INDEPENDENT AUDITORS’ REPORT
The Board of Directors
DXP Enterprises, Inc.
We have audited the accompanying consolidated statements of financial position of HSE Integrated Ltd. and subsidiaries, as of December 31, 2011 and 2010 and January 1, 2010, and the related consolidated statements of earnings and comprehensive income, changes in equity and cash flows for the years ended December 31, 2011 and 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing 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 over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HSE Integrated Ltd. and subsidiaries as at December 31, 2011 and 2010 and January 1, 2010, and the results of their operations and their cash flows for the years ended December 31, 2011 and December 31, 2010 in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board.
September 24, 2012
Consolidated Statement of Financial Position
See accompanying notes to the consolidated financial statements.
On behalf of the board:
/s/David R. Little /s/Mac McConnell
David R. Little, Director Mac McConnell, Director
Consolidated Statement of Earnings
See accompanying notes to the consolidated financial statements.
Consolidated Statement of Comprehensive Income
See accompanying notes to the consolidated financial statements.
Consolidated Statement of Changes in Equity
See accompanying notes to the consolidated financial statements.
Consolidated Statement of Cash Flows
See accompanying notes to the consolidated financial statements.
Notes to the Consolidated Financial Statements
NOTE 1 – REPORTING ENTITY
HSE Integrated Ltd. (“HSE” or the “Corporation”) is incorporated under the laws of the province of Alberta. The address of the Corporation’s head office is 1000, 630 – 6 Avenue S.W., Calgary, Alberta, Canada, T2P 0S8. The consolidated financial statements of the Corporation as at and for the years ended December 31, 2011 and 2010 include the Corporation and its subsidiaries.
The Corporation provides health and safety services in Canada and the United States to a range of customers in the energy, manufacturing, construction and other industries. Services include: safety supervision and rescue personnel, rental of breathing apparatus and associated equipment for personnel operating in high-hazard environments, fixed and mobile firefighting and fire protection services and equipment, worker shower (decontamination) services, onsite medical services, worker safety training, hazardous gas detection, wellsite blowout services, industrial hygiene services, and safety consulting and supervision.
· Subsequent Event - Business Combination
On July 11, 2012, DXP Enterprises, Inc. ("DXP") through its wholly-owned subsidiary, DXP Canada Enterprises Ltd., acquired all of the outstanding common shares of HSE by way of a plan of arrangement under the Business Corporations Act (Alberta) (the "Arrangement"). See note 28 for further information.
NOTE 2 – BASIS OF PREPARATION
The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board. These consolidated financial statements are HSE’s first IFRS annual financial statements and IFRS 1 – First-time Adoption of International Financial Reporting Standards has been applied. In these consolidated financial statements, previous Canadian Generally Accepted Accounting Principles (“Canadian GAAP”) refers to the accounting standards applied prior to the adoption of IFRS.
An explanation of how the transition to IFRS has affected the previously reported financial position, net earnings and cash flows in the comparative periods of these consolidated financial statements is provided in note 29. This note contains reconciliations of equity and total comprehensive income for comparative periods reported under Canadian GAAP to those reported for those periods under IFRS.
These consolidated financial statements were authorized for issue by the Corporation’s board of directors on September 24, 2012.
The consolidated financial statements have been prepared on the historical cost basis except for liabilities for cash-settled share-based payment arrangements, which are measured at fair value.
These consolidated financial statements are presented in Canadian dollars, which is the functional currency of the Corporation and the Corporation’s Canadian subsidiaries. The U.S. dollar is the functional currency of the Corporation’s United States subsidiaries. All financial information presented in Canadian dollars has been rounded to the nearest thousand, except for per share amounts.
The preparation of consolidated financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income, and expenses. Actual results may differ from these estimates.
Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected.
The key judgments and estimates made in applying accounting policies that have the most significant effect on the amounts recognized in the consolidated financial statements are as follows:
The classification of a lease as operating or financing depends upon whether substantially all the risks and rewards of the asset are transferred. This determination involves judgment as to whether the Corporation consumes a large portion of the useful life of the leased asset, if the net present value of the lease payments form a substantial portion of the fair value of the lease asset, and other pertinent factors. The Corporation determined that its facility leases are operating leases since the rent paid to the landlords is increased to market rates at regular intervals and the Corporation does not participate in the residual value of any of the buildings. The Corporation determined that its light duty vehicles are finance leases since ownership of the assets transfers to the Corporation at the end of the lease term.
Estimated useful lives of assets
The useful lives of the depreciable assets are based on historical experience and judgment of management. This judgment includes an assessment of expected utilization, job mix assumptions, and preventative-maintenance programs. Although management believes that the estimated useful lives and residual values are reasonable, there can be no certainty that the reduction in depreciable asset values over time matches depreciation expense using estimated useful lives. If depreciation estimates are not correct, the Corporation may record a disproportionate amount of gains or losses on disposition of these assets.
Impairment of assets
At the end of each reporting period, the Corporation assesses whether there is an indication that an asset group may be impaired. If any indication of impairment exists, HSE estimates the recoverable amount of the asset group. External triggering events include, for example, changes in customer or industry dynamics, commodity prices, drilling levels, and economic declines. Internal triggering events for impairment include lower profitability or obsolescence. Goodwill and indefinite-lived intangible assets are tested annually for impairment.
HSE’s impairment tests compare the carrying amount of the asset or cash generating unit (“CGU”) to its recoverable amount. The recoverable amount is the higher of fair value less costs to sell (“FVLCS”) and value in use (“VIU”). FVLCS is the amount obtainable from the sale of an asset or CGU in an arms-length transaction between knowledgeable, willing parties, less the costs of disposal. The determination of VIU requires the estimation and discounting of cash flows, which involves key assumptions that consider all information available on the respective testing date. Management uses its judgment, considering past and actual performance as well as expected developments in the respective markets and in the overall macro-economic environment and economic trends, to model and discount future cash flows. In addition, management is required to apply judgment when determining which assets are grouped into a particular CGU. This grouping can affect the results of an impairment test.
Allowance for doubtful accounts
The Corporation assesses its accounts receivable through a continuous process of reviewing its receivables both on an individual customer basis and on an overall basis. The review includes assessment of current aging status of receivables, historical collection experience, financial condition of customers, industry economic trends and other factors. Based on the review, allowances for specific customers are determined. The process involves a high degree of judgment and can frequently involve significant dollar amounts. Accordingly, the Corporation’s financial position and results of operations can be affected by adjustments to the allowance when actual write-offs differ from estimates.
Provision for onerous contracts
An onerous contract is defined as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.The provision for onerous lease contracts represents the present value of the future lease payments that the Corporation is presently obligated to make under non-cancellable onerous operating lease contracts, less revenue expected to be earned on the lease, including estimated future sublease revenue, where applicable. The estimate may vary as a result of changes in the utilization of the leased premises and sublease arrangements where applicable.
Income tax assets and income tax liabilities
Deferred income taxes are recorded to reflect any differences between the accounting and income tax basis of an asset or liability using substantively enacted tax rates. The Corporation does not recognize a deferred tax asset when management believes it is not probable that future tax savings will be realized. Estimates of future taxable income are considered in assessing the utilization of available tax losses. Changes in circumstances and assumptions may require changes to the recognition of the Corporation’s deferred tax assets.
NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES
The accounting policies set out below have been applied consistently to all periods presented in these consolidated financial statements and in preparing the opening IFRS statement of financial position at January 1, 2010 for the purposes of the transition to IFRS, unless otherwise indicated.
The consolidated financial statements incorporate the financial statements of the Corporation and entities controlled by the Corporation (its subsidiaries). Control is achieved where the Corporation has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.
All intra-group transactions, balances, income and expenses are eliminated in full on consolidation.
Non-controlling interests in subsidiaries are identified separately from the Corporation’s equity therein. Subsequent to acquisition or formation, the carrying amount of non-controlling interests is the amount of those interests at initial recognition plus the non-controlling interests’ share of subsequent changes in equity. Total comprehensive income is attributed to non-controlling interests even if this results in the non-controlling interests having a deficit balance.
Acquisitions prior to January 1, 2010
As part of its transition to IFRS, the Corporation elected to restate only those business combinations that occurred on or after January 1, 2010.
Acquisitions on or after January 1, 2010
For acquisitions on or after January 1, 2010, the Corporation measures goodwill as the fair value of the consideration transferred including the recognized amount of any non-controlling interest in the acquiree, less the net recognized amount (generally fair value) of the identifiable assets acquired and liabilities assumed, all measured as of the acquisition date. When the excess is negative, a bargain purchase gain is recognized immediately in profit or loss.
Acquisitions of subsidiaries and businesses are accounted for using the acquisition method in accordance with IFRS 3 – Business Combinations. The consideration for each acquisition is measured at the aggregate of the fair values (at the date of exchange) of assets given, liabilities incurred or assumed, and equity instruments issued by the Corporation in exchange for control of the acquiree. Costs of acquisition, other than those associated with the issue of debt or equity, are recognized in profit or loss as incurred.
The acquiree’s identifiable assets, liabilities and contingent liabilities that meet the conditions for recognition under IFRS 3 are recognized at their fair value at the acquisition date, except that deferred tax assets or liabilities are recognized and measured in accordance with IAS 12, Income Taxes.
Functional and presentation currencies
The individual financial statements of each legal entity are prepared in the currency of the primary economic environment in which that entity operates (its functional currency). For the purpose of the consolidated financial statements, the results and financial position of each legal entity are expressed in the functional currency of the Corporation and the presentation currency for the consolidated financial statements. The functional currency of the Corporation’s Canadian operations is the Canadian Dollar (“CAD”) and its U.S. subsidiaries is the U.S. Dollar (“USD”), while the presentation currency adopted by the Corporation in its consolidated financial statements is CAD.
Foreign currency transactions
Transactions in foreign currencies are translated to the respective functional currencies of legal entities at exchange rates at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies at the reporting date are retranslated to the functional currency at the exchange rate at that date. Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. Any foreign exchange gains or losses incurred on the retranslation of foreign currency denominated monetary assets and liabilities are included in finance costs in the Consolidated Statement of Earnings.
The assets and liabilities of foreign operations, including goodwill and fair-value adjustments arising on acquisition, are translated to CAD at exchange rates at the reporting date. The income and expenses of foreign operations are translated to CAD at exchange rates at the dates of the transactions.
Foreign currency differences are recognized in other comprehensive income. When a foreign operation is disposed of, the relevant amount in accumulated other comprehensive income is transferred to profit or loss as part of the profit or loss on disposal.
Foreign exchange gains or losses arising from a monetary item receivable from or payable to a foreign operation, the settlement of which is neither planned nor likely to occur in the foreseeable future, and which in substance is considered to form part of the net investment in the foreign operation, are recognized in other comprehensive income.
Non-derivative financial assets
The Corporation initially recognizes trade and other receivables and deposits on the date that they originate. All other financial assets (including assets designated at fair value through profit or loss) are recognized initially on the trade date at which the Corporation becomes a party to the contractual provisions of the instrument.
The Corporation classifies non-derivative financial assets into the following categories: financial assets at fair value through profit or loss, held-to-maturity financial assets, loans and receivables, and available-for-sale financial assets.
The Corporation derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in such transferred financial assets that is created or retained by the Corporation is recognized as a separate asset or liability.
Financial assets and liabilities are offset and the net amount presented in the statement of financial position when, and only when, the Corporation has a legal right to offset the amounts and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.
Loans and receivables
Loans and receivables are financial assets with fixed or determinable payments that are not quoted in an active market. Such assets are recognized initially at fair value plus any directly attributable transaction costs. Subsequent to initial recognition, loans and receivables are measured at amortized cost using the effective interest method, less any impairment losses. Loans and receivables comprise cash and cash equivalents, and trade and other receivables.
Cash and cash equivalents comprise cash balances with original maturities of three months or less. Bank overdrafts that are repayable on demand and form an integral part of HSE’s cash management are included as a component of cash and cash equivalents for the purpose of the statement of cash flows.
Non-derivative financial liabilities
The Corporation initially recognizes debt securities issued and subordinated liabilities on the date that they are originated. All other financial liabilities (including liabilities designated at fair value through profit or loss) are recognized initially on the trade date at which the Corporation becomes a party to the contractual provisions of the instrument. The Corporation derecognizes a financial liability when its contractual obligations are discharged or cancelled or expire.
The Corporation classifies non-derivative financial liabilities into the other financial liabilities category. These financial liabilities are recognized initially at fair value less any directly attributable transaction costs. Subsequent to initial recognition, these financial liabilities are measured at amortized cost using the effective interest method. Other financial liabilities comprise trade and other payables, loans and borrowings, including long-term debt and finance lease obligations.
Common shares are classified as equity. Incremental costs directly attributable to the issue of common shares are recognized as a deduction from equity, net of any tax effects.
Convertible secured subordinated debentures
The component parts of the convertible secured subordinated debentures (“Debentures”) issued by the Corporation are classified separately as financial liabilities and equity in accordance with the substance of the contractual arrangements and the definitions of a financial liability and an equity instrument. At the date of issue, the fair value of the liability component was estimated using the prevailing market interest rate for similar non-convertible instruments. This amount is recorded as a liability on an amortized cost basis using the effective interest method until extinguished upon conversion or at the instrument’s maturity date.
The value of the conversion option (labeled Convertible debentures – equity component) was determined at issue date by deducting the amount of the liability component from the fair value of the compound instrument as a whole. This conversion option is not subsequently re-measured, and has no deferred income tax impact. In addition, the conversion option will remain in equity until the conversion option is exercised, in which case the balance recognized in equity will be transferred to share capital. No gain or loss is recognized in the statement of earnings upon conversion or expiration of the conversion option. As such, a proportionate amount of any unamortized debt issue costs and accretion related to the Debentures converted into common shares is transferred to share capital on the conversion date. Any directly attributable transaction costs are allocated to the liability and equity components in proportion to their initial carrying amounts.
E) Property and equipment
Property and equipment are measured at cost less accumulated depreciation and accumulated impairment losses. Cost includes any expenditure that is directly attributable to the acquisition of the asset. Purchased software that is integral to the functionality of the related equipment is capitalized as part of that equipment. When identifiable components of a piece of property or equipment have different useful lives, each component is accounted for as a separate item for purposes of calculating depreciation and gains and losses on disposal.
Gains and losses on disposal of an item of property and equipment are determined by comparing the proceeds from disposal with the carrying amount of property and equipment, and are recognized net within profit or loss.
The cost of replacing a part of an item of property and equipment is recognized in the carrying amount of the item if it is probable that the future economic benefits embodied within the part will flow to the Corporation, and its cost can be measured reliably. The carrying amount of the replaced part is derecognized. The costs of the day-to-day servicing of property and equipment (repair and maintenance) are recognized in the profit or loss as incurred.
Depreciation is recognized in profit or loss on a straight-line basis over the estimated useful lives of each component of an item of property and equipment, since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. Items of property and equipment are depreciated from the date that they are installed and are ready for use. Leased assets are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that the Corporation will obtain ownership by the end of the lease term.
Depreciation is calculated using the straight-line method at rates calculated to write off the cost, less estimated residual value, of each asset over its expected useful life as follows:
Field equipment 3 – 20 years
Heavy duty vehicles and trailers 5 – 20 years
Light duty vehicles 4 years
Office and shop equipment 3 – 15 years
Depreciation methods, useful lives and residual values are reviewed at each reporting date and adjusted if appropriate.
Intangible assets acquired in a business combination and recognized separately from goodwill are initially recognized at their fair value at the acquisition date (which is regarded as their cost). Subsequent to initial recognition, intangible assets with finite useful lives acquired in a business combination are reported at cost less accumulated amortization and accumulated impairment losses.
The useful lives of intangible assets are assessed to be either finite or indefinite. Amortization is charged to profit or loss on assets with finite lives. Amortization is recognized on a straight-line basis over their estimated useful lives. Intangible assets with indefinite useful lives are tested for impairment annually either individually or at the cash-generating unit level. The annual review is also used to determine whether the indefinite life assessment continues to be supportable. If not, the change in the useful life assessment from indefinite to finite is made on a prospective basis.
The amortization period for the principal categories of intangible assets are as follows:
Technical knowledge 10 years
Computer software 3 years
Customer relationships 3 – 12 years
Company name and non-compete 1 – 2 years
Intangible assets are derecognized on disposal, or when no future economic benefits are expected from their use. 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 profit or loss.
Goodwill acquired in a business combination is initially measured at cost, being the excess of the cost of the business combination over the net fair value of the acquired identifiable assets, liabilities and contingent liabilities of the entity at the date of acquisition. Following initial recognition, goodwill is measured at cost less any accumulated impairment losses. Goodwill is not amortized but is reviewed for impairment annually or more frequently if events or changes in circumstances indicate that such carrying value may be impaired. For the purpose of impairment testing, goodwill is allocated to each of the Corporation’s cash-generating units expected to benefit from the synergies of the combination. Any impairment is recognized immediately in profit or loss and is not subsequently reversed. On the subsequent disposal or termination of a previously acquired business, any remaining balance of associated goodwill is included in the determination of the profit or loss on disposal or termination.
Leases are classified as either operating or finance, based on the substance of the transaction at inception of the lease. Classification is re-assessed if the terms of the lease are changed.
Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments under an operating lease (net of any incentives received from the lessor) are recognized in the profit or loss over the period of the lease.
Leases in which substantially all the risks and rewards of ownership are transferred to the Corporation are classified as finance leases. Assets meeting finance lease criteria are capitalized at the lower of the present value of the related lease payments or the fair value of the leased asset at the inception of the lease. Minimum lease payments are apportioned between the finance charge and the liability. The finance charge is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Subsequent to initial recognition, the asset is accounted for in accordance with the accounting policy applicable to that asset.
Inventory consists of products held for sale to customers or for consumption in the rendering of services provided by the Corporation. Inventories are measured at the lower of cost and net realizable value. The cost of inventories is based on the first-in first-out principle, and includes expenditures incurred in acquiring the inventories, production or conversion costs and other costs incurred in bringing them to their existing location and condition.
The carrying amounts of the Corporation’s tangible and intangible assets, other than inventories and deferred tax assets are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated. For goodwill, and for intangible assets that have indefinite useful lives or that are not yet available for use, the recoverable amount is estimated each year at the same time. The recoverable amount of an asset or cash-generating unit is the greater of its value in use and its fair value less costs to sell. 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 the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets, or groups of assets (the “cash-generating unit” or “CGU”). For the purposes of goodwill-impairment testing, goodwill acquired in a business combination is allocated to the CGU or group of CGUs that is expected to benefit from the synergies of the combination. This allocation is subject to an operating segment ceiling test and reflects the lowest level at which that goodwill is monitored for internal reporting purposes.
HSE’s corporate assets do not generate separate cash inflows. If there is an indication that a corporate asset may be impaired, then the recoverable amount is determined for the CGU to which the corporate asset belongs.
An impairment loss is recognized if the carrying amount of an asset or its CGU exceeds its estimated recoverable amount. Impairment losses are recognized in profit or loss. Impairment losses recognized in respect of CGUs are allocated first to reduce the carrying amount of any goodwill allocated to the units, and then to reduce the carrying amounts of the other assets in the unit on a pro-rata basis.
An impairment loss in respect of goodwill is not reversed. In respect of other assets, impairment losses recognized in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized.
Financial assets are assessed for indicators of impairment at the end of each reporting period. Financial assets are considered to be impaired when there is objective evidence that, as a result of one or more events that occurred after the initial recognition of the financial asset, the estimated future cash flows of the investment have been affected.
For certain categories of financial asset, such as trade receivables, assets that are assessed not to be impaired individually are, in addition, assessed for impairment on a collective basis. Objective evidence of impairment for a portfolio of receivables includes the Corporation’s past experience of collecting payments, an increase in the number of delayed payments in the portfolio past the average credit period of 60 days, as well as observable changes in national or local economic conditions that correlate with default on receivables.
The carrying amount of the financial asset is reduced by the impairment loss directly for all financial assets with the exception of trade receivables, where the carrying amount is reduced through the use of an allowance account. When a trade receivable is considered uncollectible, it is written off against the allowance account. Subsequent recoveries of amounts previously written off are credited against the allowance account. Changes in the carrying amount of the allowance account are recognized in profit or loss.
Short-term employee compensation
Short-term compensation including wages and salaries, employee benefits, short-term absences, and bonuses payable are measured on an undiscounted basis and are expensed as the related service is provided. The Corporation provides a capped Retirement Savings Plan (“RSP”) matching scheme for all of its full-time employees but does not provide its directors or employees with any other post-employment or long-term benefit plans.
Share-based compensation plans
The fair value determined at the grant date of the stock options (equity-settled share-based compensation arrangements) to employees and others providing similar services is expensed with a corresponding increase in contributed surplus, over the vesting period, based on the Corporation’s estimate of common shares that will eventually vest. At the end of each reporting period, the Corporation 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.
For deferred share units (cash-settled share-based compensation arrangements), a liability is recognized for the goods or services acquired, measured initially at the fair value of the liability. At the end of each reporting period until the liability is settled, and at the date of settlement, the fair value of the liability is re-measured, with any changes in fair value recognized in profit or loss for the year.
Provisions are recognized when the Corporation has a present legal or constructive obligation as a result of a past event, it is probable that the Corporation will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation.
Provisions are made for the anticipated settlement costs of legal or other disputes against the Corporation where an outflow of resources is considered probable and a reasonable estimate can be made of the likely outcome. No provision is made for other unasserted claims or where an obligation exists under a dispute but it is not possible to make a reasonable estimate of the amount, if any, of the obligation. Where a provision is recognized, the amount recognized is the present value of Management’s best estimate of the cash outflows required to settle the obligation, taking into account the related risks and uncertainties. When there is virtual certainty that a portion of the amount required to settle a provision will be recovered from a third party and the amount of the recovery is reliably measurable, a separate receivable is recognized for the expected recovery.
Present obligations arising under onerous contracts are recognized and measured as provisions. An onerous contract is considered to exist where the Corporation has a contract under which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The provision is measured at the present value of the lower of the expected cost of terminating the contract and the expected net cost of continuing with the contract. The onerous contract provision is re-measured at each reporting period, with changes being recognized in the Statement of Earnings.
Material contingent liabilities are disclosed where there is a possible obligation unless the transfer of economic benefits is remote. Contingent assets are only disclosed if an inflow of economic benefits is probable.
The Corporation derives most of its revenue from the provision of services and the short-term rental of equipment. The Corporation’s services are generally sold based upon service orders or contracts with customers that include fixed or determinable prices based upon daily, hourly or job rates. Revenue is recognized when the service has been provided or goods are delivered, the rate is fixed or determinable, and the collection of the amounts billed to the customer is considered probable.
Customer contract terms do not include a provision for significant post-service delivery obligations.
Income tax expense comprises current and deferred tax.
Current income tax payable is based on taxable income for the period. Taxable income differs from net earnings as reported in the consolidated statement of earnings as items of income or expense may be taxable or deductible in other years or may never be taxable or deductible. The Corporation’s liability for current tax is calculated by applying the Corporation’s best estimate of the weighted average tax rate for the full financial year for each tax jurisdiction, using rates that have been enacted or substantively enacted by the end of the reporting period, to the taxable income for that jurisdiction.
Deferred income tax is recognized on temporary differences between the carrying amounts of assets and liabilities in the financial statements and the corresponding tax bases used in the computation of taxable income. Deferred tax liabilities are generally recognized for all taxable temporary differences. Deferred tax assets are generally recognized for all deductible temporary differences to the extent that it is probable that taxable income will be available against which those deductible temporary differences can be utilized. Such deferred tax assets and liabilities are not recognized if the temporary difference arises from goodwill or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction that affects neither the taxable income nor the accounting profit.
Deferred tax liabilities are recognized for taxable temporary differences associated with investments in subsidiaries and associates, and interests in joint ventures, except where the Corporation is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax assets arising from deductible temporary differences associated with such investments and interests are only recognized to the extent that it is probable that there will be sufficient taxable profits against which to utilize the benefits of the temporary differences and they are expected to reverse in the foreseeable future.
The carrying amount of deferred tax assets is reviewed at the end of each 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 income tax assets and liabilities are measured based on income tax rates and tax laws that are enacted or substantively enacted by the end of the reporting period and that are expected to apply in the years in which temporary differences are expected to be realized or settled. The measurement of deferred tax liabilities and assets reflects the tax consequences that would follow from the manner in which the Corporation expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities.
Deferred tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority and the Corporation intends to settle its current tax assets and liabilities on a net basis.
Current and deferred tax for the period
Current and deferred tax are recognized as an expense or income in profit or loss, except when they relate to items that are recognized outside profit or loss (whether in other comprehensive income or directly in equity), in which case the tax is also recognized outside profit or loss, or where they arise from the initial accounting for a business combination. In the case of a business combination, the tax effect is included in the accounting for the business combination.
Basic per share amounts are calculated using the weighted average number of common shares outstanding during the year. Diluted per share amounts are calculated using the treasury stock method for stock options and the “if converted” method for debentures. Under the treasury stock method, the weighted average number of shares issued and outstanding during the year is adjusted by the total of the additional common shares that would have been issued assuming exercise of all stock options with exercise prices at or below the average market price for the year, offset by the reduction in common shares that would be purchased with the exercise proceeds plus the related unamortized share-based compensation costs. Under the “if converted” method, the weighted average number of shares issued and outstanding during the year is adjusted by the number of common shares that would be issued if all debenture holders converted their debenture holdings to common shares at the earliest date which the debenture’s trust Indenture allows for conversion. Net earnings and other comprehensive income are adjusted to add back the after tax impact of interest and accretion expense related to the debentures. No adjustment is made to basic earnings per share if the result of the calculation would be anti-dilutive.
An operating segment is a unit of the Corporation that engages in business activities from which it may earn revenue and incur expenses, including revenue and expenses that relate to transactions with any of the Corporation’s other components. The results of all operating segments are reviewed regularly by the Corporation’s CEO to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. Segment results that are reported to the CEO include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Unallocated items comprise mainly head office expenses and interest costs.
The Corporation’s reportable segments are Canada and the U.S.
Finance costs comprise interest expense on borrowings, finance lease interest, and unwinding of the discount on provisions.
Borrowing costs that are not directly attributable to the acquisition, construction or production of a qualifying asset are recognized in profit or loss using the effective interest method.
Foreign currency gains and losses are reported on a net basis as either finance income or finance cost depending on whether foreign currency movements are in a net gain or net loss position.
IFRS 9 – Financial Instruments
FRS 9 (2010) supersedes IFRS 9 (2009) and is effective for annual periods beginning on or after January 1, 2015, with early adoption permitted. For annual periods beginning before January 1, 2015, either IFRS 9 (2009) or IFRS 9 (2010) may be applied. The Corporation intends to adopt IFRS 9 (2010) in its consolidated financial statements for the annual period beginning on January 1, 2015. The extent of the impact of adoption of IFRS 9 (2010) has not yet been determined.
IFRS 10 – Consolidated Financial Statements
As of January 1, 2013, the Corporation will be required to adopt IFRS 10 – Consolidated Financial Statements. The IASB has stated that the objective of this standard is to develop a single consolidation model applicable to all investees. Under this model, an investor consolidates an investee when it has power, exposure to viability in returns, and a linkage between the two. The extent of the impact of adoption of IFRS 10 has not yet been determined.
IFRS 13 – Fair Value Measurement
As of January 1, 2013 the Corporation will be required to adopt IFRS 13 – Fair Value Measurement. This standard provides a single source of guidance on how fair value is measured and will be applied when fair value is required under other IFRSs. IFRS 13 provides a framework for determining fair value and clarifies factors to be considered, but does not establish standards pertaining to how valuations should be performed. The extent of the impact of adoption of IFRS 13 has not yet been determined.
NOTE 4 – DETERMINATION OF FAIR VALUES
A number of the Corporation’s accounting policies and disclosures require the determination of fair value, for both financial and non-financial assets and liabilities. Fair values have been determined for measurement and/or disclosure purposes based on the following methods. When applicable, further information about the assumptions made in determining fair values is disclosed in the notes specific to that asset or liability.
A) Trade and other receivables
The fair value of trade and other receivables is estimated as the present value of future cash flows, discounted at the market rate of interest at the reporting date. This fair value is determined for disclosure purposes.
B) Non-derivative financial liabilities
Fair value, which is determined for disclosure purposes, is calculated based on the present value of future principal and interest cash flows, discounted at the market rate of interest at the reporting date. For finance leases the market rate of interest is determined by reference to similar lease agreements.
C) Share-based payment transactions
The fair value of the employee share options and the share appreciation rights is measured using the Black-Scholes formula. Measurement inputs include share price on measurement date, exercise price of the instrument, expected volatility (based on weighted average historic volatility adjusted for changes expected due to publicly available information), weighted average expected life of the instruments (based on historical experience and general option holder behavior), expected dividends, and the risk-free interest rate (based on government bonds). Service and non-market performance conditions attached to the transactions are not taken into account in determining fair value.
The number of deferred share units issued at grant date is determined by dividing the director’s fees by the Corporation’s closing share price on the trading day immediately preceding the grant date. The units are revalued quarterly based on the Corporation’s share price on the last day of the quarter. Any changes in value are included as an increase or decrease in share-based compensation expense and accrued liabilities
NOTE 5 – ACQUISITION
On January 24, 2011, the Corporation acquired all of the outstanding common shares of Taylored Safety Services Inc. (“Taylored”). Consideration for the acquisition consisted of 1,137,532 Common Shares valued at $0.54, which was the closing price for the Corporation’s Common Shares on January 24, 2011. Taylored provides safety consulting, industrial health services and safety training to industry and is headquartered in Halifax, Nova Scotia. The Corporation acquired Taylored as part of its strategy to expand its safety consulting services across Canada. The results from operations are included in the Canada segment. The goodwill recognized in this acquisition relates to the expected synergies to be experienced from the integration of the business with existing Canadian operations. As part of the transaction, a significant shareholder of Taylored subsequently became an officer of the Corporation.
The final purchase allocation for the acquisition is as follows:
For the period from January 24, 2011 to December 31, 2011 Taylored contributed revenue of $587 and pre-tax profit of $172 to the consolidated results.
NOTE 6 – CASH AND CASH EQUIVALENTS
NOTE 7 – TRADE RECEIVABLES
The Corporation’s exposure to credit and currency risks, and allowance for doubtful debts related to trade receivables is disclosed under Financial Instruments in note 21.
NOTE 8 – PREPAID EXPENSES AND OTHER RECEIVABLES
The Corporation’s exposure to credit and currency risks, and allowance for doubtful debts related to prepaid expenses and other receivables is disclosed in note 21.
NOTE 9 – PROPERTY AND EQUIPMENT
Leased property and equipment
The Corporation leases light duty vehicles and other equipment under a number of finance lease agreements. The net carrying amount of these leases is recorded as light duty vehicles and included in property and equipment are as follows:
NOTE 10 – INTANGIBLE ASSETS AND GOODWILL
Impairment testing for cash-generating units containing goodwill
For the purpose of impairment testing, goodwill is allocated to the group’s business units that represent the lowest level within the group at which the goodwill is monitored for internal management purposes, which is not higher than the group’s operating segments. Goodwill recognized on the purchase of Taylored Safety Services Inc. (see note 5) has been allocated to the Canada CGU.
The aggregate carrying amounts of goodwill allocated to each unit are as follows:
At December 31, 2011 (the "Valuation Date") HSE Integrated Ltd. performed its annual impairment tests for goodwill and concluded that there was no impairment of goodwill in the Canada CGU as the recoverable amount for the CGU exceeded the carrying amount. Recognition of any impairment of goodwill would be recognized as an expense and reduce equity and net income but would not impact cash flows.
The business-plan revenue was projected using the same rate of growth experienced in 2011, reflecting current trading conditions. The anticipated annual-revenue growth included in the cash flow projections for the years 2013 to 2016 has been based on average growth levels experienced in the three years prior to 2009, reflecting an expectation of modest recovery in the economy at the during 2012.
A post-tax discount rate of 14.5% was applied in determining the recoverable amount of the unit. The discount rate was estimated based on past experience, and industry average weighted average cost of capital, which was based on a debt weighting of 27% at a market interest rate of 5%.
The values assigned to the key assumptions represent management’s assessment of future trends in the service industry and are based on both external sources and internal sources (historical data).
NOTE 11 – TRADE AND OTHER PAYABLES
The Corporation’s exposure to currency and liquidity risk related to trade and other payables is disclosed in note 21.
NOTE 12 – PROVISIONS
The provision for onerous lease contracts represents the present value of the future lease payments that the Corporation is presently obligated to make under non-cancellable onerous operating lease contracts, less revenue expected to be earned on the lease, including estimated future sublease revenue, where applicable. The estimate may vary as a result of changes in the utilization of the leased premises and sublease arrangements where applicable. The unexpired terms of the leases range from two to eight years.
In November 2011, a sublease arrangement was negotiated on a previously vacant building leased by the Corporation. This resulted in a reduction of the onerous contract liability of $1,015 which was credited to profit and loss.
The Corporation recognized a liability for termination benefits of $345 on the transition between CEOs in August 2011. The benefit is payable monthly over a two-year term and expires August 31, 2013.
The accrued consideration on a share purchase acquisition of $810 was derecognized at December 31, 2010. The derecognition has been recorded as a separate line on the Consolidated Statements of Earnings and Consolidated Statements of Cash Flows as all goodwill from the purchase was derecognized in prior periods.
NOTE 13 – LOANS AND BORROWINGS
This note provides information about the contractual terms of the Corporation’s interest-bearing loans and borrowings, which are measured at amortized cost. For more information about the Corporation’s exposure to interest rate, foreign currency and liquidity risk, see note 21.
Terms and debt repayment schedule
Terms and conditions of outstanding loans were as follows:
A) Non-revolving term facility and revolving operating loan facility
On April 27, 2010 the Corporation entered into a $15,000 credit facility with a regional financial institution. The facility consists of a $10,000 revolving operating loan facility for general operating purposes and a $5,000 non-revolving reducing-term loan facility.
The $5,000 non-revolving term facility is repayable in monthly payments of $109 starting July 1, 2010. The facility is payable in full 48 months after initial drawdown. The operating facility is renewable annually and is margined to accounts receivable. Both facilities bear interest at prime plus a fixed percentage. A standby fee is also required on any unused portion of the operating facility. Both facilities are subject to certain covenants including a working capital covenant, a debt to equity covenant, a fixed charge coverage ratio and other positive and negative covenants. The facilities are collateralized under a general security agreement that includes accounts receivable, inventory, prepaid expenses and other receivables, property and equipment and intangible assets.
On November 10, 2011 the Corporation signed a revised letter of commitment that provided an additional $3,000 non-revolving reducing term facility to finance the purchase of certain safety services assets from Flint Energy Services Ltd. (see note 28). As at December 31, 2011, the amount drawn under this facility was $ nil.
Deferred financing costs associated with the financing facilities have been shown as a reduction of the carrying value of the long-term debt and are being amortized over the term of the debt using the effective interest rate method.
B) Convertible debentures
On November 9, 2010, HSE announced the issue of up to $2,000 in subordinated secured convertible debentures (the “Debentures”). The Debentures mature on January 15, 2014 and bear interest at 10.0% per annum, payable quarterly in arrears on April 15, July 15, October 15, and January 15 in each year beginning April 15, 2011. The component parts of the convertible secured subordinated debentures (“Debentures”) issued by the Corporation are classified separately as financial liabilities and equity in accordance with the substance of the contractual arrangements and the definitions of a financial liability and an equity instrument.
On December 21, 2010, HSE completed the first closing with total proceeds of $1,925. On January 18, 2011, HSE completed the final closing with proceeds of an additional $75.
Provision for conversion
The Debentures are convertible at the holder’s option into common shares of the Corporation at a conversion price of $0.50 per share (the “Conversion Price”) at any time prior to the close of business on the earlier of the business day prior to the maturity date and the business day immediately preceding the date fixed for redemption of the Debentures, subject to adjustments in certain events including dividend protection for the declaration of dividends outside of the normal course. Holders converting their Debentures will receive accrued and unpaid interest thereon to the date of conversion. The ability to convert the Debentures would cease immediately prior to a “Change of Control” as defined in the offering document.
Provision for redemption
The Debentures will not be redeemable before January 15, 2012 except in the event of the satisfaction of certain conditions after a Change of Control has occurred. On or after January 15, 2012 and prior to January 15, 2013, provided that the current market price (as calculated pursuant to the indenture) of the shares is at least 133% of the conversion price, the Debentures may be redeemed at the option of the Corporation in whole or in part from time to time at a redemption price equal to their principal amount plus accrued and unpaid interest thereon up to (but excluding) the redemption date. On or after January 15, 2013 and prior to the maturity date, the Debentures may be redeemed at the option of the Corporation in whole or in part from time to time at a redemption price equal to 105% of their principal amount plus accrued and unpaid interest thereon up to (but excluding) the redemption date. If HSE wishes to redeem any Debentures, it must provide not more than 60 or fewer than 40 days prior notice of redemption.
Notwithstanding the foregoing, in the event of a Change of Control, the Debentures will be redeemable at the Corporation’s option, in whole or in part, at a price equal to 125% of the principal amount thereof plus accrued and unpaid interest for the first two years; thereafter, this amount will decline by 1.5% per month.
C) Finance lease liabilities
Finance lease liabilities are payable as follows:
Finance leases relate to vehicles and equipment with lease terms ranging from 3 to 5 years. The Corporation’s obligations under finance leases are secured by the lessors’ title to the leased assets.
The applicable interest rate on these finance leases is between 2.58% and 7.35%.
NOTE 14 – INCOME TAXES
A) Income tax expense
Income tax recognized in other comprehensive income
Reconciliation of effective tax rate
Total income tax expense (recovery) is different from the amount computed by applying the combined Canadian Federal and Provincial rates of 26.96% (2010: 28.00%) to earnings before income tax. The reasons for the difference are as follows:
B) Deferred tax assets and liabilities
Unrecognized deferred tax assets
Deferred tax assets have not been recognized in respect of the following items:
The tax losses expire between 2028 and 2031. Deferred tax assets were not recognized in 2010 in respect of these items because it was not probable at that time that future taxable profits would be available against which the Corporation could utilize the benefits.
In 2011, $661 of previously unrecognized tax losses in the United States were recognized as management considered it probable that future taxable profits will be available against which they can be utilized. Management revised its estimates as a result of changes in operating results starting in the third quarter of 2010. From that point, the subsidiary has earned income. There was not sufficient certainty at December 31, 2010, but continued and increasing operating profits throughout 2011 suggested the estimate of future profitably had changed. The amount has been recognized as a deferred tax asset on the balance sheet with a corresponding increase in the subsidiary’s results from operating activities.
Recognized deferred tax assets and liabilities
Deferred tax assets and liabilities are attributable to the following:
Movement in temporary differences during the year
NOTE 15 – SHARE CAPITAL
Authorized and issued share capital
An unlimited number of common shares have been authorized without par value. An unlimited number of preferred shares have been authorized, issuable in series.
NOTE 16 – SHARE-BASED COMPENSATION
A) Stock options
Pursuant to the stock option plan, a maximum of 10% of the issued and outstanding common shares of the Corporation are reserved from time to time for issue to eligible participants. The directors determine option prices and vesting terms at the time of granting at an exercise price based on the volume weighted average price for the five trading days immediately preceding the grant date. The term of options granted does not exceed five years.
At December 31, 2011, the Corporation had options outstanding to issue 2,167,000 shares (December 31, 2010: 2,279,165) at a weighted average price of $0.71 per share (December 31, 2010: $1.24). Of these options, 1,104,446 were exercisable (December 31, 2010: 1,154,479).
The inputs used in the measurement of the fair values at grant date are the following:
The weighted average fair value of options issued in 2011 was $0.39 (2010: $0.35).
Information about outstanding stock options is as follows:
The following table summarizes information about stock options outstanding at:
B) Deferred share unit plan (cash settled)
Expense related to the deferred share units recognized during 2011 was $150 (2010: ($21)). For the year 2010 and up to August 11, 2011, the majority of directors’ retainers and meeting fees were paid with deferred share units (“DSUs”). After August 11, 2011, all directors’ retainers and meeting fees are being paid in cash except for an annual grant for non-executive directors as provided in the original DSU plan.
The number of deferred share units is as follows:
NOTE 17 – NON-CONTROLLING INTEREST
NOTE 18 – EXPENSES BY NATURE
NOTE 19 – FINANCE COSTS
NOTE 20 – Earnings Per Share
A) Basic earnings per share
Basic earnings per share is calculated as follows:
B) Diluted earnings per share
In calculating diluted earnings per share, basic earnings per share was adjusted as follows:
NOTE 21 – FINANCIAL INSTRUMENTS
The Corporation is exposed to credit risk, liquidity risk and market risk from its use of financial instruments:
Financial risk management
The Board of Directors has overall responsibility for the establishment and oversight of the Corporation’s risk management framework. The Board, through its committees, oversees how management monitors compliance with the Corporation’s risk management practices and reviews the adequacy of the risk management framework in relation to the risks faced by the Corporation. The Corporation’s risk management policies and procedures are established to identify and analyze the risks faced by the Corporation, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. The Audit Committee reports regularly to the Board of Directors on its activities.
The Corporation’s risk management policies are established to identify and analyze the risks faced by the Corporation, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Corporation’s activities. The Corporation, through its training and management standards and procedures, aims to develop a disciplined and constructive control environment in which all employees understand their roles and obligations.
Categories of financial instruments
Credit risk is the risk of financial loss to the Corporation if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Corporation’s receivables from customers.
The Corporation’s accounts receivable are due from customers in a variety of industries including a significant proportion with customers operating in the energy and manufacturing industries. The ability of customers within the energy industry to pay the Corporation is partially affected by fluctuations in the price they receive for various hydrocarbon products. The maximum credit exposure associated with trade accounts receivable is the carrying value.
The Corporation follows a credit policy under which the Corporation reviews each new customer individually for credit worthiness before the Corporation’s standard payment and delivery terms and conditions are offered. The Corporation’s review includes external ratings, where available, and trade references. Customers that fail to meet the Corporation’s credit worthiness criteria may transact with the Corporation only on a prepayment basis. On an ongoing basis, the Corporation also reviews the payment patterns of its existing customers and the customers’ continued credit worthiness.
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Corporation’s best estimate of the amount of probable credit losses in the Corporation’s existing accounts receivable. The Corporation determines the allowance by reviewing individual accounts past due for collectability and by considering historical write-off experience, and overall account aging. The Corporation reviews its allowance for doubtful accounts on an ongoing basis, but at least monthly.
Trade receivables disclosed above are classified as loans and receivables and are therefore measured at amortized cost. Due to the short-term nature of these items, fair value approximates carrying value.
The maximum exposure to credit risk for loans and receivables at the reporting date by geographic region was:
For the years ended December 31, 2011 and 2010, one customer provided more than 10% of the Corporation’s revenue. Sales to this customer during 2011 amounted to $10,300 (2010: $8,476) related to ongoing long-term energy-related projects located entirely in Canada. Of the revenue amounts, $967 (2010: $1,510) were included in accounts receivable at the respective year ends.
The movement in the allowance for impairment (provision) in respect of trade receivables during the year was:
During the year certain customer balances totaling $641 were written off that were allowed for in prior years.
The aging of trade receivables at the reporting date was:
Subsequent to year end, payment in full was received from one customer owing $1,236 aged over 120 days.
Changes in collection estimates can affect the allowance recognized for trade and other receivables. For example, to the extent that the net present value of the estimated cash flows differs by ±1 % (plus/minus 1%), net trade and other receivables as at December 31, 2011 would be $223 higher/lower (2010: $181; January 1, 2010: $162).
Liquidity risk is the risk that the Corporation will encounter difficulty in meeting the obligations associated with its financial liabilities that are settled by delivering cash or another financial asset. The Corporation’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due and to fund future investing activities, under both normal and stressed conditions (without incurring unacceptable losses or risking damage to the Corporation’s reputation).
The Corporation generally relies on operating cash flow to provide liquidity to meet its financial obligations. This excludes the potential impact of extreme circumstances that cannot reasonably be predicted, such as natural disasters. In addition, the Corporation maintains an $18.0 million credit facility with a regional financial institution consisting of the following:
The following are the contractual maturities of financial liabilities, including estimated interest payments and excluding the impact of netting arrangements.