DIRTT Provides US GAAP Financial Information

DIRTT Environmental Solutions Ltd., (TSX:DRT; Nasdaq: DRTT) (“DIRTT” or the “Company”) an interior construction company that uses technology for client-driven design and manufacturing, today announced the following information has been disclosed on SEDAR and posted on DIRTT's website:

• Unaudited financial statements for the second quarter of 2019 prepared in accordance with the accounting standards generally accepted in the United States (“U.S. GAAP”), which include the consolidated balance sheets as of June 30, 2019 and December 31, 2018, and the related statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for the three- and six-month periods ended June 30, 2019 and June 30, 2018;

• Unaudited financial statements for the first quarter of 2019 prepared in accordance with U.S. GAAP, which include the consolidated balance sheets as of March 31, 2019 and December 31, 2018, and the related statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for the three-month periods ended March 31, 2019 and March 31, 2018; and

• Annual U.S. GAAP financial statements, which include consolidated balance sheets as of December 31, 2018 and 2017 and the related statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, 2017 and 2016 (on SEDAR such statements are contained in the Form 10 which was filed as an "Other" document on October 8, 2019).

Upon the U.S. Securities and Exchange Commission’s (“SEC”) declaration of effectiveness of the Company’s Registration Statement on Form 10 on June 8, 2019, in connection with the listing of its common shares on The Nasdaq Global Select Market ("Nasdaq"), the Company completed a conversion of its financial statements from International Financial Reporting Standards (“IFRS”) to U.S. GAAP and adopted U.S. GAAP as its financial reporting framework. The Company’s Registration on Form 10 and other filings with the SEC are available to the public through SEC’s website at www.sec.gov. The purpose of this press release is to help readers accustomed to the past preparation of DIRTT’s financial statements under IFRS understand the change in preparation to U.S. GAAP.

DIRTT changed its reporting currency to U.S. dollars (“US$”) upon adoption of U.S. GAAP. The change in reporting currencies has a material impact on the Company’s financial statements for all periods presented. DIRTT continues to consolidate the Company and its subsidiaries’ financial statements in Canadian dollars (“C$”), the Company’s functional currency, and translates the assets and liabilities at the period end rate which results in period-on-period translation adjustments recorded in comprehensive income from the impact of the change in exchange rate on net assets.

The following discussion has been prepared using the Accounting Standards Codifications (“ASCs”), Accounting Standards Updates (“ASUs”) and interpretations currently issued and expected to be effective at the end of the Company’s first U.S. GAAP annual reporting period, December 31, 2019. Management does not expect the adoption of U.S. GAAP to have a material impact on the Company’s business activities or cash flows; however, it will impact certain aspects of the reported financial results, the more significant of which are described as follows:

1. Accounting for intangible assets and software development costs

Under U.S. GAAP, product development costs are not eligible for capitalization, and therefore the initial value of the Company’s intangible assets is lower as compared to IFRS. This change also has the impact of reducing net income and Adjusted EBITDA (see Non-GAAP measures) as product development costs are expensed as incurred. This change has also resulted in a reduction in the impairment charges recognized in 2018 as development costs for the DIRTT for Life and DIRTT Timber lines of business would have been previously expensed as incurred under U.S. GAAP and therefore not subject to impairment.

Under U.S. GAAP, software development costs are capitalized as internal use software in accordance with ASC 350 – Intangibles Goodwill and Other, with no material differences to the accounting treatment under IFRS.

2. Amounts included in Cost of Sales

Certain of the Company’s fixed costs were treated as overhead items under IFRS and accounted for as operating expenditures. Under U.S. GAAP, these costs are presented within cost of sales as they relate to the production of DIRTT solutions. The impact of this is a reclassification of US$8 to US$9 million (including US$4 million to US$5 million of depreciation and amortization) annually from operating costs to cost of sales with a corresponding 3% to 4% reduction in gross profit. This change is an adjustment within the statement of operations only; there is no impact to net income or Adjusted EBITDA (see Non-GAAP measures) as compared to amounts previously reported under IFRS.

3. Adoption of ASC 842 – Leases (“ASC 842”) and onerous lease accruals

On January 1, 2019, DIRTT adopted IFRS 16 – Leases (“IFRS 16”), which had a material impact on DIRTT’s balance sheet and cash flows, and Adjusted EBITDA (see Non-GAAP measures). The impact is described in DIRTT’s unaudited condensed consolidated interim financial statements and management’s discussion and analysis for the first and second quarters of 2019, previously filed on SEDAR. Consistent with IFRS 16, the adoption of ASC 842 had a material impact on the Company’s balance sheet, resulting in the recognition of US$23 million of right-of-use (“ROU”) assets and associated US$24 million lease liabilities as at January 1, 2019. Under U.S. GAAP, the charge on the statement of operations is accounted for as rent expense on a straight-line basis. This treatment is different from that under IFRS, which classifies the expense as depreciation of the ROU asset and interest expense for the accretion of the lease liability.

This difference results in changes to cash flows from operations and Adjusted EBITDA (see Non-GAAP measures) from January 1, 2019 forward with minimal change in net income. In 2019, cash flows from operations are lower under U.S. GAAP as lease payments are classified as operating expenditures rather than as financing expenditures under IFRS. Adjusted EBITDA (see Non-GAAP measures) is lower from January 1, 2019 forward as a result of the change in classification of the expense from depreciation and interest under IFRS to lease expense under US GAAP.

Additionally, the Company recognized a provision of C$1.8 million for an onerous lease under IFRS in 2018. Under US GAAP, this provision would not be recognized.

4. Stock-based compensation

During 2018, the Company modified its employee stock option plan to provide a cash settlement alternative to its employees in connection with the exercise of stock options. At period end under U.S. GAAP, the liability is adjusted to fair value and the excess of fair value over previously recognized stock-based compensation is expensed. Increases or decreases in fair value subsequent to the modification date of the stock option plan will be recorded in earnings, except that the Company may not recognize a cumulative expense lower than the grant date fair value of the original equity awards. IFRS does not have the ‘previously recognized’ thresholds in modification accounting, which has resulted in a C$2.1 million increase in stock-based compensation charges in 2018.

Additionally, U.S. GAAP allows for a policy choice for graded or straight-line attribution of stock-based compensation expense, whereas IFRS requires stock options to be expensed using the graded vesting methodology only. On adoption of US GAAP, the Company’s management has elected to use the straight-line methodology to be more comparable with U.S. peer companies. This change resulted in a C$0.9 million increase to stock-based compensation expense for the year-ended December 31, 2018.

5. Other Items, presentation and disclosures

The Company has disclosed other items in its reconciliation from IFRS to US GAAP, which include adjustments that are considered individually immaterial to the financial statements.

The Company has incorporated changes to the presentation and disclosure of certain items in the consolidated balance sheets, statements of operations, comprehensive loss and cash flows, and notes to the consolidated financial statements to conform to the requirements of the applicable ASCs, ASUs and, if applicable, U.S. securities laws and the rules of the United States Securities and Exchange Commission.

Non-GAAP Measures

Our consolidated financial statements are prepared in accordance with GAAP. These GAAP financial statements include noncash 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, as shown in this release, 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 from period to 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, or foreign exchange movements on debt revaluation), asset base (depreciation and amortization), tax consequences and stock-based compensation. In addition, management bases certain forward-looking estimates and budgets on non-GAAP financial measures, primarily Adjusted EBITDA.

Reorganization expenses, impairment expenses, depreciation and amortization, and stock-based compensation 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 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 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 release with a reconciliation to the GAAP financial measure, and a description of the calculation for each measure is included.

• EBITDA: Net income before interest, taxes, depreciation and amortization

• Adjusted EBITDA: EBITDA adjusted for non-cash foreign exchange gains or losses on debt revaluation; impairment expenses; stock-based compensation expense; reorganization expenses; 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.

Special Note Regarding Forward-Looking Statements

Certain information and statements contained in this news release constitute “forward-looking information” and “forward-looking statements” (collectively, “Forward-Looking Information”) as defined under applicable Canadian and U.S. securities laws and the Company hereby cautions investors about important factors that could cause the Company’s actual results or outcomes to differ materially from those projected in any Forward-Looking Information contained in this news release. Any statements that express, or involve discussions as to, expectations, beliefs, plans, objectives, assumptions or future events or performance (often, but not always, through the use of words or phrases such as “will likely result”, “are expected to”, “will continue”, “is anticipated”, “believes”, “estimated”, “intends”, “plans”, “projection” and “outlook”), are not historical facts and may be forward-looking and may involve estimates, assumptions and uncertainties which could cause actual results or outcomes to differ materially from those expressed in such Forward-Looking Information. In particular and without limitation, this release contains Forward-Looking Information pertaining to whether or not the adoption of US GAAP or change in financial statement presentation currency will have a material effect on the Company’s financial statements.

Since actual results or outcomes could differ materially from those expressed in the Forward-Looking Information provided by or on behalf of the Company, investors and others should not place undue reliance on any such Forward- Looking Information.