Consolidated Financial Statements of
DIVERSIFIED ROYALTY CORP.
Years ended December 31, 2018 and 2017
KPMG LLP
PO Box 10426 777 Dunsmuir Street
Vancouver BC V7Y 1K3
Canada
Telephone (604) 691-3000
Fax (604) 691-3031
INDEPENDENT AUDITORS’ REPORT
To the Shareholders of Diversified Royalty Corp.
Opinion
We have audited the consolidated financial statements of Diversified Royalty Corp. (the
Entity), which comprise:
•
•
•
•
the consolidated statements of financial position as at December 31, 2018 and
December 31, 2017
the consolidated statements of net income and comprehensive income 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 notes to the consolidated financial statements, including a summary of significant
accounting policies
(Hereinafter referred to as the “financial statements”).
In our opinion, the accompanying financial statements present fairly, in all material respects,
the consolidated financial position of the Entity as at December 31, 2018 and December 31,
2017, and its consolidated financial performance and its consolidated cash flows for the years
then ended in accordance with International Financial Reporting Standards (IFRS).
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 “Auditors’
Responsibilities for the Audit of the Financial Statements” section of our auditors’ report.
We are independent of the Entity in accordance with the ethical requirements that are relevant
to our audit of the financial statements in Canada and we have fulfilled our other ethical
responsibilities in accordance with these requirements.
KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. KPMG Canada provides
services to KPMG LLP.
Diversified Royalty Corp.
Page 2
We believe that the audit evidence we have obtained is sufficient and appropriate to provide
a basis for our opinion.
Other Information
Management is responsible for the other information. Other information comprises:
•
the information included in Management’s Discussion and Analysis filed with the relevant
Canadian Securities Commissions.
Our opinion on the financial statements does not cover the other information and we do not
and will not express any form of assurance conclusion thereon.
In connection with our audit of the 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 financial statements or our knowledge obtained in the audit
and remain alert for indications that the other information appears to be materially misstated.
We obtained the information included in Management’s Discussion and Analysis filed with the
relevant Canadian Securities Commissions as at the date of this auditors’ report. If, based on
the work we have performed on this other information, we conclude that there is a material
misstatement of this other information, we are required to report that fact in the auditors’
report.
We have nothing to report in this regard.
Responsibilities of Management and Those Charged with Governance
for the Financial Statements
Management is responsible for the preparation and fair presentation of the financial
statements in accordance with International Financial Reporting Standards (IFRS), and for
such internal control as management determines is necessary to enable the preparation of
financial statements that are free from material misstatement, whether due to fraud or error.
In preparing the financial statements, management is responsible for assessing the Entity’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 Entity or to cease operations, or has no realistic alternative but to do so.
Those charged with governance are responsible for overseeing the Entity’s financial reporting
process.
Auditors’ Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements as
a whole are free from material misstatement, whether due to fraud or error, and to issue an
auditors’ report that includes our opinion.
Diversified Royalty Corp.
Page 3
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 the 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 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 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 Entity'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 Entity's ability
to continue as a going concern. If we conclude that a material uncertainty exists, we are
required to draw attention in our auditors’ report to the related disclosures in the 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 auditors’ report. However,
future events or conditions may cause the Entity to cease to continue as a going concern.
• Evaluate the overall presentation, structure and content of the financial statements,
including the disclosures, and whether the financial statements represent the underlying
transactions and events in a manner that achieves fair presentation.
• 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.
• Provide those charged with governance with a statement that we have complied with
relevant ethical requirements regarding independence, and communicate with them all
relationships and other matters that may reasonably be thought to bear on our
independence, and where applicable, related safeguards.
Diversified Royalty Corp.
Page 4
The engagement partner on the audit resulting in this auditors’ report is Michael J. Kennedy,
CPA, CA.
Chartered Professional Accountants
Vancouver, Canada
March 11, 2019
DIVERSIFIED ROYALTY CORP.
Consolidated Statements of Financial Position
(Expressed in thousands of Canadian dollars)
As at December 31, 2018 and 2017
Assets
Current assets:
Cash and cash equivalents
Royalties and management fees receivable
Amounts receivable
Prepaid expenses and other
Interest rate swap assets
Intangible assets
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued liabilities
Restricted share unit obligation
Long-term bank loans, net of deferred financing charges
Convertible debentures
Deferred income tax liability
Interest rate swap liabilities
Shareholders' equity:
Share capital
Contributed surplus
Equity component of convertible debentures
Accumulated deficit
Note
2018
2017
5
7
12
8
15
10
11
13
12
14
11
$
$
78,342
3,965
153
89
82,549
-
235,674
85,816
4,008
150
96
90,070
160
225,475
$
318,223
$
315,705
$
$
832
-
832
64,856
51,940
7,738
137
184,528
25,974
2,938
(20,720)
192,720
1,354
218
1,572
57,772
50,771
3,463
-
180,906
25,265
2,938
(6,982)
202,127
$
318,223
$
315,705
Nature of operations (note 1)
Contingencies (note 9)
The accompanying notes are an integral part of these consolidated financial statements.
1
DIVERSIFIED ROYALTY CORP.
Consolidated Statements of Net Income and Comprehensive Income
(Expressed in thousands of Canadian dollars, except per share amounts)
Years ended December 31, 2018 and 2017
Royalty income
Management fees
Expenses
Salaries and benefits
Share-based compensation
General and administration
Professional fees
Litigation
Income from operations
Interest expense on credit facilities
Other finance income, net
Fair value adjustment on interest rate swaps
Income before income taxes
Income tax expense
Net income and comprehensive income
Basic weighted average number of shares outstanding
Diluted weighted average number of shares outstanding
Basic income per share
Diluted income per share
Note
6
$
15
9
17
12
13
16
16
$
$
$
$
2018
26,399
310
26,709
1,627
1,406
516
258
3,120
6,927
19,782
(5,395)
305
(297)
14,395
4,275
10,120
$
2017
20,613
306
20,919
1,616
975
568
209
331
3,699
17,220
(2,080)
516
257
15,913
4,353
11,560
107,195,740
108,009,992
105,916,177
106,392,883
0.09
0.09
$
$
0.11
0.11
The accompanying notes are an integral part of these consolidated financial statements.
2
DIVERSIFIED ROYALTY CORP.
Consolidated Statements of Changes in Equity
(Expressed in thousands of Canadian dollars, except for share amounts)
Years ended December 31, 2018 and 2017
Note
Common
shares
Share Contributed
surplus
capital
convertible Accumulated
deficit
debentures
Total
equity
Equity
component of
Balance, January 1, 2018
106,481,937 $ 180,906
$ 25,265
$
2,938
$
(6,982)
$ 202,127
IFRS 2 amendments
3(n)
-
106,481,937
-
180,906
218
25,483
-
2,938
-
(6,982)
218
202,345
Common shares issued
on DRIP
Restricted share units settled
Share options exercised
Share-based compensation
Dividends declared
Comprehensive income
880,618
275,845
129,900
-
-
-
2,663
669
290
-
-
-
-
(815)
(58)
1,364
-
-
-
-
-
-
-
-
-
-
-
-
(23,858)
10,120
2,663
(146)
232
1,364
(23,858)
10,120
Balance, December 31, 2018
107,768,300 $ 184,528
$ 25,974
$
2,938
$
(20,720)
$ 192,720
Note
Common
shares
Share Contributed
surplus
capital
Equity
component of
convertible
debentures
Balance, January 1, 2017
105,481,136 $ 178,256
$ 25,161
$
Common shares issued
on DRIP
Restricted share units settled
Share options exercised
Share-based compensation
Issuance of Debentures,
net of expenses and taxes
Dividends declared
Comprehensive income
11
801,556
147,745
51,500
-
-
-
-
2,213
338
99
-
-
-
-
-
(293)
(22)
419
-
-
-
Retained
earnings
(deficit)
Total
equity
$
5,024
$ 208,441
-
-
-
-
2,213
45
77
419
-
-
-
-
-
2,938
-
-
-
(23,566)
11,560
2,938
(23,566)
11,560
Balance, December 31, 2017
106,481,937 $ 180,906
$ 25,265
$
2,938
$
(6,982)
$ 202,127
The accompanying notes are an integral part of these consolidated financial statements.
3
DIVERSIFIED ROYALTY CORP.
Consolidated Statements of Cash Flows
(Expressed in thousands of Canadian dollars)
Years ended December 31, 2018 and 2017
Cash flows from (used in) operating activities:
Net income
Adjustments for:
Deferred income taxes
Share-based compensation
Fair value adjustments on interest rate swaps
Interest expense on credit facilities
Other finance income, net
Foreign exchange gain (loss)
Interest paid
Interest received
Changes in non-cash operating items:
Royalties and management fees receivable
Amounts receivable
Prepaid expenses and other
Accounts payable and accrued liabilities
Net cash from operating activities
Cash flows from (used in) financing activities:
Proceeds from issuance of debt
Proceeds from exercise of share options
Debt financing costs
Payment of dividends
Net cash from (used in) financing activities
Cash flows used in investing activities:
Addition to intangible assets
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year
2018
2017
$
10,120
$
11,560
4,275
1,406
297
5,395
(305)
12
(5,848)
1,575
43
(3)
7
(257)
16,717
7,000
232
(29)
(21,195)
(13,992)
(10,199)
(10,199)
(7,474)
85,816
4,353
975
(257)
2,080
(516)
(14)
(1,627)
828
(2,490)
(57)
(9)
(418)
14,408
74,900
77
(3,213)
(21,353)
50,411
(53,977)
(53,977)
10,842
74,974
Cash and cash equivalents, end of year
$
78,342
$
85,816
The accompanying notes are an integral part of these consolidated financial statements.
4
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
Diversified Royalty Corp. (“DIV”), formerly BENEV Capital Inc. and prior to that Bennett Environmental Inc., is a company domiciled
in Canada and incorporated on July 29, 1992 under the Canada Business Corporation Act. The consolidated financial statements
of DIV as at and for the year ended December 31, 2018 are composed of DIV and its subsidiaries (together referred to as the
“Company”). The Company’s common shares are listed on the Toronto Stock Exchange (“TSX”) and traded under the symbol
“DIV”. The registered office of the Company is located at 902-510 Burrard Street, Vancouver, BC, V6C 3A8.
1. Nature of operations:
The current business of DIV is to acquire royalties from well-managed multi-location businesses and franchisors in North
America (“Royalty Partners”).
On June 19, 2015, the Company indirectly acquired, through SGRS Royalties Limited Partnership (“SGRS LP”) (an entity
controlled by the Company), all of the Canadian and U.S. trademarks and certain other intellectual property rights utilized by
Sutton Group Realty Services Ltd. (“Sutton”) in its residential real estate franchise business (the “SGRS Rights”). The Company
granted Sutton the licence to use the SGRS Rights for a term ending on December 31, 2114 in exchange for a royalty payment
initially equal to $56.25 per agent per month (the “Sutton Royalty Rate”) for the number of agents included in the royalty pool
(the “Sutton Royalty Pool”). Effective July 1, 2018, the Sutton Royalty Rate was increased to $59.693 per agent per month.
On August 19, 2015, the Company indirectly acquired through ML Royalties Limited Partnership (“ML LP”) (an entity controlled
by the Company), the trademarks and certain other intellectual property rights (the “ML Rights”) from Mr. Lube Canada Limited
Partnership (“Mr. Lube”). The Company granted Mr. Lube the licence to use the ML Rights for a term ending on August 19,
2114 in exchange for a royalty payment initially equal to 6.95% of system sales of Mr. Lube locations in the royalty pool (the
“Mr. Lube Royalty Pool”). On May 1, 2018, the Mr. Lube royalty rate on non-tire sales was increased by 0.5% from 6.95% to
7.45%
On August 25, 2017, the Company indirectly acquired through AM Royalties Limited Partnership (“AM LP”) (a wholly owned
subsidiary of the Company), the Canadian AIR MILES trademarks and certain Canadian intellectual property rights
(collectively, the “AIR MILES Rights”) from a subsidiary of Aimia Inc. (“Aimia”). In accordance with the terms of two license
agreements with LoyaltyOne Co. (collectively the “AIR MILES Licenses”) acquired by AM LP as part of acquisition of the AIR
MILES Rights, LoyaltyOne Co. has an exclusive right to use the AIR MILES Rights for the purposes of operating the AIR
MILES reward program in Canada (the “AIR MILES Program”) for an indefinite term in exchange for a royalty payment equal
to 1% of gross billings from the AIR MILES Program.
Substantially all of the Company’s operating revenues are earned from the receipt of royalties and management fees from its
Royalty Partners. Accordingly, the revenues of the Company and its ability to pay dividends to shareholders are dependent on
the ongoing ability of its Royalty Partners to generate cash and pay royalties and management fees to the Company.
2. Basis of preparation:
(a) Statement of compliance:
These consolidated financial statements have been prepared in accordance with International Financial Reporting
Standards (“IFRS”). The consolidated financial statements were authorized and approved for issue by the Company’s
Board of Directors on March 11, 2019.
(b) Basis of measurement:
These financial statements have been prepared on the historical cost basis except for the interest rate swaps and, prior
to January 1, 2018, restricted share unit obligation, which are measured at fair value.
(c) Functional and presentation currency:
These consolidated financial statements are presented in Canadian dollars, which is the Company’s functional currency.
5
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
2. Basis of preparation:
(d) Use of estimates and judgments:
The preparation of the consolidated financial statements 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.
(i) Critical judgments:
Consolidation:
In applying the criteria outlined in IFRS 10, Consolidated Financial Statements, judgment is required in
determining whether DIV controls SGRS LP and ML LP. Making this judgment involves taking into consideration
the concepts of power over these entities, exposure and rights to variable returns, and the ability to use power to
direct the relevant activities of these entities to generate economic returns. Using these criteria, management
has determined that DIV ultimately controls these entities through its majority ownership of the respective general
partners.
Capitalization of acquisition costs:
At the time of acquisition, the Company considers whether or not it represents a business combination or an
asset acquisition. This requires the Company to make certain judgments as to whether or not the assets acquired
include the inputs, processes and outputs necessary to constitute a business. Under a business combination,
acquisition-related costs are recognized as an expense. When the acquisition does not represent a business
combination, it is accounted as an asset acquisition, where the costs are capitalized to the respective asset.
(ii) Key estimates and assumptions:
Intangible assets:
The Company carries the intangible assets at cost and are not amortized as they have an indefinite life.
The Company tests intangible assets for impairment annually or when there is any indication that an asset may
be impaired. This requires the Company to use a valuation technique to determine if impairment exists. This
valuation technique that is dependent on a number of different variables that requires management to exercise
judgment. As a result, the estimated cash flows the intangible assets are expected to generate could differ
materially from actual results.
Fair value of exchangeable partnership units in SGRS LP and ML LP (“Exchangeable Partnership Units”):
The Company does not assign any value to the Exchangeable Partnership Units as they do not currently meet
the relevant criteria for exchange into common shares of DIV (note 8).
Deferred taxes:
Deferred tax assets and liabilities are due to temporary differences between the carrying amount for accounting
purposes and the tax basis of certain assets and liabilities, as well as undeducted tax losses. In recognizing a
deferred tax asset, management makes estimates related to expectations of future taxable income, and the
expected timing of reversals of existing temporary differences.
Convertible debentures:
The Company exercises judgment in determining the allocation of the equity and liability component of the
convertible debenture. The liability allocation is based on the estimated fair value of a similar liability that does
not have an equity conversion option and the residual amount is allocated to the equity component.
6
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
3. Significant accounting policies:
These annual consolidated financial statements have been prepared using the accounting policies described below.
(a) Basis of consolidation:
These consolidated financial statements include the accounts of DIV, SGRS LP, ML LP, AM LP and the respective general
partners. All significant intercompany transactions and balances have been eliminated on consolidation.
(b) Cash and cash equivalents:
Cash and cash equivalents consist of cash on hand, balances on deposit with Canadian chartered banks, and short-term
investments with terms of three months or less on the date of acquisition.
(c) Revenue recognition:
The Company has two revenue streams, royalty income and management fee revenue.
Royalty income: The Company licenses its intellectual property rights to third parties in exchange for royalty payments.
The royalty income is recognized based on the usage or sales that have occurred during the period.
Management fee revenue: The Company provides strategic and other services to certain royalty partners in exchange
for a fixed monthly fee. Management fee is recognized as earned over the term of the agreement.
Royalty income and management fees for Mr. Lube and Sutton are usually receivable within 21 days after the calendar
month. Royalty income from the AIR MILES Program is usually receivable within 14 days after the calendar quarter.
(d) Intangible assets:
The intangible assets are recorded at cost, which includes directly attributable acquisition costs, and are adjusted to record
the additions to the respective royalty pools. The intangible assets are not amortized as they have an indefinite life, and
are assessed for impairment as described in note 3(e).
(e) Impairment of intangible assets:
Intangible assets that are not amortized are subject to an annual impairment test or when events or changes in
circumstances indicate that the carrying value may not be recoverable. For the purpose of measuring recoverable
amounts, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash-generating
units or “CGUs”). The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use (being
the present value of the expected future cash flows of the CGU). 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 assessment of the
time value of money and the risks specific to the asset. An impairment loss is recognized for the amount by which the
intangible asset’s carrying amount exceeds its recoverable amount.
A previously recognized impairment loss is assessed at each reporting date for any indicators that the loss has decreased
or no longer exists. An impairment loss is reversed only to the extent that the intangible asset's carrying value does not
exceed the carrying amount that would have existed had the original impairment loss had been recognized.
(f) Dividends to DIV shareholders:
Dividends to the Company’s shareholders are made monthly based upon available cash at the discretion of the Board of
Directors. Dividends are recorded when declared and are subject to the Company retaining such reasonable working
capital reserves as may be considered appropriate by the Company.
7
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
3. Significant accounting policies (continued):
(g) Earnings per share:
The Company presents basic and diluted earnings per share (“EPS”) data for its common shares. Basic EPS is calculated
by dividing the net income attributable to common shareholders of the Company by the weighted average number of
common shares outstanding during the period. Diluted EPS is determined by adjusting the net income attributable to
common shareholders and the weighted average number of common shares outstanding, adjusted for dilutive potential
common shares, which comprise share options and restricted share units.
(h) Employee benefits:
(i) Share options:
The Company measures the compensation cost of share-based option awards to employees at the grant date using
the Black-Scholes option pricing model to determine the fair value of the options. The compensation cost of the
options is recognized as share-based compensation expense over the relevant vesting period of the share options.
Forfeitures are estimated and are adjusted if actual forfeitures differ from the original estimate unless forfeitures are
due to market-based vesting conditions. When the equity-settled share options are exercised, share capital is
increased by the sum of the consideration paid and the carrying value of the share options recorded to contributed
surplus.
(ii) Restricted share units:
Restricted share units (“RSUs”) are settled, in accordance with the respective RSU agreements, in common shares
or cash based on the number of vested restricted share units multiplied by the fair market value of the common shares
on the vesting date.
The Company measures the cost of equity-settled RSUs based on the fair value of the underlying shares at the grant
date, and is recorded as share-based compensation expense with a corresponding increase in equity over the vesting
period. The cost of cash-settled RSUs is based on the fair value of the underlying shares at the grant date, and is re-
measured at the end of each reporting period until the liability is settled. The fair value of the cash-settled RSUs is
recognized as compensation expense and a liability over the vesting period.
RSUs that have a net settlement feature for withholding tax obligations are classified in its entirety as equity-settled
(note 3(n)).
(i) Provisions:
A provision is recognized if, as a result of a past event, the Company has a legal or constructive present 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 reviewed at the end of each reporting period and adjusted or reversed to reflect management’s best
estimate of the expenditure required to settle the present obligation at the end of the reporting period. Provisions are
reduced by actual expenditures for which the provision was originally recognized. Where discounting has been used, the
carrying amount of the provision is accreted during the period to reflect the passage of time.
8
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
3. Significant accounting policies (continued):
(j)
Income tax:
Income tax expense comprises current and deferred tax. Current tax and deferred tax are recognized in profit or loss
except to the extent that it relates to a business combination, or items recognized directly in equity or in other
comprehensive income.
Current tax is the expected tax payable or receivable on the taxable income or loss for the year, using tax rates enacted
or substantively enacted at the reporting date, and any adjustment to tax payable in respect of the previous year.
Deferred tax is recognized in respect of temporary differences between the carrying amounts of assets and liabilities on
the consolidated statements of financial position and the amounts attributed to the assets and liabilities for tax purposes.
Deferred tax is not recognized for the following temporary differences: the initial recognition of assets or liabilities in a
transaction that is not a business combination and that affects neither accounting nor taxable profit or loss, and differences
relating to investments in subsidiaries and jointly controlled entities to the extent that it is probable that they will not reverse
in the foreseeable future.
Deferred tax is measured at the tax rates that are expected to be applied to temporary differences when they reverse,
based on the laws that have been enacted or substantively enacted by the reporting date. Deferred tax assets and
liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets, and they relate to income
taxes levied by same tax authority on the same taxable entity, or on different tax entities, but they intend to settle current
tax liabilities and assets on a net basis or their tax assets and liabilities will be realized simultaneously.
A deferred tax asset is recognized for unused tax losses, tax credits and deductible temporary differences, to the extent
that it is probable that future taxable profits will be available against which they can be utilized. Deferred tax assets are
reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will
be realized.
(k) Financial instruments:
Financial assets are classified and measured based on the business model in which they are held and the characteristics
of their cash flows. At initial recognition, all financial assets classified as amortized cost and fair value through other
comprehensive income (“FVOCI”) are measured at fair value plus transaction costs that are directly attributable to its
acquisition. The Company classifies its financial assets in the following categories:
Financial assets at amortized cost: A financial asset is measured at amortized cost if it meets both of the following
conditions and is not designated as FVTPL: it is held in a business model whose objective is to hold the asset to
collect contractual cash flows and the contractual terms give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount outstanding. Financial assets within this category are
subsequently measured at amortized cost using the effective interest method. Interest income, foreign exchange
gains and losses, impairment losses and gain or loss on de-recognition are recognized in profit or loss.
Debt investments at FVOCI: A debt instrument is classified as FVOCI if it meets both of the following conditions and
is not designated as FVTPL: it is held in a business model whose objective is achieved by collecting contractual cash
flows and the sale of the financial asset and the contractual terms give rise on specified dates to cash flows that are
solely payments of principal and interest on the principal amount outstanding. Financial assets within this category
are subsequently measured at fair value. Interest income, dividend income, foreign exchange gains and losses are
recognized in profit or loss. Other gains and losses are recognized in other comprehensive income (“OCI”) and are
reclassified to profit or loss on de-recognition.
Equity investments at FVOCI: On initial recognition of an equity instrument that is not held for trading, the
Company may irrevocably elect to present subsequent changes in the investment’s fair value in OCI. This
election is made on an investment-by-investment basis. Financial assets within this category are subsequently
measured at fair value. Dividend income and foreign exchange gains and losses are recognized in profit or
loss. Other gains and losses are recognized in OCI and are never reclassified to profit or loss.
9
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
3. Significant accounting policies (continued):
(k) Financial instruments (continued):
Financial assets at fair value through profit and loss (“FVTPL”): Financial assets not classified as amortized cost or
FVOCI are measured at FVTPL. This includes all derivative financial instruments. On initial recognition, the Company
may irrevocably designate a financial asset that otherwise meets the requirements to be measured at amortized cost
or at FVOCI at FVTPL if doing so eliminates or significantly reduces an accounting mismatch that would otherwise
arise. These assets are subsequently measured at fair value, with net gains or losses, including any interest or
dividend income, recognized through profit or loss.
Financial liabilities are classified as measured at amortized cost or FVTPL. Once the classification of a financial liability
has been determined, reclassification is not permitted.
Financial liabilities at amortized cost: A financial liability is measured at amortized cost using the effective interest
method if it is not designated as FVTPL. Interest expense and foreign exchange gains and losses are recognized in
profit or loss.
Financial liabilities at FVTPL: A financial liability is classified as FVTPL if it is classified as held-for-trading, it is a
derivative or it is designated as such on initial recognition. Financial liabilities at FVTPL are measured at fair value
and net gains and losses, including any interest expense are recognized in profit or loss. For financial liabilities
classified as FVTPL, changes in credit risk will be recognized in other comprehensive income, with the remainder of
changes recognized in profit or loss. However, if this requirement creates or enlarges an accounting mismatch in
profit or loss, the entire change in fair value will be recognized in profit or loss.
Financial assets and liabilities are offset and the net amount is reported in the consolidated statements of financial position
when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis
or realize the asset and settle the liability simultaneously.
The Company has elected as an accounting policy choice for non-substantial modifications of variable or fixed rate debt,
if certain criteria are met, to adjust the carrying amount of the financial liability on modification for directly attributable
transaction costs and any consideration paid to or received from the counterparty. The effective interest rate is then
adjusted to amortize the difference between the revised carrying amount and the expected cash flows over the life of the
modified instrument. No gain or loss is recognized in profit or loss. This accounting policy applies to variable or fixed rate
debt that had an insignificant original issue discount that can be prepaid at par, or prepaid with insignificant prepayment
fees, to the extent that modification has the effect of repricing the debt to a market rate of interest.
(l)
Impairment of financial assets:
The Company uses an expected credit loss (“ECL”) impairment model. The ECL impairment model applies to financial
assets measured at cost, contract assets and debt investments at FVOCI, but not to investments in equity instruments.
The Company has elected to use the lifetime ECL approach. Under this approach, the impairment allowance is recorded
as a result of all possible default events over the expected life of the financial asset. ECLs are a probability-weighted
estimate of credit losses. Credit losses are measured as the present value of all cash shortfalls (i.e. the difference between
the cash flows due to the Company in accordance with the contract and the cash flows that the Company expects to
receive) and are discounted at the effective interest rate of the financial asset. The Company considers reasonable and
supportable information when assessing the credit risk of a financial asset and in estimating the ECLs, which includes:
Significant financial difficulty of the Company’s counterparty;
Delinquencies in interest or principal payments over 30 days; and
It becomes probable that the borrower will enter into bankruptcy or other financial reorganization.
ECLs are a probability-weighted estimate of credit losses. Credit losses are measured as the present value of all cash
shortfalls (i.e. the difference between the cash flows due to the entity in accordance with the contract and the cash flows
that the Company expects to receive). ECLs are discounted at the effective interest rate of the asset.
10
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
3. Significant accounting policies (continued):
(m) Convertible debentures:
The Company accounts for convertible debentures by allocating the proceeds of the debentures, net of financing costs,
between liability and equity based on estimated fair values of the debt and conversion option. The liability component is
valued first and the difference between the proceeds of the convertible debentures and the fair value of the liability
component is assigned to the equity component. Interest expense is recorded as a charge to earnings and is calculated
at an effective rate with the difference between the coupon rate and the effective rate being credited to the debt component
of the convertible debentures (accretion expense) such that, at maturity the debt component is equal to the face value of
the outstanding convertible debentures.
(n) Changes in accounting policies and disclosures:
IFRS 15, Revenue from Contracts with Customers:
On January 1, 2018, the Company adopted IFRS 15, Revenue from Contracts with Customers (“IFRS 15”). The standard
contains a single model that applies to contracts with customers. The model features a contract-based five-step analysis
of transactions to determine whether, how much and when revenue is recognized. IFRS 15 supersedes IAS 18, Revenue,
and related interpretations.
The Company adopted IFRS 15 using the cumulative effect method with the effect of initially applying this standard
recognized at the date of initial application, January 1, 2018. The adoption of IFRS 15 did not have an impact on the
Company’s accumulated deficit as at January 1, 2018.
IFRS 9, Financial Instruments:
On January 1, 2018, the Company adopted IFRS 9, Financial Instruments (“IFRS 9”) on a retrospective basis. IFRS 9 sets
out the requirements for recognizing and measuring financial assets and liabilities. IFRS 9 replaced IAS 39, Financial
Instruments: Recognition and Measurement (“IAS 39”).
Under IFRS 9, financial assets are classified and measured based on the business model in which they are held and the
characteristics of their cash flows. IFRS 9 retains the existing requirements in IAS 39 for the classification of financial
liabilities as amortized cost or FVTPL.
The following table and the accompanying notes explain the original measurement categories under IAS 39 and the new
measurement categories under IFRS 9 for each class of the Company’s financial assets and liabilities.
Original classification
under IAS 39
New classification
under IFRS 9
Cash and cash equivalents
Royalties and management fees receivable
Amounts receivable
Interest rate swap assets and liabilities
Accounts payable and accrued liabilities
Long-term bank loans
Convertible debentures
Loans and receivables
Loans and receivables
Loans and receivables
FVTPL
Financial liabilities at amortized cost
Financial liabilities at amortized cost
Financial liabilities at amortized cost
Amortized cost
Amortized cost
Amortized cost
FVTPL
Amortized cost
Amortized cost
Amortized cost
IFRS 9 replaces the “incurred loss” model in IAS 39 and has an expected credit loss (“ECL”) impairment model. The new
impairment model applies to financial assets measured at cost, contract assets and debt investments at FVOCI, but not
to investments in equity instruments.
The adoption of IFRS 9 did not have an impact on the Company’s accumulated deficit as at January 1, 2018.
11
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
3. Significant accounting policies (continued):
(n) Changes in accounting policies and disclosures (continued):
Amendments to IFRS 2, Share-Based Payments:
On January 1, 2018, the Company adopted the amendments to IFRS 2, Share-Based Payments (“IFRS 2”). The
amendments to IFRS 2 address three main areas: the effects of vesting conditions on the measurement of a cash-settled
share-based payment transaction, the classification of a share-based payment transaction with net settlement features for
withholding tax obligations, and accounting where a modification to the terms and conditions of a share-based payment
transaction changes its classification from cash-settled to equity-settled.
On January 1, 2018, as a result of adopting the amendments to IFRS 2, the Company reclassified $0.2 million related to
its restricted share unit obligation from liabilities to contributed surplus. The Company ceased to apply mark-to-market
accounting on share-based payment transactions with a net settlement feature for withholding tax obligations.
4. New standards applicable in future periods:
In January 2016, the IASB issued IFRS 16, Leases. This standard introduces a single lessee accounting model and requires
a lessee to recognize assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of
a low value. A lessee is required to recognize a right-of-use asset representing its right to use the underlying asset and a lease
liability representing its obligation to make lease payments. The mandatory effective date of IFRS 16 is for annual periods
beginning on or after January 1, 2019. The Company does not have any leases within the scope of IFRS 16, therefore the
adoption of IFRS 16 will not have an impact on its financial statements.
5. Cash and cash equivalents:
Cash
Cash equivalents
6. Royalty pools:
(a) Mr. Lube:
2018
1,024
77,318
78,342
$
$
$
$
2017
1,263
84,553
85,816
Pursuant to the terms of the licence and royalty agreement dated August 19, 2015 (the “Mr. Lube Licence and Royalty
Agreement”), the royalty paid by Mr. Lube to ML LP is calculated by multiplying the system sales of locations within the
Mr. Lube Royalty Pool by an agreed royalty fee (the “Mr. Lube Royalty Rate”, initially set at 6.95%). In addition, ML LP is
entitled to receive a make-whole payment in the event that a Mr. Lube location in the ML Royalty Pool is permanently
closed during the royalty payment period. The make-whole payment is based on the lost system sales multiplied by the
Mr. Lube Royalty Rate. Mr. Lube will also, subject to meeting certain performance criteria, be provided opportunities to
increase the Mr. Lube Royalty Rate in four, 0.5% increments (note 8(b)).
In September 2017, Mr. Lube launched a new tire program. In connection with this incremental line of business, on October
20, 2017, ML LP amended its licence and royalty agreement (the “ML LRA Amendment”) with Mr. Lube in respect of this
new retail tire program. Mr. Lube is charging a lower royalty fee and waived certain other fees payable by Mr. Lube
franchisees on the sale of tires and rims to account for the lower margins on these hard goods. Pursuant to the ML LRA
Amendment, ML LP has agreed to charge an effective royalty rate payable on system sales derived from the sale of tires
and rims of 2.5% (compared to 6.95% on all other system sales) for the locations currently in the Mr. Lube Royalty Pool.
The ML LRA Amendment is effective from September 18, 2017.
12
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
6. Royalty pools (continued):
(a) Mr. Lube (continued):
Effective May 1, 2018, the royalty rate paid by Mr. Lube on non-tire sales at flagship locations has been increased by 0.5%
from 6.95% to 7.45% (note 8(b)). In addition, the Mr. Lube Royalty Pool was adjusted to include the royalties from two
new Mr. Lube locations and to remove one Mr. Lube location that has been permanently closed. With the adjustment for
these two new locations and one closure, the Mr. Lube Royalty Pool had 118 locations effective May 1, 2018 (note 8(b)).
Royalty income from Mr. Lube for the years ended December 31, 2018 and 2017 was as follows:
Expressed in thousands of Canadian dollars, except
for number of locations
Locations in the Mr. Lube Royalty Pool at period end
Mr. Lube Royalty Pool system sales
Royalty income
2018
118
206,482
14,845
$
$
2017
117
198,549
13,816
During the year ended December 31, 2018, royalty income from Mr. Lube includes make-whole payments totaling $0.02
million (2017 - $0.06 million) on lost system sales of $0.3 million (2017 - $0.8 million).
(b) Sutton:
Pursuant to the terms of the licence and royalty agreement dated June 19, 2015 (the “Sutton Licence and Royalty
Agreement”), the royalty paid by Sutton to SGRS LP is calculated by multiplying a determined number of agents in the
Sutton Royalty Pool by the Sutton Royalty Rate. Sutton has the ability, subject to meeting certain performance criteria, to
increase the amount of the annual royalty payable to the Company by increasing the number of agents in the Sutton
Royalty Pool. The number of agents in the Sutton Royalty Pool may be increased annually, and will never be decreased.
The Sutton Royalty Rate will automatically increase by 2% each July 1st beginning in 2016. Sutton will also have the ability,
subject to meeting certain performance criteria, to increase the Sutton Royalty Rate in 10.0% increments four times during
the life of the royalty (note 8(a)).
Royalty income from Sutton for years ended December 31, 2018 and 2017 were calculated as follows:
Expressed in thousands of Canadian dollars, except
for number of agents and the Sutton Royalty Rate
Agents in the Sutton Royalty Pool at period end
Royalty income
2018
5,400
3,830
$
$
2017
5,400
3,754
Effective July 1, 2018, the monthly Sutton Royalty Rate increased from $58.523 per agent to $59.693 per agent,
representing the 2.0% annual contractual increase in the Sutton Royalty Rate for 2018. Effective July 1, 2017, the
monthly Sutton Royalty Rate increased from $57.375 per agent to $58.523 per agent, representing the 2.0% annual
contractual increase in the Sutton Royalty Rate for 2017.
(c) AIR MILES:
The royalty paid by LoyaltyOne Co. to AM LP is equal to 1% of the gross billings from the AIR MILES Program in
accordance with the terms of the AIR MILES Licenses. Royalty income related to the AIR MILES Program for the year
ended December 31, 2018 and the period from August 25, 2017 (the date of the AIR MILES Rights acquisition) to
December 31, 2017 was as follows:
Expressed in thousands of Canadian dollars
Gross billings
Royalty income
$
2018
772,396
7,724
$
2017
304,306
3,043
13
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
7. Royalties and management fees receivable:
Mr. Lube
Sutton
AIR MILES
8.
Intangible assets:
2018
1,242
347
2,376
3,965
$
$
$
$
2017
1,175
340
2,493
4,008
Balance, January 1, 2017
Acquisition of AIR MILES Rights
Balance, December 31, 2017
Mr. Lube Royalty Rate increase
and store roll-in
SGRS Rights
(a)
ML Rights
(b)
AIR MILES
Program
(c)
$
$
32,273
-
$
139,225
-
$
-
$
53,977
32,273
$
139,225
$
53,977
Total
171,498
53,977
225,475
-
10,199
-
10,199
Balance, December 31, 2018
$
32,273
$
149,424
$
53,977
$
235,674
(a) SGRS Rights:
SGRS LP licensed the SGRS Rights back to Sutton for 99 years in exchange for a royalty payment equal to the Sutton
Royalty Pool multiplied by the Sutton Royalty Rate (note 6(b)).
Upon closing the Sutton Acquisition, SGRS LP issued 100,000,000 Class A, Class B, Class C, Class D, and Class E LP
units to Sutton. These units will become exchangeable into common shares of the Company through the exchange
agreement dated June 19, 2015 among Sutton, SGRS Royalties GP Inc. and the Company upon the satisfaction of certain
performance criteria. The Class A LP Units become exchangeable into common shares of the Company on the contribution
of additional agents into the Sutton Royalty Pool. The Class B, Class C, Class D, and Class E LP units become
exchangeable into common shares of the Company on increases in the Sutton Royalty Rate of 10.0% increments four
times during the life of the royalty, in accordance with the partnership agreement dated June 19, 2015 among Sutton, the
Company, and SGRS Royalties GP Inc. (the “Sutton Exchange Agreement”).
In addition to the royalty, Sutton will pay the Company a management fee of approximately $0.1 million per year for
strategic and other services. The management fee will be increased by 10.0% every five years.
Annually on July 1, the Sutton Royalty Pool may be adjusted, subject to meeting certain performance criteria, to increase
the number of agents. In return for increasing the number of agents in the Sutton Royalty Pool, Sutton receives the right
to indirectly acquire common shares of the Company through the exchange of Class A LP Units of SGRS LP (the “SGRS
Additional Entitlement”). The SGRS Additional Entitlement is determined based on 92.5% of the estimated net tax-adjusted
royalty revenue added to the Sutton Royalty Pool, divided by the yield of the Company’s shares, divided by the weighted
average share price of the Company’s shares over the 20 days preceding May 31. The SGRS Additional Entitlement is
automatically exchanged by Sutton into common shares of DIV, or settled in cash at DIV’s option, pursuant to the Sutton
Exchange Agreement.
14
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
8.
Intangible assets (continued):
(b) ML Rights:
ML LP licensed the ML Rights back to Mr. Lube for 99 years in exchange for a royalty payment equal to the system sales
of the Mr. Lube locations in the Mr. Lube Royalty Pool multiplied by the Mr. Lube Royalty Rate (note 6(a)).
Upon closing the Mr. Lube Acquisition, ML LP issued 100,000,000 Class B, Class C, Class D, Class E, and Class F units
to Mr. Lube. These units will become exchangeable into common shares of the Company through the exchange agreement
dated August 19, 2015 among Mr. Lube, ML Royalties GP Inc. and the Company (the “Mr. Lube Exchange Agreement”)
upon the satisfaction of certain performance criteria. The Class B LP units of ML LP become exchangeable into common
shares of the Company upon adding Mr. Lube locations to the ML Royalty Pool. The Class C, Class D, Class E, and Class
F LP units become exchangeable into common shares of the Company on increases in the ML Royalty Rate of 0.5%
increments four times during the life of the royalty, in accordance with the partnership agreement dated August 19, 2015
among Mr. Lube, the Company, and ML Royalties GP Inc.
In addition to the royalty, Mr. Lube will pay the Company a management fee of approximately $0.2 million per year for
strategic and other services. The management fee will be increased at a rate of 2.0% per annum over the term of the Mr.
Lube Licence and Royalty Agreement.
Annually on May 1, the Mr. Lube Royalty Pool may be adjusted, subject to meeting certain criteria, to include gross sales
from new Mr. Lube locations less gross sales from Mr. Lube locations that were permanently closed during the preceding
calendar year. In return for adding these net sales to the Mr. Lube Royalty Pool, Mr. Lube receives the right to indirectly
acquire common shares of the Company through the exchange of Class B LP Units of ML LP (the “ML Additional
Entitlement”). The ML Additional Entitlement is determined based on the estimated net tax-adjusted royalty revenue added
to the Mr. Lube Royalty Pool (adjusted by a 20% discount for locations that were open for business prior to June 30, 2019,
or a 7.5% discount for all other additions), divided by the yield of the Company’s shares, divided by the weighted average
share price of the Company’s shares over the 20 days preceding March 31. Mr. Lube receives 80% of the estimated ML
Additional Entitlement initially, with the balance received on May 1 of the subsequent year when the actual full year
performance of the new locations is known with certainty. The ML Additional Entitlement is automatically exchanged by
Mr. Lube into common shares of DIV, or settled in cash at DIV’s option, pursuant to the Mr. Lube Exchange Agreement.
On May 1, 2018, the Mr. Lube royalty rate increased by 0.5% from 6.95% to 7.45%. In exchange for increasing the Mr.
Lube royalty rate, Mr. Lube received the right to exchange Class C LP units of ML LP for common shares of DIV. DIV
elected to pay for the Mr. Lube royalty rate increase in cash, in lieu of common shares of DIV, which was partially financed
by an increase in the term loan facility of ML LP (note 10). The total consideration paid to Mr. Lube for the royalty rate
increase was $9.2 million.
On May 1, 2018, the Mr. Lube Royalty Pool was adjusted to include two new Mr. Lube locations and to remove one Mr.
Lube location that was permanently closed. The initial consideration payable to Mr. Lube for the estimated net additional
royalty revenue is $0.9 million, representing 80% of the total estimated consideration of $1.2 million. In exchange for the
net addition to the Mr. Lube Royalty Pool, Mr. Lube received the right to exchange Class B LP units of ML LP for common
shares of DIV. DIV elected to pay for the initial consideration to Mr. Lube in cash, which was partially financed by an
increase in the term loan facility of ML LP (note 10). The remaining consideration payable for the net additional royalty
revenue will be paid to Mr. Lube on May 1, 2019, the next adjustment date, and will be adjusted to reflect the actual system
sales of the two new locations added to the Mr. Lube Royalty Pool for the year ended December 31, 2018.
During the year ended December 31, 2017, there were no additions to the Mr. Lube Royalty Pool.
15
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
8.
Intangible assets (continued):
(c) AIR MILES Rights:
On August 25, 2017, the Company acquired, through AM LP, the AIR MILES Rights from a subsidiary of Aimia for $53.8
million plus additional contingent consideration of up to $13.8 million. The Company funded the payment through cash on
hand of $36.4 million and the issuance of $17.4 million in debt. Additionally, $0.2 million in costs incurred for the acquisition
of the AIR MILES Program in Canada were capitalized as part of the purchase. The contingent consideration is subject to
certain milestones being met. The milestones relate to the renewal of The Bank of Montreal’s AIR MILES sponsorship
contract, or the replacement of the AIR MILES sponsorship contract with another one of the four other major Canadian
chartered banks on or prior to July 31, 2019, as well as the royalty revenue post contract renewal or replacement. If
payable, the contingent consideration would be recorded as an expense.
In accordance with the terms of the AIR MILES Licenses, AM LP will receive an aggregate royalty, payable quarterly,
equal to 1% of gross billings from the AIR MILES Program in Canada in perpetuity.
(d) Impairment assessment:
Annually, on December 31, the Company tests the carrying value of its intangible assets for impairment. Impairment exists
if the present value of the net cash flows is greater than the carrying value of the CGU. The estimates of future cash flows
require a number of key assumptions about future business performance. These assumptions and estimates are based
on the relevant business’ historical experience, economic trends, as well as past and ongoing communications with
relevant stakeholders of the Company.
The expected future cash flows are based on the most recent annual forecasts prepared by management and extrapolated
over five years, with a terminal capitalization rate applied on the expected cash flows thereafter to reflect the indefinite life
of the intangible assets. Subsequent to the most recent annual forecast, revenue is projected to grow at a rate ranging
from 1.5% to 2.75% (2017 – 2.0%). These projected cash flows are discounted at pre-tax rates, based on the risks
associated with the assets, which range from 11.2% to 14.8% (2017 - 12.4% to 18.1%).
The Company also considers other reasonably possible scenarios where forecasted revenue is less than budget, along
with other reasonably possible higher discount rates to determine whether the intangible assets would be impaired under
those scenarios. As the carrying values of the SGRS Rights at December 31, 2018 approximate the estimated recoverable
amounts, a subsequent change in any key assumption utilized in the estimate of future cash flows may result in an
impairment loss. As at December 31, 2018, the Company has determined that no additional impairment exists.
9. Contingencies:
In 2008, Sevenson Environmental Services Inc. (“Sevenson”), a prime contractor on a U.S. Federal Government project filed
a complaint against the Company and many other persons in a U.S. court.
On February 11, 2015, Sevenson filed its third amended complaint against the Company. The complaint alleges that
employees of the Company conspired with an employee of the prime contractor relating to, among other things, the awarding
of contracts during the years 2002 through 2004.
On November 28, 2018, in an effort to avoid the expense and uncertainty of further litigation, and with no admission of fault by
any party, the Company and Sevenson entered into a settlement agreement (the “Settlement Agreement”). Under the
Settlement Agreement, Sevenson surrendered and released all claims it has against the Company. The Company surrendered
and released all claims it has against Sevenson. As consideration for the Settlement Agreement, the Company made a
payment totaling US$1.86 million on November 29, 2018.
16
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
10. Borrowings:
As at December 31, 2018, the Company had the following term loan facilities and operating lines of credit:
Term loan facilities
Interest rate
Maturity date
Face value
Carrying value
SGRS LP term loan
ML LP term loan
AM LP term loan
BA + 2.00%
BA + 1.95%
BA + 2.25%
Jun 30, 2022
Jul 31, 2022
Sep 6, 2022
$
6,300
41,600
17,400
$
6,245
41,361
17,250
Operating lines of credit
Interest rate
Maturity date
SGRS LP line of credit
ML LP line of credit
AM LP line of credit
BA + 2.00%
Prime + 0.25%
BA + 2.25%
Jun 30, 2022
Jul 31, 2022
Sep 6, 2022
$
65,300
$
64,856
Maximum
available
500
1,000
3,000
4,500
$
$
Available
for use
500
1,000
3,000
4,500
$
$
As at December 31, 2017, the Company had the following term loan facilities and operating lines of credit:
Term loan facilities
Interest rate
Maturity date
Face value
Carrying value
SGRS LP term loan
ML LP term loan
AM LP term loan
BA + 2.00%
BA + 1.95%
BA + 2.25%
Jun 30, 2022
Jul 31, 2022
Sep 6, 2022
$
6,300
34,600
17,400
$
6,230
34,329
17,213
Operating lines of credit
Interest rate
Maturity date
SGRS LP line of credit
ML LP line of credit
AM LP line of credit
BA + 2.00%
Prime + 0.25%
BA + 2.25%
Jun 30, 2022
Jul 31, 2022
Sep 6, 2022
$
58,300
$
57,772
Maximum
available
500
1,000
3,000
4,500
$
$
Available
for use
500
1,000
3,000
4,500
$
$
(a) SGRS LP term loan and line of credit:
SGRS LP has a credit agreement that consists of a non-amortizing $6.3 million term loan and a $0.5 million demand
operating facility from a Canadian chartered bank. The SGRS LP term loan and line of credit are secured by the SGRS
Rights and the royalties payable by Sutton under the Sutton Licence and Royalty Agreement.
On June 20, 2017, SGRS LP amended the terms of its term loan and line of credit agreement to extend the maturity date
from June 19, 2018 to June 30, 2022.
The SGRS LP term loan and line of credit are subject to certain financial covenants, including a covenant for SGRS LP to
maintain EBITDA for the trailing twelve-month period of at least $2.9 million. As at December 31, 2018 and 2017, SGRS
LP was in compliance with all financial covenants associated with this facility.
17
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
10. Borrowings (continued):
(b) ML LP term loan and line of credit:
ML LP has a credit agreement that originally consisted of a non-amortizing $34.6 million term loan and a $1.0 million
demand operating facility from a Canadian chartered bank. On May 1, 2018, ML LP amended its credit agreement to
increase its term loan facility from $34.6 million to $41.6 million. The increase in the term loan facility was used to partially
finance the consideration paid to Mr. Lube for the increase in the Mr. Lube Royalty Rate and the net addition to the Mr.
Lube royalty pool (note 8). The ML LP term loan and line of credit are secured by the ML Rights and the royalties payable
by Mr. Lube under the Mr. Lube Licence and Royalty Agreement.
On July 31, 2017, ML LP amended the terms of its term loan and line of credit agreement to extend the maturity date from
August 19, 2018 to July 31, 2022.
The ML LP term loan and line of credit are subject to certain financial covenants, including a covenant for ML LP to
maintain a funded debt to EBITDA ratio of not more than 3.0:1.0. As at December 31, 2018 and 2017, ML LP was in
compliance with all financial covenants associated with this facility.
(c) AM LP term loan and line of credit:
AM LP has a credit agreement that consists of a non-amortizing $17.4 million term loan facility and $3.0 million demand
operating facility from a Canadian chartered bank. The AM LP term loan and line of credit are secured by the AIR MILES
Rights and the royalties payable by LoyaltyOne Co. under the AIR MILES Licenses.
The AM LP term loan and line of credit are subject to certain financial covenants, including a covenant for AM LP to
maintain a funded debt to EBITDA ratio of not more than 2.5:1.0. As at December 31, 2018 and 2017, AM LP was in
compliance with all financial covenants.
11. Convertible debentures:
On November 7, 2017, the Company issued convertible unsecured subordinated debentures (“Debentures”) for an aggregate
principal amount of $57.5 million at a price of $1,000 per Debenture. The Debentures mature on December 31, 2022 and bear
interest at an annual rate of 5.25% payable semi-annually in arrears on the last day of December and June in each year,
commencing June 30, 2018. At the holder’s option, the Debentures may be converted into common shares of the Company at
any time prior to the earlier of: (i) the last business day immediately preceding December 31, 2022; or (ii) the date specified by
the Company for redemption of the Debentures. The conversion price will be $4.55 per common share (the “Conversion Price),
subject to adjustment in certain circumstances.
The Debentures are not redeemable prior to January 1, 2021, except upon the satisfaction of certain conditions after a change
of control has occurred. On or after January 1, 2021 and prior to December 31, 2021, the Debentures may be redeemed in
whole or in part from time to time at DIV’s option, provided that the volume weighted average trading price of the common
shares on the TSX during the 20 consecutive trading days ending on the fifth trading day preceding the date on which the
notice of the redemption is given is not less than 125% of the Conversion Price. On or after December 31, 2021 and prior to
the maturity date, DIV may, at its option, redeem the Debentures, in whole or in part, from time to time at par plus accrued and
unpaid interest. On redemption or at maturity, the Company will repay the indebtedness of the Debentures by paying an amount
equal to the principal amount of the outstanding Debentures, together with accrued and unpaid interest thereon.
The Company may, at its option, elect to satisfy its obligation to repay the principal amount of the convertible debentures,
which are to be redeemed or which have matured, by issuing shares to the holders of the convertible debentures. The number
of shares to be issued will be determined by dividing $1,000 of principal amount of the convertible debentures by 95% of the
then current market price on the day preceding the date fixed for redemption or the maturity date.
On initial recognition, the Company valued the liability component at $53.2 million and the equity component at $4.3 million. In
addition, the Company incurred transaction costs of $2.8 million, of which $2.6 million was allocated to the liability component
and $0.2 million was allocated to the equity component. The net amount recognized as the equity component of the Debentures
was $2.9 million, after deferred taxes of $1.2 million and transaction costs of $0.2 million.
18
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
11. Convertible debentures (continued):
The following table reconciles the principal amount of the convertible debentures to the carrying value of the liability component.
Principal amount
Equity component of debentures
Unamortized deferred financing fees
Accretion on liability component of debentures
2018
2017
$
57,500
$
57,500
(4,312)
(2,080)
832
(4,312)
(2,522)
105
$
51,940
$
50,771
12. Interest rate swaps:
The Company has interest rate swap agreements that entitle the Company to receive interest at floating rates and effectively
pay interest at fixed rates for 100% of the SGRS LP term loan facility, 83% of the ML LP term loan facility, and 50% of the AM
LP term loan facility.
The interest rate swaps are re-measured at fair value at the end of each reporting period with fair values calculated as the
present value of contractual cash flows based on quoted forward curves and discount rates incorporating the applicable yield
curve. The following table summarizes the interest rate swap agreements the Company has entered into as of December 31,
2018:
SGRS LP
ML LP
AM LP
Effective date
Maturity date
Jun 19, 2018
Aug 13, 2018
Sep 6, 2017
Jun 21, 2021
Jul 31, 2022
Aug 19, 2022
Fixed
interest rate
4.64%
4.17%
4.42%
Notional amount
$
6,300
34,600
8,700
13. Deferred income taxes:
Deferred income tax expense
2018
4,275
4,275
$
$
$
$
2017
4,353
4,353
19
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
13. Deferred income taxes (continued):
Income tax expense as reported differs from the amount that would be computed by applying the combined Federal and
Provincial statutory income tax rates to the income before income taxes. The reason for the difference is as follows:
Income before income taxes
Combined Canadian federal and provincial rates
$
Expected tax expense
Increased (decreased) by:
Permanent and other non-deductible differences
Impact of deferred tax rates applied versus current tax rates
Change in prior year estimates
$
2018
14,395
27%
3,887
388
-
-
2017
15,913
26%
4,137
123
92
1
$
4,275
$
4,353
The tax effect of temporary differences that gives rise to the net deferred tax liability are as follows:
Non-capital losses
Financing and share issuance costs
Intangible assets
Investment tax credits
Other
Convertible debentures
Intangible assets
Net deferred tax liability
$
$
2018
1,016
185
282
199
37
(939)
(8,518)
$
(7,738)
$
2017
2,225
704
304
199
16
(1,136)
(5,775)
(3,463)
As at December 31, 2018, the Company has non-capital loss carry forwards of $3.8 million (2017 - $8.2 million), which can be
carried forward and applied against future taxable income. Non-capital loss carry forwards expires as summarized in the table
below.
2033
2034
$
$
643
3,120
3,763
The deferred tax liability as at December 31, 2018 is largely associated with the temporary differences on the Company’s
intangible assets, which have an undepreciated capital cost allowance of approximately $150.3 million (2017 - $160.4 million).
14. Share capital:
As at December 31, 2018, the authorized share capital of the Company consists of an unlimited number of common shares.
The Company has a dividend reinvestment plan (“DRIP”) that allows eligible holders of the Company’s common shares to
reinvest some or all cash dividends paid in respect of their common shares in additional common shares of the Company. At
the Company’s election, these additional common shares may be issued from treasury or purchased on the open market. If
the Company elects to issue common shares from treasury, the common shares will be purchased under the DRIP at a 3%
discount to the volume weighted average of the closing price for the common shares on the TSX for the five trading days
immediately preceding the relevant dividend payment date. The Company may, from time to time, change or eliminate the
discount applicable to common shares issued from treasury.
20
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
15. Share-based compensation:
(a) Restricted share units:
The Company has a long-term incentive plan (the “Plan”) available to both employees and non-employees as a form of
retention and incentive compensation. The maximum number of common shares issued under the Plan is 10% of the
issued and outstanding common shares of the Company at the time of the grant.
Under the Plan, the Company can issue RSUs whereby each RSU is equal in value to one common share of the Company
and is entitled to dividends that would arise thereon if it was an issued and outstanding common share. The notional
dividends are recorded as additional issuance of RSUs during the life of the RSU. Currently, all the outstanding RSUs will
be settled in common shares, unless the RSU holder elects to settle a portion of the RSUs in cash to pay the applicable
withholding taxes.
The number of RSUs outstanding is as follows:
Balance, beginning of year
Granted
Dividends earned
Settled
Balance, end of year
Unvested
Vested
2018
Weighted
average grant-
date fair value
$
$
$
$
3.08
3.21
3.08
2.59
3.30
3.31
2.90
Number of
RSUs
892,674
307,042
56,404
(334,599)
921,521
898,615
22,906
Number of
RSUs
606,016
609,913
49,639
(372,894)
892,674
722,911
169,763
2017
Weighted
average grant-
date fair value
$
$
$
$
2.42
3.36
2.80
2.43
3.08
3.29
2.19
As at December 31, 2018, approximately 14% of the unvested RSUs will vest in 2019, 75% will vest in 2020, and the
remainder in 2021.
(b) Share options:
The following table summarizes the changes in the Company’s share options during the years ended December 31, 2018
and 2017:
2018
Weighted
average
exercise price
$
3.15
-
1.79
1.50
3.26
Number of
options
232,900
2,300,000
(51,500)
-
$
2,481,400
$
2017
Weighted
average
exercise price
1.66
3.26
1.50
-
3.15
Balance, beginning of year
Granted
Exercised
Expired
Number of
options
2,481,400
-
(129,900)
(51,500)
Balance, end of year
2,300,000
$
21
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
15. Share-based compensation (continued):
(b) Share options (continued):
The total fair value of the share options granted of $0.9 million during the year ended December 31, 2017 was calculated
as of the grant date using the Black-Scholes option pricing model with the following assumptions and inputs:
Expected life
Expected volatility
Expected dividend yield
Risk-free interest rate
Weighted average share price
2017
5 years
29.3%
6.8%
1.8%
$ 3.26
The following table summarizes information relating to outstanding and exercisable options as at December 31, 2018:
Options outstanding
Weighted
average
remaining
life (years)
Weighted
average
exercise price
per share
Options exercisable
Number
exercisable
Weighted
average
exercise price
per share
3.80
3.80
$
$
3.26
3.26
-
-
$
$
-
-
Number
of options
2,300,000
2,300,000
Exercise
prices
$ 3.22 - $ 3.53
16. Income per share:
Income for the year
Weighted average number of shares outstanding – basic
Dilutive adjustment for share options
Dilutive adjustment for RSUs
Weighted average number of shares outstanding – diluted
Net income per common share:
Basic
Diluted
17. Other finance income (costs), net:
Finance income
Foreign exchange gain (loss)
Amortization of deferred financing charges
Accretion expense
2018
2017
$
10,120
$
11,560
107,195,740
36,865
777,387
108,009,992
105,916,177
93,245
383,461
106,392,883
0.09
0.09
$
$
0.11
0.11
2018
1,575
12
(555)
(727)
2017
828
(14)
(193)
(105)
516
$
$
$
$
$
$
305
22
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
18. Financial instruments:
The Company must classify fair value measurements according to a hierarchy that reflects the significance of the inputs used
in performing such measurements. The Company’s fair value hierarchy comprises the following levels:
Level 1 – quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active
markets are those in which transactions occur in sufficient frequency and volume to provide pricing information on an
ongoing basis.
Level 2 – pricing inputs are other than quoted in active markets included in Level 1. Prices in Level 2 are either directly or
indirectly observable as of the reporting date.
Level 3 – valuations in this level are those with inputs for the asset or liability that are not based on observable data.
The carrying value of current financial assets and liabilities approximate their fair value due to their short-term nature. The
carrying value of the long-term bank loans approximates their fair value as these facilities bear interest at floating market
interest rates. The fair value of the restricted share unit obligation is measured using Level 1 inputs. The fair value of the
convertible debentures of $56.6 million is measured using Level 1 inputs. The fair value of the interest rate swap assets
(liabilities) are measured using Level 2 inputs.
The following table presents the carrying amounts of each category of financial assets and liabilities:
Assets carried at amortized cost:
Cash and cash equivalents
Royalties and management fees receivable
Amounts receivable
Assets carried at fair value:
Interest rate swap assets
Liabilities carried at amortized cost:
Accounts payable and accrued liabilities
Long-term bank loans
Convertible debentures
Liabilities carried at fair value:
Interest rate swap liabilities
Restricted share unit obligation
2018
2017
$ 78,342
3,965
153
$ 82,460
$
$
-
832
64,856
51,940
$
85,816
4,008
150
$
89,974
$
$
160
1,354
57,772
50,771
$ 117,628
$
109,987
$
$
137
-
137
$
$
-
218
218
23
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
19. Financial risk management:
The Company has exposure to the following risks from its use of financial instruments: credit risk, market risk, liquidity risk,
currency risk and interest rate risk. This note presents information about the Company’s exposure to each of the above risks,
the Company’s objectives, policies and processes for measuring and managing risk, and the Company’s management of
capital. Further quantitative disclosures are included throughout these consolidated financial statements.
The Company’s risk management policies are established to identify and analyze the risks faced by the Company, 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 Company’s activities. The Company, 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.
The Board of Directors has responsibility for the oversight of the Company’s risk management framework. The Board of
Directors has mandated the Audit Committee to review how management monitors compliance of the Company’s risk
management policies and procedures and review the adequacy of the risk management policies and procedures.
(a) Credit risk:
Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet
its contractual obligations. Credit risk is associated with the Company’s cash and cash equivalents, royalties and
management fees receivable, and amounts receivable.
Credit risk on the Company’s cash and cash equivalents are mitigated by holding these amounts with a Canadian
chartered bank of high creditworthiness. Credit risk on the royalties and management fees receivable is monitored through
regular review of the operating and financing activities of the Company’s Royalty Partners. The carrying amount of financial
assets represents the maximum credit exposure.
The maximum exposure to credit risk at December 31, 2018 and 2017 were as follows:
Cash and cash equivalents
Royalties and management fees receivable
Amounts receivable
2018
78,342
3,965
153
82,460
$
$
$
2017
85,816
4,008
150
$
89,974
The aging of royalties and management fees receivable, as well as amounts receivable at December 31, 2018 and 2017
were as follows:
Current
Over 30 days
2018
4,118
-
4,118
$
$
2017
4,118
40
4,158
$
$
24
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
19. Financial risk management (continued):
(b) Liquidity risk:
Liquidity risk is the risk that the Company will encounter difficulty in meeting the obligations associated with its financial
liabilities that are settled by delivering cash or another financial asset. The Company’s approach to managing liquidity
risk is to monitor consolidated cash flow to ensure that there will always be sufficient liquidity to meet liabilities when due.
As at December 31, 2018, the Company had a cash and cash equivalents balance of $78.3 million (2017 - $85.8 million)
and positive working capital of $81.7 million (2017 - $88.5 million). Management expects to refinance the non-amortizing
loans as they become due, and has sufficient cash resources to settle other contractual liabilities as they become payable.
The following are the contractual maturities of financial liabilities, including estimated interest payments and excluding the
impact of netting agreements.
Accounts payable and
accrued liabilities
Long-term bank loans(1)
Convertible debentures
Total contractual obligations
(1)
Includes the impact of interest rate swap agreements.
Carrying Contractual
cash flow
amount
2019
2020
2021
2022
Thereafter
$
832
64,856
51,940
832 $
$
75,397
69,576
832 $
2,805
3,019
-
2,805
3,019
$
-
2,805
3,019
$
-
66,982
60,519
$
$117,628 $ 145,805 $ 6,656 $ 5,824
$ 5,824
$127,501 $
-
-
-
It is not expected that the cash flows included in the maturity analysis could occur significantly earlier, or at significantly
different amounts.
(c) Currency risk:
Currency risk is the risk that the fair value or future cash flows will fluctuate due to changes in foreign exchange rates. The
Company’s exposure to foreign currency risk at the reporting date is described below:
Expressed in thousands of U.S. dollars
Cash and cash equivalents
Net exposure in thousands of U.S. dollars
2018
144
144
$
$
2017
293
293
$
$
A 10% strengthening (weakening) of the Canadian dollar against the U.S. dollar would have increased (decreased) equity
and comprehensive income and loss by a nominal amount as at December 31, 2018 and 2017.
(d) Interest rate risk:
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes
in market interest rates. The Company’s exposure to interest rate risk mainly arises from the long-term bank loans, which
are subject to floating interest rates. As at December 31, 2018, interest rate risk was mitigated by interest rate swap
arrangements on $49.6 million of $65.3 million of the Company’s term loan facilities. As at December 31, 2017, interest
rate risk is mitigated by interest rate swap arrangements that fix the interest rates on $49.6 million of $58.3 million of the
Company’s term loan facilities.
Based on the balance outstanding on December 31, 2018 and 2017, a one percentage point increase (decrease) in the
interest rate would increase (decrease) interest expense by a nominal amount.
25
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
19. Financial risk management (continued):
(e) Capital management:
The Company’s objective is to maintain a strong capital base to maintain investor, creditor and market confidence and to
develop the business.
Management defines capital as the Company’s total shareholders’ equity, long-term bank loans and convertible
debentures. The Board of Directors does not establish quantitative return on capital criteria for management. The Board
of Directors reviews the capital structure on a quarterly basis.
In order to maintain or adjust the capital structure, the Company may issue new shares, warrants, or debt, draw on its
operating line of credit, purchase shares for cancellation pursuant to normal course issuer bids, or reduce debt.
20. Related party transactions:
In addition to information disclosed elsewhere in these consolidated financial statements, the Company had the following
related party transactions during the years ended December 31, 2018 and 2017:
Key management personnel of the Company includes Members of the Board of Directors, the President and CEO, and CFO.
The table below provides a breakdown of the compensation of key management personnel included in net income:
Short-term benefits
Share-based compensation
2018
1,490
1,406
2,896
$
$
2017
1,473
975
2,448
$
$
During the year ended December 31, 2018, the Company paid fees of $0.2 million (2017 - $0.6 million) to a legal firm where a
former director of the Company is a partner.
The Company’s President and CEO and one of the Company’s directors are co-founders and managing partners of Maxam
Capital Corp (“Maxam”). The Company entered into a services agreement with Maxam whereby Maxam provides rent and
administrative services to the Company. During the year ended December 31, 2018, the Company paid Maxam approximately
$0.1 million (2017 - $0.1 million).
The above transactions are in the normal course of operations and are measured at the exchange amount, which is the amount
of consideration established and agreed to by the related parties.
26
DIVERSIFIED ROYALTY CORP.
Notes to Consolidated Financial Statements
(Tabular amounts expressed in thousands of Canadian dollars)
For the years ended December 31, 2018 and 2017
21. Supplemental cash flow information:
The following table reconciles the movements in liabilities to cash flows arising from financing activities:
Balance, December 31, 2016
$
40,659
$
-
$
40,659
Long-term debt
(note 10)
Debentures
(note 11)
Total
Changes from financing cash flows:
Proceeds from issuance of debt
Debt financing and prepayment fees
Liability-related other changes:
Equity component of debentures
Amortization of deferred financing charges
Accretion expense
17,400
(415)
-
128
-
57,500
(2,798)
(4,101)
65
105
74,900
(3,213)
(4,101)
193
105
Balance, December 31, 2017
$
57,772
$
50,771
$
108,543
Changes from financing cash flows:
Proceeds from issuance of debt
Debt financing costs
Liability-related other changes:
Amortization of deferred financing charges
Accretion expense
7,000
(29)
113
-
-
-
442
727
7,000
(29)
555
727
Balance, December 31, 2018
$
64,856
$
51,940
$
116,796
27