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DIRTT Environmental Solutions Ltd. Consolidated Financial Statements For the years ended December 31, 2018 and 2017

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Page 1: Zdd v À ] } v u v o ^ } o µ ] } v > X } v } o ] & ] v v ] o ^ u v & } Z Ç v u ï ... · 2019-03-20 · PricewaterhouseCoopers LLP 111 5 Avenue SW, Suite 3100, Calgary, Alberta,

DIRTT Environmental Solutions Ltd.

Consolidated Financial Statements

For the years ended December 31, 2018 and 2017

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INDEX

Independent Auditor’s Report 3

Consolidated Financial Statements

Consolidated Statements of Financial Position 6

Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) 7

Consolidated Statements of Changes in Equity 8

Consolidated Statements of Cash Flows 9

Notes to the Consolidated Financial Statements 10

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PricewaterhouseCoopers LLP 111 5 Avenue SW, Suite 3100, Calgary, Alberta, Canada T2P 5L3 T: +1 403 509 7500, F: +1 403 781 1825

“PwC” refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership.

Independent auditor’s report

To the Shareholders of DIRTT Environmental Solutions Ltd.

Our opinion

In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of DIRTT Environmental Solutions Ltd. and its subsidiaries (together, the Company) as at December 31, 2018 and 2017, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards (IFRS).

What we have audited The Company’s consolidated financial statements comprise:

the consolidated statements of financial position as at December 31, 2018 and 2017;

the consolidated statements of income (loss) and comprehensive income (loss) for the years then ended;

the consolidated statements of changes in equity for the years then ended;

the consolidated statements of cash flows for the years then ended; and

the notes to the consolidated financial statements, which include a summary of significant accounting policies.

Basis for opinion

We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated financial statements section of our report.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada. We have fulfilled our other ethical responsibilities in accordance with these requirements.

Other information

Management is responsible for the other information. The other information comprises the Management’s Discussion and Analysis.

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Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon.

In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated.

If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard.

Responsibilities of management and those charged with governance for the consolidated financial statements

Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRS, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so.

Those charged with governance are responsible for overseeing the Company’s financial reporting process.

Auditor’s responsibilities for the audit of the consolidated financial statements

Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements.

As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:

Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from

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error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.

Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control.

Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.

Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern.

Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation.

Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Company to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion.

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.

The engagement partner on the audit resulting in this independent auditor’s report is Joon Chan.

“(signed) PricewaterhouseCoopers LLP”

Chartered Professional Accountants

Calgary, Alberta March 20, 2019

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DIRTT Environmental Solutions Ltd. Consolidated Statements of Financial Position (Stated in thousands of Canadian dollars)

As at December 31, Notes 2018 2017 ASSETS Current Assets Cash and cash equivalents 72,865 79,641 Trade and other receivables 6 59,852 24,133 Inventory 7 25,442 24,297 Prepaids and other current assets 3,025 2,549 Total Current Assets 161,184 130,620 Non-current Assets Property, plant and equipment 8 50,104 60,860 Intangible assets 9 18,922 24,718 Deferred tax assets 12 8,618 8,365 Goodwill 1,845 1,845 Other assets 2,385 1,228 Total Assets 243,058 227,636 LIABILITIES Current Liabilities Accounts payable and accrued liabilities 10 42,673 34,599 Other liabilities 10 9,262 3,494 Customer deposits 14 9,832 7,325 Current portion of long-term debt 11 3,411 5,715 Total Current Liabilities 65,178 51,133 Deferred tax liabilities 12 1,314 1,248 Other liabilities 10 1,773 -Long-term debt 11 4,263 7,057 Total Liabilities 72,528 59,438 SHAREHOLDERS' EQUITY Share capital 198,552 195,656 Contributed surplus 8,163 12,158 Translation reserve 6,407 5,973 Accumulated deficit (42,592) (45,589)Total Shareholders' Equity 170,530 168,198 Total Liabilities and Shareholders' Equity 243,058 227,636 Commitments and contingencies 10,22 Subsequent events 11,15

The accompanying notes are an integral part of these consolidated financial statements.

Approved by the Directors:

/s/ Steve Parry /s/ Christine McGinley Lead Director Director

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DIRTT Environmental Solutions Ltd. Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) (Stated in thousands of Canadian dollars)

For the year ended December 31, Notes 2018 2017 Product revenue 14 356,679 293,424 Cost of sales 206,856 170,880 Gross profit 149,823 122,544 Operating expenses Sales and marketing 52,602 59,687General and administrative 38,366 38,589 Operations support 19,665 19,497 Technology and development 8,275 9,126 Reorganization 9,600 1,453 Impairments 5 19,975 -Total operating expenses 15 148,483 128,352 Operating income (loss) 1,340 (5,808) Other (income) expenses Foreign exchange (gain) loss (3,280) 6 Interest income (550) (519)Finance costs 655 610 Total other (income) expenses (3,175) 97 Income (loss) before tax 4,515 (5,905) Income taxes Current tax expense 12 2,798 4,276 Deferred tax recovery 12 (1,280) (2,772) 1,518 1,504 Net income (loss) for the year 2,997 (7,409) Other comprehensive income (loss) Exchange differences on translation of foreign operations, net of tax expense

434 (2,746)Comprehensive income (loss) for the year 3,431 (10,155) Income (loss) per share Basic and diluted 0.04 (0.09) Weighted average number of shares outstanding (stated in thousands) Basic 16 84,477 84,679 Diluted 16 85,009 84,679

The accompanying notes are an integral part of these consolidated financial statements.

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DIRTT Environmental Solutions Ltd. Consolidated Statements of Changes in Equity (Stated in thousands of Canadian dollars, except for share data)

Notes

Number of common

shares1 Share capital WarrantsContributed

surplusTranslation

reserveAccumulated

deficit

Total shareholders'

equity

As at December 31, 2016 84,878,891 $ 195,000 $ 37 $ 10,253 $ 8,719 $ (32,040) $ 181,969 Net loss for the year - - - - - (7,409) (7,409) Other comprehensive loss for the year - - - - (2,746) - (2,746) Stock-based compensation 13 - - - 3,233 - - 3,233 Issued on exercise of stock options 13 967,498 4,479 - (1,328) - - 3,151 Shares repurchased2 (1,672,187) (3,860) - - - (6,140) (10,000) Issued on exercise of warrants 50,325 37 (37) - - - - As at December 31, 2017 84,224,527 $ 195,656 $ - $ 12,158 $ 5,973 $ (45,589) $ 168,198 Net income for year - - - - - 2,997 2,997 Other comprehensive income for the year - - - - 434 - 434 Stock-based compensation 13 - - - 1,954 - - 1,954 Issued on exercise of stock options 13 435,792 2,896 - (812) - - 2,084 Stock option conversion to cash-settled awards 13 - - - (5,137) - - (5,137) As at December 31, 2018 84,660,319 $ 198,552 $ - $ 8,163 $ 6,407 $ (42,592) $ 170,530 1 The Company has an unlimited number of voting common shares authorized for issue. 2 During the year ended December 31, 2017, the Company purchased 1,672,187 Common Shares at a weighted average price of $5.98 per Common Share for

a total cost of $10.0 million through a Normal Course Issuer Bid.

The accompanying notes are an integral part of these consolidated financial statements.

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DIRTT Environmental Solutions Ltd. Consolidated Statements of Cash Flows (Stated in thousands of Canadian dollars)

For the year ended December 31, Notes 2018 2017 Cash flows from operating activities: Net income (loss) for the year 2,997 (7,409)Adjustments: Impairment expenses 5 19,975 -Depreciation and amortization 8,9 19,474 17,917 Stock-based compensation 13 1,761 3,233 Finance costs 655 610 Deferred income tax recovery (1,280) (2,772)Foreign exchange loss (gain) on debt revaluation 741 (945)Foreign exchange gain (2,307) (173)Loss on disposal of property, plant and equipment 89 36 Net change in non-cash working capital related to operating activities 17 (26,129) 18,610 Net cash flows provided by operating activities 15,976 29,107 Cash flows from investing activities: Purchase of property, plant and equipment 8 (11,173) (18,613)Capital expenditures on internally generated intangible assets 9 (7,908) (10,616)Proceeds on sale of property, plant and equipment 76 144 Net cash flows used in investing activities (19,005) (29,085) Cash flows from financing activities: Cash received on exercise of stock options 2,084 3,151 Common shares repurchased - (10,000)Repayment of long-term debt 17 (5,988) (4,900)Interest paid on long-term debt (655) (610)Net cash flows used in financing activities (4,559) (12,359) Effect of foreign exchange on cash and cash equivalents 812 (1,576)Net decrease in cash and cash equivalents (6,776) (13,913)Cash and cash equivalents, beginning of year 79,641 93,554 Cash and cash equivalents, end of year 72,865 79,641

The accompanying notes are an integral part of these consolidated financial statements.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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1. GENERAL INFORMATION DIRTT Environmental Solutions Ltd. and its subsidiaries (“DIRTT” or the “Company”) is a leading technology-driven manufacturer of highly customized interiors. DIRTT combines its proprietary 3D design, configuration and manufacturing software (“ICE®” or “ICE Software”) with integrated in-house manufacturing of its innovative prefabricated interior construction solutions and an extensive distribution partner network. ICE provides accurate design, drawing, specification, pricing and manufacturing process information, allowing rapid production of high-quality custom solutions using fewer resources than traditional manufacturing methods. ICE is also licensed to unrelated companies and distribution partners of the Company.

DIRTT is incorporated under the laws of the province of Alberta, Canada and its headquarters and registered office is 7303 - 30th Street S.E., Calgary, AB, Canada T2C 1N6. DIRTT trades on the Toronto Stock Exchange (“TSX”) under the symbol “DRT”.

2. SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the periods presented, unless otherwise stated.

Statement of compliance

These consolidated financial statements, including comparative figures, have been prepared using accounting policies in compliance with International Financial Reporting Standards (“IFRS”) issued by the International Accounting Standards Board (“IASB”).

The consolidated financial statements were approved by the Board of Directors and authorized for issue on March 20, 2019.

Basis of measurement

These consolidated financial statements have been prepared on the historical cost convention except for certain financial instruments 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.

Functional and presentation currency

These consolidated financial statements are presented in Canadian dollars which is the functional currency of the Canadian entities. The functional currency of the United States (“U.S.”) entities is the United States dollar (“US$”), and the functional currency of the United Kingdom (“U.K.”) subsidiary is the British Pound.

Basis of consolidation

The consolidated financial statements include the accounts of DIRTT and its subsidiaries. Subsidiaries are consolidated from the date of acquisition, being the date on which the Company obtains control, and continue to be consolidated until the date that such control ceases. Control exists when the Company has

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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the power, directly or indirectly, to govern the functional and operating policies of an entity so as to obtain benefits from its activities. The financial statements of the subsidiaries are prepared for the same reporting period as DIRTT, using accounting policies consistent with DIRTT. All intercompany balances, income and expenses and unrealized gains and losses resulting from intercompany transactions are eliminated in full. Significant subsidiaries of the Company at December 31, 2018 include DIRTT Environmental Solutions Inc. which is 100% owned and domiciled in the US.

Cash and cash equivalents

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.

Inventory

Inventory is comprised of raw materials and work in progress. Inventory is valued at the lower of cost and net realizable value. Cost is determined using a weighted average cost basis and includes costs of purchase (including taxes, transport, and handling) net of trade discounts received, costs of conversion and other costs incurred to bring inventory to its present condition and location. Net realizable value is based on an item’s usability in the manufacture of the Company’s products. Work in progress is valued at an estimate of cost, based on stage of completion.

Leases

Leases where the Company assumes substantially all the risks and rewards of ownership 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 consolidated statement of income (loss) and comprehensive income (loss). Other leases that qualify as operating leases are not recognized in the Company’s consolidated statement of financial position. Operating lease payments are recognized as an expense on a straight-line basis over the lease term in the consolidated statement of income (loss) and comprehensive income (loss).

Property, plant and equipment

Tangible assets (as listed below) are recognized when it is probable that the future economic benefits associated with the assets will flow to the Company and the cost of the assets can be reliably measured. The assets are recorded at cost less accumulated depreciation and/or accumulated impairment losses, if any. The cost of an asset is comprised of the purchase price (including import duties and taxes) and any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in a manner intended by management. Repair and maintenance costs are recognized in the consolidated statement of income (loss) and comprehensive income (loss) as incurred.

Depreciation is not recorded until such time as the asset is available for use, (i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management). Depreciation is recognized in a manner that reflects the pattern in which the actual economic benefits are expected to be consumed and realized by the Company.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Depreciation is calculated on a straight-line basis to recognize the cost less estimated residual value over the estimated useful life of the assets as follows:

Computer equipment 3 years Leasehold improvements Over term of lease (1 to 10 years) Manufacturing equipment 10 years Office equipment 5 years Tooling and prototypes 4 years Building 25 years Vehicles 3 years

Residual values, useful lives and methods of depreciation are reviewed at each financial reporting period and adjusted prospectively, if appropriate. Gains or losses arising from derecognition of an item of property, plant and equipment are measured as the difference between the net disposal proceeds and the carrying amount of the asset and are recognized in the consolidated statement of income and comprehensive income when the asset is derecognized. An item of property, plant and equipment is derecognized upon disposal or when no further economic benefits are expected to arise from the continued use of the asset.

Intangible assets

Intangible assets represent patents, trademarks and product and software development costs. Product development costs represent the costs incurred, primarily employment compensation, in relation to newly designed customized interior solutions. Software development costs represent the costs incurred, primarily employment compensation, in developing ICE software, which will support the business from the point of sale through delivery and installation by providing real-time 3D renderings, price quotations, and manufacturing data. These costs are capitalized up to the point of product and/or software commercialization. Following initial recognition, intangible assets are carried at cost less any accumulated amortization and any accumulated impairment losses.

Internally generated intangible assets arising from development are recognized if all of the following are demonstrated:

• the technical feasibility of completing the intangible asset so that it will be available for use or sale;

• the intention to complete the intangible asset and use or sell it;

• the ability to use or sell the intangible asset, if applicable;

• how the intangible asset will generate probable future economic benefits;

• the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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• the ability to measure reliably the expenditure attributable to the intangible asset during its development.

Expenditures not meeting these criteria, or arising on research activities, are expensed in the period in which they are incurred.

Intangible assets with finite lives are amortized over the useful economic life and assessed for impairment whenever there is an indication that the intangible asset may be impaired. The amortization period and the amortization method for an intangible asset with a finite useful life are reviewed at least at each financial period end. Changes in the expected useful life or the expected pattern of consumption of future economic benefits embodied in the asset is accounted for by changing the amortization period or method, as appropriate, and are treated as changes in accounting estimates.

Gains or losses arising from derecognition of an intangible asset are measured as the difference between the net disposal proceeds and the carrying amount of the asset, and are recognized in the consolidated statement of income (loss) and comprehensive income (loss) when the asset is derecognized. An intangible asset is derecognized upon disposal or when no further economic benefits are expected to arise from the continued use of the asset.

Intangible assets with indefinite useful lives and intangible assets not yet available for use are tested for impairment at least annually, or whenever there is an indication that the asset may be impaired. The Company does not have any intangible assets with indefinite lives.

Amortization is calculated on a straight-line basis over the economic useful life of finite intangible assets as follows:

Patents and trademarks 10 years Product and software development 5 years Other intangibles 10 years

Impairment of non-financial assets excluding goodwill

At the end of each reporting period, the Company reviews the carrying amounts of its tangible and intangible assets to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). Where it is not possible to estimate the recoverable amount of an individual asset, the Company estimates the recoverable amount of the cash generating unit (“CGU”) to which the asset belongs. Where a reasonable and consistent basis of allocation can be identified, corporate assets are also allocated to individual CGUs, or otherwise they are allocated to the smallest group of CGUs for which a reasonable and consistent allocation basis can be identified.

Recoverable amount is the higher of fair value less cost to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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If the recoverable amount of an asset or CGU is estimated to be less than its carrying amount, the carrying amount of the asset or CGU is reduced to its recoverable amount. An impairment loss is recognized immediately in the consolidated statement of income (loss) and comprehensive income (loss).

Where an impairment loss subsequently reverses, the carrying amount of the asset or CGU is increased to the revised estimate of its recoverable amount, but only to the extent that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognized for the asset or CGU in prior periods. A reversal of an impairment loss is recognized immediately in the consolidated statement of income (loss) and comprehensive income (loss).

Provisions

General

A provision is recognized if, as a result of a past event, the Company has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. The unwinding of the discount is recognized as finance cost.

Onerous contract provision

A provision for an onerous contract is recognized when the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be derived from the contract. The provision is measured at the present value of the estimated future cash flows associated with the contract. Subsequent to the initial measurement, the provision is adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation as well as any changes in the discount rate. The net amount of actual costs incurred and any recoveries earned are charged against the onerous contract provision.

Warranties

The Company provides a warranty on all products sold to its clients and distribution partner's clients. 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.

Partner rebates

Rebates to distribution 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 distribution partners in accordance with their distribution partner agreements, being the difference between the price to the end customer and the distribution partners’ price. Prior to the second quarter of 2018, the Company had a program with its distribution partners whereby they were eligible for a 5% rebate on projects that met specific criteria.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Goodwill

Goodwill represents the excess of the purchase price over the fair value of net assets acquired and liabilities assumed in a business combination. Goodwill is not amortized but is reviewed for impairment at least annually. For the purposes of impairment testing, goodwill is allocated to the CGU, or group of CGUs, that are expected to benefit from synergies of the business combination. CGUs to which goodwill has been allocated are tested for impairment annually, or more frequently when there is an indication that the CGU may be impaired. If the recoverable amount of the CGU is less than its carrying amount, the impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the unit, and then to the other assets of the unit pro-rata on the basis of the carrying amount of each asset in the unit. An impairment loss recognized for goodwill is not reversed in a subsequent period.

Impairment of Goodwill

The Company performs an impairment test on goodwill annually in the fourth quarter. This requires an estimation of the recoverable amount of the groups of CGUs to which the goodwill is allocated. The Company has two separate CGUs, DIRTT and Ice Edge. Goodwill was allocated to DIRTT.

Income taxes

Income tax expense comprises current and deferred tax. Income tax is recognized in the consolidated statement of income (loss) and comprehensive income (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 as adjusted for items that are not taxable or not deductible. Current tax is calculated using tax rates and laws that were enacted or substantively 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 statement of financial position. Deferred tax is calculated using tax rates and laws that have been enacted or substantively enacted at the end of the reporting period, and which are expected to apply when the related deferred tax asset is realized or the deferred tax liability is settled.

Deferred tax assets are recognized to the extent it is probable that taxable profits will be available against which the deductible temporary differences can be utilized; and are reviewed at the end of the reporting period and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered.

Deferred tax liabilities are generally recognized for all taxable temporary differences; are recognized for taxable temporary differences arising on investments in subsidiaries except where the reversal of the temporary difference can be controlled and it is probable that the difference will not reverse in the

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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foreseeable future; and are not recognized on temporary differences that arise from goodwill which is not deductible for tax purposes.

Deferred tax assets and liabilities are not recognized in respect of temporary differences that arise on initial recognition of assets and liabilities acquired other than in a business combination and, at the time of the transaction, affects neither the accounting profit nor taxable profit.

Revenue recognition

For the year-ended December 31, 2018, the Company’s revenue recognition policy was as follows:

Product sales

The Company's revenues reflect sales to its clients and distribution partners for resale to their clients. The Company considers its performance obligations to be satisfied and control to be transferred typically when the product is shipped from the factory and when all of the following conditions are met:

• it is probable that the economic benefits will flow to the Company;

• the Company has transferred to the buyer the significant risks and rewards of ownership of the goods;

• the amount of revenue can be reliably measured;

• the Company retains neither continuing managerial involvement to the degree usually associated with ownership, nor effective control over the goods sold; and

• costs incurred or to be incurred in respect of the transaction can be measured reliably.

The Company usually requires a 50% deposit on certain orders. The Company does not require deposits on US government orders or in some special contractual situations. These deposits are recognized as contract liabilities. See Note 14 for the breakdown of contract liabilities.

Installation

The Company provides installation services for customers as required in certain contractual situations. Revenue from installation services, is recognized once the service has been performed on a percentage of completion basis.

Transportation

The Company ships products through third party carriers. Revenue is typically recognized once the product is shipped from the factory, which is where title and risk associated with the product is typically transferred to the customer.

The Company offers certain arrangements whereby a customer can purchase products, installation and transportation together. Where such arrangements exist, the amount of revenue allocated to each performance obligation is based upon their relative fair values. The fair values of each performance obligation are determined based on the current market price of each of the performance obligations sold separately. When the fair value cannot be determined based on when it was sold separately, the Company uses the residual method to determine a value that most reasonably reflects the selling price that might

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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be achieved in a stand-alone transaction. Any discounts identified as part of these arrangement are allocated to all separate performance obligations based on relative selling price.

Licenses and Services

The Company derives revenue from ICE Software licenses, maintenance, and professional services. For sales to distribution partners, ICE Software revenue is not considered a separate performance obligation. ICE Software is related to the distribution partner’s sale of DIRTT products and is recognized as product revenue as DIRTT products are sold over the license period. For third party ICE Software sales, license revenue is allocated between the Company’s performance obligations. License revenue is recognized when the customer is provided the right to use the license, maintenance and professional services revenues are recognized over the term of the agreement.

See Note 14 for the disclosure of disaggregation of revenue.

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 distribution partners. The Company records these revenues gross when the Company is obligated to fulfill the services and has the risk associated with service delivery. The Company records these revenues net when the distribution partner has the obligation to fulfill the services and the associated risk of service delivery.

Prior Accounting Policy

For the year-ended December 31, 2017, the Company’s revenue recognition policy was as follows:

Revenue is measured at the fair value of the consideration received or receivable, excluding discounts, rebates and sales or income taxes and duty.

Sale of goods

The Company’s revenues reflect sales to its clients and Partners for resale to their clients. The Company recognizes revenue when the product is shipped from the factory and when all of the following conditions are met:

it is probable that the economic benefits will flow to the Company; the Company has transferred to the buyer the significant risks and rewards of ownership of the

goods; the amount of revenue can be reliably measured; the Company retains neither continuing managerial involvement to the degree usually associated

with ownership, nor effective control over the goods sold; and costs incurred or to be incurred in respect of the transaction can be measured reliably.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Rendering of Services

The Company derives revenue from licenses, maintenance, installation and other service fees. Ice Edge recognizes license revenue when it is probable that the economic benefits will flow to the Company and the revenue can be reliably measured. Revenue is measured at the fair value of the consideration received or receivable, excluding discounts, rebates, and sales or income taxes or duty. Revenue from installation services is recognized once service is performed. Revenue from maintenance and other recurring services is recognized over the term of the agreement. If it is not considered probable that the revenue is collectible, then it is only recognized when the fee is collected. Revenue from professional services is recognized when the services are provided.

The Company offers certain arrangements whereby a customer can purchase products and services together. Where such multiple-element arrangements exist, the amount of revenue allocated to each element is based upon the relative fair values of the various elements. The fair values of each element are determined based on the current market price of each of the elements when sold separately. When the fair value cannot be determined based on when it was sold separately, the Company uses the residual method to determine a value that most reasonably reflects the selling price that might be achieved in a stand-alone transaction. Any discounts identified as part of a multi-element arrangement are proportionately allocated to all separately identifiable components.

Stock-based compensation

Equity-settled options

Equity-settled stock-based compensation to employees and others providing similar services are measured at the fair value of the equity instruments at the grant date.

The fair value determined at the grant date of the equity-settled stock-based payments is expensed on a graded basis over the vesting period, based on the Company’s estimate of equity instruments that will eventually vest. The exercise price is based on the weighted average price of the common shares on the TSX for the five trading days prior to the date of grant or the price on the grant date, whichever is greater. At the end of each reporting period, the Company revises its estimate of the number of equity instruments expected to vest. The impact of the revision of the original estimates, if any, is recognized in profit or loss such that the cumulative expense reflects the revised estimate, with a corresponding adjustment to contributed surplus.

Equity-settled stock-based compensation transactions with parties other than employees are measured at the fair value of the goods or services received, except where that fair value cannot be estimated reliably, in which case they are measured at the fair value of the equity instruments granted, measured at the date the entity obtains the goods or the counterparty renders the service.

Cash-settled options

Commencing in July 2018, the Company allowed for certain stock options to be surrendered for cash. On the date of the change in the share option plan, the modified stock options were classified as liabilities from stock-based payment reserve. Subsequently, at each reporting date between grant date and

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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settlement date, the fair value of the liability is remeasured with any changes in fair value recognized in profit or loss for the period (see Note 13).

Performance Share Units

The Company has a cash-settled Performance Share Unit (“PSU”) Plan for certain employees of the Company. Management makes a fair value assessment of each grant of PSUs with respect to the timing and likelihood of vesting of the PSUs considering the performance conditions attached. The fair value of the PSUs is expensed over the expected vesting period, and until the full value of the liability is recognized it is revalued at each period end to the expected value until they are fully vested. As PSUs are cash settled they are excluded from diluted earnings per share calculations.

Deferred Share Units

The Company has a cash-settled Deferred Share Unit (“DSU”) Plan for non-employee directors of the Company. The fair value of the cash liability is determined and recorded as compensation expense at the date of the grant. The liability is remeasured at the end of each reporting period with a corresponding adjustment to the related compensation expense until the date of settlement. As DSUs are cash settled they are excluded from diluted earnings per share calculations.

Borrowing costs

Borrowing costs are interest and other costs incurred by the Company in connection with the borrowing of funds. Borrowing costs include interest on bank overdrafts and short-term and long-term borrowings and finance charges in respect of finance leases. Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are required to be capitalized as part of the cost of that asset. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. All other borrowing costs are recognized as an expense in the period in which they are incurred.

Foreign currency translation

In the accounts of individual Canadian subsidiaries included in the consolidated financial statements, transactions in currencies other than the functional currency are recorded at the prevailing rate of exchange at the date of the transaction. At period end, monetary assets and liabilities denominated in foreign currencies are translated at the rates of exchange prevailing at that date. Non-monetary assets and liabilities measured at fair value in a foreign currency are translated using the rates of exchange at the date the fair value was determined. All foreign exchange gains and losses are taken to the consolidated statement of income (loss) and comprehensive income (loss).

The assets and liabilities on the consolidated statements of financial position of foreign subsidiaries are translated into Canadian dollars at the rates of exchange prevailing at the period end date. The consolidated statements of income (loss) and comprehensive income (loss) of foreign subsidiaries are translated at average exchange rates for the reporting period. Exchange differences arising on translation are taken to other comprehensive income.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Gains or losses resulting from these translation adjustments are recognized initially in other comprehensive income and reclassified from equity to net earnings on disposal or partial disposal of the foreign operation.

Financial instruments

The Company measures its financial assets and financial liabilities at fair value on initial recognition, which is typically the transaction price unless a financial instrument contains a significant financing component. Initial recognition is considered to be when the Company becomes party to the contractual provisions of the instrument. Subsequent measurement is dependent on the financial instrument’s classification which in the case of financial assets is determined by the context of DIRTT’s business model and the contractual cash flow characteristics of the financial asset. Financial assets are classified into three categories: measured at amortized cost, fair value through other comprehensive income (“FVTOCI”) and fair value through profit and loss (“FVTPL”). Financial liabilities are subsequently measured at amortized cost, other than financial liabilities that are measured at FVTPL or designated as FVTPL where any change in fair value resulting from an entity’s own credit risk is recorded as other comprehensive income (loss) (“OCI”).

Amortized Cost

DIRTT classifies its cash and cash equivalents, trade and other receivables, trade accounts payable and accrued liabilities, customer deposits and long-term debt as measured at amortized cost. The contractual cash flows received from the financial assets are solely payments of principal and interest and are held within a business model whose objective is to collect the contractual cash flows. These financial assets and financial liabilities are subsequently measured at amortized cost using the effective interest method.

FVTOCI

Financial assets measured at FVTOCI are subsequently measured at fair value with changes in fair value recognized in OCI, net of tax. Transaction costs related to the purchase of financial assets measured at FVTOCI, as well as interest, impairment and foreign currency gains or losses are recognized in the statements of income and all other gains or losses are recognized in OCI. Upon derecognition of the financial asset, amounts in OCI are reclassified to the statements of income. The Company has no financial instruments designated as FVTOCI.

FVTPL

Financial assets and liabilities classified as FVTPL are subsequently measured at fair value with changes in fair value charged immediately to the statements of income. DIRTT does not have any financial assets or financial liabilities designated as measured at FVTPL.

Impairment of Financial Assets

DIRTT’s cash and cash equivalents and short-term investments consist of cash and guaranteed investment certificates. Expected credit loss (“ECL”) allowances have not been recognized for these financial assets due to the virtual certainty associated with their collectability. Within accounts receivable, the Company has applied a practical expedient and used a simplified provision matrix to estimate the ECL for trade

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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receivables which do not contain a significant financing component. The Company assesses the lifetime ECL applicable to its receivables at initial recognition and re-assesses the provision at each reporting date.

Lifetime ECLs are a probability-weighted estimate of all possible default events over the expected life of a financial asset. In making an assessment as to whether DIRTT’s financial assets are credit-impaired, the Company considers bad debts that DIRTT has incurred historically, evidence of a debtor’s present financial condition and whether a debtor has breached certain contracts, the probability that a debtor will enter bankruptcy or other financial reorganization, changes in economic conditions that correlate to increased levels of default, and the term to maturity of the specified receivable. The carrying amounts of receivables are reduced by the amount of the ECL through an allowance account and losses are recognized within SG&A expense in the consolidated statement of income (loss) and comprehensive income (loss).

Derecognition of Financial Assets and Financial Liabilities

Financial assets are derecognized when the rights to receive cash flows from the assets have expired or have been transferred and the Company has transferred substantially all risks and rewards of ownership. Disclosure of the accounting policy is limited to categories relevant to the Company.

The Company derecognizes financial liabilities when, and only when, the Company’s obligations are discharged, canceled or they expire. The difference between the carrying amount of the financial liability derecognized and the consideration paid and payable is recognized in the consolidated statement of income (loss) and comprehensive income (loss).

Equity Instruments

An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all its liabilities. Equity instruments issued by the Company are recognized at the proceeds received, net of direct issue costs.

Repurchase of the Company’s own equity instruments is recognized and deducted directly in equity. No gain or loss is recognized in the consolidated statement of income (loss) and comprehensive income (loss) on the purchase, sale, issue or cancellation of the Company’s own equity instruments.

Other comprehensive income (loss)

Other comprehensive income (loss) includes foreign exchange differences arising from the translation of the financial statements of foreign subsidiaries into Canadian dollars.

Impairment of financial assets – 2017 accounting policy

Financial assets are assessed at each reporting date to determine whether objective evidence exists that the assets are impaired as a result of one or more events which have had a negative effect on the estimated future cash flows of the asset. If there is objective evidence that a financial asset has become impaired, the amount of the impairment loss is calculated as the difference between its carrying amount and the present value of the estimated future cash flows from the asset discounted at its original effective interest rate. Impairment losses are recorded in the consolidated statement of income (loss) and comprehensive income (loss). If the amount of the impairment loss decreases in a subsequent period and the decrease can be objectively related to an event occurring after the impairment was recognized, the

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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impairment loss is reversed up to the original carrying value of the asset. Any reversal is recognized in the consolidated statement of income (loss) and comprehensive income (loss). Earnings (loss) per share (“EPS”)

Basic EPS is calculated by dividing the profit or loss attributable to owners of the Company (the numerator) by the weighted average number of common shares outstanding (the denominator) during the year. The denominator is calculated by adding the shares issued and outstanding at the beginning of the year and the number of common shares repurchased or issued during the year, multiplied by a time-weighting factor.

Diluted EPS is calculated by adjusting the profit or loss attributable to equity holders of the Company and number of common shares for the effects of dilutive options into potential common shares. The Company uses the treasury share method of calculating diluted earnings per common share. Under this method, the exercise of share options is assumed to have occurred at the beginning of a year and the related common shares are assumed issued at that time.

The proceeds from exercise are assumed to have purchased common shares of the Company for cancellation at the average value price during the year. The incremental common shares (the difference between the number of common shares assumed issued and the number of common shares assumed purchased) are included in the denominator of the diluted earnings per common share calculation. The effects of anti-dilutive potential common shares are excluded in calculating diluted EPS. All options and other potential common shares are considered anti-dilutive when the Company is in a loss position.

Segment reporting

Operating segments are reported in a manner consistent with internal reporting provided to the chief operating decision-maker. The chief operating decision-maker is responsible for allocating resources and assessing performance of the operating segment and has been identified as the Company’s Chief Executive Officer and the senior management team. The Company has identified one operating segment.

3. SIGNIFICANT ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS

The preparation of the financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and contingent liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Estimates and judgments are continuously evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the year in which the estimate is revised if the revision affects only that year or in the year of the revision and future years if the revision affects both current and future years.

In the application of the Company’s accounting policies, which are described in Note 2, management is required to make judgments, estimates and assumptions about the carrying amounts of assets and liabilities that are not readily apparent from other sources. The estimates and associated assumptions are

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates.

Critical judgments in applying accounting policies

The following are the critical judgments, apart from those involving estimations, that management has made in the process of applying the Company’s accounting policies and that have the most significant effect on the amounts recognized in the financial statements.

Impairment of non-financial assets

The values associated with non-financial assets involve significant estimates and assumptions, including those with respect to the determination of cash generating units (“CGUs”), future cash inflows and outflows, discount rates, and asset lives. At least annually, the carrying value of non-financial assets is reviewed for potential impairment. Among other things, this review considers the recoverable amounts of the CGUs based on the higher of value in use or fair value less cost to sell using discounted estimated future cash flows. These significant estimates require considerable judgment, which could affect the Company’s future results if the current estimates of future performance and fair values change. Refer to Note 5 for discussion of impairment charges.

Income tax

The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities arise from temporary differences between the tax bases of assets and liabilities and their carrying amounts reported in the financial statements. Deferred income tax assets also reflect the benefit of unutilized tax losses that can be carried forward to reduce income taxes in future years. Such method requires the exercise of significant judgment in determining whether or not the Company’s deferred tax assets are probable of recovery from taxable income of future years and therefore, can be recognized in the financial statements. Also, estimates are required to determine the expected timing upon which tax assets will be realized and upon which tax liabilities will be settled. Refer to Note 12 for further discussion of income taxes.

Key sources of estimation uncertainty

The following are the key assumptions concerning the future, and other key sources of estimation uncertainty at the end of the fiscal year, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

Useful lives of property, plant and equipment and intangible assets

The Company estimates the useful lives of property, plant and equipment and intangible assets based on the period over which the assets are expected to be available for use. The estimated useful lives are reviewed annually and are updated if expectations differ from previous estimates due to physical wear and tear, technical or commercial obsolescence and legal or other limits on the use of the relevant assets. In addition, the estimation of the useful lives of the relevant assets may be based on internal technical evaluation and experience with similar assets. It is possible, however, that future results of operations could be materially affected by changes in the estimates brought about by changes in factors mentioned

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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above. The amounts and timing of recorded expenses for any period would be affected by changes in these factors and circumstances. A reduction in the estimated useful lives of the property, plant and equipment and intangible assets would increase the recorded expenses and decrease the non-current assets. Refer to Note 5 for additional details on impairment charges recognized and notes 8 and 9 for additional details on property plant and equipment and intangible assets.

Provisions

Provisions set aside for warranty exposures, are estimated based on historical experience under contractual warranty obligations or specific provisions created in respect of expected repair and warranty costs. Management believes the provided warranty provisions are sufficient. Provisions for onerous contracts are recorded based on management’s best estimate of the unavoidable costs of meeting the obligations under the contract and any ability to recover costs from leases currently in place (e.g. rent recovery). Provisions recorded for contingent liabilities are determined based on management’s best estimate of the likelihood of having to pay claims against the Company. Should plans or costs change, the provisions and associated expenses could increase or decrease. Refer to Notes 5 and 10 for additional details on provisions recognized as impairment charges in the year, included in the statement of financial position as other liabilities.

Key assumptions used in discounted cash flow projections

Key assumptions used in the calculation of impairment tests are discount rates, growth rates, and other assumptions.

4. ADOPTION OF NEW AND REVISED IFRS

The Company has adopted new and revised accounting pronouncements outlined below and has determined these standards did not have a material impact upon adoption on January 1, 2018.

IFRS 15 “Revenue from Contracts with Customers”

IFRS 15 "Revenue from Contracts with Customers" establishes a comprehensive framework for determining whether, how much and when revenue is recognized. IFRS 15 replaced International Accounting Standard (“IAS”) 18 "Revenue", IAS 11 "Construction Contracts" and related interpretations.

IFRS 9 “Financial Instruments”

IFRS 9 "Financial Instruments" sets out requirements for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. There was no financial impact on the opening balances as at January 1, 2018 upon the adoption of IFRS 9.

The Company adopted both IFRS 9 and IFRS 15 as issued by the IASB as at January 1, 2018 using the modified retrospective basis. Accordingly, the information presented for 2017 has not been restated. There was no material impact on the Company's consolidated statement of financial position, consolidated statement of income (loss) and comprehensive income (loss), consolidated statement of cash flows and condensed consolidated statement of changes in equity.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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The Company has reviewed the impact of the new and revised accounting pronouncements outlined below, and has determined whether the standard had a material impact upon adoption on January 1, 2019:

IFRS 16 “Leases”

In January 2016, the IASB issued IFRS 16 “Leases”, which replaces IAS 17 “Leases”. IFRS 16 introduces a single recognition and measurement model for leases which requires the recognition of assets and liabilities for most leases. The standard will come into effect for annual periods beginning on or after January 1, 2019.

DIRTT will adopt IFRS 16 on January 1, 2019 using the modified retrospective approach, whereby the cumulative effect of initially applying the standard will result in the recognition of right-of-use assets and lease obligations on the statement of financial position. The right-of-use assets will be initially measured at amounts equal to the lease obligations. The discount rate that will be used to determine the lease obligation on adoption will be the weighted average incremental borrowing rate. The right-of-use assets and lease obligations to be recognized primarily relate to building leases in Canada and the United States.

As a result of this adoption, DIRTT will revise its accounting policy for leases to the following:

A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. A lease obligation is recognized at the commencement of the lease term at the present value of the lease payments that are not paid at that date. Interest expense is recognized on the lease obligations using the effective interest rate method and payments are applied against the lease obligation. At the commencement date, a corresponding right-of-use asset is recognized at the amount of the lease obligation, adjusted for lease incentives received and initial direct costs. Depreciation is recognized on the right-of-use asset on a straight-line basis over the lease term.

The preparation of the consolidated financial statements in accordance with IFRS requires management to make judgments, estimates, and assumptions that affect the reported amount of assets, liabilities, income, and expenses. Actual results could differ significantly from these estimates.

The key area where management has made judgments, estimates, and assumptions related to the application of IFRS 16 is the incremental borrowing rate. The incremental borrowing rates are based on judgments including economic environment, term, currency, and the underlying risk inherent to the asset. See Note 22 for additional discussion of DIRTT’s commitments.

IFRIC 23 “Uncertainty over Income Tax Treatments”

The Company has reviewed the impact of the new and revised accounting pronouncement outlined below and has determined the standard did not have material impact upon adoption on January 1, 2019.

In June 2017, the IASB issued International Financial Reporting Interpretations Committee (“IFRIC”) 23 “Uncertainty over Income Tax Treatments” is effective for annual reporting periods beginning on or after January 1, 2019. The interpretation is to be applied to the determination of taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates, when there is uncertainty over income tax

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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treatments under IAS 12. The Company will consider these new requirements when completing 2019 income tax calculations and no material impact is anticipated.

5. IMPAIRMENT EXPENSES

For the year ended December 31, 2018 2017 DIRTT Timber 13,250 -Onerous contract 2,583 -Leasehold and other assets 2,399 -DIRTT for Life 1,743 - 19,975 - DIRTT Timber

During 2018, management decided to shift from the early stage development of its DIRTT Timber market to a commercialized approach focused on large, standalone timber projects and as a pull-through for other DIRTT solutions. Management concluded that this strategy requires significantly less timber capacity than currently exists and therefore took steps to right-size its timber capacity. Management determined these decisions to be an indicator of impairment of the assets of the timber solution line.

Management performed an assessment of the carrying values of DIRTT Timber’s property, plant and equipment, and intangible assets. The net book value of the assets was evaluated against the greater of value-in-use and fair value, less cost of disposal. The value-in-use of the timber assets reflects current projected sales for timber projects on a standalone basis and the pull-through impact to other DIRTT solutions. In its evaluation, management determined it was unable to reliably quantify the pull-through impact of timber on other DIRTT solutions. As a result, management concluded that the fair value less cost of disposal exceeded the standalone value-in-use of its timber assets. The equipment related to the timber market was custom built for DIRTT and there is no active market for resale. Therefore, the fair value was determined to be management’s estimate of scrap value for the specialized assets and an estimated resale value for less specialized assets that cannot be redeployed for DIRTT’s other solutions. Management estimated the expected resale values based on the current market and on experience of management in the industry. The fair value less cost of disposal of the timber assets was estimated to be $1.5 million. This assessment resulted in an impairment charge of $13.3 million, of which $8.2 million related to tangible assets and $5.1 million related to intangible assets.

Onerous contract losses

At December 31, 2018, the Company recognized a provision of $2.6 million related to onerous contracts (December 31, 2017 – nil). During 2018, management reviewed its facilities used in operations and the corresponding leases in place. The outcome of this review was the consolidation of the Company’s production in Kelowna, British Columbia, into other plants, and discontinuing use of other locations that were not considered necessary in the Company’s current operations.

These leases were considered onerous as the costs of meeting lease obligations exceeded the economic benefits expected to be received. The provision represents the present value of the difference between the minimum future lease payments the Company is obligated to make under the non-cancellable

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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onerous operating lease contract and any estimated sublease recoveries. This estimate may vary as a result of changes in estimated sublease recoveries. The onerous contract provision is estimated to be settled in periods up to and including the year 2023. No amounts were included for estimated subleases as, while best efforts are being undertaken to sublease these locations, the likelihood of a material sublease is considered low at this time.

Leasehold and other assets

In relation to the review noted in the paragraph above, certain assets were identified as no longer having future value to the Company. These assets related to leasehold improvements for locations where activity is being relocated, as well as projects in process that were curtailed. These leasehold and other assets represented assets with a carrying value of $2.4 million at December 31, 2018, of which the entire amount was expensed as there is no future value attributable to these assets or market for resale.

DIRTT for Life

During 2018, management commenced a review of its solution lines and as a result decided to exit its DIRTT for Life residential services. This decision by management was determined to be an indicator of impairment for these assets.

DIRTT for Life had intangible assets with a carrying value of $1.7 million. As these assets cannot be resold and there is no future use for the assets, the entire carrying amount was impaired and a corresponding impairment charge of $1.7 million was recorded during 2018.

6. TRADE AND OTHER RECEIVABLES

As at December 31, 2018 2017 Trade receivables 58,090 22,113 Sales tax receivable 657 551 Current tax receivable 1,217 269 Due from related party (Note 19) - 1,307 59,964 24,240 Allowance for doubtful accounts (112) (107) 59,852 24,133 See Note 21 for aging analysis of trade and other receivables and for a discussion on their collectability.

7. INVENTORY

As at December 31, 2018 2017 Raw material 23,481 22,796 Allowance for obsolescence (499) (527)Work in progress 2,460 2,028 25,442 24,297

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Cost of sales for the year ended December 31, 2018 includes the write-down of the value of specific inventory items of $28 thousand (2017 - $31 thousand). During the year ended December 31, 2018, $171.8 million (2017 - $134.5 million) of materials inventory was consumed as cost of sales.

8. PROPERTY, PLANT AND EQUIPMENT

Office and computer

equipment Factory

equipment Leasehold

improvements Total Cost At December 31, 2016 21,222 47,164 41,206 109,592 Additions 4,114 7,886 6,613 18,613 Disposals (76) (211) (1,394) (1,681)Exchange differences (727) (585) (1,035) (2,347)At December 31, 2017 24,533 54,254 45,390 124,177 Additions 2,598 5,357 3,218 11,173 Disposals (58) - (225) (283)Exchange differences 953 990 691 2,634 At December 31, 2018 28,026 60,601 49,074 137,701 Accumulated depreciation and impairment At December 31, 2016 11,526 21,906 20,550 53,982 Depreciation expense 2,126 4,603 5,346 12,075 Disposals (62) (72) (1,368) (1,502)Exchange differences (241) (331) (666) (1,238)At December 31, 2017 13,349 26,106 23,862 63,317 Depreciation expense 2,326 5,225 5,066 12,617 Disposals (41) - (77) (118)Impairments (Note 5) - 7,634 2,894 10,528 Exchange differences 392 507 354 1,253 At December 31, 2018 16,026 39,472 32,099 87,597 Net book value At December 31, 2017 11,184 28,148 21,528 60,860 At December 31, 2018 12,000 21,129 16,975 50,104

As at December 31, 2018, the Company had $1.2 million of assets in progress of completion which were excluded from assets subject to depreciation (December 31, 2017 - $6.0 million).

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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9. INTANGIBLE ASSETS

Product

development Software

development

Patents, trademarks and

other Total Cost At December 31, 2016 8,816 28,651 5,898 43,365 Additions 3,496 5,985 1,135 10,616 Exchange differences - - (40) (40)At December 31, 2017 12,312 34,636 6,993 53,941 Additions 1,226 5,512 1,170 7,908 Exchange differences - - 49 49 At December 31, 2018 13,538 40,148 8,212 61,898 Amortization and impairment At December 31, 2016 1,636 19,665 2,103 23,404 Amortization expense 1,153 4,090 599 5,842 Exchange differences - - (23) (23)At December 31, 2017 2,789 23,755 2,679 29,223 Amortization expense 1,727 4,418 712 6,857 Impairments (Note 5) 6,864 - - 6,864 Exchange differences - - 32 32 At December 31, 2018 11,380 28,173 3,423 42,976 Net book value At December 31, 2017 9,523 10,881 4,314 24,718 At December 31, 2018 2,158 11,975 4,789 18,922

As at December 31, 2018, the Company had $0.1 million of assets in progress of completion which were excluded from assets subject to amortization (December 31, 2017 - $1.6 million). Amounts capitalized for product and software development include 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.

10. ACCOUNTS PAYABLE, ACCRUED LIABILITIES AND OTHER LIABILITIES

Accounts payable and accrued liabilities

As at December 31, 2018 2017 Trade accounts payable 14,010 12,155 Accrued liabilities 11,888 10,801 Wages and commissions payable 7,563 8,270 Rebates accrued 8,601 2,375 Taxes payable 611 998 42,673 34,599

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Other liabilities

As at December 31, 2018 2017 Contingency provision1 2,722 1,625 Stock option liability (Note 13) 2,408 -Warranty provision 2,037 735 Onerous contracts - current portion (Note 5)2 1,072 -Lease inducements 1,023 1,134 9,262 3,494 1 The Company has provided $2.7 million as the estimated amounts likely payable for claims against the Company,

which include various claims. The amount provided for is management’s best estimate of the potential payments for amounts claimed.

2 The current portion of the onerous contract represents lease payments that are anticipated to be made within the next 12 months, the remaining $1.6 million has been classified as other long-term liabilities.

11. LONG-TERM DEBT

As at December 31, 2018 2017 Capital financing facility, secured by a charge on all assets including manufacturing equipment, with 36 monthly payments of US$139 plus interest at floating rates, which is based on the lender's US prime rate minus 0.25%. Prior to March 31, 2016, the interest rate was prime plus 0.5%. This facility matured on April 1, 2018. - 697 Term loan, secured by a charge on all assets including manufacturing equipment, with 60 monthly payments of US$21 plus interest at floating rates, which is based on the lender's US prime rate minus 0.25%. Prior to March 31, 2016, the interest rate was prime plus 0.5%. This facility matured on December 1, 2018. - 1,882 Capital financing facility, secured by a charge on all assets including manufacturing equipment, with 48 monthly payments of US$208, commencing on April 1, 2017, plus interest at floating rates, which is based on the lender's US prime rate minus 0.25%. This facility matures on March 1, 2021. 7,674 10,193 7,674 12,772 Less: Current portion of long-term debt (3,411) (5,715)Long-term debt 4,263 7,057 At December 31, 2018 and 2017, the Company had not drawn on its US$18.0 million revolving operating facility. Advances under the revolving operating facility are subject to interest at the lender’s prime rate minus 0.25% for Canadian dollar advances and the US prime rate minus 0.25% for US dollar advances and are repayable at any time. In November 2018, the Company signed an eighth amendment to the amended and restated loan agreement to amend certain covenant definitions. As at December 31, 2018 and 2017, the Company was in compliance with all of its lender’s covenants. On January 31, 2019, the Company repaid all remaining principal and interest amounts on the capital financing facility.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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12. INCOME TAXES

Reconciliation of income taxes:

For the year ended December 31, 2018 2017 Net income (loss) before tax 4,515 (5,905)Canadian statutory rate 27% 27%Expected income tax 1,219 (1,591) Effect on taxes resulting from: Non-deductible expenses 571 330 Non-deductible stock-based compensation 527 871 Tax rate impacts (534) 1,566 True up of prior year tax expense (327) 275 Other 62 53Income tax expense 1,518 1,504 Current tax expense 2,798 4,276 Deferred tax recovery (1,280) (2,772)Income tax expense 1,518 1,504 Recognized deferred tax assets and liabilities consists of the following: 1

At December 31, 2018 Assets Liabilities NetOperating losses 11,769 - 11,769Research and development expenditures 532 - 532 Property and equipment - (3,258) (3,258)Intangible assets - (3,792) (3,792)Other 2,324 (271) 2,053Net deferred taxes 14,625 (7,321) 7,304

At December 31, 2017 Assets Liabilities NetOperating losses 14,032 - 14,032Research and development expenditures 531 - 531 Property and equipment 175 (3,181) (3,006)Intangible assets - (5,505) (5,505)Other 1,272 (207) 1,065Net deferred taxes 16,010 (8,893) 7,117

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Summary of temporary difference movements during the year:

Balance January 1,

2018

Recognized in Comprehensive

Income

Foreign Exchange

Balance December 31,

2018 Operating losses 14,032 (2,263) - 11,769Research and development expenditures 531 1 - 532Property and equipment (3,006) (350) 98 (3,258)Intangible assets (5,505) 1,713 - (3,792)Other 1,065 969 19 2,053Net deferred taxes 7,117 70 117 7,304

Balance

January 1, 2017

Recognized in Comprehensive

Income

Foreign Exchange

Balance December 31,

2017 Operating losses 7,639 6,492 (99) 14,032Research and development expenditures 2,389 (1,858) - 531Property and equipment (2,585) (420) (1) (3,006)Intangible assets (4,359) (1,146) - (5,505)Other 1,398 (296) (37) 1,065Net deferred taxes 4,482 2,772 (137) 7,117 The Tax Cuts and Jobs Act (the “Act”) in the U.S. became law on December 22, 2017. The Act includes significant changes to the U.S. corporate income tax system, including a federal corporate rate reduction from 35 percent to 21 percent beginning in 2018, changes to capital depreciation, limitations on the deductibility of interest expense and executive compensation, and the transition of U.S. international taxation from a worldwide tax system to a territorial tax system. As a result of the Act, the Company remeasured its U.S. deferred tax liability based upon the new statutory federal rate of 21 percent.

The amount shown on the statements of financial position as deferred income tax assets and liabilities represent the net differences between the tax basis and book carrying values on the Company's statements of financial position at enacted tax rates.

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:

For the year ended December 31, 2018 2017 2018 2017 $ $ $ US $ USNon-capital loss carry forwards 43,616 47,950 - 4,214 Undepreciated capital costs 25,211 35,049 12,748 14,803 Share issuance costs 519 1,931 - -SR&ED expenditure pool 1,971 1,971 - -Total future tax deductions 71,317 86,901 12,748 19,017

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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At December 31, 2018, the Company has $43.6 million of non-capital carryforward losses which begin to expire in 2031.

13. STOCK-BASED COMPENSATION

Stock Options

The Company has a stock option plan which was approved by the Board of Directors and by its shareholders at the annual and special meeting of shareholders held on May 5, 2016, whereby the aggregate number of shares reserved for issuance shall not exceed 10% of the issued and outstanding common shares as at the time of grant of any options. Except as disclosed below, options granted under the plan generally have a term of five years and vest one third every year over a three-year period from the date of grant.

During the year, the Company allowed certain vested share options to be surrendered for cash. On the date of modification, the fair value of the liability of options eligible for cash surrender of $5.1 million was reclassified on the statement of financial position from shareholders' equity to other liabilities and a $0.4 million recovery was recognized to adjust the liability to the fair value at year-end. During the period, $2.3 million of share options were surrendered for cash and at period end the Company had a liability of $2.4 million in other liabilities for the remaining vested share options.

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

Number of options

Weighted average exercise price C$

Outstanding at December 31, 2016 6,867,752 5.04Granted 57,500 6.35Exercised (967,498) 3.26Forfeited (352,511) 5.71Expired (51,850) 5.96Outstanding at December 31, 2017 5,553,393 5.31Granted 3,327,525 6.40 Exercised (435,792) 4.78 Forfeited (203,516) 5.26 Surrendered (1,365,348) 5.17 Expired (17,886) 6.02 Outstanding at December 31, 2018 6,858,376 5.88Exercisable at December 31, 2018 3,123,369 5.34 Included in the 2018 share option grant above, 1,725,000 share options were granted to an executive with performance conditions for vesting. For 825,000 share options, vesting is upon an increase in the Company's share price to $13.26, and for 900,000 share options, vesting is upon an increase in the Company's share price to $19.89. These options were valued using the Monte Carlo valuation method and determined to have a weighted average grant fair value of $2.14.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Range of exercise prices outstanding at December 31, 2018:

Options outstanding Options exercisable

Range of exercise prices Number

outstanding

Weighted average

remaining

Weighted average

exercise price Number

exercisable

Weighted average

remaining

Weighted average

exercise price $2.01 - $3.00 31,600 0.4 2.93 31,600 0.4 2.93 $3.01 - $4.00 804,883 0.5 3.59 804,883 0.5 3.59 $5.01 - $6.00 1,162,669 2.9 5.76 746,028 2.9 5.76 $6.01 - $6.47 4,859,224 3.7 6.31 1,540,858 1.6 6.10 Total 6,858,376 3,123,369 All exercisable stock options can be surrendered for cash settlement, as discussed above.

Range of exercise prices outstanding at December 31, 2017:

Options outstanding Options exercisable

Range of exercise prices Number

outstanding

Weighted average

remaining

Weighted average

exercise price Number

exercisable

Weighted average

remaining

Weighted average

exercise price $2.01 - $3.00 59,600 1.2 2.96 59,600 1.2 2.96 $3.01 - $4.00 1,477,681 1.5 3.59 1,477,681 1.5 3.59 $5.01 - $6.00 1,505,123 3.8 5.76 522,802 3.8 5.76 $6.01 - $7.00 2,508,489 2.6 6.10 1,695,639 2.6 6.10 $7.01 2,500 2.9 7.01 1,667 2.9 7.01 Total 5,553,393 3,757,389 The stock options granted had a weighted average grant date fair value of $2.13 (2017 - $2.11) estimated using the Black-Scholes option-pricing model with the following assumptions for December 31, 2018 and 2017: a 3.5 year expected life (2017 – 3.5 years), 2.2% risk-free interest rate (2017 – 0.8%), a 3.8% expected forfeitures rate (2017 – 5%); and 42.0% expected volatility (2017 – 44.6%).

Performance Share Units

The Company has a PSU plan for certain employees of the Company. Under the terms of the PSU plan, PSUs granted vest at the end of a three-year term. At the end of a three-year term, employees will be awarded cash at the discretion of the Board of Directors, calculated based on certain earnings before interest, taxes, depreciation and amortization ("EBITDA") and total shareholder return ("TSR") related performance conditions.

The fair value of the PSUs on the date of issuance is expensed over the vesting term. The fair value of the liability and the expense attributable to the vesting period is charged to profit or loss at the grant date. Subsequently, at each reporting date between grant date and settlement date, the fair value of the liability is remeasured with any changes in fair value recognized in profit or loss. As at December 31, 2018, there were 85,728 PSUs outstanding and during the period ended December 31, 2018, $58 thousand was expensed and has been recorded in other liabilities on the statement of financial position.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Deferred Share Units

During 2018, the Company initiated a DSU plan for its non-employee Directors. Under the terms of the DSU plan, DSUs awarded will vest immediately and will be settled with cash in the amount equal to the closing price of the Company’s common shares on the date the director resigns from the Board.

The fair value of the liability and the corresponding expense is charged to profit or loss at the grant date. Subsequently, at each reporting date between grant date and settlement date, the fair value of the liability is remeasured with any changes in fair value recognized in profit or loss for the year. There were 25,861 DSUs outstanding at December 31, 2018 (2017 – nil) with a fair value of $158 thousand which is included in other liabilities on the statement of financial position (2017 – $nil). During the year, stock-based compensation recognized was $0.2 million (2017 – $nil million)

Stock-based compensation expense

For the year ended 2018 2017 Stock options 1,954 3,233 PSUs 58 -DSUs 158 -Fair value adjustment (409) - 1,761 3,233 14. REVENUE

In the following table, revenue is disaggregated by major products and services lines and timing of revenue recognition. See Note 18 for the disaggregation of revenue by geographic region. All revenue is derived from contracts with customers.

For the year ended December 31, 2018 2017 Product 311,406 252,590 Transportation 31,878 24,931 Installation 8,975 11,645

Licenses and services1 4,420 4,258 356,679 293,424 1 2018 license revenue includes $2.7 million related to product sale performance obligations.

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 is based upon agreed contractual terms with the customer and is not subject to variability.

For the year ended December 31, 2018 2017 At a point in time 344,428 278,927 Over time 12,251 14,497 356,679 293,424

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Revenue recognized at a point in time represents the majority of the Company’s sales and revenue is recognized when a customer obtains legal title to the product, which is when ownership of products is transferred to, or services are delivered to the contract counterparty. 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. Revenue receivables are non-interest bearing and are generally on 30 day payment terms.

Contract liabilities

For the year ended December 31, 2018 2017 Customer deposits 9,832 7,325 Commissions payable 5,664 4,039 Contract liabilities 15,496 11,364 Contract liabilities primarily relate to deposits received from customers, commission liabilities and maintenance revenue from license subscriptions. The balance of contract liabilities was higher as at December 31, 2018 compared to the prior year period mainly due to higher 2018 revenues. 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.

15. OPERATING EXPENSES

The Company changed its presentation of operating expenses from 2017 to further separate expenses by function to provide financial statement readers with a better understanding of DIRTT’s operations. The following table provides a reconciliation from last year’s financial statement presentation to the current year presentation:

For the year ended December 31, Previously stated Representation Current Sales, general and administration 128,352 (128,352) -Sales and marketing - 59,687 59,687 General and administrative - 38,589 38,589 Operations support - 19,497 19,497 Technology and development - 9,126 9,126 Reorganization costs - 1,453 1,453 Operating expenses 128,352 - 128,352 The Company classifies the consolidated statement of comprehensive income (loss) using the function of expense method, which presents expenses according to their function, such as cost of sales, sales and marketing, general and administrative, and technology and development expenses. This method provides more relevant information as it is more closely aligned to the Company business structure.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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The following table provides additional information on the nature of the expenses:

For the year ended December 31, 2018 2017 Purchased materials, supplies and services 146,209 122,773 Personnel expenses 111,925 98,366 General expenses 46,395 55,490 Depreciation and amortization 19,474 17,917 Stock-based compensation (Note 13) 1,761 3,233 Reorganization costs 9,600 1,453 Impairments 19,975 -Total operating expenses 355,339 299,232

Effective January 15, 2019, DIRTT announced certain executive management changes, including the departure of DIRTT’s chief operating officer and vice president of software development. These and other changes resulted in reorganization expenditures in the first quarter of 2019 of approximately $3.0 million.

16. BASIC AND DILUTED INCOME (LOSS) PER SHARE

For the year ended December 31, 2018 2017 Weighted average shares outstanding 84,477 84,679 Stock options 532 -Diluted shares outstanding 85,009 84,679 Net income (loss) ($) 2,997 (7,409)Basic and diluted earnings (loss) per share ($/share) 0.04 (0.09)

The 2018 diluted weighted average number of common shares calculation excludes 6,326,819 (2017 – 5,553,393) share options as their effect would have been anti-dilutive to the income (loss) per share calculation.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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17. SUPPLEMENTAL CASH FLOW INFORMATION

For the year ended December 31, 2018 2017 Trade and other receivables (34,491) 7,945 Inventory (370) (2,876)Prepaids and other current assets (413) (491)Other assets 235 (78)Accounts payable, accrued liabilities and other 10,940 10,318 Customer deposits 2,466 3,101 Options surrendered (2,321) -

Cash taxes payable (2,175) 691 (26,129) 18,610 18,610 Cash and cash equivalents consists of:

Cash 53,950 32,417 Cash equivalents 18,915 47,224

72,865 79,641 Interest paid (655) (610)

Income taxes paid (4,973) (3,585)

Reconciliation of movements of liabilities to cash flows arising from financing activities:

For the year ended December 31, 2018 2017 Opening balance - total long-term debt 12,772 18,760 Changes from financing cash flows

Repayment of long-term debt (5,988) (4,900)Realized foreign exchange gain (loss) 741 (945)

Non-cash changes Unrealized foreign exchange gain (loss) 149 (143)

Ending balance - total long-term debt 7,674 12,772 18. SEGMENT REPORTING

The Company has one operating segment and operates in three principal geographic locations, Canada, the U.S. and International. Currently, the majority of revenue from international projects are included in the US revenue amount as these projects are sold by US-based distribution partners and are delivered to international locations. The Company’s revenue from operations from external customers, based on location of operations, and information about its non-current assets, are detailed below.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Revenue from external customers

For the year ended December 31, 2018 2017 Canada 54,017 44,816 U.S. 300,727 246,973 International 1,935 1,635 356,679 293,424 Non-current assets

As at December 31, 2018 1 2017 1 Canada 52,311 68,890 U.S. 20,945 19,477 U.K. - 284 73,256 88,651 1 Amounts include property, plant and equipment, intangible assets, goodwill and other assets.

19. TRANSACTIONS AND BALANCES WITH RELATED PARTIES

The Company reported no revenues to a former director of the Company for the year ended December 31, 2018 (2017 - $1.2 million). As at December 31, 2018, the Company had no accounts receivable balance from this former director as the balance was fully repaid during 2018 (December 31, 2017 - $1.3 million). The sales to the former director during 2017 were based on price lists in force and terms that would be available to all employees. Effective September 10, 2018, this director ceased to be a director of the Company.

One of the Company’s distribution partners is owned by a former director of the Company. Effective June 26, 2018, the owner of this distribution partner ceased to be a director of the Company. Up until June 26, 2018, the Company reported revenue of $3.8 million and rebates paid of $0.1 million. For the year ended December 31, 2017, the Company reported revenue of $7.6 million and and rebates of $0.1 million. As at December 31, 2017, the Company reported an accounts receivable balance of $0.4 million and deposits of $22 thousand.

A director of the Company provided advisory and consulting services to the Company of $0.4 million during the year ended December 31, 2018.

Compensation of key management personnel

The total remuneration of ten officers and nine directors (2017 – five officers and nine directors) was as follows:

For the year ended December 31, 2018 2017Compensation including bonuses 8,669 6,140 Termination benefits 1,756 1,146 Stock-based compensation 725 11 11,150 7,297

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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As at December 31, 2018 there is a commitment of up to $3.2 million (2017 – $3.1 million) relating to change of control or the termination of employment of certain key management personnel.

20. CAPITAL MANAGEMENT

For the year ended December 31, 2018 2017 Long-term debt (Note 11) 7,674 12,772 Shareholders' equity 170,530 168,198 178,204 180,970 The Company manages its capital resources to ensure financial strength and to maximize its financial flexibility by maintaining strong liquidity and by utilizing alternative sources of capital including equity, debt and bank loans or lines of credit to fund continued growth, as necessary.

At December 31, 2018, the Company had $72.9 million (2017 - $79.6 million) in cash and cash equivalents and had not drawn on its US$18.0 million revolving operating facility.

21. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

The Company’s activities expose it to a variety of financial risks: credit risk; liquidity risk; market risk; interest rate risk; foreign exchange risk; and commodity price risk. The Company’s overall risk management program focuses on the unpredictability of financial markets and seeks to minimize potential adverse effects on the Company’s financial performance. The Company considers credit risk to be one of its main financial risks.

Credit risk

The Company’s principal financial assets are cash and cash equivalents, and trade and other receivables.

The Company’s credit risk is primarily concentrated in its trade receivables. The amounts disclosed in the consolidated statement of financial position are net of allowances for doubtful accounts, estimated by management based on the lifetime expected credit loss model. In order to reduce its risk, management maintains credit policies that include regular review of credit limits of individual customers and the use of accounts receivable insurance (described below) for a portion of trade receivables. Aging of trade receivables is systematically monitored by management. Trade balances are spread amongst a broad customer base which is geographically dispersed.

The Company has trade credit insurance on certain trade receivables. The trade credit insurance provider determines the coverage amount, if any, on a customer-by-customer basis. Based on the Company’s trade receivables balance as at December 31, 2018, 70% (2017 - 58%) of that balance is covered by trade credit insurance provider. The majority of the remaining balance is less than 90 days old and is owed by a small number of DIRTT’s distribution partners, on which the Company regularly reviews collectability, and government sales that are not covered by the trade credit insurance provider. In addition, the Company generally collects a 50% deposit on non-government sales, unless otherwise agreed with the customer.

The Company only provides for balances determined using the lifetime expected credit loss model and had a provision of $0.1 million at both December 31, 2018 and 2017. As at December 31, 2018, $6.5 million

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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of accounts receivable was due from one customer (2017 - $2.7 million). Management reviews this customer’s creditworthiness on an ongoing basis.

Total Current

0-30 days past due

31-60 days past due

61-90 days past due

Greater than 90 days past

As at December 31, 2018 59,852 36,008 14,248 4,837 2,985 1,774 As at December 31, 2017 24,133 14,430 5,870 1,580 1,348 905

The credit risk on cash and cash equivalents is limited because the counterparties are chartered banks with high credit ratings assigned by national credit-rating agencies. The carrying amount of financial assets represents the maximum credit exposure and therefore the credit risk at the reporting date was:

As at December 31, 2018 2017Cash and cash equivalents 72,865 79,641 Trade and other receivables 59,852 24,133 132,717 103,774 Liquidity risk

The Company’s objective is to have sufficient liquidity to meet its financial obligation as they become due. The Company monitors its cash balances and cash flows generated from operations to meet its requirements. The Company has the following contractual obligations at the reporting dates:

As at December 31, 2018 Carrying amount

Contractual cash flows

Less than 1 year

1 to 2 years

2 to 5 years

Greater than 5

Accounts payable, accrued liabilities and other liabilities 51,935 51,935 51,935 - - -Current and long-term debt (principal and interest) 7,674 8,144 3,732 3,553 859 - 59,609 60,079 55,667 3,553 859 -

As at December 31, 2017 Carrying amount

Contractual cash flows

Less than 1 year

1 to 2 years

2 to 5 years

Greater than 5

Accounts payable, accrued liabilities and other liabilities 38,093 38,093 38,093 - - -

Current and long-term debt (principal and interest) 12,772 13,548 6,170 3,375 4,003 - 50,865 51,641 44,263 3,375 4,003 -

Market risk

Market risk is the risk that changes in market prices, such as foreign currency exchange rates and interest rates, will affect the Company’s income or the value of the financial instruments held.

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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Interest rate risk

Certain of the Company’s financial liabilities are subject to interest charges at floating rates, and are exposed to fluctuations in interest rates. At December 31, 2018, term loans totaling $7.7 million (2017 - $12.8 million) are subject to floating interest rates. An increase in overall interest rates by 0.5% would increase interest expense related to these items and decrease net income (loss) and comprehensive income (loss) by $57 thousand for the year ended December 31, 2018 (2017 - $62 thousand). An equal decrease in rates would generate an equal amount of interest savings.

Foreign exchange risk

Historically, the majority (approximately 80%) of the Company’s revenue is collected in US$. Approximately 60% of the Company’s costs are also incurred in US$. As a result, the Company is exposed to fluctuations in the US dollar against the Canadian dollar which could have a positive or negative impact on its revenue and costs. The recent strengthening of the US dollar versus the Canadian dollar has had a positive impact on revenue but a negative impact on costs.

The Company’s financial instruments are exposed primarily to fluctuations in the US dollar. The table below details the Company’s exposure to currency risk at the reporting dates and a sensitivity analysis to changes in currency. The sensitivity analysis includes US dollar denominated monetary items and adjusts their translation at period end for their respective change in the US dollars. For the respective weakening of the US dollar, there would be an equal and opposite impact on net income (loss) and comprehensive income (loss).

Amount (US$)

Change in currency (%)

Effect of net income and comprehensive income for the year ended December 31, 2018

Cash and cash equivalents 37,503 10.0 3,750 Trade and other receivables 29,436 10.0 2,944 Inventory 6,976 10.0 698 Prepaids and other current assets 615 10.0 62 Accounts payable and accrued liabilities (15,699) 10.0 (1,570)Customer deposits (600) 10.0 (60)Long-term debt (5,625) 10.0 (563) 52,606 5,261 Commodity price risk

The Company consumes raw materials such as aluminum, hardware, wood and veneer, timber, plastic, electrical, paint and powder, and fabric and vinyl. Aluminum represents the largest component of the Company’s raw materials expenditure however comprises approximately 10% of cost of sales so impact of price fluctuations is relatively low.

Fair value of financial instruments

This analysis is based on the degree to which the fair value is observable and grouped into categories accordingly:

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DIRTT Environmental Solutions Ltd. Notes to the Consolidated Financial Statements December 31, 2018 and 2017 (Amounts stated in thousands of Canadian dollars unless otherwise stated)

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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.

• 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.

• 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; trade and other receivables; trade accounts payable and other liabilities; and customer deposits approximate fair value due to their short-term nature.

22. COMMITMENTS

The Company rents facilities and capital assets under operating lease commitments with respect to certain premises, equipment and vehicles, and has continuing contractual commitments for operating expenses. Other commitments are comprised of inventory and capital commitments. The Company had the following commitments:

Payments due by period As at December 31, 2018 1 year or less 1 to 5 years 5 years thereafter Total Operating leases 6,390 23,085 6,096 35,571 Customer deposits 9,832 - - 9,832 Other commitments 3,661 - - 3,661 19,883 23,085 6,096 49,064

Payments due by period As at December 31, 2017 1 year of less 1 to 5 years 5 years thereafter Total Operating leases 7,088 23,053 4,250 34,391 Customer deposits 7,325 - - 7,325 Other commitments1 5,475 - - 5,475 19,888 23,053 4,250 47,191 1 In 2017, other commitments included unaccrued employee-related obligations earned over time.