the level of performance, the PSUs will vest 100%,160% or 190% up to a maximum of 4,909,907 PSUs. Settlement will be made in the form of shares issued from treasury. The performance measures are a combination of Revenue and Earnings Before Interest, Taxes, Depreciation and Amortization and both targets have to be achieved. As of December 31, 2023, the fair value of these PSUs have been deemed to be nil based on the likelihood of achieving the targets compared to current results. During the third quarter of 2023,738,553 PSUs with a $nil value were forfeited as a result of an executive departure and 1,845,608 PSUs with a $nil value are outstanding as at December 31, 2023.

Deferred share units

Granted under the DSU Plan

The fair value of the DSU liability and the corresponding expense is charged to profit or loss at the grant date. Subsequently, at each reporting date between the grant date and settlement date, the fair value of the liability is remeasured with any changes in fair value recognized in the statement of operations and comprehensive loss for the period. The weighted average fair value of the DSUs granted in 2023 was C$0.63 ($0.47), which was determined using the closing price of the Company’s common shares on the grant date. DSUs outstanding at December 31, 2023, had a fair value of $0.5 million which is included in other liabilities on the balance sheet (2022 – $0.6 million).

Granted under the 2023 LTIP

DSUs granted after May 30, 2023, (the “New DSUs”) will be settled by way of the provision of cash or shares (or a combination thereof) to the Directors, at the discretion of the Company. The Company intends to settle these DSUs through issuances of common shares. The weighted average fair value of the New DSUs granted in 2023 was C$0.46 ($0.34), which was determined using the closing price of the Company’s common shares on the grant date. New DSUs outstanding at December 31, 2023, had a fair value of $0.6 million which is included in other liabilities on the balance sheet (2022 – $nil).

Options

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

Range of exercise prices outstanding at December 31, 2023:

Range of exercise prices outstanding at December 31, 2022:

Dilutive instruments

For the year ended December 31, 2023,0.2 million options (2022 –1.5 million, 2021 –4.1 million) and 3.6 million RSUs and PRSUs (2022 –2.2 million, 2021 – 3.4 million),1.8 million new DSUs (2022 and 2021 – nil) and 156.8 million shares which would be issued if the principal amount of the Debentures were settled in our common shares at the year-end share price (2022 –109.1 million and 2021 – 27.4 million) were excluded from the diluted weighted average number of common shares calculation as their effect would have been anti-dilutive to the net loss per share.

17. NET LOSS PER SHARE

On November 21, 2023, the Company announced a Rights Offering which allowed holders of common shares, as of the close of business on December 12, 2023, transferable subscription rights to purchase up to an aggregate of 85,714,285 common shares at a subscription price of C$0.35 per common share (refer to Note 23). An adjustment is required on the calculation of net loss per share for the year ended December 31, 2023, as well as retrospectively for the years ended December 31, 2022 and December 31, 2021, to account for the bonus factor that resulted from this event.

18. REVENUE

In the following table, revenue is disaggregated by performance obligation and timing of revenue recognition. All revenue comes from contracts with customers. Refer to Note 19 for the disaggregation of revenue by geographic region.

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

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

Contract Liabilities

Contract liabilities primarily relate to deposits received from customers and maintenance revenue from license subscriptions. The balance of contract liabilities was higher as at December 31, 2023, compared to the prior year period mainly due to the timing of orders and payments. Contract liabilities as at December 31, 2022 and 2021, respectively, totaling $4.9 million and $2.4 million were recognized as revenue during 2023 and 2022, respectively.

Sales by Industry

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

19. SEGMENT REPORTING

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

Revenue from external customers

Non-current assets

The DIRTT solution segment derives revenues from customers by providing physical products and digital tools through our ICE software to create interior spaces for our customers across commercial, healthcare, education and government industries. The accounting policies of the solution segment are the same as those described in Note 2 - significant accounting policies.

The chief operating decision maker assesses performance for the solution segment and decides how to allocate resources based on gross profit and net loss that also is reported on the consolidated statement of operations and comprehensive loss as consolidated gross profit and net loss. The measure of segment assets is reported on the balance sheet as total consolidated assets. The chief operating decision maker uses net income to evaluate income generated from segment assets (return on assets) in deciding whether to reinvest profits into the solution segment or into other parts of the entity, such as to repay long term debt.

Gross profit and net income (loss) are used to monitor budget versus actual results. The chief operating decision maker also uses net income in competitive analysis by benchmarking to DIRTT’s competitors. The competitive analysis along with the monitoring of budgeted versus actual results are used in assessing performance of the segment and in establishing management’s compensation.

DIRTT has one reportable segment: Solutions. The solutions segment provides digital tools (access to ICE software) and physical products to create modular interior construction spaces for our customers. DIRTT derives revenue in North America and manages the business activities on a consolidated basis. The technology used in the customer arrangements is based on a single software platform that is deployed to, and implemented by, customers in a similar manner. DIRTT’s chief operating decision maker is the executive leadership team that includes the chief operating officer, chief financial officer, and the chief executive officer.

20. COMMITMENTS

As at December 31, 2023, the Company had outstanding purchase obligations of approximately $2.8 million related to inventory and property, plant and equipment purchases (2022 – $2.2 million). Refer to Note 8 for lease commitments.

21. LEGAL PROCEEDINGS

The Company is pursuing multiple lawsuits against its former founders, Mogens Smed and Barrie Loberg, their new company Falkbuilt Ltd. (“Falkbuilt”), and other related individual and corporate defendants for violations of fiduciary duties and non-competition and non-solicitation covenants contained in their executive employment agreements, and the misappropriation of DIRTT’s confidential and proprietary information in violation of numerous Canadian and U.S. state, and federal laws pertaining to the protection of DIRTT’s trade secrets and proprietary information and the prevention of false advertising and deceptive trade practices.

As of December 31, 2023, the Company’s litigation against Falkbuilt, Messrs. Smed and Loberg, and their associates was comprised of three main lawsuits: (i) an action in the Alberta Court of King’s Bench instituted 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. We recently requested the Court of King’s Bench of Alberta to schedule the summary judgment application for our Canadian litigation. The court has proposed three potential dates in September 2025 and we expect to have the date finalized in the next several weeks.

Falkbuilt also filed a lawsuit against the Company on November 5, 2019, in the Court of King’s Bench of Alberta, alleging that DIRTT has misappropriated and misused their alleged proprietary information in furtherance of DIRTT’s product development. Falkbuilt seeks monetary relief and an interim, interlocutory and permanent injunction of DIRTT’s alleged use of the alleged proprietary information. The Company believes that the suit is without merit and filed an application for summary judgment to dismiss Falkbuilt’s claim.

No amounts are accrued for the above legal proceedings.

22. RELATED PARTY TRANSACTIONS

On November 30, 2022, the Company closed a private placement of 8,667,449 common shares for aggregate gross consideration of $2.8 million (the “Private Placement”) with its two largest shareholders, 22 NW Fund, LP (“22NW”) and 726 BC LLC and 726 BF LLC (together “726”) and all the directors and officers, including 638,996 common shares issued at the deemed per share price equal to the Subscription Price, as reimbursement for the costs incurred by 726 in connection with the Company’s contested director elections in 2022.

On March 15, 2023, the Company entered into a Debt Settlement Agreement (the “Debt Settlement Agreement”) with 22NW and Aron English, 22NW’s principal and a director of DIRTT, (together, the "22NW Group") who, collectively, beneficially owned approximately 19.5% of the Company’s issued and outstanding common shares at such time.

Pursuant to the Debt Settlement Agreement, the Company agreed to reimburse the 22NW Group for the costs incurred by the 22NW Group in connection with the contested director election at the annual and special meeting of shareholders of the Company held on April 26, 2022, being approximately $1.6 million (the “Debt”). Pursuant to the Debt Settlement Agreement, the Company agreed to repay the Debt by either, or a combination of (i) a payment in cash by the Company to the 22NW Group, and/or (ii) the issuance of equity securities of the Company to the 22NW Group. In connection with the Debt Settlement Agreement, on March 15, 2023, the Company entered into a share issuance agreement with the 22NW Group, pursuant to which the Company agreed to repay the Debt with the issuance to the 22NW Group of 3,899,745 common shares at a deemed price of $0.40 per common share, subject to approval by the Company’s shareholders. At the annual general and special meeting of shareholders held on May 30, 2023, shareholders voted to approve the issuance of common shares to 22NW Group, and on June 2, 2023, the Company issued 3,899,745 common shares to 22NW Group as repayment for the Debt. Upon settlement, the debt was revalued at the higher of the deemed price of $0.40 per common share and the May 30, 2023, market price of $0.38 per common share resulting in a recovery from the balance recorded at March 31, 2023, which had been valued at a price of $0.53 per common share.

As at December 31, 2023, C$18.9 million and C$13.6 million of the January Debentures and December Debentures, respectively, are held by 22NW Group. Interest accrued on the debentures owned by 22NW Group for the year ended December 31, 2023, is C$0.4 million and interest expense paid was C$0.5 million(2022 – $nil and $nil respectively). Interest is earned on terms applicable to all Debenture holders.

Other related party transactions for the year ended December 31, 2023, relate to the sale of DIRTT products and services to the 22NW Group for $0.3 million (2022 – $nil). The sale to 22NW Group was based on price lists in force and terms that are available to all employees. 2023 reorganization costs include $nil paid to related parties (2022 - $0.2 million).

23. SUBSEQUENT EVENTS

On November 21, 2023, the Company announced that the Board of Directors had approved a Rights Offering to its common shareholders for aggregate gross proceeds of C$30.0 million.

In connection with the Rights Offering, the Company entered into a standby purchase agreement with 22NW Fund, LP (“22NW”) and 726 dated November 20, 2023 (the “Standby Purchase Agreement”), pursuant to which each of 22NW and 726, or their permitted assigns (collectively and including WWT Opportunity #1 LLC, to which 726 transferred their entire holdings on December 1, 2023, the “Standby Purchasers”). Subject to the terms and conditions of the Standby Agreement, each Standby Purchaser agreed to exercise its Basic Subscription Privilege in full and to collectively purchase from the Company, at the Subscription Price, all common shares not subscribed for by holders of Rights under the Basic Subscription Privilege or Additional Subscription Privilege, up to a maximum of C$15.0 million each, so that the maximum number of common shares that may be issued in connection with the Rights Offering will be issued and the Company will receive aggregate gross proceeds of C$30.0 million. No standby fee will be paid to the Standby Purchasers in connection with the Rights Offering; however, DIRTT will reimburse the Standby Purchasers for their reasonable expenses in connection with the Standby Agreement up to a maximum of C$30,000.

On January 9, 2024, the Company announced the completion of the Rights Offering to its common shareholders and the issuance of 85,714,285 common shares at a price of C$0.35 ($0.26) per whole Common Share for aggregate gross proceeds of C$30.0 million ($22.4 million). Each right distributed under the Rights Offering (each, a “Right”) entitled eligible holders to subscribe for 0.81790023 common shares, exercisable for whole common shares only, meaning 1.22264301 Rights were required to purchase one Common Share (the “Basic Subscription Privilege”). In accordance with applicable law, the Rights Offering included an additional subscription privilege (the “Additional Subscription Privilege”) under which eligible holders of Rights who fully exercised the Rights issued to them under their Basic Subscription Privilege, were entitled to subscribe for additional common shares, on a pro rata basis, that were not otherwise subscribed for under the Basic Subscription Privilege.

DIRTT issued an aggregate of 67,379,471 common shares pursuant to the Basic Subscription Privilege and 18,334,814 common shares pursuant to the Additional Subscription Privilege. As a result of the common shares issued under the Basic Subscription Privilege and Additional Subscription Privilege, no common shares were available for issuance pursuant to the Standby Agreement.

On February 4, 2024, the Company entered into a Litigation Funding Agreement with a third party for the funding of up to $4.0 million of litigation costs in respect of specific claims against Falkbuilt, Inc., Falkbuilt Ltd. and Henderson. In return, the Company has agreed to pay from any proceeds received from the settlement of such claims, a reimbursement of funded amounts plus diligence and underwriting costs, plus a multiple of such funded amount based on certain milestones.

On February 15, 2024, the Company announced a substantial issuer bid and tender offer (the "Issuer Bid"), under which the Company will offer to repurchase for cancellation: (i) up to C$6,000,000 principal amount of its issued and outstanding January Debentures (or such larger principal amount as the Company, in its sole discretion, may determine it is willing to take‑up and pay for, subject to applicable law) at a purchase price of C$720 per C$1,000 principal amount of January Debentures; and (ii) up to C$9,000,000 principal amount of its issued and outstanding December Debentures (or such larger principal amount as the Company, in its sole discretion, may determine it is willing to take‑up and pay for, subject to applicable law) at a purchase price of C$600 per C$1,000 principal amount of December Debentures. Holders of Debentures who validly tender and do not withdraw their Debentures will receive the applicable purchase price, plus a cash payment for all accrued and unpaid interest up to, but excluding, the date on which such Debentures are taken up by the Company. The applicable purchase price will be denominated in Canadian dollars and payments of amounts owed to holders of deposited Debentures, including for interest, will be made in Canadian dollars. The Issuer Bid will remain open for acceptance until 5:00 p.m. (Eastern Standard Time) on March 22, 2024, unless withdrawn or extended by the Company. If the aggregate principal amount of the Debentures properly tendered and not withdrawn under the Issuer Bid exceeds C$6,000,000 for the January Debentures or C$9,000,000 for the December Debentures, the Company will purchase a pro-rated portion of the January Debentures or the December Debentures so tendered, as applicable (with adjustments to maintain C$1,000 minimum denominations of Debentures). DIRTT will return all Debentures not purchased under the Issuer Bid, including Debentures not purchased because of pro-ration. Debentures taken up and paid for by the Company will be immediately cancelled.

The Company intends to fund the Issuer Bid with a portion of the proceeds from the Company’s previously completed Rights Offering to its common shareholders, which closed in January 2024 for aggregate gross proceeds of C$30.0 million.