Hammond Power Solutions Annual Report 2021

Plain-text annual report

ELECTRIFICATION Annual Report 2021 “ Our planet and life are underpinned by electric power and the expansion of electrification is accelerating. We hear it every day as companies and countries globally are looking to reduce their carbon footprint through the use of electrical power. ” What’s Inside: Electrification Business Growth What Transformers Do 2021 Highlights Where We’re Headed Strategic Thinking CEO’s Message Review of Operations 1 3 4 6 8 10 13 14 The Numbers Management’s Discussion and Analysis Audit Report 18 20 43 Consolidated Financial Statements 46 Notes to Consolidated Financial Statements Company Information 51 100 Passionate People Electrifying a Better World Electrification: The action or process of charging something with electricity; the conversion of a machine or system to the use of electrical power. Transformers are the unsung heroes of the regulated the power all night long stepping modern world. They function quietly in the down the 7,200 volts to the 240 volts that background, working tirelessly, yet rarely your household electrical service requires. receiving the praise they deserve for keeping As you look at your phone to check society electrified and functioning each and the weather, the transformers in the data every day. centre housing that critical application Transformers affect nearly just about and data play a vital role in the monitoring every part of our daily lives, reducing or and metering of operations, ensuring that increasing the voltage of an alternating systems are kept up and running to deliver current in many industries and in many the information you need on demand. You’ll applications. continue to benefit from the functioning It’s 6:00am and your alarm goes off of these transformers as you go about signaling the start of your day. The transformer your day from your home or away from on the power line feeding into your home has home office. 1 ANNUAL REPORT 2021 HPS Electrifies Communities When you turn the key in your vehicle to As the world looks to replace the head out for groceries at the end of the day, technologies that use fossil fuels with you can thank the transformer on the oil rig technologies that use electricity, HPS in the Atlantic that was an integral part in the is meeting the electrification demand. operation to extract, process and store the Depending on the resources used to generate petroleum and natural gas that lies in the rock electricity, electrification can potentially 2 formations beneath the seabed. Or perhaps reduce carbon dioxide (Co2) emissions from you have decided to go electric, quietly pulling the transportation, building and industrial into the parking lot of the grocery store in sectors which account for about 63 percent your electric vehicle and into a spot equipped of all United States (“U.S.”) greenhouse to charge your car while you’re filling up your gas emissions.1 cart. A series of transformers can be thanked The combination of our resilience, for ensuring that you are getting the right drive, decades of experience, commitment, power, right when you need it. engineering expertise, solid supplier As the day draws to a close and you dim relationships, and a broad and unique the lights to wind down before bed, take a business perspective gained through our moment to thank the unsung transformer diverse products, customers and markets are heroes that have kept your day electrified – all key success factors critical to our success working quietly behind the scenes delivering in 2022 and beyond. the power you’ve needed when you needed it – every time. 1 Source: Electrification 101, Kathryne Cleary, December 2019. Data from EPA “Inventory of US Greenhouse Gas Emissions and Sinks” (2017) HAMMOND POWER SOLUTIONS 21Global Locations 1,400 Employees $380M Global Sales ~600,000 Units/Year Business Growth Sales through our expanded U.S. distributor pandemic. In addition, we are seeing significant network have been growing at the highest rate growth and future opportunities in sectors such we’ve seen as the U.S. economy recovers from the as oil and gas, mining, and data centres. Sales Channel Geographic Sales 3 12% Private Label 24% OEM 64% Distribution $18,280 India $130,184 Canada $231,738 United States/ Mexico (in thousands of Canadian dollars) ANNUAL REPORT 2021Transformers are essential/multi-purpose/ubiquitous in all electrical grids GENERATION Transformers step up power for long distance transmission. TRANSMISSION Transmission may require several transformers based on distance and voltage. 4 HAMMOND POWER SOLUTIONS COMMERCIAL Change voltage levels to supply electrical loads required. DISTRIBUTION Electricity is stepped down for delivery along distribution lines. RESIDENTIAL Change voltage levels to supply electrical loads for consumption in residential settings. INDUSTRIAL Change voltage levels to supply electrical loads for specific equipment. 5 ANNUAL REPORT 20212021 Highlights 6 HPS’ ERP System The implementation of a company-wide Enterprise Employee Health & Safety In 2020 and 2021, HPS implemented robust health Resource Planning (“ERP”) system has allowed and safety precautions dedicated to providing HPS to enhance the availability and quality of a safe working environment for our employees information accessible to support operational while continuing to manufacture and serve our performance, improve customer service, customers during this volatile, unpredictable time. supplement strategic decision making and audit As an essential service, the Company has continued and control – working toward providing one global, to remain operational during the entire pandemic integrated, consistent source of information to ensure our customers have the transformers and data. During Quarter 2, 2021 the ERP they require to fulfill the many applications they system went live in our operation in Granby, are purchased for. Quebec and represents the Company’s final operation to be converted to the platform. HAMMOND POWER SOLUTIONS Data Centres The global pandemic forced companies to work EV Charging Stations To recharge an electric vehicle (“EV”), you treat it remotely and schools to teach remotely creating like your smartphone – just plug it in while you’re more demand for rapid access to information not using it. EV owners are used to plugging from data centres. Maintaining the quality and their vehicles in when they can, as every hour availability of online services while at the same adds approximately 40km back into the battery. time regulating the general increase in demand Why not have it filling up, while you’re going on is no simple task. Data centres not only ensure about your life? One Canadian grocery store chain that information technology (“IT”) companies knows this, so they have committed to installing function smoothly but also society in general. Level 2 EV charging stations in 90 of their locations HPS transformers are integral to this estimated integrating HPS transformers to regulate the $105.6 billion by 2026 – rapid growth industry.1 power for different voltage and power level needs. 7 Hospital Infrastructure Growth HPS transformers were specified by five of the largest hospital infrastructure projects in Canada and the U.S. in 2021. HPS earned a “preferred supplier” status because of our proven track record of delivering a high quality product, on time and within budget – resulting in no down time. 1 www.mordorintelligence.com/industry-reports/service-market-for-data-center ANNUAL REPORT 2021Where We’re Headed 8 HPS is in on the ground floor of expanding As companies refine ways to reach other energy needs, powering communities planets, HPS transformers power the when the load gets too heavy for the technology and systems to continue current infrastructure due to the increase advancement in these areas. of internet usage or when they experience the effects and devastation of extreme More sustainable technologies that reduce weather events. environmental impact are a must for the future of our planet, HPS is an integral Potted transformers used in high efficiency part of the power process of new breaking solar-powered bridge lighting have been technology – meeting the specifications of specified nationally through HPS channels. the innovators. These low voltage tough-as-nails units operate in all conditions keeping the power We are poised and ready to meet the future on even when the weather is extreme. needs of the world’s communities. HAMMOND POWER SOLUTIONS HPS Provides: For our Customers • Compliance with regulatory requirements; For our Shareholders • Escalating growth of the distribution channel; • New product development – including an • New global customers; expanded power quality offering; • Expanded relationships with existing customers; • Expanded product offering using cast • Capital investment in North American resin technology; manufacturing facilities in Canada, the U.S., • Superior customer service; • Accurate ship on time; and India and Mexico; • Establishment of a state-of-the-art core • Competitive pricing for our products. manufacturing facility in Mexico; • Strong earnings per share, solid cash generation; and • Quarterly dividends paid with an attractive yield. For our Employees • The tools to facilitate their best work; • Space and time for innovation and development; • Safety in the workplace, including heightened protocols during the COVID-19 pandemic; and • Ability for remote work, where able, to help manage school closures and health concerns. HPS’ strategic vision and operational initiatives support our industry leadership, operational strength and financial stability now and into the future. 9 ANNUAL REPORT 2021 Strategic Thinking Our Purpose We are passionate people energizing a better world. Our Vision To be a leading global supplier of transformers and magnetics within our chosen markets. Our Mission We are a growing and profitable global supplier of transformers and related magnetic products dedicated to satisfying the collective needs of our shareholders, customers, suppliers, employees and community. Our Strategic Pillars 10 Customers and Markets Operational and Financial Excellence Drive organic growth through Achieve operational excellence via competitive product offering and continuous improvement and efficiency unparalleled customer experience, and plays, and grow revenue / EBITDA with enhance strategic growth via acquisitions. opportunistic acquisitions and cost reduction initiatives. People and Culture Build the next leadership team, and be a preferred employer due to our clarity of purpose and employee value proposition. Sustainability Design energy-efficient products; shrink the ecological footprint of our operations and energize the world responsibly for generations to come. HAMMOND POWER SOLUTIONS Our Values We value the safety and well-being of all We expect honesty, integrity and ethical behaviour We embrace diversity by nurturing an inclusive environment and treating everyone with dignity and respect We promote innovation and a relentless pursuit of continuous improvement through teamwork We believe in a collaborative approach to social and environmental sustainability 11 HPS Corporate Sustainability Our passion for sustainability ensures that the world is energized today for future generations to come. We commit to designing energy-efficient products; to shrinking the ecological footprint of our operations; and to developing a workplace which fosters inclusion and innovation. Our 5 Pillars of Sustainability 1. Economics 2. People 3. Community 4. Environment 5. Continuous Improvement ANNUAL REPORT 2021“ The demand for our transformers particularly in North America continues to accelerate and sales volumes have returned to pre-pandemic levels. ” 12 HAMMOND POWER SOLUTIONS To Our Shareholders We are very pleased to report a strong year of performance given the challenging and volatile environment that we faced in 2021. We delivered sales growth of 18% and earnings and meet the needs of our customers that made growth of almost 8% during a year riddled with the difference. None of this would have been material shortages and supply chain delays, possible without the passion, engagement and unprecedented material cost increases, and an hard work of our employees. I would like to take unpredicted resurgence in business from all this opportunity to recognize and thank not only quarters, all the while managing through the our employees who helped to make 2021 a very challenges created by two new variant surges of positive year, but also our valued suppliers who the COVID-19 pandemic, never losing sight of our did their best during very difficult times to support focus on customer service as well as the health our plants building all of the products we could to and well-being of our employees. meet our growth and satisfy our distributors and It doesn’t seem that long ago when we were customers. all dealing with the first wave of the COVID-19 I believe that 2022 will be even better, yet pandemic as it washed over the world and unfortunately as I write this, serious geopolitical 13 caused a short but very severe global recession events in Eastern Europe are creating new in 2020. The significant rebound in growth in late uncertainties while their effects on us and the 2020 which accelerated in 2021 presented both broader global economy are still speculative. But opportunities and challenges. The strengths and as we did in 2020 and 2021, I believe there is no capabilities that we built across our organization stronger company in the dry transformer business over the last decade helped HPS weather these that can weather these storms than Hammond storms better than any dry transformer company Power Solutions. We have a strong momentum in North America. Our diversity in geography, carrying us into 2022. markets, channels and products, as well as being the biggest in our business, gave Hammond both tactical and strategic advantages. But through all of this, it was our focus on doing the best that we can under difficult circumstances to try William G. Hammond CHAIRMAN OF THE BOARD & CHIEF EXECUTIVE OFFICER ANNUAL REPORT 2021 Review of Operations Over the last five years, we have built a business with greater resilience and diversity. Over the last two years, we have all been the shortage of containers, shortages of tested by so many new and unexpected workers and COVID-19 outbreaks shutting events. It has been a very challenging time, ports down, coupled by the sheer volume and I am hopeful that the worst of this of things moving around the world again, pandemic is behind us and we can move lengthy supply chain delays complicated onto whatever the new normal looks like. the situation even more. After the global recession of 2020, we Despite all of this, we were able to were all looking for a better 2021. Business increase our sales by 18% and our net in many sectors started to rebound in earnings by almost 8% over 2020. I am the last part of 2020 and this momentum very proud of our performance under the accelerated into 2021. I don’t think any of circumstances and feel that we are even us were expecting the new challenges that stronger after maneuvering through the came with the growing economy. Mines, crucible of the last two years. Much of this steel mills and factories across the world is because of the strategic and operational were shut down during the severe recession advantages that we have built over the last of 2020. As the first wave of the COVID-19 decade that can be defined by one word - pandemic started to pass and the global diversification. In our business, there is no economy came to life again, the production other dry transformer company that has the of materials and components could not diversity of geographical markets, multiple catch up fast enough. These issues became plants in multiple countries, the diversity even more evident as growth accelerated of markets and channels, as well as the even more in 2021, and if this wasn’t broadest range of dry transformers, both challenging enough, costs of everything custom and standard, of any competitor. began to increase as well. In fact, we had In addition to this, we also have a highly to deal with the greatest inflation we have engaged and passionate employee culture experienced in over 40 years. Then on top focused on doing whatever we can to meet of this, for a variety of reasons such as the needs of our distributors and customers. 14 HAMMOND POWER SOLUTIONS Growth in 2021 came from multiple geographies, capabilities and participate in the consolidation of the markets and channels. Our U.S. sales grew by 16.8%, Mexican transformer industry. We have already seen in Canada we grew by 19.3%, in India our sales grew keen interest from distributors, OEMs and building by 24.4%, and by the end of 2021 we began to sell developers in working with Hammond – all supported transformers in Mexico and Latin America. Our U.S. from our facilities and staff in Monterrey. We see very distributor channel continued to be a massive growth sizable potential and growth in the years to come from engine for HPS. In the last two years we have added Mexico, Central America, selective countries in South over 400 new distributor branches across the U.S. – and America and the Caribbean. since 2015 we have added close to 2,000. With this In addition to growth from our traditional markets, large network of distributors, we have not only increased we are also starting to see new growth opportunities our market share but also been able to participate in from our expansion into power quality. For many years, new markets and applications as the North American we designed and built reactors for certain kinds of economy has come back to life. Much of this growth is power quality applications. This market has evolved over the result of the superior service we can provide from the last decade with the introduction of more active the largest and broadest inventory of transformers from product solutions and as a result, we decided to expand our nine regional warehouses across North America. our product offering and capabilities to broaden our With the global economy surging back and the participation in this growing market. We also recognized increased consumption of resources, we have also seen the opportunity to take advantage of our relationships interest grow in our Original Equipment Manufacturer and scale in the North American distribution channel (“OEM”) business late in the year. As part of this growth, to grow and take market share from two established we have added a number of new large OEM customers competitors in this business. One of the ways that we building data centre systems for the North American have done this is through the acquisition of a company market as well as new oil drilling technology being used called Mesta located near Pittsburgh, Pennsylvania in in the Middle East. 2021. This small but highly profitable company builds 15 This growth, be it through our distributor channel a line of specialized active filter systems which will help or direct to our OEM customers, is coming from a broad us broaden our power quality experience and product range of markets. They include new emerging markets capabilities. They are also involved in producing a line of like Electric Vehicle (“EV”) recharging, solar and energy products used in the induction heating business or more storage, data centers, distribution centers, oil and gas simply put furnaces that melt silica for the production pumping, pipeline expansions, mining equipment, of computer chips. This particular market is very busy condominium construction, hospitals, transit expansions, right now given the expansion of chip manufacturing in new naval ship construction, elevator manufacturers North America and Europe. and factory expansions. Through all of this growth, we have had to deal with As mentioned earlier in 2021, after a delay of the greatest inflationary pressures since the 1970’s. This almost two years caused by the COVID-19 pandemic, has resulted in multiple and significant cost increases in HPS started to market and sell our products in Mexico core steel, copper and aluminum conductors, enclosures, and Latin America. With three plants in Monterrey packaging and everything in between that goes into and a highly engaged and enthusiastic group of building transformers. During 2021, we increased managers and employees, we believe that HPS is well our prices four times in an effort to recoup our cost positioned to take advantage of our broad product increases. Despite these price increases throughout ANNUAL REPORT 2021 REVIEW OF OPERATIONS the year, we were at times not able to recover some remain cautious about investing in new plants until costs that were rising faster than expected. In the end we understand and feel more comfortable about how because of all of this, our gross margins did not grow the global economy may perform through the current as much as we would have expected given the higher uncertainty in the years ahead. volumes during the year. As an organization however, We were also very active in a variety of ways we reacted with greater speed and agility than ever to improve the talent and engagement of our before to these cost increases, projecting them forward employees across the organization. This included the as best as possible, and implementing multiple price implementation of our new HRMS, as well as a new increases. I firmly believe that our margins would have leadership development program and broadening the been more adversely affected if we hadn’t acted with talent depth across the organization in concert with our such speed and aggressiveness. I would also like to formal succession planning process. recognize the tremendous time and effort of our supply And in order to improve how we align and manage all chain employees working with our suppliers to expand business functions in the Company, we began a project our allocations, looking for substitute materials and to design and implement a formal process to drive components where possible, as well as trying their best continuous improvement of management and business to keep the containers of materials and products moving practices. Corporations that have these management from Europe and China to North America. systems in place improved efficiencies, reduced waste During the year we made some significant and costs, improved communication and alignment and investments in systems and equipment across ultimately drive better customer service and financial the organization. Like most companies, we had to performance. We are continuing to design and plan quickly expand and improve a myriad of capabilities to roll out an initial version of the Hammond Business to allow remote working by most of our salaried System in 2022 before implementing it more fully and employees. We invested time and money into a across all locations at the beginning of 2023. 16 variety of business system improvements including the Given our goal of growing sales and expanding our continued implementation of our global ERP platform market penetration, we engaged on multiple fronts to upgrade across all locations, a new Human Resource try and acquire one or more companies in 2021. One Management System, (“HRMS”), electrical and was a competitor, one was in a different segment of mechanical design automation, as well as shop floor the electrical business and one was the power quality information automation And lastly, we began to evaluate company called Mesta. We were only successful in new Customer Relationship Management (“CRM”) tool acquiring Mesta. But we have recently engaged a U.S. and price management systems that would improve M&A firm in 2022 to help us look for and hopefully the flow of information and decision making across succeed in acquiring a company and business that will the Company. help us grow and further diversify in the decade ahead. In addition to business systems, we also invested in I would like to point out that we accomplished all new equipment to expand the capacity of our existing of the above during a year when we had no choice but facilities in order to handle the increased growth rate. to deal with the challenges and uncertainty created by This included equipment investments in our Walkerton, this ongoing pandemic. Like all companies, we had to Ontario plant, our Mexican plants, as well as our manage through two new COVID-19 pandemic variants operations in India. Our goal is to maximize the output that swept across our communities causing higher from our seven existing North American plants and absenteeism and ever changing restrictions depending HAMMOND POWER SOLUTIONS on the country, province, state and health district you We are the dominant North American leader in were located in. We happen to have operations in dry-type transformers, and we are one of the largest and four countries, two provinces, four states, and eight most profitable companies in this business worldwide. local health districts – all with differing policies and Our superior service, scale and product quality gives guidelines. I am proud to say that we were successful us premium pricing power. We have a hard working in our most important goal of protecting the health and and passionate employee culture. We are committed safety of our employees over the last two years, and to continuous innovation and investment in the during this time did not have to shut down any of our transformer business. We have a relentless focus on our North American plants due to infections. Unfortunately, customers and their needs. All of this is the foundation our Indian plants were forced to shut down in 2020 of our industry leading reputation and success. and 2021 for a period of time due to a country-wide We are very proud of our performance in 2021 order that closed all companies. Despite all these new and the Company we have built over the last 21 years. challenges, we still accomplished so much without ever Nothing seems easy anymore given what has happened losing focus on doing whatever we could to service the just in the last two years, but we remain cautiously needs of our distributors and customers. This makes optimistic about our future as we navigate an even 2021 an even more impressive year in my opinion. more challenging external landscape. We entered 2022 with great optimism as the strong momentum of 2021 spilled over into the new year. Backlog is at the highest levels we have ever experienced. I believe that we are going to have an even stronger year of growth in sales and profitability, but our crystal ball has become a little murkier with the disturbing events unfolding in Eastern Europe – with the vast majority of our business disconnected from the events and impacts of what is currently happening in Europe. However, the world order has been shaken by these events and we need to be mindful of how this situation effects the global economy going forward particularly in 2023 and 2024. Over the last five years, we have built a business with greater resilience and diversity. We are a 105-year- old company now serving more than 4,000 distributor branches and OEM customers worldwide – shipping over 600,000 units a year from our 21 global locations. We are in the electrification business and our planet and life are underpinned by electric power. Hammond will benefit from not only the growth of the traditional electrical infrastructure but also new trends like expansion of the smart grid, the accelerating move towards EVs, renewable energy and energy storage. 17 ANNUAL REPORT 2021Consolidated Sales* (in thousands of dollars) Geographic Sales (in thousands of dollars) $301,750 $301,750 $314,082 $358,782 $358,782 $322,097 $380,202 U.S. $174,479 $197,860 $225,709 $198,324 $231,738 Canada $84,325 $93,641 $116,996 $109,080 $130,184 India Italy* $25,722 $22,581 $16,077 $14,693 $18,280 $17,224 2017 2017 2018 2018 2019 2020 2021 * 2017 not restated to reflect discontinued operations 2017 2018 2019 2020 2021 * 2017 not restated to reflect discontinued operations 18 18 COVID-19 Business Update HPS is committed to managing the impact the pandemic will have on its financial performance through: • Robust health and safety precautions; • A dedication to providing a safe working environment for our employees; and • Continuing to serve our customers during this volatile and unpredictable time. HPS has performed very well during these erratic and unpredictable times and remains steadfast in its execution of its operational and strategic plans. HAMMOND POWER SOLUTIONS Gross Margin %* 25.6% 23.2% 24.5% 27.0% 26.9% Basic Earnings (Loss)* Per Share (in dollars) $0.53 $(1.10) $0.99 $1.20 $1.29 2017 2018 2019 2020 2021 2017 2018 2019 2020 2021 * 2017 not restated to reflect discontinued operations * 2017 not restated to reflect discontinued operations EBITDA*+ (in thousands of dollars) Net Operating (Debt) Cash*+ to Equity $23,069 $17,915 $28,175 $29,482 $30,114 (0.15) (0.16) (0.08) (0.01) 0.01 19 19 2017 2018 2019 2020 2021 2017 2018 2019 2020 2021 + * 2017 not restated to reflect discontinued operations * 2017 not restated to reflect discontinued operations Non-GAAP financial measure, refer to page 21 of the annual report Non-GAAP financial measure, refer to page 21 of the annual report + HAMMOND POWER SOLUTIONS ANNUAL REPORT 2021Management’s Discussion and Analysis I am very proud of the overall performance of our Company during the most challenging global environment since the Great Depression. Hammond Power Solutions Inc. (“HPS” or March 24, 2022. All amounts in this report the “Company”) is a leader in the design are expressed in thousands of Canadian and manufacture of custom electrical dollars unless otherwise noted. Additional engineered magnetics, standard electrical information relating to the Company may dry-type, cast resin and liquid filled be found on SEDAR’s website at www. transformers. Advanced engineering sedar.com or on the Company’s website at capabilities, high quality products and fast www.hammondpowersolutions.com. responsive service to customers’ needs have established the Company as a technical and innovative manufacturer serving the Caution regarding forward-looking information electrical and electronic industries. The Company has manufacturing plants in Canada, the United States (“U.S.”), Mexico, and India. The following is Management’s Discussion and Analysis (“MD&A”) of the Company’s consolidated financial position and performance for the years ended December 31, 2021 and 2020, and should be read in conjunction with the accompanying Consolidated Financial Statements of the Company as at December 31, 2021 and 2020, which have been prepared in accordance with International Financial Reporting Standards (“IFRS”). This information is based on Management’s knowledge as at This MD&A contains forward-looking statements that involve a number of risks and uncertainties, including statements that relate to among other things, HPS’ strategies, intentions, plans, beliefs, expectations and estimates, and can generally be identified by the use of words such as “may”, “will”, “could”, “should”, “would”, “likely”, “expect”, “intend”, “estimate”, “anticipate”, “believe”, “plan”, “objective” and “continue” and words and expressions of similar import. Although HPS believes that the expectations reflected in such forward- looking statements are reasonable, such statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors 20 HAMMOND POWER SOLUTIONS or assumptions are applied in making forward-looking operations, EBITDA and Adjusted EBITDA to net statements, and actual results may differ materially earnings for the years ended December 31, 2021 and from those expressed or implied in such statements. December 31, 2020 is contained within this MD&A. Important factors that could cause actual results to Earnings from operations, EBITDA and Adjusted differ materially from expectations include but are not EBITDA should not be construed as a substitute for net limited to: general business and economic conditions earnings determined in accordance with IFRS. (including but not limited to currency rates); changes in “Order bookings” represent confirmed purchase laws and regulations; legal and regulatory proceedings; orders for goods or services received from our and the ability to execute strategic plans. HPS does not customers. “Backlog” represents all unshipped customer undertake any obligation to update publicly or to revise orders. “Book value per share” is the total shareholders’ any of the forward-looking statements contained in equity divided by the average outstanding shares. The this document, whether as a result of new information, terms “earnings from operations”, “EBITDA”, “adjusted future events or otherwise, except as required by law. EBITDA”, “order bookings”, “backlog” and “book value per share” do not have any standardized meaning prescribed Additional GAAP and Non-GAAP measures within IFRS and therefore may not be comparable to This document uses the terms “earnings from similar measures presented by other companies. operations” which represents earnings before finance The Company’s 2021 consolidated financial and other costs/(income) and income taxes. “EBITDA” statements, which comprise the consolidated is also used and is defined as earnings before interest, statements of financial position as at December 31, taxes, depreciation and amortization. Adjusted EBITDA 2021 and December 31, 2020, the consolidated represents EBITDA adjusted for foreign exchange gain statements of operations, comprehensive income, or loss. Net cash or net indebtedness is defined as the changes in equity and cash flows for the years ended bank operating lines of credit net of cash and cash December 31, 2021 and December 31, 2020, and Notes equivalents. Net income taxes payable or receiveable is thereto, have been prepared under IFRS. 21 defined as current income taxes receiveable less current income taxes payable. Operating earnings, EBITDA Overview and Adjusted EBITDA are some of the measures the With an established global market presence and a focus Company uses to evaluate the operational profitability. on market growth, HPS is positioned as a transformer Net cash or net indebtedness and net income taxes industry leader providing standard and custom order payable or receivable are measures the Company uses to solutions, a broad product offering, market access evaluate balance sheet strength. The Company presents through multiple sales channels, outstanding quality EBITDA to show its performance before interest, taxes products and exceptional service. The Company’s and depreciation and amortization. Management operational initiatives and strategic vision culminate believes that HPS shareholders and potential investors to achieve these competitive differentiators. As an in HPS use additional GAAP and non-GAAP financial essential service business HPS has been allowed to measures, such as operating earnings, net cash or net continue to operate during the global coronavirus indebtedness, net income taxes payable/receivable, (“COVID-19”) pandemic. HPS has continued to produce EBITDA and Adjusted EBITDA in making investment transformers for our customers throughout the entire decisions about the Company and to measure its pandemic period while also supporting and ensuring operational results. A reconciliation of earnings from employee safety during this time. ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS Demand for our product is increasing, and in 2021 efficient, diverse transformers and related magnetic we realized our highest annual revenues in company products. The Company’s alignment of its operational history. HPS’ customers and end-users operate in a initiatives and strategic vision enhances these variety of industries and the varying levels of economic competitive differentiators. HPS has a well-established activity within those industries will have an impact on and growing market presence and a focus on continued HPS’ overall sales. During 2021, we saw activity in the growth through current and new customers and project and industrial markets increase, which are sectors products. The Company has a strong financial footing that had stalled when the pandemic began in 2020. The that allows for continued focus on market share growth. Canadian lockdown imposed in early 2020 and again in The Company’s broad global footprint provides a early 2021 impacted several of our markets. While the gateway to new technologies, customers and markets. impact of mandated lockdowns in our customer markets These strengths are important to future revenue and has diminished, there are lingering impacts as a result of earnings growth. supply chain disruptions and rapid inflation. Technology and know-how obtained through With our sales dollar increase came continued acquisitions have allowed the Company to accelerate market share growth. The Company continued to take the product research and development program of its market share in North America, particularly through cast resin transformer technology, which is now utilized its North American Electrical Distributor (“NAED”) in several HPS facilities. The most recent acquisition channel. In response to rising material and logistic of Mesta Electronics Inc. has expanded HPS’ offering costs, we implemented several price increases during into standard and custom active filter and induction 2021. These increases, coupled with strong organic heating products. Mesta shares an excellent reputation growth, lifted sales, bookings and backlog, particularly for product quality, design and reliability. Mesta not towards the end of 2021. Other significant drivers of only expands HPS’ U.S. presence but also broadens our sales and profitability in 2021 were a sales mix shift power solutions product offering and manufacturing 22 towards the distribution channel, the effectiveness of capabilities in power quality solutions. price increases in our OEM and private label channels, Looking forward, in an effort to deliver resilient higher fixed cost absorption, the Canadian Emergency financial performance, HPS continues to concentrate on Wage Subsidy (“CEWS”) benefit and cost reductions. future sales growth, additional gross margin generation The Company has incurred significant costs related and operational improvement. Globally in the U.S., to COVID-19 to ensure the safety of our employees. Canada and Asia, HPS is well situated to grow electrical HPS has been fortunate that there have been a limited industry market share and it continues to be a leader in number of cases impacting our employees and their the markets it serves. In 2021, we began our expansion families to date. We continue to ensure our efforts do of sales efforts into Mexico, with the addition of sales not waiver as the length of the pandemic continues and marketing resources, and corporate infrastructure to extend. HPS’ health and safety practices, including to support this important new market. remote work where possible, have allowed the Company The Company continues to build market presence to continue to operate during the pandemic, ensuring through its product capabilities, product quality, cost business continuity and supplying our customers with effectiveness, service, channel development and the products they need. geographical market expansion. Booking rates and HPS’ history of success is achieved through its backlog have increased in 2021 and are strong moving commitment to producing quality, innovative, energy into 2022. The benefit of the HPS diversified market HAMMOND POWER SOLUTIONS approach allows for the capitalization of growth in $322,097 in 2020, a significant increase of $58,105 expanding market segments, while counterbalancing or 18.0%. the impact of cyclical market declines. A portion of U.S. and Mexico market sales (stated in Canadian annual sales are derived from major customer projects, dollars) were $231,738, an increase of $33,414, or for which exact timing continues to be difficult to 16.8%, compared to 2020 sales of $198,324. U.S. and predict and will influence quarterly sales fluctuations. Mexico sales, (stated in U.S. dollars), have increased Order booking rates continue to grow in strategic from $147,561 in 2020 to $184,900 in 2021, an target markets delivering additional market share increase of $37,339 or 25.3%. Sales were negatively penetration, new account development and expansion impacted by the weakening of the U.S. dollar relative of organic sales. to the Canadian dollar versus 2020. The average U.S. The Company maintains a strong and stable balance to Canadian exchange rate for 2021 was $1.253 versus sheet and excellent liquidity supported by a committed $1.343 in 2020, a U.S. dollar weakening of 6.7%. The credit facility available to implement investment 2021 U.S. sales at prior year exchange rates would have strategies, operational plans and advance growth been $16,142 or 7.0% higher at $247,880. initiatives. The Company’s North American credit The U.S. market experienced significant increases agreement was renegotiated in 2021 and matures in in the NAED channel as the Company continues to June 2026. This agreement provides the Company add additional distributors to the network. There were with the resources necessary to continue to grow also improvements in the specialty, motor control and and expand. switchgear markets during 2021. HPS remains confident in its ability to continue to Canadian sales were $130,184, an increase of generate growth – through our strategic vision merged $21,104 or 19.3% as compared to sales of $109,080 with our operational strategies. Management is aware in 2020. The Canadian market experienced increases in of the need to plan and build for the future and is the NAED, mining and capital equipment markets. determined to proactively confront the profitability Indian sales in 2021 were $18,280, an increase 23 pressures presented in the market. The Company is of $3,587 or 24.4% compared to sales of $14,693 in persistent in identifying and developing new market 2020. The prior year sales, and the second quarter of opportunities, which will come from organic and new 2021 were negatively impacted by COVID-19 as the customer sales expansion, product and technology pandemic dramatically constrained the Indian market, development, cost effectiveness, competitive lead- leading to delays in projects because of government times and manufacturing flexibility. Our capabilities imposed lockdowns. 2021 sales benefited from the are extended through our multi-national operations, realization of these delayed orders. which provide expanded market opportunities, allowing Stated by geographic segment, sales in the U.S. and HPS to deliver results. The Company’s commitment Mexico were 61.0% (2020 – 61.6 %), In Canada were to continuous improvement, cost reduction, improved 34.2% (2020 – 33.9 %) and India accounted for 4.8% efficiencies and overall cost effectiveness will assist in (2020 – 4.5 %) of our total sales. reaching these goals. These strategies will improve and HPS is dedicated to its growth strategy through our build revenue and profitability trends. focus on product development, our capital expenditure Sales Sales in 2021 were $380,202 as compared to sales of program to increase capacity, vertical integration strategies, geographic diversification, innovative research and development projects and our expanded ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS NAED network. Expanded product offerings, the a number of market and geographical segments. In addition of new customers, geographically diverse terms of organic growth, our strategic sales initiatives, manufacturing facilities and market influence will allow service, broad distributor footprint, new product the Company to continue to grow market share globally. development and low industry inventories have all The Company experienced significant increases in supported backlog growth. North American sales through its established NAED HPS is sensitive to the volatility and unpredictability and OEM channels. In the prior year, these markets of current global economies and the impact that this were significantly impacted by COVID-19, resulting could have on booking trends. While several markets in an overall drop in demand, project deferrals and are seeing positive quotation and order trends, the cancellations. HPS continues to grow its market Company is very cognizant that it may see some volatility share through distributor conversions and its custom and unpredictability in longer term booking rates. Some transformer capabilities. The ability to continue to industry-related factors may be contributing to the expand these segments is a result of new customer higher booking rates and backlog, such as global supply additions, organic customer diversity, expanded product chain constraints and low inventories, and therefore offerings and geographically diverse manufacturing may be temporary in nature. capabilities. HPS is not single-market or industry dependent and our market diversification strategies Gross margin provide a natural business hedge. The consolidated gross margin rate in 2021 declined We are committed to consistent quality, competitive slightly to 26.9% versus 27.0% in 2020, a decrease product design, expertise in custom engineered of 0.1% of sales. The small decline in margin rates is products and product breadth. These factors combined significant given the volatile commodity pricing and with a strong, effective distribution channel and multi- supply chain challenges experienced during 2021, national manufacturing capabilities will continue to be a and the inclusion of higher CEWS benefits in 2020. 24 competitive advantage for the Company and important The ability to maintain this margin rate is attributed to to continued revenue growth. HPS prides itself on favourable sales mix, selling price increases, higher fixed providing value to our customers. cost absorption and cost reductions. Backlog1 The CEWS program provides an employee wage subsidy for our Canadian entities for periods where The Company’s December 31, 2021 backlog has there was a significant decline in Canadian trade sales increased by a record 58.8% as compared to December due to the impact of COVID-19. During 2021, the wage 31, 2020 and has increased 25.9% from Quarter 3, subsidy received for production labour was $2,482 or 2021. The combination of price increases, strong 0.7% of sales (2020 – $5,557 or 1.7% of sales). The demand in the third and fourth quarters, and delayed Company did incur additional operating expenses of shipments due to material availability contributed to $956 during 2021 (2020 – $1,902) relating to amounts the record-high backlog. Both the direct and distributor paid for suspended operational employee wages, non- channels contributed to higher demand towards the productive wages support for “at risk” employees, end of the year, and that demand was compounded by employee transportation, increased cleaning, sanitation the realization of price increases implemented over the and personal protective equipment expenses for the course of 2021. The increased bookings were across safety of employees. Excluding the wage subsidy and 1Refer to Non-GAAP financial measures on page 21 of this annual report HAMMOND POWER SOLUTIONS COVID-19 related expenses, gross margins increased social and industrial aspects of the pandemic, combined from 25.9% in 2020 to 26.6% in 2021. with an increasing backlog allow for cautious optimism Sales and margins were impacted by the Company’s in 2022. ability to source materials and maintain a continuous While some growth strategies can have a shorter- supply to meet demand, which was exacerbated term dilutive effect on gross margin rates, the Company by global logistical disruptions. The manufacture of continues to focus on long-term investment to fuel transformers requires copper, aluminum and electrical future growth. Gross margin rates are supported by the steel. All of these commodities, particularly electrical maintenance of market prices combined with material steel, have seen significant price increases driven mainly procurement and engineering cost reduction initiatives. by supply constraints. During 2021, there has been a While the Company has reaped the benefits of higher heightened awareness of the challenges and strain on absorption of factory overheads due to the increased the global supply markets and a focus on ensuring that sales volume, we continue to implement a number of materials required for production are received on a cost reduction and expense management initiatives to timely basis and when needed. protect our margin rates. Given the rapid rise in the prices of the commodities HPS continues to commit resources to its continuous noted above, HPS has had to increase prices several improvement program, which will result in implementing times during 2021 in order to protect our gross margins. productivity enhancements, cost reductions and lead- In raising prices, we have been proactive in anticipating time improvements across the entire organization. cost increases, judicious in maintaining margins, and HPS is confident that these actions will enhance future conscientious of our customer relationships. For some margin rates and improve profitability and overall channels, particularly those with longer backlog dates financial performance. and lead times, as is the case in our OEM and private Quotation activity, improving bookings and backlog label channels, raising prices is more difficult to do in a since the end of 2020 as well as an encouraging sales timely way due to the nature of the contracts. Because outlook support optimism for the future. Looking 25 of that, we believe there was some margin deterioration ahead, HPS remains cautiously optimistic for the future during 2021 as we were catching up to cost increases. as growth will be realized in some markets along with HPS continues to focus on price realization strategies a decline in others – underscoring the volatility of and achievement of cost reductions in an effort to markets and sales demand. Over the past few years, to maintain and increase margin rates. manage the impact of volatility, the Company widened Fluctuating markets, product mix and the continued its distributor footprint in North America, expanded effects of COVID-19 on the current global economy its Indian market presence, implemented engineering may still have a short-term impact on financial results. and material cost reduction initiatives, invested in new However, through the two years of the pandemic, HPS product development and broadened manufacturing was identified as an essential service in all countries that capabilities. A diversified geographic approach supports we operate in, and was able to continue to manufacture anticipated growth from implemented market strategies with the exception of India. Country-wide lockdowns and subsequent economic improvement. impacted HPS’ India location from the end of Quarter Margin rates can be sensitive to selling price 1 and the majority of Quarter 2 in 2020. Lockdowns pressures, volatility in commodity costs, customer were also in place for a month in Quarter 2 during 2021. mix and geographic blend. The Company continues Looking forward, the lessening impact of the economic, to combat competitor short-sighted pricing strategies ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS through its total value-added engineered solutions. HPS’ focus during the year has been on execution of its selling price realization strategies and achievement of cost reductions in an effort to protect and eventually raise margin rates. Selling and distribution expenses • Approximately $1,103 of the increase in the current year is associated with strategic investments in people resources and incentive plans. There were critical roles replaced during 2021 as a large number of individuals within the organization retired; • The Mesta acquisition contributed an additional $452 to the general and administrative expenses; Total selling and distribution expenses were $46,459 for 2021 versus $40,217 in 2020, an increase of $6,242 • Additional investment in information technology contributed additional expenses of $460 related to or 15.5%. On a percentage-of-sales basis, total selling maintenance contracts; and distribution expense decreased to 12.2% of sales for 2021 from 12.5% in 2020. The higher sales value for • The higher share price and additional awards granted in 2021 has caused the DSU expense to increase the year resulted in additional commission expense of $691 from prior year; and $1,841 and higher freight expense of $2,653 which are variable selling expenses that naturally fluctuate with • Higher spending with outside services such as placement and legal fees account for $1,296 of the sales changes. The CEWS benefit in 2021 of $352 or current year increase. 0.1% of sales was lower than the benefit of $766 of 0.2% in 2020, therefore contributing $414 to the increased HPS continues to invest in growth while remaining very cognizant of prudent general and administrative net expenses. Approximately $980, or 0.3% of selling expense management. and distribution expenses increase relates to strategic investments in people resources as well as increased Earnings from operations1 incentive plan payments related to higher sales. 26 General and administrative expense General and administrative expenses in 2021 were $32,821 compared to $24,736 for 2020, an increase Earnings from operations improved finishing at $23,151 in 2021, as compared to earnings of $22,041 in 2020 – an increase of $1,110 or 5.0%. The increase in earnings from operations is due to higher sales and additional gross margin dollars, offset by higher selling, distribution, of $8,085 or 32.7%. On a percentage-of-sales basis general and administrative expenses. these costs have increased from 7.7% in 2020 to 8.6% Earnings from operations are calculated as outlined in 2021. Key drivers for the current year increase are in the following table: as follows: • During the prior year there was a reversal of an abnormal expected credit loss provision related to the settlement of the note receivable balance in the amount of $956; • The CEWS benefit related to general and administrative employees in 2021 was $649 or 0.2% of sales and was $1,950 or 0.6% of sales in 2020, resulting in additional net expenses of $1,310 in 2021 compared to 2020; 1Refer to Non-GAAP financial measures on page 21 of this annual report Net earnings for the year $ 15,176 $ 14,062 2021 2020 Add: Income tax expense 6,074 6,904 Finance and other costs 1,901 1,075 Earnings from operations $ 23,151 $ 22,041 HAMMOND POWER SOLUTIONS Net Finance and other costs current year earnings before income tax were higher Net finance and other costs increased $826 from sales and additional gross margin dollars. These gains $1,075 in 2020 to $1,901 in 2021. The increase from were offset by increases in selling, distribution, general the prior year is a result of a foreign exchange loss in and administration expenses, lower government the current year and a gain in the prior year, as well as wage subsidy support in the current year, the foreign higher interest expense and lower income from the joint exchange loss in 2021 and a gain in 2020, as well as venture in the current year. higher interest expense and lower income from the joint Interest expense for the year-ended December venture in the current year. 31, 2021 finished at $1,301 as compared to $1,247 in 2020, a small increase of $54. Interest expense includes all bank fees. The foreign exchange loss in 2021 of $561 related primarily to the transactional exchange loss of the Company’s U.S. dollar trade accounts receivable, compared to a foreign exchange gain of $123 in 2020. The increase of the foreign exchange expense for the year is related to the volatility in the exchange rates during the year – primarily the U.S. dollar which decreased 6.7% relative to the Canadian dollar in 2021. As at December 31, 2021, the Company had outstanding foreign exchange contracts in place to buy 17,350 Euros (“EUR”) and $23,275 USD – both of which were implemented as an economic hedge against translation gains and losses on inter-company loans as well as $68,500 USD to economically hedge the U.S. dollar denominated accounts payable in Canadian HPS operations. The Company also had outstanding foreign exchange contracts to sell for 34,700 EUR and $69,757 USD. Exchange rate volatility is managed by HPS’ foreign exchange contract hedging program. Details of the outstanding forward foreign exchange contracts at December 31, 2021 can be found in note 27 in the Notes to Consolidated Financial Statements included in our 2021 Annual Report. Earnings before income tax Income taxes Income tax expense from operations for 2021 was $6,074 as compared to $6,904 in 2020 – a decrease of $830 or 12.0%. The consolidated effective tax rate on earnings from operations for 2021 decreased to 28.6% versus 32.9% last year – a decrease of 4.3%. The Company’s deferred tax assets and liabilities are related to temporary differences in various tax jurisdictions, primarily reserves and allowances, which are not deductible in the current year. A difference in the carrying value of property, plant and equipment and intangible assets for accounting purposes and for tax purposes is a result of business combination accounting and a different basis of depreciation utilized for tax purposes. The Company’s income tax 27 provision is explained further in note 16 in the Notes to Consolidated Financial Statements included in our 2021 Annual Report. Net earnings Net earnings from operations for 2021 finished at $15,176 compared to net earnings of $14,062 in 2020, an increase of $1,114 or 7.9%. The main contributors to the higher current year earnings before income tax were higher sales and additional gross margin dollars. These gains were offset by increases in selling, distribution, general and administration expenses, lower government wage subsidy support in the current year, the foreign exchange loss in 2021 and a gain in 2020, as well as 2021 earnings before income taxes were $21,250 as higher interest expense and lower income from the joint compared to earnings of $20,966 in 2020, – growing venture in the current year. The effective tax rate was by $284 or 1.4%. The main contributors to the higher 4.3% lower in the current year than prior year. ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS EBITDA1 EBITDA from operations for the year-ended December 31, 2021 was $30,114 versus $29,482 in 2020 – an increase of $632 or 2.1%. Adjusted for foreign exchange loss/gain, adjusted EBITDA for 2021 was $30,675 versus $29,359 in 2020 – an increase of $1,316 or 4.5%. EBITDA and adjusted EBITDA are calculated as outlined in the following table: Net earnings Add: Interest expense Income tax expense Depreciation and amortization EBITDA Add (subtract): Foreign exchange loss (gain) Adjusted EBITDA 2021 2020 $ 15,176 $ 14,062 1,301 6,074 7,563 1,247 6,904 7,269 $ $ 30,114 $ 29,482 561 (123) 30,675 $ 29,359 Summary of quarterly financial information (unaudited) Fiscal 2021 Quarters Sales Net earnings 28 Net earnings per share – basic Net earnings per share – diluted Average U.S. to Canadian exchange rate Fiscal 2020 Quarters Sales Net earnings Net earnings per share – basic Net earnings per share – diluted Average U.S. to Canadian exchange rate Q1 80,121 2,298 0.19 0.19 1.268 Q1 88,420 2,148 0.18 0.18 1.339 $ $ $ $ $ $ $ $ $ $ Q2 Q3 Q4 Total $ $ $ $ $ $ $ $ $ $ 88,277 4,689 0.40 0.40 1.231 Q2 75,393 4,420 0.38 0.38 1.391 $ $ $ $ $ $ $ $ $ $ 95,526 $ 116,278 $ 380,202 3,948 0.34 0.34 1.257 Q3 78,115 3,462 0.30 0.30 1.335 $ $ $ $ $ $ $ $ $ 4,241 0.36 0.35 1.258 $ $ $ $ 15,176 1.29 1.28 1.253 Q4 Total 80,169 $ 322,097 4,032 0.34 0.34 1.309 $ $ $ $ 14,062 1.20 1.20 1.343 With the exception of Quarter 1, sales increased significantly versus the comparable quarters in 2020. Quarter 2, 1Refer to Non-GAAP financial measures on page 21 of this annual report HAMMOND POWER SOLUTIONS 2020 was the first quarter where the Company saw sales declines due to the pandemic. A portion of the sales escalation was due to price increases but the Company has also experienced volume growth over previous quarters. There has been an upward trend over the past six quarters due to an overall improvement in general economic activity. Sales in the current year were negatively impacted by the weaker USD exchange and the price increases had a cumulative impact on sales as 2021 progressed. Changing and challenging economic conditions, changes in product mix and competitive pricing pressures have all had an impact on the year-over-year quarterly fluctuations for both sales and income. Quarter 4, 2021 financial results Sales Gross margin rate Earnings from operations Exchange loss Net earnings Earnings per share – basic Earnings per share – diluted Cash provided by operations Quarter ended December 31, 2021 Quarter ended December 31, 2020 $ 116,278 27.4% 6,220 129 4,241 0.36 0.35 19,900 $ $ $ $ $ $ $ $ $ $ $ $ $ 80,169 28.9% 7,047 401 4,032 0.34 0.34 8,073 29 Sales for the quarter ended December 31, 2021 were $116,278, an increase of $36,109 or 45.0% from the comparative quarter last year. Gross margin rates for the fourth quarter have decreased from the same quarter last year by 1.5% from 28.9% in 2020 to 27.4% in 2021. Included in the fourth quarter 2020 gross margin was $1,722 of CEWS (2.15% of sales), and none in the fourth quarter of 2021. The margin was also impacted by sales mix, market specific pricing, raw material commodity costs, cost reductions and expense containment. Total selling and distribution expenses amounted to $14,559 in Quarter 4, 2021 versus $10,202 in Quarter 4, 2020 – an increase of $4,357 or 42.7%. Selling and distribution expenses as a percentage of sales have decreased to 12.5% in 2021 compared to 12.7% in 2020. The increases were a result of higher commission and freight variable expenses. General and administrative expenses as a percentage of sales have increased to 9.5% in 2021 compared to 7.4% in 2020. General and administrative expenses for Quarter 4, 2021 totaled $11,055, an increase of $5,105 when compared to Quarter 4, 2020 costs of $5,950. During the prior year there was a reversal of an abnormal expected credit loss provision related to the settlement of the note receivable balance in the amount of $956. The Mesta acquisition contributed an additional $452 to the general and administrative expenses. Additional salary, incentive and outside service costs and other miscellaneous accruals also account for the increase in the quarter. ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS Quarter 4, 2021 net finance and other costs were Cash provided from operating activities during $490 compared to $582 for the same quarter in 2020, a 2021 was $20,447 versus $19,683 in 2020, an increase decrease of $92 or 15.8%. The Quarter 4, 2021 interest in cash generated of $764 or 3.9%. This increase in cash cost increased from $296 in Quarter 4, 2020 to $368 generated from operating activities was due to a lower in Quarter 4, 2021. Foreign exchange loss in Quarter 4, increase in non-cash working capital versus 2020. Non- 2021 was $129 compared to a foreign exchange loss of cash working capital used cash of $4,777 in 2021 versus $401 in Quarter 4, 2020. $4,992 in 2020, resulting in a decrease of $215 from Earnings from operations for the quarter were 2020. The change in non-cash working capital in 2021 $6,220 in 2021 and $7,047 in 2020 a decrease of was primarily a result of increases in accounts receivable $827 or 11.7%. Additional gross margin dollars were and inventory, offset by increases in accounts payable. offset by higher general, administrative, selling and Accounts receivable finished the year at $72,004 distribution expenses. as compared to $53,078 as at December 31, 2020, Quarter 4, 2021 income tax expense was $1,489 on an increase of $18,926 – a result of higher sales in earnings before income taxes of $5,730 (an effective tax Quarter 4, 2021 compared to Quarter 4, 2020. HPS’ rate1 of 26.0%) as compared to an income tax expense days sales outstanding ratio remains stable, which can of $2,433 on income before income taxes of $6,465 be attributed to effective credit policies and tightly (an effective tax rate1 of 37.6%) in Quarter 4, 2020 – a managed accounts receivable administration. decrease of $944. Inventories finished the year at $62,467 as at Net income for Quarter 4, 2021 was $4,241 December 31, 2021, versus $49,206 as at December compared to net income of $4,032 in Quarter 4, 2020 – 31, 2020, an increase of $13,261. The higher inventory an improvement of $209. levels in 2021 were attributed to increased sales volume, Cash provided by operations for Quarter 4, 2021 and the higher cost of raw materials. was $19,900 versus $8,073 in Quarter 4, 2020 – an Accounts payable and accrued liabilities, excluding 30 increase of $11,827. The main driver for this change derivative and share-based compensation liabilities, was cash generated from working capital of $9,447 for increased by $29,599 finishing at $73,826 as at Quarter 4, 2021 versus cash used by working capital of December 31, 2021 compared to $44,227 at the end $825 for Quarter 4, 2020, an improvement of $10,272. of 2020. The change in accounts payable is due to Overall net operating cash balance1 was $1,638 as higher sales volumes, higher raw materials costs, higher at December 31 2021, an improvement of $2,916 as accruals and the timing of purchases from and payments compared to a net operating debt balance of $1,278 as to suppliers. at December 31, 2020, primarily reflecting improved Net income taxes payable2 were $1,181 as at profitability and cash generated from operations. December 31, 2021, versus net income taxes payable Capital resources and liquidity The Company continued to focus on generating cash from operations, debt management, investment and liquidity. of $454 (income taxes receivable of $488 less income taxes payable of $942) as at December 31, 2020 – a change of $727 due to changes in the effective tax rate3. Cash used in financing activities was $4,257 in 1Overall net operating cash balance is the bank operating lines of credit of $19,267 net of cash and cash equivalents of $20,905. Refer to Non-GAAP financial measures on page 21 of this annual report. 2Effective tax rate is calculated as the income tax expense divided by the earnings before income taxes 3Net income taxes payable consists of income taxes receivable of $807 less income taxes payable of $1,988. Refer to Non-GAAP financial measures on page 21 of this annual report. HAMMOND POWER SOLUTIONS 2021, compared to cash used of $24,184 in 2020, a capital resources is effectively managed for current and decrease of $19,927. The change in the balance can future requirements. be attributed to repayment from the operating line in The Company has outstanding capital expenditure 2020 compared to advances on the bank operating commitments of $483 primarily for manufacturing lines in 2021. efficiency improvement projects and capacity expansion. Cash used in investing activities in 2021 increased These ongoing projects are in support of future business $6,167 from $4,747 in 2020 to $10,914 in 2021, development and growth. a result of the Mesta acquisition in the amount of Additional details of our change in non-cash $5,032. There was an increase in capital spending for working capital can be found in note 25 in the Notes property, plant and equipment of $829 over the prior to Consolidated Financial Statements contained in our year, totaling $5,051 in 2021 – compared to $4,222 for 2021 Annual Report. 2020. The Company continues to invest in the areas of manufacturing processes and capabilities as well as Credit Agreement information technology. Bank operating lines of credit finished the year at $19,267 as at December 31, 2021, compared to $16,073 as at December 31, 2020 resulting in an increase of $3,194 in the year. The Company had cash and cash equivalent balances of $20,905 as at December 31, 2021 as compared to $14,795 as at December 31, 2020. Overall net operating cash balance1 was $1,638 as at December 31 2021, an improvement of $2,916 as compared to a net operating debt balance of $1,278 as at December 31, 2020, primarily reflecting improved profitability and cash generated from operations. All bank covenants were met as at December 31, 2021, and the Company was in compliance with its During the year, the Company entered into a new banking agreement, which expires on June 20, 2026, consisting of a $50,000 U.S. revolving credit facility. This new agreement provides an additional $10,000 U.S. of credit to HPS. Based on exchange rates in effect at December 31, 2021, the combined Canadian dollar equivalent available prior to any utilization of the facilities was $78,000. This is an unsecured 5-year committed facility that provides financing certainty for the future. The new financing better aligns our Canadian, U.S. and European 31 banking requirements, supports our hedging strategies, and provides financing for our operational requirements and capital for our strategic initiatives. covenants throughout the year. Hammond Power Solutions S.p.A – Italy The Company’s liquidity is strong. HPS is well As part of the VPI asset sale agreement, the lease funded, with sufficient cash and debt capacity to fund its agreement relating to the Meledo, Italy building includes operating activities, investments and strategic growth a put and call sale option related to the leased premises, initiatives. The Company has several alternatives to exercisable within 60 days after September 30, 2023. The fund future capital requirements, including its existing call option grants the purchaser an option to purchase cash position, credit facility, future operating cash flows the premises from the Company for consideration equal and debt financing. The Company continually evaluates to 2,225 EUR. The plant purchase price will be reduced these options to ensure that the appropriate mix of by 50% of the monthly rent installments received, to 1Overall net operating cash balance is the bank operating lines of credit of $19,267 net of cash and cash equivalents of $20,905. Refer to Non-GAAP financial measures on page 21 of this annual report. ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS Contractual obligations The following table outlines payments due for each of the next 5 years and thereafter related to debt, lease, purchase and other long-term obligations. Accounts payable and accrued liabilities $ 75,669 Capital expenditure purchase commitments Operating lines of credit Derivative liability Lease liabilities Contingent liabilities Total 2022 2023 2024 2025 483 – 91 2,762 616 – – – – – – – – 2,034 595 1,806 298 – – – – 978 – 2026 & Thereafter Total – $ 75,669 – 19,267 – 733 – 483 19,267 91 8,313 1,509 $ 79,621 $ 2,629 $ 2,104 978 $ 20,000 $ 105,332 a maximum of 375 EUR (approximately $573). If the 2021 to shareholders of record at the close of business purchaser does not execute the call option HPS can on March 18, 2021 – the ex-dividend date was March exercise its put option which grants HPS an option to 17, 2021. The Quarter 2 dividend was paid on June 29, sell the plant to the purchaser for consideration equal 2021 to shareholders of record at the close of business to the same plant purchase price. If the purchaser on the 22nd day of June 2021 – the ex-dividend date rejects the put option, the purchaser will pay 500 EUR was June 21, 2021. The dividend for Quarter 3 was (approximately $764) as liquidated damages. paid on September 24, 2021 to shareholders of record Contingent liabilities at the close of business on September 17, 2021 – the ex-dividend date was September 16, 2021. The In June 2017, the Corporation received notice of an Quarter 4 dividend was paid on December 17, 2021 32 environmental claim from the owner of a property to shareholders of record at the close of business located nearby to a property that was once partially on December 10, 2021 – the ex-dividend date was owned by the Corporation. At this time, the Company December 9, 2021. feels that there is no merit to the claim. In 2021, the Company has paid a total cash dividend Management is not aware of any further contingent of thirty-four cents ($0.34) per Class A Subordinate liabilities, other than contingent consideration issued in Voting Share and thirty-four cents ($0.34) per Class B connection with the acquisition of Mesta. Refer to Common Share. In 2020, the Company had paid a total note 30 to the consolidated financial statements for cash dividend of thirty-four cents ($0.34) per Class A additional information. Subordinate Voting Share and thirty-four cents ($0.34) per Class B Common Share. Regular quarterly dividend The Board of Directors of HPS declared quarterly cash Controls and procedures dividend of eight and a half cents ($0.085) per Class A The Chief Executive Officer and the Chief Financial Subordinate Voting Share of HPS and of eight and a half Officer are responsible for establishing and maintaining cents ($0.085) per Class B Common Share of HPS, for disclosure controls and procedures and for establishing each of the quarters of 2021. and maintaining adequate internal controls over financial The Quarter 1 dividend was paid on March 25, reporting. The control framework used in the design of HAMMOND POWER SOLUTIONS disclosure controls and procedures and internal control use a control framework such as the COSO Framework over financial reporting is the 2013 Internal Control to design internal controls over financial reporting. As Integrated Framework issued by the Committee of well, the threshold for reporting a weakness of internal Sponsoring Organizations of the Treadway Commission controls over financial reporting should be of a “material (“2013 COSO Framework”). Our internal control system weakness” rather than “reportable deficiency.” HPS was designed to provide reasonable assurance to our has designed its internal controls in accordance with Management and Board of Directors regarding the the COSO Framework and has carried out retesting in preparation and fair presentation of published financial 2021, which was completed in the fourth quarter. statements in accordance with International Financial As of December 31, 2021 Management, with the Reporting Standards. All internal control systems, no supervision and participation of the Chief Executive matter how well designed, have inherent limitations, Officer and Chief Financial Officer, assessed the therefore, even those systems determined to be effective effectiveness of the Company’s internal control over can provide only reasonable assurance with respect to financial reporting. Based on that assessment, the financial statement preparation and presentation. Chief Executive Officer and Chief Financial Officer As at December 31, 2021, the Company conducted have concluded that the internal controls are effective an evaluation, under the direction and supervision of and that there were no material weaknesses in the the Chief Executive Officer and the Chief Financial Company’s internal control over financial reporting as of Officer, of the effectiveness of the design and operation December 31, 2021. of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Changes in internal control over financial reporting Financial Officer have concluded that as of December and disclosure controls and procedures 31, 2021 such disclosure controls and procedures were During 2021 there were no material changes identified operating effectively. in HPS’ internal controls over financial reporting that had materially affected, or were reasonably likely to 33 Internal controls over financial reporting materially affect HPS’ internal control over financial Management is responsible for establishing and reporting. HPS does carry out ongoing improvements to maintaining adequate internal controls over financial its internal controls over financial reporting but nothing reporting. Our internal control system was designed was considered at a material level. to provide reasonable assurance to our Management and Board of Directors regarding the preparation and fair presentation of published financial statements in accordance with International Financial Reporting Standards. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Subsequent events Dividends On March 4, 2022, the Company declared a dividend of eight and a half cents ($0.085) per Class A subordinate voting shares of HPS and a quarterly cash dividend of eight and a half cents ($0.085) per Class B common shares of HPS payable on March 24, 2022 to shareholders of record at the close of business on March 16, 2022. The Canadian Securities Administrators require that ex-dividend date is March 18, 2022. companies certify the effectiveness of internal controls over financial reporting. It also requires a company to ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS Joint venture ownership change caused by logistics disruptions and global conflicts may The Company and National Material L.P. (“National”) interrupt manufacturing production, and therefore affect have operated the joint venture in Monterray, Mexico our ability to ship product to customers. These risks are under the name Corefficient S. de R.L. de C.V. Subsequent mitigated through strategic supply line agreements and to year-end, the Company and National have amicably alliances in place with suppliers. agreed to divide the operations. In connection with The cyclical effects and unprecedented rise of this transaction, HPS will retain certain equipment, global commodity prices, including prices for copper, employees, obligations and other financial assets and aluminum and electrical steel may put margins at risk. liabilities, and National will withdraw ceratin assets There is a risk in our ability to recoup the rapid escalating and capital in exchange for redeeming their ownership commodity costs through timely and effective selling interest. The Compnay will operate the retained portion price increases. of the joint venture as a wholly owned subsidiary of the Group. The operation will continue to produce Other Business Risks transformer cores to supply the Group’s facilities in If any of the following risks were to occur they could Mexico. The Corefficient name will be retained by materially adversely affect HPS’ financial condition, National. Further details can be found in note 31 in the liquidity or results of operations. Notes to Consolidated Financial Statements included in our 2021 Annual Report. Coronavirus (COVID-19) Pandemic – Business Disruption/Interruption Risks and uncertainties Markets, governments and health organizations around The Company’s goal is to proactively manage risks in the world have been impacted by the COVID-19 a structured approach in conjunction with strategic pandemic. COVID-19 has presented a wide range of planning, with the intent to preserve and enhance issues and complications for the Company, some of 34 shareholder value. However, as with most businesses, which the Company is unable to know the full extent. HPS is subject to a number of marketplace, industry and Looking forward, while the increase in vaccination economic-related business risks, which could cause our levels are climbing, there is a guarded business optimism results to vary materially from anticipated future results. but some uncertainty and unpredictability persist on the The Company is aware of these risks and continually impacts of the COVID-19 pandemic on the business assesses the current and potential impacts that they have climate and governmental and health authorities’ on the business. HPS continuously strives to curtail the legislation. The full negative financial impact of the negative impact of these risks through diversification of unprecedented pandemic will not be fully known until its core business, market channel expansion, breadth of the economy fully recovers. product offering, geographic diversity of its operations and business hedging strategies. We may not realize all of the anticipated benefits of our acquisitions, divestitures, joint ventures or Market supply and demand impact on commodity prices strategic initiatives, or these benefits may take HPS relies on a global supply chain to meet its longer to realize than expected. manufacturing needs. We source both raw materials In order to be profitable, the Company must successfully and components from our own factories and third party execute upon its strategic initiatives and effectively suppliers. Industry supply shortages, including those manage the resulting changes in its operations. The HAMMOND POWER SOLUTIONS Company’s assumptions underlying its strategic plans legal and operating risks, such as political and economic may be subjective, the market may react negatively to instability; prevalence of corruption in certain countries; these plans, and HPS may not be able to successfully enforcement of contract and intellectual property execute these plans, and even if successfully executed, rights and compliance with existing and future laws, its actions may not be effective or may not lead to the regulations and policies, including those related to anticipated benefits within the expected time frame. tariffs, investments, taxation, trade controls, product These strategic initiatives can include acquisitions content and performance, employment and repatriation and joint ventures. To be successful, management of earnings. will conduct due diligence to identify valuation issues and potential loss contingencies, negotiate Our global business translates into conducting transaction terms, complete complex transactions and business in various currencies, all of which are manage post-closing matters such as the integration subject to fluctuations. of acquired startup businesses. Management’s due HPS’ global footprint exposes the Company to diligence reviews are subject to the completeness and currency fluctuations and volatility and, at times, has accuracy of disclosures made by third parties. The had a significant impact on the financial results of the Company may incur unanticipated costs or expenses Company. The Company’s functional currency is the following a completed acquisition, including post- Canadian dollar with its operating results reported in closing asset impairment charges, expenses associated Canadian dollars. A significant portion of the Company’s with eliminating duplicate facilities, litigation or other sales and material purchases are denominated in U.S. liabilities. dollars. There is a natural hedge, as sales denominated Many of the factors that could have an adverse in U.S. dollars are largely offset by the cost of raw impact will be outside of management’s control and could materials purchased from the U.S., and commodities result in increased costs and decreases in the amount tied to U.S. dollar pricing. A change in the value of of expected revenues and diversion of management’s the Canadian dollar against the U.S. dollar will impact 35 time and attention. Failure to implement an acquisition earnings, significantly at times. Generally, a lower value strategy, including successfully integrating acquired for the Canadian dollar compared to the U.S. dollar will businesses, could have an adverse effect on our have a beneficial impact on the Company’s results, while business, financial condition and result of operations. a higher value for the Canadian dollar compared to the U.S. dollar will have a corresponding negative impact on We sell to customers around the world and have the Company’s profitability. global operations and, therefore, are subject to HPS has partially reduced the impact of foreign the risks of doing business in many countries. exchange fluctuations by increasing our U.S. dollar We do business in a host of countries around the world. driven manufacturing output, periodically instituting Approximately 70% of our sales were to customers price increases to help offset negative changes and outside of Canada. In addition, a number of our entering into forward foreign exchange contracts. manufacturing operations, suppliers and employees are located in many places around the world. The Worldwide HPS is subject to, and required to comply future success of our business depends in large part with, multiple income and other taxes, regulations and on growth in our sales in non-Canadian markets. Our is exposed to uncertain tax liabilities risk. global operations are subject to numerous financial, The Company operates and is subject to income tax and ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS other forms of taxation in numerous tax jurisdictions. business that crosses borders and any changes in the Taxation laws and rates, which determine taxation current trade structure could have a material impact expenses, may vary significantly in different jurisdictions, for us. HPS’ global footprint will be critical to mitigating and legislation governing taxation laws and rates is also any impact for political changes that would modify the subject to change. Therefore, the Company’s earnings current trade relationships. may be impacted by changes in the proportion of earnings taxed in different jurisdictions, changes in Our industry is highly competitive. taxation rates, changes in estimates of liabilities and HPS faces competition in all of our market segments. changes in the amount of other forms of taxation. Tax Current and potential competitors may have greater structures are subject to review by both domestic and brand name recognition, more established distribution foreign taxation authorities. Tax filings are subject to networks, access to larger customer bases and audits, which could materially change the amount of substantially greater financial, distribution, technical, current and deferred income tax assets and liabilities. sales and market, manufacturing and other resources We face the potential harms of natural disasters, pandemics, acts of war, terrorism, international conflicts or other disruptions to our operations. Our business depends on the movement of goods around the world. Natural disasters, pandemics, acts or threats of war or terrorism, international conflicts, political instability and the actions taken by governments could cause damage to or disrupt our business operations, our suppliers or our customers and could create economic 36 instability. Although it is not possible to predict such than HPS does. As a result, those competitors may have advantages relative to HPS; including stronger bargaining power with suppliers that may result in more favourable pricing, the ability to secure supplies at time of shortages, economies of scale in production, the ability to respond more quickly to changing customer demands and the ability to devote greater resources to the development, promotion and sales of their products and services. If HPS is unable to compete effectively, it may experience a loss of market share or reduced profitability. We expect the level of competition to events or their consequences, these events could remain high in the future. decrease demand for our products make it difficult or impossible to deliver our products, or disrupt our global Our business is highly sensitive to global and regional material sourcing. Political uncertainty and potential for changes in the business environment can lead to legislative changes that could impact business. Changing legislative mandates in the countries with which we do business may result in a number of economic conditions in the industries we serve. Current global economic conditions influence the Company’s focus, direction, strategic initiatives and financial performance. To address the current uncertainty, we are focusing our efforts on projects that will increase our market reach, advance our cost competitiveness, expand capacity and improve our geopolitical risks that could be challenging for the manufacturing flexibility. Company. The impact of these political changes can be difficult to predict and can have a pervasive impact on the global business climate. Changes in political leaders can impact trade relations as well as taxes and/or duties. HPS’ current structure includes a significant amount of The Company believes that being an agile organization will hold even greater importance in order to respond quickly to both unexpected opportunities and challenges. HPS’ management believes that the key to expanding our market share is growing our access HAMMOND POWER SOLUTIONS to a variety of domestic and global markets. This will cyber attacks and viruses on companies’ information be achieved through our current and new OEM and infrastructure and technologies. A successful cyber distributor channels. attack could result in misappropriation of assets, cause interruptions to manufacturing and our ability to take The disruption to businesses that can come from orders, as well as impact our general productivity. unpredictable weather can have an impact on sales This risk is reduced through a number of initiatives to volume as customer projects can be delayed or mitigate exposure. cancelled. Extreme weather conditions such as heavy rains, Off-balance sheet arrangements flooding, snowfall, tornadoes and hurricanes can The Company has no off-Balance Sheet arrangements, potentially have a negative impact on the Company’s other than capital commitments disclosed in note 15 sales trends and booking rates. When these conditions in the Notes to the Consolidated Financial Statements are present, the Company may see short-term effects of contained in our 2021 Annual Report. such occurrences due to their unpredictability. This may impact delivery and capacity requirements. Transactions with related parties The business practice of extending credit to customers can lead to a risk of uncollectability. The Company had transactions with related parties in 2021, as disclosed in note 23 in the Notes to the Consolidated Financial Statements contained in our A substantial portion of the Company’s accounts 2021 Annual Report. receivable are with customers in manufacturing sectors and are subject to credit risks normal to those industries. The Company’s expansion into emerging markets increases credit risk. This risk is partially mitigated by managements credit policy under which each new customer is analysed individually for creditworthiness before the Company’s standard payment and delivery Proposed transactions The Company had no proposed transactions as at December 31, 2021. The Company continues to evaluate potential business expansion initiatives in 37 accordance with its long-term growth strategy. terms and conditions are offered. The Company’s Financial instruments review includes external ratings, if they are available, financial statements, credit agency information, industry information and in some cases bank references. Sale limits are established for each customer and reviewed quarterly. Any sales exceeding those limits require The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, long-term lease receivable, note receivable, bank operating lines of credit, accounts payable and accrued liabilities, contingent consideration and the following derivative approval from Executive management. Although the instruments: Company has historically incurred very low bad debt expense, the current economic environment conditions elevate this exposure and the Company’s future collection rate may differ from its historical experience. Risk of cyber attack At December 31, 2021, the Company had outstanding foreign exchange contracts in place to buy for 17,350 EUR and $23,275 USD – which were implemented as an economic hedge against translation gains and losses on inter-company loans and $68,500 USD to economically hedge the U.S. dollar denominated Globally there have been increased incidences of outside accounts payable in the Canadian operations of HPS. ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS The Company also had outstanding foreign exchange Business Combinations requires acquirers to contracts to sell for 34,700 EUR and $69,757 USD. recognize the identifiable assets acquired and liabilities The Company had total outstanding foreign exchange assumed at fair value. The determination of fair value contracts in place as at December 31, 2020 for 17,500 requires Management to make estimates around the EUR and $12,500 USD and 330,000 INR as economic value an independent third party, under no compulsion hedges against translation gains and losses on inter- to act, would pay for an asset acquired or liability company loans and $46,500 USD to economically assumed on a standalone basis. Where possible, hedge the U.S. dollar denominated accounts payable in Management engages third-party appraisers to assist the Canadian operations. in the determination of the fair value of real property Further details regarding the Company’s financial acquired. The fair value of acquired intangible assets instruments and the associated risks are disclosed in are generally determined using discounted cash flow note 27 in the Notes to the Consolidated Financial models and involve the use of cash flow forecasts, Statements contained in our 2021 Annual Report. market-based discount rates, and/or market-based Critical accounting estimates royalty rates. The fair values of liabilities assumed is generally based on discounted cash flow models which The preparation of the Company’s consolidated financial involve the use of market-based discount rates. The statements requires Management to make estimates and development of cash flow forecasts involve the use assumptions that affect the reported amounts of assets, of estimates, which may differ from actual cash flows liabilities, revenues and expenses and the disclosure realized. Assumptions are involved in the determination of contingent assets and liabilities. These estimates of discount rates and royalty rates. are based upon Management’s historical experience The Company records a provision for warranties and various other assumptions that are believed by based on historical warranty claim information and Management to be reasonable under the circumstances. anticipated warranty claims, based on a weighted 38 Such assumptions and estimates are evaluated on an probability of possible outcomes. ongoing basis and form the basis for making judgments The key assumptions made by management in about the carrying values of assets and liabilities that recording the provision are i) warranty cost, ii) probability are not readily apparent from other sources. Actual of claim, and iii) quantum of units which may be subject results could differ from these estimates. to any warranty claim. The Company conducts its annual impairment Quantifying provisions inherently involves assessment of goodwill, intangible assets and property, judgment, and future events and conditions may plant and equipment in the fourth quarter of each year, impact these assumptions. Differences in actual future which corresponds with its annual planning cycle, and experience from the assumptions utilized may result in whenever events or changes in circumstances indicate a greater or lower warranty cost. that the carrying amount of an asset or Cash Generating Unit (“CGU”) may not be recoverable. The Company did Outstanding share data not identify any triggering events during the course of Details of the Company’s outstanding share data as of 2021 indicating that the carrying amount of its assets December 31, 2021, are as follows: and CGUs may not be recoverable, which would require 9,011,624 Class A Shares the performance of an impairment test for those CGUs 2,778,300 Class B Common Shares which did not contain goodwill. 11,789,924 Total Class A and B Shares HAMMOND POWER SOLUTIONS There have been no material changes to the outstanding Cloud computing arrangement costs share data as of the date of this report. On April 28, 2021 the IFRS Interpretations Committee issued a final agenda decision on cloud computing New accounting pronouncements arrangements. The agenda aimed to clarify guidance IBOR – Phase 2 (Amendments to IFRS 9, IAS 39, on how customers should account for implementation IFRS 7, IFRS 4 and IFRS 16) costs incurred in a software-as-a-service arrangement. In August 2020, the IASB issued Phase 2 amendments, This further builds upon the March 2019 agenda which amended the requirements in IFRS 9, IAS 39, which distinguished hosting arrangements in which IFRS 7, IFRS 4, and IFRS 16, principally addressing the the customer receives a software intangible asset from following areas: those that do not, and therefore are service contracts. • modification of a financial asset or a financial The Company adopted this agenda decision on a liability; • modification of a lease; • additional reliefs for hedging relationships; • new disclosures; and • effective date and transition. retrospective basis. The adoption of the amendments did not have a material impact on the financial statements. New accounting pronouncements to be adopted The International Accounting Standards Board has The Company adopted the amendments in its issued the following Standards, Interpretations and financial statements for the annual period beginning on Amendments to Standards that are not yet effective, January 1, 2021. The adoption of the amendments have not yet been adopted by the Group and are not did not have a material impact on the consolidated expected to have a material impact on the consolidated financial statements. financial statements. The Group intends to adopt the following COVID-19-related rent concessions amendments in its financial statements for the annual (Amendments to IFRS 16) period beginning on January 1, 2022: 39 In May 2020, the IASB issued COVID-19-related • Property, Plant and Equipment – Proceeds before rent concessions, which amended IFRS 16. The Intended Use (Amendments to IAS 16); 2020 amendments introduced an optional practical • Onerous Contracts – Cost of Fulfilling a Contract expedient that simplifies how a lessee accounts for rent (Amendments to IAS 37); concessions that are a direct consequence of COVID-19, • Reference to the Conceptual Framework only if certain conditions are met. Under the practical (Amendments to IFRS 3); and expedient, a lessee is not required to assess whether • Annual Improvements to IFRS Standard 2018-2020. eligible rent concessions are lease modifications, instead The following amendments are effective for the accounting for them in accordance with other applicable annual period beginning on January 1, 2023: guidance. • Classification of Liabilities as Current or Non-Current The Company adopted the amendments in its (Amendments to IAS 1); financial statements for the annual period beginning • Definition of accounting estimates (Amendments to on January 1, 2021. The adoption of the amendments IAS 8); did not have any impact on the consolidated financial • Disclosure initiative – accounting policies statements. (Amendments to IAS 1 and IFRS Practice Statement 2 Making Materiality Judgments); and ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED MANAGEMENT’S DISCUSSION AND ANALYSIS • Deferred tax related to assets and liabilities arising o Designing energy efficient products; from a single transaction (Amendments to IAS 12 o Shrinking our ecological footprint; and Income Taxes). o Energizing the world in a responsible way for the The Group is evaluating the impact of adoption. generations to come. The Group intends to adopt the following amendment The demand for our transformers particularly in once an effective date has been announced: North America continues to accelerate and sales volumes • Sale or Contribution of Assets Between an Investor have returned to pre-pandemic levels. While we have and its Associate or Joint Venture. seen improvements in business activity and demand, we have also experienced rapidly rising commodity Strategic direction and outlook costs as well as supply shortages. Based on the HPS has a rich and extensive history of growth, combination of these factors, the Company expects to innovation and resilience. The Company has navigated see continued growth in revenues. It is difficult to know through difficult and fluctuating economic times, for how long higher commodity prices will be sustained, increased globalization, adapted to changes in customers in particular those for grain-oriented electrical steel, and markets and has experienced significant advances but at this time there are few indicators that would in technology. HPS has framed these challenges as indicate that these costs will come down during the opportunities and developed strategies to address first half of the year. It has been, and is, HPS’ objective these rapid changes. to maintain gross margins in the face of rising prices. The Company is confronting these challenges We will continue to do so in the future. and continuously building our strategic advantage by During 2021, we added over 200 new distributors focusing on: and began to put the infrastructure in place to support • Developing our Customers and Markets by: our growth initiative into Mexico. We believe that o Driving organic growth through continuing to Mexico has strong potential for us as a sales market 40 develop our NAED channel; due to its proximity to our manufacturing locations and o Offering competitive products, including an our ability to leverage existing people, product, and expanding product quality offering; supply chain. o Providing unparalleled service to our customers; The most recent acquisition of Mesta Electronics and Inc. has expanded HPS’ offering into standard and o Growing through strategic acquisitions. custom active filter and induction heating products. • Achieving Operational and Financial Excellence by: Mesta shares an excellent reputation for product quality, o Driving continuous improvement; design and reliability. Mesta not only expands HPS’ o Improving efficiency by investing in equipment, U.S. presence but also broadens our power solutions people and technology; and product offering and manufacturing capabilities in o Optimizing the efficiency of our global manufacturing power quality solutions. footprint. Our Canadian entities received a government • Developing our People and Culture by: subsidy for eligible wages in Quarter 2, 3 and 4, 2020 o Building our leadership team for the future; and Quarter 1, 2, and 3, 2021 which supported our o Developing our people to perform; and Canadian staff employment. Despite lower sales volumes o Making HPS a preferred employer. and a high degree of uncertainty during 2020 and 2021, • Building a Sustainabilty Program by we were able to protect Canadian jobs as a result of HAMMOND POWER SOLUTIONS the subsidy. The Company has implemented robust investing in equipment and machinery that will allow us health and safety precautions dedicated to providing to keep up with future demand and allow us to optimize a safe working environment for our employees while our manufacturing capabilities at our various locations. continuing to manufacture and serve our customers We are also investing in business technology that will during this volatile, unpredictable time. Where able, help us become more efficient and provide us with the the Company has provided tools to allow employees to data that we need to improve our business. work remotely to assist with managing school closures The Company continues to have a strong reputation and health concerns. of being an industry leader and is both operationally and The implementation of our ERP system has allowed financially strong. HPS is well positioned to meet the HPS to enhance the availability and quality of information evolving needs of our traditional markets while becoming accessible to support operational performance, improve a leading player in a growing number of other market customer service, supplement strategic decision making sectors. We continue to be focused on escalation of and audit and control. During Quarter 2, 2021 the ERP market share, improved sales growth from new product system went live in our operation in Granby, Quebec. development, geographic diversification, productivity This implementation project began in Quarter 1, 2020 gains, cost reduction and capacity flexibility. and represents the Company’s final operation to be HPS’ strategic vision and operational initiatives converted to our ERP platform. The consolidation to the have supported our industry leadership, operational ERP platform is an important step towards providing strength and financial stability. The combination of our one global, integrated, consistent source of information resilience, drive, decades of experience, commitment, and data. engineering expertise, solid supplier relationships and a During 2021, the Company implemented a new broad and unique business perspective gained through Human Resource Management System, (“HRMS”) our diverse products, customers and markets are all key platform to move the Company to a common payroll success factors critical to our success. and human resource system. This platform will enhance The Company has provided shareholders with strong 41 our internal communications, create efficiencies, earnings per share, solid cash generation and quarterly improve controls, incorporate additional career planning dividends paid with an attractive yield. To continue this and allow for better data analysis. This implementation trend HPS is focused on sales development, continued project began in Quarter 1, 2021 and went live on NAED channel expansion, product development, and January 1, 2022. bringing quality and value to all that we produce. Our HPS has modern manufacturing facilities throughout strategic initiatives and focused plans will continue to the world and this continues to be enhanced through allow HPS to grow and expand. our committed capital investment. As we grow, we are ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED Selected Annual and Quarterly Information (tabular amounts in thousands of dollars) Annual Information (1) 2017 2018 2019 2020 2021 Sales Earnings from operations EBITDA Net earnings (loss) Total assets Non-current liabilities Total liabilities Total shareholders’ equity attributable to equity holders of the Company Operating debt, net of cash Cash provided by operations Basic earnings (loss) per share Diluted earnings (loss) per share Dividends declared and paid Average exchange rate (USD$=CAD$) Book value per share 301,750 314,082 358,792 322,097 380,202 14,470 23,069 6,114 192,449 3,641 77,438 114,848 (16,983) 1,032 0.53 0.52 2,809 1.298 9.80 2020 13,779 17,915 (12,917) 205,527 2,528 96,793 20,543 28,175 11,607 214,953 11,271 105,186 22,041 29,482 14,062 23,151 30,114 15,176 189,394 235,099 8,329 75,478 7,104 109,097 108,734 109,767 113,916 126,002 (17,056) 6,474 (1.10) (1.10) 2,818 1.294 9.26 (9,326) 17,810 0.99 0.99 3,287 1.327 9.36 (1,278) 19,683 1.20 1.20 3,993 1.343 9.70 2021 1,638 20,447 1.29 1.28 4,009 1.253 10.69 Quarterly Information Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Sales 88,420 75,393 78,115 80,169 80,121 88,277 95,526 116,278 Earnings from operations 42 EBITDA Net earnings Total assets 3,033 5,678 2,148 6,514 8,447 4,420 5,447 7,466 3,462 7,047 7,891 4,032 3,402 5,349 2,298 7,620 8,694 4,689 5,909 7,378 3,948 6,220 8,693 4,241 212,929 197,895 203,443 189,394 192,395 208,865 221,549 235,757 Non-current liabilities 9,729 9,039 8,558 8,329 7,546 7,018 6,486 7,104 Total liabilities 97,156 81,375 87,215 75,478 77,559 91,691 98,951 109,097 Total shareholders’ equity attributable to equity holders of the Company 115,773 116,520 116,228 113,916 114,836 117,174 122,598 126,002 Operating debt, net of cash (18,356) (12,906) (4,790) (1,278) (11,754) (14,392) (15,399) 1,638 Cash (used) provided by operations Basic earnings per share Diluted earnings per share Dividends declared and paid Average exchange rate (USD$=CAD$) (6,038) 7,229 10,419 8,073 (6,854) 0.18 0.18 998 0.38 0.38 999 0.30 0.30 998 0.34 0.34 998 0.19 0.19 (29) 0.40 0.40 7,430 19,900 0.34 0.34 0.36 0.35 1,002 1,002 1,002 1,002 1.339 1.391 1.335 1.309 1.268 1.231 1.257 1.258 Book value per share 9.86 9.92 9.90 9.70 9.78 9.94 10.4 10.69 (1) Balances for 2017 not restated to reflect discontinued operations HAMMOND POWER SOLUTIONS Management’s Responsibility for Financial Statements The Consolidated Financial Statements are the responsibility of the management of Hammond Power Solutions Inc. These statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”), using management’s best estimates and judgments where appropriate. Management is responsible for the reliability and integrity of the Consolidated Financial Statements, the Notes to Consolidated Financial Statements and other financial information contained in the report. In the preparation of these statements, estimates were sometimes necessary because a precise determination of certain assets and liabilities is dependent on future events. Management believes such estimates have been based on careful judgment and have been properly reflected in the accompanying Consolidated Financial Statements. Management is responsible for the maintenance of a system of internal controls designed to provide reasonable assurances that the assets are safeguarded and that accounting systems provide timely, accurate and reliable financial information. The Board of Directors is responsible for ensuring that management fulfills its responsibilities through the Audit Committee of the Board, which is composed of all of the directors, of whom six are non-management directors. The Audit Committee meets periodically with management and the auditors to satisfy itself that management’s responsibilities are properly discharged, to review the Consolidated Financial Statements and to recommend approval of the Consolidated Financial Statements to the Board of Directors. KPMG LLP, the independent auditors appointed by the shareholders, has audited the Company’s Consolidated Financial Statements in accordance with Canadian generally accepted auditing standards, and their report follows. The independent auditors have full and unrestricted access to the Audit Committee to discuss their audit and related findings as to the integrity of the financial reporting process. William G. Hammond Chairman of the Board & Chief Executive Officer Richard C. Vollering Corporate Secretary & Chief Financial Officer March 24, 2022 43 To the Shareholders of Hammond Power Solutions Inc. Opinion We have audited the consolidated financial statements of Hammond Power Solutions Inc. (the Entity), which comprise: • the consolidated statements of financial position as at end of December 31, 2021 and end of December 31, 2020 • the consolidated statements of operations for the years then ended • the consolidated statements of 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 December 31, 2021 and December 31, 2020, 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. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Key Audit Matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial ANNUAL REPORT 2021 statements for the year ended December 31, 2021. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. We have determined the matters described below to be the key audit matters to be communicated in our auditors’ report. Evaluation of the carrying value of goodwill for the India cash generating unit Description of the matter We draw attention to notes 2(d)(ii), 3(g) and 12 of the financial statements. The goodwill balance is $12,766 thousand, of which, $8,527 thousand relates to the Hammond Power Solutions Private Limited (“India”) cash generating unit (“CGU”). The Entity conducts its annual impairment assessment of goodwill on an annual basis or whenever events or changes in circumstances indicate that the carrying amount of a CGU may not be recoverable. Performing impairment testing requires management to determine the estimated recoverable amount of the relevant cash-generating units on the basis of projected future cash flows. The determination of the recoverable amount requires management to make significant estimates and assumptions which include projected revenue, projected gross margin rates, terminal growth rates, and the discount rate. Why the matter is a key audit matter We identified the evaluation of the goodwill impairment analysis for the India CGU as a key audit matter. The estimated recoverable amount of the India CGU approximated its carrying value. This indicated a significant risk of misstatement as changes to certain significant assumptions had a significant effect on the recoverable amount of the India CGU. As a result, significant auditor judgment was required in evaluating the results of the audit procedures. How the matter was addressed in the audit The following are the primary procedures we performed to address this key audit matter: • We compared the Entity’s historical projected revenue and projected gross margin rates to actual results to assess the Entity’s ability to accurately project revenue and gross margin rates. • We performed sensitivity analyses over the projected revenue and gross margin rate assumptions by using average actual growth rates realized in previous years to assess the impact on the Entity’s determination that the estimated recoverable amount of the CGU exceeded its carrying value. • We evaluated the terminal growth rate by comparing to overall market and industry conditions and overall macro-economic conditions. • We involved valuation professionals with specialized skills and knowledge, who assisted in evaluating the appropriateness of the discount rate assumption used in the estimated recoverable amount, by comparing it to a discount rate range that was independently developed using publicly available information and considering risks specific to the CGU. 44 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. • The information, other than the financial statements and the auditors’ report thereon, included in a document entitled “Annual Report 2021”. 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 and the Annual Report 2021 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, HAMMOND POWER SOLUTIONS 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. 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. • Responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. 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 • 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. 45 • 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. • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group Entity to express an opinion on the financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. • Determine, from the matters communicated with those charged with governance, those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditors’ report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our auditors’ report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. Chartered Professional Accountants, Licensed Public Accountants The engagement partner of the audit resulting in this auditors report is R. Alexander Dilts March 24, 2022 Waterloo, Canada ANNUAL REPORT 2021 Consolidated Statements of Financial Position (in thousands of dollars) As at December 31, 2021 December 31, 2020 Assets Current assets Cash and cash equivalents Accounts receivable (note 4) Inventories (note 5) Income taxes receivable Prepaid expenses and other assets (note 6) Total current assets Non-current assets Long-term lease and note receivable (note 7) Property, plant and equipment (note 8) Investment in properties (note 9) Investment in joint venture (note 10) Deferred tax assets (note 16) Intangible assets (note 11) Goodwill (note 12) Total non-current assets Total assets Liabilities Current liabilities $ 20,905 $ 72,004 62,467 807 3,515 159,698 2,779 30,960 3,294 13,279 2,370 10,503 12,216 14,795 53,078 49,206 488 2,687 120,254 3,201 30,372 3,649 13,300 1,809 5,901 10,908 75,401 69,140 $ 235,099 $ 189,394 Bank operating lines of credit (note 13) $ Accounts payable and accrued liabilities (notes 17, 21 and 27) Income taxes payable Provisions (note 20) 46 Current portion of lease and other liabilities (notes 14, and 30) $ 19,267 75,760 1,988 1,850 3,128 16,073 46,179 942 1,811 2,144 Total current liabilities Non-current liabilities Provisions (note 20) Deferred tax liabilities (note 16) Long-term portion of lease and other liabilities (notes 14 and 30) Total non-current liabilities Total liabilities Shareholders’ Equity Share capital (note 17) Contributed surplus Accumulated other comprehensive income Retained earnings Total shareholder’s equity Commitments (note 15) Subsequent events (note 31) Total liabilities and shareholders’ equity See accompanying Notes to Consolidated Financial Statements. On behalf of the Board: $ 101,993 $ 67,149 342 401 6,361 7,104 $ 109,097 $ 14,886 2,432 2,109 106,575 126,002 317 836 7,176 8,329 75,478 14,491 2,498 1,519 95,408 113,916 $ 235,099 $ 189,394 William G. Hammond Chairman of the Board & Chief Executive Officer David J. FitzGibbon Chairman Audit Committee HAMMOND POWER SOLUTIONS Consolidated Statements of Operations Years ended December 31, 2021 and 2020 (in thousands of dollars except for per share) Sales (note 21) Cost of sales (note 5 and 22) Gross margin Selling and distribution (note 22) General and administrative (note 22) Earnings from operations Finance and other costs Interest expense Foreign exchange loss (gain) Share of income of investment in joint venture, net of tax (note 10) Other Net finance and other costs 2021 2020 $ 380,202 $ 322,097 277,771 102,431 46,459 32,821 $ 79,280 $ 23,151 1,301 561 (61) 100 1,901 235,103 86,994 40,217 24,736 64,953 22,041 1,247 (123) (153) 104 1,075 Earnings before income taxes 21,250 20,966 Income tax expense (recovery) (note 16): Current Deferred Net earnings Earnings per share (note 18) Basic earnings per share Diluted earnings per share See accompanying Notes to Consolidated Financial Statements. 7,110 (1,036) 6,074 47 7,827 (923) 6,904 15,176 $ 14,062 1.29 1.28 $ $ 1.20 1.20 $ $ $ ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATEDConsolidated Statements of Comprehensive Income Years ended December 31, 2021 and 2020 (in thousands of dollars) 2021 2020 Net earnings $ 15,176 $ 14,062 Other comprehensive income (loss) Items that will be recognized within profit and loss: Foreign currency translation differences for foreign operations Other comprehensive income (loss), net of income tax 590 590 Total comprehensive income $ 15,766 $ (5,920) (5,920) 8,142 See accompanying Notes to Consolidated Financial Statements. 48 HAMMOND POWER SOLUTIONS Consolidated Statements of Changes in Equity Years ended December 31, 2021 and 2020 (in thousands of dollars) SHARE CAPITAL CONTRIBUTED SURPLUS AOCI* RETAINED EARNINGS TOTAL SHAREHOLDERS’ EQUITY Balance as at January 1, 2020 $ 14,491 $ 2,498 $ 7,439 $ 85,339 $ 109,767 Total comprehensive income for the period Net income Other comprehensive loss Foreign currency translation differences related to joint venture (note 10) Foreign currency translation differences Total other comprehensive loss Total comprehensive income for the period Transactions with owners, recorded directly in equity Dividends to equity holders (note 17) Total transactions with owners Balance at December 31, 2020 Balance at January 1, 2021 Total comprehensive income for the period Net income Other comprehensive (loss) income Foreign currency translation differences related to joint venture (note 10) Foreign currency translation differences Total other comprehensive income Total comprehensive income for the period Transactions with owners, recorded directly in equity Dividends to equity holders (note 17) Stock options exercised (note 17) Total transactions with owners Balance at December 31, 2021 *AOCI – Accumulated other comprehensive income See accompanying Notes to Consolidated Financial Statements. – – – – – – – – – – – – – – – 14,062 14,062 (281) (5,639) (5,920) (5,920) – – – 14,062 – – (3,993) (3,993) (281) (5,639) (5,920) 8,142 (3,993) (3,993) $ 14,491 $ 14,491 $ $ 2,498 $ 1,519 $ 95,408 $ 113,916 2,498 $ 1,519 $ 95,408 $ 113,916 – – – – – – – – – – – – 395 395 (66) (66) – 15,176 15,176 (82) 672 590 590 – – – – – – (82) 672 590 49 15,176 15,766 (4,009) – (4,009) (4,009) 329 (3,680) $ 14,886 $ 2,432 $ 2,109 $ 106,575 $ 126,002 ANNUAL REPORT 2021DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED Consolidated Statements of Cash Flows Years ended December 31, 2021 and 2020 (in thousands of dollars) Cash flows from operating activities Net earnings Adjustments for: Share of income of investment in joint venture Depreciation of property, plant and equipment, right-of-use assets and investment properties Amortization of intangible assets Gain on disposal of right to use asset Provisions Interest expense Income tax expense Unrealized (gain) loss on derivatives Share-based compensation expense Change in non-cash working capital (note 25) Cash generated from operating activities Income tax paid Net cash provided from operating activities Cash flows from investing activities Repayment of note and lease receivable Acquisition (note 30) 50 Acquisition of property, plant and equipment Acquisition of intangible assets Cash used in investing activities Cash flows from financing activities Proceeds from issue of share capital (note 17) Cash dividends paid (note 17) Net advances (repayments) of bank operating lines of credit Interest paid Payment of lease liabilities (note 14) Cash used in financing activities Foreign exchange on cash and cash equivalents held in a foreign currency Cash acquired in business combination (note 30) Increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period $ See accompanying Notes to Consolidated Financial Statements. 2021 2020 $ 15,176 $ 14,062 (61) 6,092 1,471 – 433 1,301 6,074 (89) 1,210 31,607 (4,777) 26,830 (6,383) 20,447 185 (5,032) (5,051) (1,016) (10,914) 329 (4,009) 3,194 (1,047) (2,724) (4,257) 578 256 6,110 14,795 20,905 $ (153) 6,233 1,036 (10) 1,080 1,247 6,904 560 518 31,477 (4,992) 26,485 (6,802) 19,683 188 – (4,222) (713) (4,747) – (3,993) (16,624) (917) (2,650) (24,184) 672 – (8,576) 23,371 14,795 HAMMOND POWER SOLUTIONS 1. Reporting entity Hammond Power Solutions Inc. (“HPS” or “the Company”) is a corporation domiciled in Canada. The address of the Company’s registered office is 595 Southgate Drive, Guelph, Ontario. The Company’s Class A subordinate voting shares are listed on the Toronto Stock Exchange and trade under the symbol HPS.A. The consolidated financial statements of the Company comprise the Company and its subsidiaries (together referred to as the “Group” and individually as “Group entities”). The Group is primarily involved in the design and manufacture of custom electrical magnetics, cast resin, custom liquid filled distribution and power transformers and standard electrical transformers, serving the electrical and electronic industries. The Group has manufacturing plants in Canada, the United States (“U.S.”), Mexico and India. The Company also holds a 55% economic interest in a joint venture located in Mexico called Corefficient de R.L. de C.V. (“Corefficient”). 2. (a) Basis of preparation Statement of compliance These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”), and were approved by the Board of Directors on March 24, 2022. (b) Basis of measurement The consolidated financial statements have been prepared on the historical cost basis except for inventories carried at net realizable value, derivative financial instruments and share based payments which are measured at fair value, and the initial present value of finance leases receivable which are determined using cash flows implicit in the lease and a discount rate reflecting the interest rate implicit in the lease. Assets acquired and liabilities assumed in connection with business combinations are recorded based on their fair values at the date of acquisition, and contingent consideration granted concurrent with a business combination is recognized initially at fair value, with subsequent measurement occurring at fair value. Changes in the fair value of contingent 51 consideration are recorded either through the statement of operations, or through equity, depending on the characteristics of the consideration granted. (c) Functional and presentation currency The functional currency of the Group’s entities is the currency of their primary economic environment. In individual companies, transactions in foreign currencies are recorded at the rate of exchange at the date of the transaction. Monetary assets and liabilities in foreign currencies at the reporting date are re-measured to the functional currency at the exchange rate at that date. Any resulting exchange differences are taken to the statement of operations. 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. On consolidation, assets and liabilities of Group entities reported in their functional currencies are translated into the Canadian dollar (“CDN”), being the presentation currency, at the exchange rate on the reporting date. The income and expenses of foreign operations are translated to Canadian dollars using average exchange rates for the month during which the transactions occurred. Foreign currency differences are recognized in other comprehensive income in the cumulative translation account within accumulated other comprehensive income. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Canadian and Subsidiary Operations Functional Currency Canada United States Mexico Mexico – Corefficient Italy India Canadian dollar U.S. dollar Mexican Peso U.S. dollar Euro Rupee ($) ($ USD) (Pesos) ($ USD) (EU €) (INR) (d) Use of estimates and judgments The preparation of the 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. (i) Critical judgments in applying accounting policies The following are the critical judgments, apart from those involving estimations, that Management has made in the process of applying the Group’s accounting policies and that have the most significant effects on the amounts recognized in the consolidated financial statements. Cash generating units As indicated in note 3(g) and 3(k); the Group conducts its impairment tests at the individual asset level or, where the recoverable amount cannot be determined for an individual asset, or for goodwill, at the cash generating 52 unit (“CGU”) level. The Group defines its CGUs based on the way it monitors and derives economic benefits from the acquired goodwill and intangibles. A cash-generating unit is the smallest group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. The identification of a cash-generating unit involves judgment. The Company has defined its cash generating units primarily as each manufacturing and contract manufacturing location, due to the fact that each location is managed separately and has its own dedicated human resources and property, plant and equipment. Each manufacturing facility produces products largely independent of the other facilities and is ultimately responsible for producing products that generate revenue. Management monitors the performance of each manufacturing unit through the use of profitability analysis, and also considers the profitability of each manufacturing unit relative to the Group’s business plan. Initial lease term The Group leases certain manufacturing facilities, warehouse facilities, vehicles and other assets. In determining the value of a right-of-use asset and lease liability, IFRS 16 requires the Group to determine the lease payments to be made over the initial term of the lease, including renewal options which are reasonably certain to be exercised. Such payments are then discounted based on the interest rate implicit in the lease or the Group’s incremental borrowing rate. In determining the initial lease term, Management makes an assessment of the HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) renewal periods available to the Group within each lease and evaluates the likelihood and corresponding time horizon of available renewal options. Such assessments involve judgment and ultimately may differ from the terms of leases actually experienced. Operating segments An operating segment is a component of an entity that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. The determination of operating segments involves judgment. Management has determined that the Group operates as a single operating segment, being the design, manufacture and sale of transformers. Identification of acquired assets and liabilities IFRS 3, Business Combinations, requires acquirers to recognize, separately from goodwill, the identifiable assets acquired and liabilities assumed. The identification of acquired assets and liabilities involves judgment. (ii) Key sources of estimation uncertainty The following are the key sources of estimation uncertainty at the end of the reporting period that have a significant risk of causing a material adjustment to the consolidated financial statements within the next twelve months. Recoverability of goodwill and intangible assets The Group tests annually or more frequently if necessary, whether goodwill or other long-lived assets have suffered any impairment in accordance with the accounting policy provided in note 3(k). Performing impairment 53 testing requires management to determine the estimated recoverable amount of the relevant cash-generating units on the basis of projected future cash flows using internal business plans or forecasts, and discounting these cash flows to appropriately reflect the time value of money. The key assumptions made by management in deriving the recoverable amount are i) projected revenue, ii) projected gross margin rates, iii) terminal growth rates, and iv) the discount rate. Impairment assessments inherently involve judgment as to assumptions about expected future cash flows and the impact of market conditions on those assumptions. Future events and changing market conditions may impact the Company’s assumptions as to prices, costs or other factors that may result in changes in the Company’s estimates of future cash flows. Failure to realize the assumed revenues at an appropriate gross margin or failure to improve the financial results of a CGU could result in impairment losses in the CGU in future periods. For assumptions relating to impairment testing, refer to note 12. Determination of fair value of acquired long-lived assets, intangible assets, and assumed liabilities IFRS 3, Business Combinations, requires acquirers to recognize the identifiable assets acquired and liabilities assumed at fair value. The determination of fair value requires Management to make estimates around the value an independent third party, under no compulsion to act, would pay for an asset acquired or liability assumed on For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 a standalone basis. Where possible, Management engages third-party appraisers to assist in the determination of the fair value of real property acquired. The fair value of acquired intangible assets are generally determined using discounted cash flow models and involve the use of cash flow forecasts, market-based discount rates, and/or market-based royalty rates. The fair values of liabilities assumed is generally based on discounted cash flow models which involve the use of market-based discount rates. The development of cash flow forecasts involve the use of estimates, which may differ from actual cash flows realized. Assumptions are involved in the determination of discount rates and royalty rates. Provisions for warranty claims The Group records a provision for warranties based on historical warranty claim information and anticipated warranty claims, based on a weighted probability of possible outcomes. The key assumptions made by management in recording the provision are i) warranty cost, ii) probability of claim, and iii) quantum of units which may be subject to any warranty claim. Quantifying provisions inherently involves judgment, and future events and conditions may impact these assumptions. Differences in actual future experience from the assumptions utilized may result in a greater or lower warranty cost. For further information on the Group’s provisions, refer to note 20. 3. Summary of significant accounting policies The accounting policies set out below have been applied consistently to all periods presented in these consolidated financial statements and by all Group entities. (a) Basis of consolidation The consolidated financial statements include the accounts of Hammond Power Solutions Inc. and its wholly- 54 owned subsidiaries: • Hammond Power Solutions, Inc. • Hammond Power Solutions, S.A. de C.V. • Montran S.A. de C.V. • Delta Transformers Inc. • Hammond Power Solutions Private Limited • Continental Transformers s.r.l. • Hammond Power Solutions S.p.A. • Mesta Electronics, Inc. • Hammond Power Solutions Latin America S.A de C.V. Joint operations arise from an arrangement in which the interested parties are bound by a contract which gives two or more parties joint control of the arrangement, and those parties have rights to the assets and obligations for the liabilities relating to the arrangement. The Company has a 50% interest in Glen Ewing Properties, an unincorporated co-tenancy. The consolidated financial statements include the Group’s share of the entity’s assets, liabilities, revenue and expenses with items of a similar nature on a line-by-line basis. Joint ventures arise in which the interested parties are bound by a contract which gives two or more parties joint control of the arrangement, and those parties have rights to the net assets of the arrangement. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) The Company’s interest in Corefficient is considered to represent a joint venture. Interests in joint ventures are initially recognized at cost. Subsequent to initial recognition, the consolidated financial statements include the Group’s share of the profit or loss and other comprehensive income. All significant inter-company transactions and balances have been eliminated. (b) Financial instruments Financial assets and financial liabilities, including derivatives, are recognized on the consolidated statement of financial position when the Group becomes a party to the financial instrument or derivative contract. The Group classifies its financial assets and financial liabilities in the following measurement categories i) those to be measured subsequently at fair value (either through other comprehensive income or through profit or loss) and ii) those to be measured at amortized cost. The classification of financial assets depends on the business model for managing the financial assets and the contractual terms of the cash flows. Financial liabilities are classified as those to be measured at amortized cost unless they are designated as those to be measured subsequently at fair value through profit or loss (irrevocable election at the time of recognition). For assets and liabilities measured at fair value, gains and losses are either recorded in profit or loss or other comprehensive income. The Group reclassifies financial assets when and only when its business model for managing those assets changes. Financial liabilities are not reclassified. The Group has applied the following classifications: • Cash and cash equivalents, accounts receivable and long-term lease and note receivable are classified as assets at amortized cost and are measured using the effective interest rate method. Interest income is recorded in the consolidated statement of operations, as applicable. • Accounts payable, accrued liabilities and bank operating lines of credit are classified as other financial liabilities and are measured at amortized cost using the effective interest rate method. Interest expense is 55 recorded in the consolidated statement of operations, as applicable. • Derivatives are initially recognized at fair value on the date a derivative contract is entered into and are subsequently re-measured to their fair value at the end of each reporting period. The accounting for subsequent changes in fair value depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged and the type of hedge relationship designated. The Group has not historically designated such items as hedging instruments and accordingly changes in fair value are recorded through the statement of operations. • Contingent consideration issued in connection with a business combination that meets the definition of a financial liability is initially recognized at fair value at the acquisition date and is subsequently re-measured at fair value at the end of each reporting period. All financial instruments are required to be measured at fair value on initial recognition, plus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. Transaction costs of financial assets and financial liabilities carried at fair value through profit or loss are expensed in profit or loss. Financial assets with embedded derivatives are considered in their entirety when determining whether their cash flows are solely payment of principal and interest. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Financial assets that are held within a business model whose objective is to collect the contractual cash flows, and that have contractual cash flows that are solely payments of principal and interest on the principal outstanding are generally measured at amortized cost at the end of the subsequent accounting periods. The Group assesses all information available, including, on a forward-looking basis, the expected credit losses associated with its assets carried at amortized cost. The impairment methodology applied depends on whether there has been a significant increase in credit risk. To assess whether there is a significant increase in credit risk, the Group compares the risk of a default occurring on the asset as at the reporting date with the risk of default as at the date of initial recognition based on all information available, and reasonable and supportive forward-looking information. For trade receivables only, the Group applies the simplified approach as permitted by IFRS 9 which requires expected lifetime losses to be recognized from initial recognition of receivables. (c) Cash and cash equivalents Cash and cash equivalents include cash and short-term deposits with maturities of three months or less. (d) Property, plant and equipment Property, plant and equipment are shown in the statement of financial position at their historical cost. Cost includes expenditure that is directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials and direct labour, any other costs directly attributable to bringing the assets to a working condition for their intended use, the costs of dismantling and removing the items and restoring the site on which they are located, and borrowing costs on qualifying assets. Purchased software that is integral to the functionality of the related equipment is capitalized as part of that equipment. When parts of an item of property, plant and equipment have different useful lives, they are accounted for as separate items (major components) of property, plant and equipment. 56 Depreciation is provided on components that have homogenous useful lives by using the straight-line method so as to depreciate the initial cost down to the residual value over the estimated useful lives. The estimated useful lives for the current and comparative periods are as follows: • Buildings 14-30 years • Leaseholds and improvements lesser of 5 years and lease term • Machinery and equipment • Office equipment • Land is not depreciated 4-10 years 4-10 years Depreciation methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate. Assets included in construction-in-progress are not depreciated until the assets are available for use. Idle assets that are available for use are depreciated. (e) Intangible assets other than goodwill Intangible assets that are acquired either separately or in a business combination are recognized when they are identifiable and can be reliably measured. Intangible assets are considered to be identifiable if they arise from contractual or other rights, or if they are separable (i.e. they can be disposed of either individually or together HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) with other assets). Intangible assets comprise finite life intangible assets. Finite life intangible assets are those for which there is an expectation of obsolescence that limits their useful economic life or where the useful life is limited by contractual or other terms. They are amortized over the shorter of their contractual or useful economical lives. The estimated useful lives for the current and comparative periods are as follows: • Customer lists and relationships 15 years • • Technology Software and other • Branding 10-20 years 4-14 years 5-15 years Amortization methods, useful lives and residual values are reviewed at each year-end and adjusted if appropriate. (f) Research and development expenses Research expenses are recognized as expenses in the financial period incurred. Development expenses are recognized as an intangible asset if the Group can demonstrate the technical feasibility of making the intangible asset ready for commissioning or sale; its intention to complete the intangible asset and use or sell it; its ability to use or sell the intangible asset; how the intangible asset will generate future economic benefits; the availability of the appropriate resources (technical, financial or other) to complete development and use or sell the intangible asset; and its ability to provide a reliable estimate of expenses attributable to the intangible asset during its development. (g) Business Combinations and Goodwill The Group accounts for business combinations using the acquisition method when the acquired set of activities and assets meets the definition of a business and control is transferred to the Group. In determining whether a 57 particular set of activities and assets is a business, the Group assesses whether the set of assets and activities acquired includes, at a minimum, an input and substantive process and whether the acquired set has the ability to produce outputs. The consideration transferred in the acquisition is generally measured at fair value, as are the identifiable net assets acquired. Any gain on a bargain purchase is recognised in profit or loss immediately. Transaction costs are expensed as incurred, except if related to the issue of debt or equity securities Any contingent consideration is measured at fair value at the date of acquisition. If an obligation to pay contingent consideration that meets the definition of a financial instrument is classified as equity, then it is not re-measured and settlement is accounted for within equity. Otherwise, other contingent consideration is remeasured at fair value at each reporting date and subsequent changes in the fair value of the contingent consideration are recognised in profit or loss. Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amount allocated to the identifiable assets acquired, less liabilities assumed, based on their fair values. Goodwill is allocated as of the date of the business combination to the Company’s cash generating units that are expected to benefit from the synergies of the business combination, and is tested for impairment at ANNUAL REPORT 2021 least annually and upon the occurrence of an indication of impairment. The impairment tests are performed at the CGU level. The Group defines its CGUs based on the way it monitors and derives economic benefits from the acquired goodwill and intangibles. The impairment tests are performed by comparing the carrying value of the assets of these CGUs with the greater of its value in use and its fair value, less costs to sell. The value in use is based on their future projected cash flows discounted to the present value at an appropriate pre-tax discount rate. The cash flows correspond to estimates made by Group management in financial and strategic business plans covering a period of five years. They are then projected beyond five years using a steady or declining terminal growth rate given that the Group businesses are of a long-term nature. The Group assesses the uncertainty of these estimates by conducting sensitivity analyses. The discount rate used approximates the CGUs weighted average cost of capital, with business risk incorporated into the development of the cash flow projections. An impairment loss in respect of goodwill is never subsequently reversed. The Group completed its annual goodwill impairment tests at December 31, 2021. (h) Investment properties Investment property is property held either to earn rental income or for capital appreciation or for both, but not for sale in the ordinary course of business use in the production or supply of goods or services or for administrative purposes. The Group measures its investment properties, being the property held by Glen Ewing Properties and the Italian Marnate properties, at historical cost. (i) Joint venture The Company applies the equity method of accounting for its investment in the joint venture. Under the equity method of accounting, interests in joint ventures are initially recognized in the Consolidated Statements of 58 Financial Position at initial cost and adjusted thereafter to recognize the Group’s share of profits or losses and movements in other comprehensive income in the income statement and in other comprehensive income respectively. When the Group’s share of losses in a joint venture equals or exceeds its interest in the joint venture, the Group does not recognize further losses unless it has incurred obligations or made payments on behalf of the joint venture. Unrealized gains or transactions between the Group and its joint venture are eliminated to the extent of the Group’s interest in the joint venture. Unrealized losses are also eliminated unless the transaction provides evidence of impairment of the assets transferred. (j) Inventories Inventories are valued 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. In the case of manufactured inventories and work in progress, cost includes an appropriate share of production overheads based on normal operating capacity. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) of completion and selling expenses. When circumstances which previously caused inventories to be written down to their net realizable value no longer exist, the previous impairment is reversed. (k) Impairment of property, plant and equipment and finite life intangible assets The Group periodically reviews the useful lives and the carrying values of its long-lived assets for continued appropriateness. Consideration is given at each reporting date to determine whether there is any indication of impairment of the carrying amounts of the Group’s property, plant and equipment and finite life intangible assets. The Group reviews for impairment of long-lived assets, or asset groups, held and used whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The recoverable amount is the greater of the fair value less cost of disposal and value in use. If the recoverable amount cannot be determined for one individual asset, the Group conducts its impairment test at the CGU level. In assessing value in use, the estimated future cash flows are discounted to their present value, based on the time value of money and the risks specific to the country where the assets are located. Assets that suffer impairment are assessed for possible reversal of the impairment at each reporting date. (l) Share-based payment transactions Stock option plan The Group has a stock-based compensation plan, which is described in note 17. The Group accounts for all stock-based payments using the fair value based method. Under the fair value based method, compensation cost for stock options and direct awards of stock is measured at fair value at the grant date. Compensation cost is recognized in earnings on a straight-line basis over the relevant vesting period, with a corresponding amount recorded in contributed surplus. The amount recognized as an expense, is adjusted to reflect the number of awards for which the related services are expected 59 to be met. Upon exercise of a stock option, share capital is recorded at the sum of the proceeds received and the related amount of contributed surplus. Deferred share unit plan The Company maintains a deferred share unit plan (“DSU Plan”) for its senior-executive management and Directors. Under the DSU Plan, participants may elect to defer compensation and receive DSUs equal to the value of the deferred compensation. DSUs are increased by the dividend rate on a quarterly basis. Under IFRS, DSUs are classified as cash-settled share-based payment transactions as the participants shall receive cash following a Redemption Event, as defined in the DSU Plan. DSUs do not contain any vesting conditions or forfeiture provisions, as they are issued in exchange for deferred compensation. As such, the Company recognizes the expense and the liability to pay for eventual redemption when DSUs are issued. Thereafter, the Company re-measures the fair-value of the liability at the end of each reporting date and the date of settlement, with the difference recognized in income or expense for the period. The fair value of DSUs is determined in accordance with the DSU Plan, which uses the average closing price for HPS shares for the five trading days immediately preceding the relevant date. The DSU liability is included within accrued liabilities. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 (m) Provisions Provisions comprise liabilities of uncertain timing or amounts that arise from restructuring plans, environmental, litigation, commercial or other risks. Provisions are recognized when there exists a legal or constructive obligation stemming from a past event and when the future cash outflows can be reliably estimated. A provision for warranties is recognized when the underlying products or services are sold. The provision is based on historical warranty data and a weighting of all possible outcomes against their associated probabilities. A restructuring provision relating to a sale or termination of a line of business, the closure of business locations in a country or region, changes in management structure or fundamental reorganizations that have a material effect of the nature or focus of the Group’s operations are recognized when the Group has a detailed, formal plan for the restructuring that identifies: • The business or part of a business concerned; • The principal locations affected; • The location, function and approximate number of employees affected; • The expenditures that will be undertaken; and • When the plan will be implanted. Notwithstanding the above, no provision is recorded until such time a valid expectation by those affected by the plan has been raised. (n) Revenue The Group recognizes revenue using a 5-step approach: • Step 1: Identify the contract(s) with a customer. • Step 2: Identify the performance obligations in the contract. 60 • Step 3: Determine the transaction price. • Step 4: Allocate the transaction price to the performance obligations in the contract. • Step 5: Recognize revenue when (or as) the Group satisfies a performance obligation. The Group considers a performance obligation satisfied when “control” of the goods or services underlying the particular performance obligation is transferred to the customer. A performance obligation represents a good and service (or a bundle of goods or services) that is distinct or a series of distinct goods or services that are substantially the same. The Group typically satisfies its performance obligation upon shipment of its transformers. Any required testing or compliance requirements will have been satisfied prior to shipment of the transformer. Payment is typically due within 30 days of shipment, with limited customers being granted extended terms of up to 60 days. As a result, consideration is generally fixed and does not contain any significant financing components. The Group has a return policy for credit on standard stocked items and no custom build product can be returned. Historically, returns have been minimal and are expected to continue to remain low. The Group’s product is purchased with a standard warranty and there is no option to purchase any additional warranty coverage. A contract asset represents the Group’s right to consideration in exchange for goods or services that the Group has transferred to a customer that is not yet unconditional. In contrast, a receivable represents the Group’s unconditional right to consideration in that only the passage of time is required before payment of that HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) consideration is due. A contract liability represents the Group’s obligation to transfer goods or services to a customer for which the Group has received consideration (or an amount of consideration is due) from the customer. Incremental costs to obtain a contract are typically short-term in nature and the Group applies the practical expedient permitted under IFRS 15 to recognize such costs as an expense when incurred if the amortization of the asset that the Group would have otherwise recognized is less than one year. (o) Income taxes Income tax expense comprises current and deferred tax. 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 previous years. Deferred tax is recognized in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. 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 at the reporting date. 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. (p) Employee benefits The Group maintains a defined contribution plan, which is described in note 19, and have short-term employee benefits. A defined contribution plan is a post-employment benefit plan under which an entity pays fixed contributions 61 into a separate entity and will have no legal or constructive obligation to pay further amounts. Obligations for contributions to defined contribution pension plans, are recognized as an employee benefit expense in profit or loss in the periods in which services are rendered by employees. Short-term employee benefit obligations are measured on an undiscounted basis and are expensed as the related service is provided. A liability is recognized for the amount expected to be paid under short-term cash bonus or profit-sharing plans if the Group has a present legal or constructive obligation to pay this amount as a result of past service provided by the employee and the obligation can be estimated reliably. (q) Finance income and finance costs Finance income and finance costs comprise interest income, interest expense on borrowings, foreign currency losses (including changes in fair value of derivative foreign currency financial instruments measured at fair value through profit and loss), the Group’s share of income or losses arising from its investment in joint ventures and other finance costs. Foreign currency gains and losses are reported on a net basis. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 (r) Earnings per share The Group presents basic and diluted earnings per share (“EPS”) data for its common shares. Basic EPS is calculated by dividing net earnings of the Group by the weighted average number of common shares outstanding during the reporting period. Diluted EPS are computed similar to basic EPS except that the weighted average shares outstanding are increased to include additional shares from the assumed exercise of stock options, if dilutive. The number of additional shares is calculated by assuming that outstanding stock options were exercised and that proceeds from such exercises along with any unamortized stock-based compensation were used to acquire common shares at the average market price during the year. (s) Leases The Group recognizes a right-of-use asset and a lease liability at the lease commencement date. The right-of-use asset is initially measured at cost, and subsequently at cost less any accumulated depreciation and impairment losses, and adjusted for certain remeasurements of the lease liability. The lease liability is initially measured at the present value of the lease payments that are not paid at the commencement date, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the Group’s incremental borrowing rate. Generally, the Group uses its incremental borrowing rate as the discount rate. The group applies a single discount rate to the portfolio of leases with reasonably similar characteristics. The lease liability is subsequently increased by the interest cost on the lease liability and decreased by lease payments made. It is remeasured when there is a change in future lease payments arising from a change in an index or rate, a change in the estimate or the amount expected to be payable under a residual value guarantee, or as appropriate, changes in the assessment of whether a purchase or extension option is reasonably certain to 62 be exercised or a termination option is reasonably certain not to be exercised. The Group does not recognize right-of-use assets and lease liabilities for contracts that have a lease term of 12 months or less or are low-value assets (under $5,000). (t) Government assistance The Group recognizes government assistance in the statement of operations on a systematic basis over the periods in which the entity recognises expenses for the related costs for which the assistance is intended to compensate. (u) New accounting pronouncements adopted during the period IBOR – Phase 2 (Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16) In August 2020, the IASB issued Phase 2 amendments, which amended the requirements in IFRS 9, IAS 39, IFRS 7, IFRS 4, and IFRS 16, principally addressing the following areas: • modification of a financial asset or a financial liability; • modification of a lease; • additional reliefs for hedging relationships; • new disclosures; and • effective date and transition. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) The Company adopted the amendments in its financial statements for the annual period beginning on January 1, 2021. The adoption of the amendments did not have a material impact on the consolidated financial statements. COVID-19-related rent concessions (Amendments to IFRS 16) In May 2020, the IASB issued COVID-19-Related Rent Concessions, which amended IFRS 16. The 2020 amendments introduced an optional practical expedient that simplifies how a lessee accounts for rent concessions that are a direct consequence of COVID-19, only if certain conditions are met. Under the practical expedient, a lessee is not required to assess whether eligible rent concessions are lease modifications, instead accounting for them in accordance with other applicable guidance. The Company adopted the amendments in its financial statements for the annual period beginning on January 1, 2021. The adoption of the amendments did not have any impact on the consolidated financial statements. Cloud computing arrangement costs On April 28, 2021 the IFRS Interpretations Committee issued a final agenda decision on cloud computing arrangements. The agenda aimed to clarify guidance on how customers should account for implementation costs incurred in a software-as-a-service arrangement. This further builds upon the March 2019 agenda which distinguished hosting arrangements in which the customer receives a software intangible asset from those that do not, and therefore are service contracts. The Company adopted this agenda decision on a retrospective basis. The adoption of the amendments did not have a material impact on the financial statements. (v) New accounting pronouncements 63 The International Accounting Standards Board has issued the following Standards, Interpretations and Amendments to Standards that are not yet effective, have not yet been adopted by the Group and are not expected to have a material impact on the consolidated financial statements. The Group intends to adopt the following amendments in its financial statements for the annual period beginning on January 1, 2022: • Property, Plant and Equipment – Proceeds before Intended Use (Amendments to IAS 16); • Onerous Contracts – Cost of Fulfilling a Contract (Amendments to IAS 37); • Reference to the Conceptual Framework (Amendments to IFRS 3); and • Annual Improvements to IFRS Standard 2018-2020. The following amendments are effective for the annual period beginning on January 1, 2023: • Classification of Liabilities as Current or Non-Current (Amendments to IAS 1); • Definition of accounting estimates (Amendments to IAS 8); • Disclosure initiative – accounting policies (Amendments to IAS 1 and IFRS Practice Statement 2 Making Materiality Judgements); and • Deferred tax related to assets and liabilities arising from a single transaction (Amendments to IAS 12 Income Taxes). For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 The Group is evaluating the impact of adoption. The Group intends to adopt the following amendment once an effective date has been announced: • Sale or Contribution of Assets Between an Investor and its Associate or Joint Venture. 4. Accounts receivable Trade accounts receivable Other receivables December 31, 2021 December 31, 2020 $ $ 67,359 $ 4,645 72,004 $ 49,129 3,949 53,078 Trade accounts receivable is presented net of expected credit losses of $2,359,000 (December 31, 2020 – $2,577,000). A continuity of the Group’s allowance for doubtful accounts is as follows: Opening balance Additional allowances Writeoffs Adjustments 5. Inventories 64 Raw materials Work in progress Finished goods December 31, 2021 December 31, 2020 $ 2,577 $ 2,997 214 (6) 494 (25) (426) (889) $ 2,359 $ 2,577 December 31, 2021 December 31, 2020 $ 30,731 $ 19,002 4,206 1,867 27,530 28,337 $ 62,467 $ 49,206 Raw materials and changes in finished goods, and work in progress recognized as cost of sales during the year amounted to $276,850,000 (2020 – $234,395,000). In addition, during the year, write-downs in the amount of $23,000 were recognized (2020 – reversal of write-downs $4,000). Inventories carried at net realisable value as at December 31, 2021 were $1,054,000 (December 31, 2020 – $821,000). 6. Prepaid and other assets Prepaid expenses Fair value of derivative Current portion of long-term lease and note receivable (note 7) December 31, 2021 December 31, 2020 $ $ 3,121 $ 2,455 180 214 – 232 3,515 $ 2,687 HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) 7. Long-term lease and note receivable Concurrent with the disposal of the VPI product line in 2017, the Group entered into a lease agreement for one of its manufacturing facilities in Italy, under which the purchaser will have the use of the plant, which includes both the land and the building, to October 2023. Consideration was in the form of a lease receivable, which the Company has determined meets the definition of a finance lease. The lease receivable is calculated based on the present value of the future principal and interest cash flows, discounted at the market rate of interest at the lease inception date, determined to be 1.15%. Unless one of the Parties sends to the other a twelve month prior written notice of termination, at the end of each six year term, the agreement will be automatically renewed by an equal period. Put and call option The lease agreement includes a put and call option related to the leased premises, exercisable within 60 days after September 30, 2023. The call option grants the purchaser an option to purchase the premises for consideration equal to 2,225,000 Euros (“EUR”) (approximately $3,305,000). The put option grants HPS an option to sell the plant to the purchaser for consideration equal to the initial plant purchase price of 2,225,000 EUR. Under both the call and put option the plant purchase price will be reduced by 50% of the monthly rent installments received, to a maximum of 375,000 EUR (approximately $557,000). If the purchaser fails to complete the acquisition of the leased premises upon the exercise of the put option by the Company and pay the required consideration, the purchaser will pay 500,000 EUR (approximately $743,000) in liquidated damages. Management has determined that ownership of the leased premises is reasonably certain to be tranferred by virtue of the put and call options and accordingly has accounted for the lease as a finance lease. The put and call options expire November 23, 2023. As at December 31, 2021 consideration receivable consists of: December 31, 2021 December 31, 2020 65 Lease receivable of 2,083 EUR (2020 – 2,208 EUR), with monthly lease payments of 13 EUR, bearing interest of 1.15% per annum. Gross cash entitlement: Less: unearned finance income Net lease receivable Less: current portion included within prepaid and other assets $ 3,057 $ (64) 2,993 214 $ 2,779 $ The aggregate amount of principal payments to be received in each of the next two years is as follows: 2022 2023 $ 3,538 (105) 3,433 232 3,201 214 2,779 2,993 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 8. Property, plant and equipment Property, plant and equipment comprise owned and leased assets that do not meet the definition of investment property. Carrying amounts of owned and right of use assets are as follows: Property, plant and equipment owned Right-of-use assets (note 14) December 31, 2021 December 31, 2020 $ $ 25,152 $ 5,808 30,960 $ 23,648 6,724 30,372 Land Buildings Leaseholds & Improvements Machinery & Equipment Office Equipment Construction in Progress & Deposits Total Cost Balance at January 1, 2020 $ 4,232 $17,724 $ 1,582 $53,028 $ 11,075 $ 1,123 $ 88,764 Additions Effect of movements in exchange rates – 301 325 1,612 489 1,495 4,222 (22) (46) (107) (574) (106) – (855) Balance at December 31, 2020 $ 4,210 $17,979 $ 1,800 $54,066 $ 11,458 $ 2,618 $ 92,131 Balance at January 1, 2021 $ 4,210 $17,979 $ 1,800 $54,066 $ 11,458 $ 2,618 $ 92,131 Acquisition (note 30) Additions Disposal Effect of movements in exchange rates – – – – 564 – – 106 – 8 2,067 (671) – – 486 1,828 – – 8 5,051 (671) (12) (25) (41) (263) (45) (93) (479) 66 Balance at December 31, 2021 $ 4,198 $18,518 $ 1,865 $55,207 $ 11,899 $ 4,353 $ 96,040 Accumulated Depreciation Balance at January 1, 2020 $ Depreciation for the year Effect of movements in exchange rates Balance at December 31, 2020 $ Balance at January 1, 2021 $ Depreciation for the year Disposal Effect of movements in exchange rates Balance at December 31, 2021 $ Carrying amounts – – – – – – – – – $11,350 $ 1,133 $42,836 $ 10,030 $ 779 106 2,456 416 (19) (80) (444) (80) $12,110 $ 1,159 $44,848 $ 10,366 $12,110 $ 1,159 $44,848 $ 10,366 $ $ 816 – 121 – 2,183 (667) 436 – (10) (34) (401) (39) $ 12,916 $ 1,246 $45,963 $ 10,763 $ – – – – – – – – – $ 65,349 3,757 (623) $ 68,483 $ 68,483 3,556 (667) (484) $ 70,888 At December 31, 2020 $ 4,210 $ 5,869 $ 641 $ 9,218 $ 1,092 $ 2,618 $ 23,648 At December 31, 2021 $ 4,198 $ 5,602 $ 619 $ 9,244 $ 1,136 $ 4,353 $ 25,152 HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)Depreciation is recorded in the statement of earnings as follows: cost of sales $3,198,000 (2020 – $3,430,000), selling and distribution $nil (2020 – $5,000) and general and administrative $358,000 (2020 – $322,000). Right of use assets The Group leases many assets including buildings, vehicles and office equipment. Information about leases for which the Group is a lessee is presented below. Buildings Vehicles Office Equipment Total Balance at January 1, 2020 $ 8,503 $ 523 $ 27 $ 9,053 Additions Disposal Depreciation Effect of movements in exchange rates Balance at December 31, 2020 Balance at January 1, 2021 Additions Depreciation Effect of movements in exchange rates – – (1,909) (407) 343 (15) (313) (9) $ $ 6,187 $ 529 $ 6,187 $ 529 $ 853 (1,668) (135) 299 (290) (3) – – (18) (1) 8 8 $ $ 44 (16) – Balance at December 31, 2021 $ 5,237 $ 535 $ 36 $ 343 (15) (2,240) (417) 6,724 6,724 1,196 (1,974) (138) 5,808 Certain building leases maintained by the Group contain renewal options. Where practicable, the Group seeks to include extension options in new leases to provide operational flexibility. The majority of the Group’s lease payments related to its production facilities located in Mexico. The first renewal option commenced in May 67 2020, with annual lease payments of $621,000, and is for a five-year term. The Group retains rights to renew this lease for 3 successive 5-year periods. The Group’s lease on its second Mexican production facility expires in March 2023 and carries annual lease payments of $581,000. The Group holds a right to renew this lease for one four-year period following the expiry of the current lease term. The extension options held are exercisable only by the Group and not by the lessors. The Group assesses at lease commencement whether it is reasonably certain to exercise the options. 9. Investment in properties Glen Ewing Property Marnate Property (net of accumulated depreciation of $1,415 (2020 - $1,360)) December 31, 2021 December 31, 2020 $ $ 1,044 $ 1,044 2,250 3,294 $ 2,605 3,649 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Glen Ewing Property The Group has a 50% ownership interest in a property in Georgetown, Ontario (referred to as the Glen Ewing Property). It is a vacant plot of land currently under environmental remediation, and no revenue was derived from it in 2021 or 2020. The property is carried at cost. The estimated fair value of the property as at December 31, 2021 is $1,150,000 (2020 – $1,150,000). The fair value was determined based on independent available market evidence, with reference to comparable market transactions. The Group’s share of ongoing legal, consulting and remediation costs during the year was $139,000 (2020 – $121,000). Marnate Property The Group owns a property in Marnate, Italy (referred to as the Marnate Property). As part of the sale transaction of certain of the assets and liabilities of the Italian company in 2019, the purchaser has leased the Marnate Property for a period of five years at an annual rental amount of 90,000 EUR (approximately $134,000). The operating expenses for this property were 169,000 EUR (approximately $251,000) in 2021 and 202,000 EUR (approximately $307,000) in 2020. Depreciation on the facility was recorded in the statement of earnings as general and administrative expenses in the amount of $163,000 (2020 – $236,000). The estimated fair value of the property as at December 31, 2021 is 1,566,000 EUR (approximately $2,250,000). The fair value was determined based on independent available market evidence, based on comparable property sales, by an independent valuator. 10. Investment in joint venture The Company has a 55% economic and voting interest in Corefficient. By virtue of the contractual arrangement with National Material L.P., the other shareholder in Corefficient, decisions about significant, relevant, operating and strategic activities require the unanimous consent of both parties, and distributions of dividends and 68 returns of capital from Corefficient are subject to unanimous Corefficient shareholder approval. Accordingly, the Company jointly controls Corefficient and has treated its investment as a joint arrangement. Corefficient’s principal place of business is in Monterrey, Mexico. The carrying value of the Company’s interest in Corefficient is as follows: Cost of investment in joint venture December 31, 2021 December 31, 2020 $ 20,023 $ 20,023 Cumulative share of loss in investment in joint venture, net of tax (3,172) (3,233) Cumulative foreign currency translation differences related to the joint venture (3,572) (3,490) $ 13,279 $ 13,300 During the year the Company made no additional contributions (2020 – $nil) and recognized its share of income of $61,000 (2020 – $153,000). HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) Selected financial information relating to Corefficient is as follows: Cash Trade and other receivables Inventories Other current assets Total current assets Non-current assets Total assets Current liabilities Non-current liabilities Total liabilities Revenue Income for the year December 31, 2021 December 31, 2020 $ 1,741 $ 17,933 3,224 217 3,553 8,155 2,932 89 $ 23,115 $ 14,729 13,659 $ 36,774 $ $ 12,905 $ – $ 12,905 $ 16,425 31,154 6,508 746 7,254 2021 2020 $ 67,908 $ 56,605 113 278 Net income for the year ended December 31, 2020 includes depreciation and amortization expense of $2,893,000 (2020 – $3,118,000), net interest expense of $14,000 (2020 – $62,000) and an income tax expense of $nil (2020 – $nil) related to Corefficient. 69 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 11. Intangible assets Intangible assets Cost Technology and Patents Customer lists, relationships and branding Externally acquired software Total Balance at January 1, 2020 $ 6,241 $ 8,746 $ 6,690 $ 21,677 Additions Effect of movements in exchange rates Balance at December 31, 2020 Balance at January 1, 2021 Acquisition (note 30) Additions Effect of movements in exchange rates $ $ – (122) – (87) 713 35 713 (174) 6,119 $ 8,659 $ 7,438 $ 22,216 6,119 $ 8,659 $ 7,438 $ 22,216 1,710 – (53) 3,374 – (27) – 1,016 (1) 5,084 1,016 (81) Balance at December 31, 2021 $ 7,776 $ 12,006 $ 8,453 $ 28,235 Accumulated Amortization Balance at January 1, 2020 Amortization for the year Effect of movements in exchange rates Balance at December 31, 2020 70 Balance at January 1, 2021 Amortization for the year Effect of movements in exchange rates $ 4,545 $ 6,750 $ 4,051 $ 15,346 $ $ 138 (53) 481 (50) 417 36 1,036 (67) 4,630 $ 7,181 $ 4,504 $ 16,315 4,630 $ 7,181 $ 4,504 $ 16,315 216 (27) 833 (26) 422 (1) 1,471 (54) Balance at December 31, 2021 $ 4,819 $ 7,988 $ 4,925 $ 17,732 Balance at At December 31, 2020 At December 31, 2021 $ $ 1,489 $ 1,478 $ 2,934 $ 5,901 2,957 $ 4,018 $ 3,528 $ 10,503 Amortization of $617,000 (2020 – $342,000) has been recognized in cost of sales, $123,000 (2020 – $131,000) has been recognized in selling and distribution and $731,000 (2020 – $563,000) has been recognized in general and administrative. None of the intangible assets has been internally developed. Research and development expenses of $945,000 (2020 – $704,000) have been recognized in cost of sales in the consolidated statements of earnings. No research and development costs have been capitalized (2020 – $nil). HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) 12. Goodwill and impairment testing for cash-generating units Goodwill Opening balance Addition (note 30) Effect of movements of exchange rates Ending balance December 31, 2021 December 31, 2020 $ 10,908 $ 11,309 1,422 (114) – (401) $ 12,216 $ 10,908 The Company conducts its annual impairment assessment of goodwill, intangible assets and property, plant and equipment in the fourth quarter of each year, which corresponds with its annual planning cycle, and whenever events or changes in circumstances indicate that the carrying amount of an asset or CGU may not be recoverable. The Company did not identify any triggering events during the course of 2021 indicating that the carrying amount of its assets and CGUs may not be recoverable, which would require the performance of an impairment test for those CGUs which did not contain goodwill. Impairment testing for cash-generating units containing goodwill The Company has three subsidiaries identified as CGUs that contain goodwill. The CGUs and their respective goodwill balances are as follows: Delta Transformers Inc. $2,180,000 (2020 – $2,180,000), Hammond Power Solutions Private Limited (“India”) $8,527,000 (2020 – $8,728,000) and Mesta Electronics Inc. $1,509,000. For its 2021 annual impairment assessment of CGUs containing goodwill, the Company used cash flow projections based primarily on its business plan for the following year, and projections for the ensuing four year period. The Company’s business plan is primarily based on financial projections submitted by its subsidiaries in the fourth quarter of each year, together with inputs from customer teams. This plan is subjected to reviews by various levels of management as part of its annual planning cycle, and is approved by the Board of Directors. 71 The values used in the cash flow projections are based on historical sales, internal growth rate assumptions and available market data. India Based on the Company’s projections, a five year cash flow forecast was completed and discounted to present- value using discount rate of 20.0% (2020 – 21.9%). Through the five year cash flow projections, the Company’s model also incorporated year 1 sales growth rates of 82.3%, which reflects returning to normal production levels post the COVID-19 pandemic as well as the manufacturing of a new product line in India. The annual sales growth rates for year 2 to year 5 are in the range of 10.5% – 36.2% (2020 – year 1 to year 5 – 6.0% – 80.3%) based on the CGUs operating history and strategic sales growth initiatives. Cash flows beyond the five year period have been extrapolated using terminal growth rate of 8% (2020 – 8%). This was then compared to the carrying value of the CGU to determine if there was impairment. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Delta Based on the Company’s projections, a five year cash flow forecast was completed and discounted to present- value using discount rate of 12.3% (2020 – 12.3%). Through the five year cash flow projections, the Company’s model also incorporated year 1 sales growth rates of 19.9% which reflects returning to normal production levels post COVID-19 pandemic. The annual sales growth rates for year 2 to year 5 are 3.0% (2020 – year 1 to year 5 – 2.4% – 5.3%) based on the CGUs operating history and strategic sales growth initiatives. Cash flows beyond the five year period have been extrapolated using terminal growth rate of 2% (2020 – 2%). This was then compared to the carrying value of the CGU to determine if there was impairment. Mesta Based on the Company’s projections, a five year cash flow forecast was completed and discounted to present- value using discount rate of 26.8%. Through the five year cash flow projections, the Company’s model also incorporated annualized year 1 sales growth rates of 304%. The annual sales growth/contraction rates for year 2 to year 5 range from 15.4% to 5.0% based on the CGUs operating history and strategic sales growth initiatives. Cash flows beyond the five year period have been extrapolated using terminal growth rate of 3%. This was then compared to the carrying value of the CGU to determine if there was impairment. Management’s approach to determining projected revenue includes consideration of current bookings, committed product line expansions (for which no additional capital expenditure is required), consultation with its salesforce and historical results. The Company’s process for determining projected gross margin rates includes consideration of current pricing information from suppliers and historical gross margin rates realized by the Company. The Company determines the terminal growth rate with reference to published economic data pertaining to the applicable industry and country in which the cash generating unit operates. The discount rate 72 is determined with reference to the cash generating unit’s weighted average cost of capital. While management believes that estimates of future cash flows and discount rates are reasonable, different assumptions regarding future cash flows or discount rates could materially affect the outcome of the impairment test. Management believes that certain reasonable possible changes in the key assumptions on which the recoverable amounts are based could cause the carrying amount to exceed the recoverable amount in the India CGU. As of December 31, 2021, a discount rate increase of 4.8% or a 8.2% lower terminal growth rate than the assumptions utilized would cause the estimated recoverable amount to be equal to the carrying amount for this CGU (December 31, 2020 – a discount rate increase of 2.1% or a 3.5% lower terminal growth rate). For the Delta Transformers Inc. and Mesta Electronics Inc. CGUs, management believes that any reasonable possible change in the key assumptions on which the recoverable amounts are based would not cause the carrying amount to exceed the recoverable amount. Upon completion of the 2021 annual impairment assessment of goodwill it was determined that the recoverable amount of the CGUs exceeded their respective carrying values and no impairment existed at December 31, 2021. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)13. Bank operating lines of credit The Group’s North American current banking agreement, which expires in June 2026, consists of a $50,000,000 U.S. revolving credit facility. The revolving credit facility can be drawn in U.S. Prime borrowings, Canadian Prime borrowings, Canadian Dollar Offered Rate (“CDOR”) borrowings or the London Inter-Bank Offered rate (“LIBOR”) benchmark replacement rate borrowings. The facilities are unsecured. Interest on the revolving credit lines is dependent on certain financial ratios and ranges from Canadian bank prime rate to Canadian bank prime rate plus 0.04% for the Canadian dollar denominated revolving credit lines or, if designated, the bank’s CDOR rate plus 1.40% to 1.90% and the Canadian overdraft loans at Canadian bank prime rate; and from U.S. base rate minus 1.00% to U.S. base rate minus 0.50% for the U.S. dollar denominated revolving credit lines or, USD overdraft loan at USD prime minus 1.00%. The Group also has a 4,070,000 EUR unsecured Euro facility that matures June 2026 and may be renewed in writing each year to extend the maturity date for the facility for a further 365 days, subject to approval from the lender. The facility is comprised of a 3,750,000 EUR revolver and 250,000 EUR overdraft facility, as well as a 70,000 EUR letter of credit line. The revolver facility bears interest at 1.75% plus the relevant Market Index (2020 – plus margin of 2.25%, Euribor on December 31, 2021 – 0.499%, Euribor on December 31, 2020 – 0.499%). Hammond Power Solutions Private Limited maintains an additional demand credit facility for an unsecured working capital loan up to 515,000,000 INR (2020 – 375,000,000 INR) consisting of the sub-facilities of a 90,000,000 INR (2020 – 131,000,000 INR) short-term working capital demand loan, a 425,000,000 INR (2020 – 244,000,000 INR) facility for bank guarantees. The demand loan bears interest at a MCLR + 2.5% and the bank guarantees are at a rate of 1.0%. As at December 31, 2021, there was $nil Canadian dollar equivalent of Rupees drawn against the working capital demand loan (2020 – $nil). As at December 31, 2021 there was $4,481 INR (2020 – nil INR) drawings against the bank guarantees. Based on exchange rates in effect at December 31, 2021, the combined Canadian dollar equivalent available 73 across all facilities, prior to any utilization of the facilities was $77,788,000 (2020 – $76,477,000). As at December 31, 2021, the Canadian dollar equivalent outstanding under the U.S. dollar revolving credit facility was $14,777,000, consisting of $12,598,000 Canadian dollars drawn and the Canadian equivalent of $2,179,000 U.S. dollars drawn (2020 – $11,215,000 – consisting of $7,577,000 Canadian dollars drawn and the Canadian equivalent of $3,638,000 U.S. dollars drawn). As well, $4,490,000 (2020 – $4,858,000) Canadian dollar equivalent of Euros was outstanding under the Euro facility, and $nil (2020 – $nil) Canadian dollar equivalent of Indian rupees under the Rupee facility. Amounts drawn on the facility have been recognized as current liabilities based on the Company’s anticipated repayment plans. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 14. Lease and other long-term liabilities Lease liabilities Contingent consideration (note 30) Current Non-Current Right of use liability maturity analysis – contractual undiscounted cash flows Less than one year One to five years More than five years Total undiscounted lease liabilities Less: effect of discounting and foreign exchange Lease liabilities included in the statement of financial position Current Non-current December 31, 2021 December 31, 2020 $ $ 7,980 $ 9,320 1,509 9,489 $ 3,128 6,361 – 9,320 2,144 7,176 December 31, 2021 December 31, 2020 $ $ $ $ $ $ 2,762 5,457 94 8,313 (333) 7,980 2,512 5,468 $ $ $ $ $ $ 2,719 7,017 705 10,441 (1,121) 9,320 2,144 7,176 Amounts recognized in statement of operations Year Ended December 31, 2021 Year Ended December 31, 2020 74 Interest on lease liabilities $ 254 $ 330 Amounts recognized in statement of cash flows Year Ended December 31, 2021 Year Ended December 31, 2020 Payment of lease liabilities $ 2,724 $ 2,650 15. Commitments December 31, 2021 December 31, 2020 Capital expenditure commitments $ 483 $ 1,029 HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)16. Income taxes Income tax expense Current tax expense Current period Deferred tax recovery 2021 2020 $ 7,110 $ 7,827 Origination and reversal of temporary differences Decrease in tax rate (1,071) 35 (1,036) Total income tax expense $ 6,074 $ (924) 1 (923) 6,904 Reconciliation of effective tax rate 2021 2021 2020 2020 $ 15,176 $ 14,062 Net earnings Income tax expense Earnings before income taxes Income tax expense using the Company’s domestic tax rate Effect of tax rates in foreign jurisdictions Decrease in tax rate Non-deductible expenses/non-taxable 39.50% (12.49%) 0.16% 6,074 21,250 8,394 (2,654) 34 39.50% (12.03%) 0.00% income 0.23% 49 0.43% Reduced rate for active business and manufacturing and processing Losses for which no deferred tax asset was recognized Basis difference in subsidiary Dividend withholding tax Other (1.81%) (385) (2.69%) (564) 2.29% 0.15% 0.00% 0.55% 487 (1.40%) 32 – 117 – 6.11% 3.01% 28.58% $ 6,074 32.93% $ (294) – 1,281 631 6,904 6,904 20,966 8,282 (2,522) – 90 75 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Unrecognized temporary differences At December 31, 2021, pre-tax temporary differences of $94,347,000 (2020 – $80,250,000) related to investments in subsidiaries were not recognized because the Company controls whether the liability will be incurred and it is satisfied that it will not be incurred in the foreseeable future. The tax liability in the event the Company were to sell these investments would be $11,793,000 (2020 – $10,031,000) based on current tax rates. Deferred tax assets have not been recognized in respect of the following items: Tax losses Basis difference in subsidiary Financial interests deductible in a future period Warranty provisions Inventory provisions December 31, 2021 December 31, 2020 $ 13,529 $ 32,831 3,309 115 434 13,777 31,361 3,381 – 332 $ 50,218 $ 48,851 The tax losses, financial interests deductible, warranty provisions and inventory provisions carry forward indefinitely and relate to HPS S.p.A and Continental Transformers s.r.l. The basis difference in subsidiary, when realized, will provide the Company a capital loss that carries forward indefinitely. The benefit of these items has not been reflected in the consolidated financial statements as it is uncertain as to whether the Company will be able to utilize the deductions. 76 HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)Recognized deferred tax assets and liabilities Deferred tax assets and liabilities are attributable to the following: Property, plant and equipment $ 811 $ 849 $ (3,552) $ (4,075) Assets Liabilities 2021 2020 2021 2020 4 (555) (641) Intangible assets Scientific research and experimental development Inventories Long-term lease and note receivable Loans and borrowings Employee benefits Unrealized losses (gains) on forward contracts and foreign denominated loans payable/receivable Provisions and tax reserves Tax loss carry-forwards Basis difference in subsidiary Tax assets (liabilities) Set off of tax Net tax assets (liabilities) 91 44 225 – 1,950 593 274 2,263 2,164 1,339 9,754 44 291 – 2,414 340 201 1,964 2,035 1,448 9,590 (36) – (3,402) – (159) (77) (4) – – (7,785) 7,384 (32) – (3,636) – (160) (71) (2) – – (8,617) 7,781 (7,384) (7,781) $ 2,370 $ 1,809 $ (401) $ (836) 77 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021Movement in temporary differences during the year ended December 31, 2021: Balance December 31, 2020 Recognized in retained earnings Recognized in profit or loss Recognized in other comprehensive income Balance December 31, 2021 Property, plant and equipment $ 3,226 $ Intangible assets Scientific research and experimental development Inventories Long-term lease and note receivable Loans and borrowings Employee benefits Unrealized gains on forward contracts and foreign-denominated loans payable/receivable Provisions and tax reserves Tax loss carry-forwards Basis difference in subsidiary 637 (12) (291) 3,636 (2,414) (180) (130) (1,962) (2,035) (1,448) 78 Foreign exchange Income tax expense $ (973) $ – – – – – – – – – – – – $ (485) $ (173) 4 66 (234) 464 (254) (67) (297) (129) 109 $ $ $ (996) $ (40) (1,036) – – – – – – – – – – – – $ $ 2,741 464 (8) (225) 3,402 (1,950) (434) (197) (2,259) (2,164) (1,339) (1,969) HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)Movement in temporary differences during the year ended December 31, 2020: Balance December 31, 2019 Recognized in retained earnings Recognized in profit or loss Recognized in other comprehensive income Balance December 31, 2020 Property, plant and equipment $ 3,997 $ Intangible assets Scientific research and experimental development Inventories Long-term lease and note receivable Loans and borrowings Employee benefits Unrealized gains on forward contracts and foreign-denominated loans payable/receivable Provisions and tax reserves Tax loss carry-forwards Basis difference in subsidiary Foreign exchange Income tax expense 767 37 (228) 2,974 (3,123) (80) (728) (1,463) (1,151) (1,127) $ (125) $ – – – – – – – – – – – – $ (771) $ (130) (49) (63) 662 709 (100) 598 (499) (884) (321) $ $ $ (848) $ (75) (923) – – – – – – – – – – – – $ $ 3,226 637 (12) (291) 3,636 (2,414) (180) (130) (1,962) (2,035) (1,448) (973) 79 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 202117. Share capital (a) Authorized: Unlimited number of special shares, discretionary dividends, non-voting, redeemable and retractable. Unlimited number of Class A subordinate voting shares, no par value. Unlimited number of Class B common shares with four votes per share, convertible into Class A subordinate voting shares on a one-for-one basis. Annual dividends on the Class B common shares may not exceed the annual dividends on the Class A subordinate voting shares, no par value. (b) Issued: 9,011,624 Class A subordinate voting shares (2020 – 8,966,624) 2,778,300 Class B common shares (2020 – 2,778,300) 11,789,924 Total A and B shares (2020 – 11,744,924) December 31, 2021 December 31, 2020 $ $ 14,879 $ 14,484 7 7 14,886 $ 14,491 During the year ended December 31, 2021, 45,000 Class A shares were issued upon exercise of stock options, resulting in cash proceeds of $329,000 and a transfer of $66,000 from contributed surplus. During the year ended December 31, 2020 there were no stock options exercised. The following dividends were declared and paid by the Company: 34 cents per Class A subordinate voting shares (2020 – 34 cents) 34 cents per Class B common shares (2020 – 34 cents) December 31, 2021 December 31, 2020 $ $ 3,064 $ 945 4,009 $ 3,048 945 3,993 80 (c) Stock option plan The Company uses a stock option plan to attract and retain key employees, officers and directors. Shareholders have approved a maximum of 1,200,000 Class A shares for issuance under the Stock Option Plan, with the maximum reserved for issuance to any one person at 5% of the Class A shares outstanding calculated immediately prior to the time of the grant. As per the Stock Option Plan, the Board of Directors may, at its sole discretion, determine the time during which the options shall vest and the method of vesting, or that no vesting restriction shall exist. The stock option exercise price is the price of the Company’s common shares on the Toronto Stock Exchange at closing for the day prior to the grant date on which the Class A shares traded. The period during which an option will be outstanding shall be 7 years, or such other time fixed by the Board of Directors, subject to earlier termination upon the option holder ceasing to be a director, officer or employee of the Company. Options issued under the plan are non-transferable unless specifically provided in the Stock Option Plan. Any option granted, which is cancelled or terminated for any reason prior to exercise, shall become available for future stock option grants. All options are to be settled by physical delivery of shares. There were no options granted for the year ended December 31, 2021, or the year ended December 31, 2020. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)Options outstanding and exercisable as at December 31, 2021: December 31, 2021 December 31, 2020 Number of options Weighted average exercise price Number of options Weighted average exercise price Outstanding, beginning of year 190,000 $ Exercised Cancelled Expired (45,000) (10,000) (20,000) Outstanding, end of year 115,000 $ 6.77 7.30 7.50 7.50 6.36 330,000 $ – (10,000) (130,000) 190,000 $ 7.99 – 6.20 10.00 6.77 Options outstanding Options exercisable Exercise price 6.62 6.20 Number of options outstanding 45,000 70,000 115,000 Weighted average remaining contractual life (years) Weighted average exercise price Number of options exercisable Weighted average exercise price 0.2 1.2 0.8 $ 6.62 6.20 6.36 45,000 70,000 115,000 $ 6.62 6.20 6.36 Terms and conditions of the stock option plan Options grants detailed below vest as follows: • Options granted to directors vest immediately. 81 • Options granted to officers and senior management vest evenly over two or three years from the grant date, with one-half of the grant vesting immediately for grants with a two-year vesting period, and one-third of the grant vesting immediately for grants with a three-year vesting period. The contractual life of the options granted below is seven years from the grant date. Option grant date March 12, 2015 March 10, 2016 Number of options Recipients 45,000 Board of Directors and Officers 70,000 Board of Directors and Officers Total stock options outstanding 115,000 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 (d) Deferred Share Units Under the Company’s DSU Plan, participants may elect to defer compensation and receive DSUs equal to the value of the deferred compensation. The first DSUs were issued in March 2017. The number of DSUs was determined by dividing the amount of deferred compensation by the fair market value (“FMV”) of DSUs, defined in the DSU Plan as the weighted average closing price of HPS shares for the five business days immediately preceding the relevant date. Upon the occurrence of the redemption event, which could include ceasing to hold any position in the Company and/or any subsidiary or upon death of the participant, the affected participant will be entitled to receive a lump sum cash payment, net of applicable withholding taxes, equal to the product of number of DSUs held by that participant and the FMV on the date of the redemption event. The DSUs do not contain any vesting conditions or forfeiture provisions, as they are issued in exchange for deferred compensation, nor are they performance based. Under the DSU Plan, outstanding DSUs as at the record date are increased by the dividend rate whenever dividends are paid to shareholders. The movement in DSUs for the years ended December 31, 2020 and 2021 is as follows: Balance at January 1, 2020 DSUs issued DSUs redeemed DSUs forfeited Balance at December 31, 2020 82 Balance at January 1, 2021 DSUs issued DSUs redeemed Balance at December 31, 2021 Number of DSUs Closing Share Price 121,571 $ 65,905 (14,788) (12,154) 160,534 $ 8.47 6.99 6.24 7.17 8.47 Number of DSUs Closing Share Price 160,534 $ 61,799 (20,941) 8.47 9.20 7.41 201,392 $ 11.99 An expense of $1,210,000 (2020 – $518,000) was recorded in general and administrative expenses. The liability of $2,346,000 (2020 – $1,360,000) related to these DSUs is included in accounts payable and accrued liabilities. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)18. Earnings per share The computations for basic and diluted earnings per share from net earnings are as follows: (earnings in thousands of dollars) Basic earnings per share Calculated as: Net earnings attributable to the equity holders of the Company Weighted average number of shares outstanding Fully diluted earnings per share Calculated as: Net earnings attributable to the equity holders of the Company 2021 1.29 $ 2020 1.20 15,176 $ 14,062 11,778,674 11,744,924 1.28 $ 1.20 15,176 $ 14,062 $ $ $ $ Weighted average number of shares outstanding including effects of 11,824,822 11,748,360 dilutive potential ordinary shares Reconciliation of weighted average number of shares outstanding: Weighted average number of shares outstanding used to calculate basic earnings per share Adjustment for dilutive effect of stock option plan 11,778,674 11,744,924 46,148 3,436 Weighted average number of shares outstanding used to calculate diluted earnings per share 11,824,822 11,748,360 As at December 31, 2021, nil options (2020 – 120,000) are excluded from the diluted average number of 83 shares calculation as their effect would have been anti-dilutive. 19. Pension plans Defined contribution plan The Group has defined contribution pension plans that are available to virtually all of its Canadian employees with eligible employee contributions based on 2.00% – 6.75% of annual earnings. The Group’s contributions of $1,748,000 (2020 – $1,655,000) matches the employee contributions. The Group’s contributions related to its defined contribution pension plans are recorded as follows: $1,313,000 (2020 – $1,240,000) in cost of sales, $216,000 (2020 – $205,000) in selling and distribution, and $219,000 (2020 – $210,000) in general and administrative. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 202120. Provisions Warranties Site restoration Benefits Restructuring $ 229 $ 947 $ Balance at January 1, 2020 $ 620 $ Provisions made during the 1,439 199 257 period Provisions used during the (392) (225) period Recovery of provisions Balance at December 31, 2020 Balance at January 1, 2021 Provisions made during the $ $ period – 1,667 1,667 161 $ $ – 231 231 130 $ $ 61 (60) – 230 230 142 $ $ Provisions used during the (110) (145) (114) period Total 1,995 1,757 – (855) (1,532) $ $ (92) – – – – (92) 2,128 2,128 433 (369) Balance at December 31, 2021 $ 1,718 $ 216 $ 258 $ – $ 2,192 Current portion Non-current portion $ $ 1,718 – $ $ 71 145 $ $ 61 197 $ $ – – $ $ 1,850 342 Warranties The provision for warranties relates mainly to transformers sold during the years ended December 31, 2021 and December 31, 2020. The provision is based on estimates made from historical warranty data associated with similar products and claims experience. The Group expects to incur most of the liability over the next year. 84 Site restoration The Group has committed to undertaking a joint remediation plan for the Glen Ewing property with the owner of an adjoining industrial property and the co-owner of the property. The Group has recorded a liability for its estimated portion of the joint remediation. Benefits The benefit provision relates to statutory pension and leave benefits related to the India facility. Substantially all of this benefit is long-term. Restructuring charges The restructuring charges related to severance, termination benefits and closure costs in respect of the closure of the Italian operations. During 2020 the cancellation and closure costs of $855,000 were paid and $92,000 of the provision was reversed into income to bring the provision balance to nil. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)21. Sales Sales have been captured based on the geography of where the product was sold, as follows: Canada United States and Mexico India 2021 2020 $ 130,184 $ 109,080 231,738 18,280 198,324 14,693 $ 380,202 $ 322,097 As at December 31, 2021 the Group had contract liabilities of $5,027,000 (2020 – $204,000) included in accounts payable and accrued liabilities. As disclosed in note 30, during the year the Group acquired Mesta Electronics Inc. (“Mesta”). From time to time, Mesta will require certain customers to advance payment prior to the satisfaction of performance obligations, which generally occurs at a point in time, upon the assumption of ownership of the transformer ordered by the customer. 22. Government assistance The Government of Canada implemented the Canada Emergency Wage Subsidy program (“CEWS”) that provides a subsidy of up to 75% of eligible remuneration paid by an eligible entity that experienced significant revenue declines due to the COVID-19 pandemic. In 2020 and 2021, the Company has qualified for subsidy payments. The subsidy amounts relating to the year have been recorded as a reduction in expenses as follows: cost of sales $2,482,000, selling and distribution $352,000 and general and administrative $649,000 for a total of $3,483,000. In 2020, the subsidy amounts relating to the year were recorded as a reduction in expenses as 85 follows: cost of sales $5,557,000, selling and distribution $776,000 and general and administrative $1,950,000 for a total of $8,283,000. 23. Related party transactions Related parties William G. Hammond, Chief Executive Officer and Chairman of the Company, directly and indirectly, through Arathorn Investments Inc., beneficially owns 2,778,300 (2020 – 2,778,300) Class B common shares of the Company, representing 100% of the issued and outstanding Class B common shares of the Company and 921,808 (2020 – 1,065,191) Class A subordinate voting shares of the Company, representing approximately 10.2% (2020 – 11.9%) of the issued and outstanding Class A subordinate voting shares of the Company and as a result controls the Company. William G. Hammond owns all of the issued and outstanding shares of Arathorn Investments Inc. Total dividends paid during the year, directly and indirectly to William G. Hammond were $1,283,000 (2020 – $1,306,000). For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Key management personnel compensation Key management personnel include the Company’s directors and members of the executive management team. Compensation awarded to key management is as follows: Salaries and benefits Share-based awards 24. Personnel expenses 2021 $ $ 3,511 $ 1,210 4,721 $ 2020 2,809 518 3,327 2021 2020 Wages and salaries $ 60,492 $ 57,246 Group portion of government pension and employment pension and employment benefits Contributions to defined contribution plans 15,467 1,748 $ 77,707 $ 16,636 1,655 75,537 25. Change in operating working capital The table below depicts the receipt of (use of) cash for working capital purposes by the Group: 86 Accounts receivable Inventories Prepaid expenses and other assets Accounts payable and accrued liabilities Provisions Settlement of derivatives Foreign exchange 2021 2020 $ (18,836) $ (12,705) (666) 29,349 (369) (1,952) 402 $ (4,777) $ 10,926 1,720 (15) (11,115) (947) – (5,561) (4,992) HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)26. Segment disclosures The Company operates in a single operating segment, being a manufacturer of transformers. The Company and its subsidiaries operate in Canada, the United States, Mexico and India. Inter-segment sales are made at fair market value. Geographic Segments Sales Canada United States and Mexico India Property, plant and equipment and right-of-use assets – net Canada United States Mexico Italy India Investment in properties Canada Italy Investment in joint venture Mexico Intangibles, net Canada United States Italy India Goodwill Canada United States India 2021 2020 130,184 $ 231,738 18,280 380,202 $ 109,080 198,324 14,693 322,097 15,091 $ 8,686 3,439 – 3,744 30,960 $ 1,044 $ 2,250 3,294 $ 15,981 7,767 3,929 75 2,620 30,372 1,044 2,605 3,649 13,279 $ 13,300 3,856 $ 3,593 4,664 – 1,983 10,503 $ 2,180 $ 1,509 8,527 12,216 $ – 8 2,300 5,901 2,180 – 8,728 10,908 87 $ $ $ $ $ $ $ $ $ $ $ For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 202127. Financial instruments Fair value The fair value of the Group’s financial instruments measured at fair value has been segregated into three levels. Fair value of assets and liabilities included in Level 1 are determined by reference to quoted prices in active markets for identical assets and liabilities. Fair value of assets and liabilities included in Level 2 include valuations using inputs other than quoted prices for which all significant inputs are observable, either directly or indirectly. Fair value of assets and liabilities included in Level 3 valuations are based on inputs that are unobservable and significant to the overall fair value measurement. The Group’s financial instruments measured at fair value consist of foreign exchange forward contracts and contingent consideration issued in conjunction with a business combination. The forward foreign exchange contracts have a fair value of a net asset of $89,000 as at December 31, 2021 (2020 – net liability of $1,952,000) and are included in Level 2 in the fair value hierarchy. The contingent consideration liability is valued at $1,509,000 as at December 31, 2021 (2020 - $nil) and is included in Level 3 of the fair value hierarchy. To determine the fair value of the forward foreign exchange contracts, Management used a valuation technique in which all significant inputs were based on observable market data. There have been no transfers between levels in 2021 or 2020. The gains and losses from these contracts are grouped with foreign exchange gain on the statement of operations. The contingent consideration is comprised of two components: • Employee performance – $1,211,000 To determine the fair value of the contingent consideration, Management calculated the present value of the expected future payments of four installments of approximately $316,000, discounted using a risk-adjusted discount rate of 3.5%. These payments will be made starting January 2022. Management considers the risk 88 of non-payment to be low. The estimated fair value would increase (decrease) if: ° the risk-adjusted discount rate were lower (higher) • Revenue achievement - $298,000 To determine the fair value of the contingent consideration, Management calculated the fair value of the liability based on the present value of the expected payment and a probability weighted formula, discounted using a risk-adjusted discount rate of 2.5%. The estimated fair value would increase (decrease) if: ° ° the risk-adjusted discount rate were lower (higher) the ultimate revenue achievement were lower (higher) than the initial probability weighting There have been no transfers between levels in 2021. The carrying values of cash and cash equivalents, accounts receivable, bank operating lines of credit, and accounts payable and accrued liabilities and other liabilities approximate their fair value due to the relatively short period to maturity of the instruments. The lease receivable is valued at the present value of the future receipts which approximates the fair value. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) Derivative instruments The Group has entered into forward foreign exchange contracts in order to reduce the Company’s exposure to changes in the exchange rate of the U.S. Dollar, Euro, Mexican Peso and Indian Rupee as compared to the Canadian Dollar. At December 31, 2021, the Company had outstanding forward foreign exchange contracts to buy and sell the following contracts, all with maturity dates in January 2022. Buy/Sell Buy Currency Selling Currency Amount of Buy Currency BUY BUY BUY BUY BUY EUR EUR USD USD USD CAD USD CAD INR MXN 12,050 5,300 68,500 8,477 14,798 Buy/Sell Sell Currency Buying Currency Amount of Buy Currency SELL SELL SELL SELL SELL USD EUR EUR USD USD MXN CAD USD CAD INR 29,000 24,100 10,600 36,500 4,257 Traded Rate 1.4390 1.1385 1.2620 – 1.2652 74.7100 – 74.8800 20.530 Traded Rate 20.6100 – 20.9530 1.4288 – 1.4391 1.1298 – 1.1385 1.2614 74.4700 At December 31, 2020, the Company has outstanding forward foreign exchange contracts to buy and sell the following contracts, all with maturity dates in January 2021. 89 Buy/Sell Buy Currency Selling Currency Amount of Buy Currency BUY BUY BUY BUY BUY EUR EUR USD USD USD CAD USD CAD INR MXN 11,800 5,700 83,500 8,949 12,657 Buy/Sell Buy Currency Selling Currency Amount of Buy Currency SELL SELL SELL SELL SELL USD EUR EUR USD USD MXN CAD USD CAD INR 25,000 23,600 11,400 46,500 4,529 Traded Rate 1.5540 1.2210 1.2704 – 1.3099 73.0300 – 74.4800 19.892 Traded Rate 19.9260 – 20.1420 1.5541 – 1.5550 1.1846 – 1.2221 1.2702 72.8500 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 As at December 31, 2021 the Group has recognized a net unrealized gain of $89,000 representing the fair value of these forward foreign exchange contracts, comprised of an asset of $180,000 included with prepaid expenses and other assets, and a liability of $91,000 included within accounts payable and accrued liabilities. As at December 31, 2020 the Group recognized a net unrealized loss of $1,952,000, comprised of obligation recognized within accounts payable and accrued liabilities. Financial risk management: The Group is exposed to a variety of financial risks by virtue of its activities: market risk (including currency risk, interest rate risk and commodity price risk) credit risk and liquidity risk. The overall risk management program focuses on the unpredictability of financial markets and seeks to minimize potential adverse effects on financial performance. There were no changes to types of risk arising from the Group’s financial instruments from the previous period. Risk management is carried out by the finance department under the guidance of the Board of Directors. This department identifies and evaluates financial risks in close cooperation with management. The finance department is charged with the responsibility of establishing controls and procedures to ensure that financial risks are mitigated. Currency risk: The Group operates internationally and is exposed to foreign exchange risk from various currencies, primarily U.S. dollars, Mexican Pesos, the Euro and the Indian Rupee. Foreign exchange risk arises mainly from U.S. dollar denominated purchases in Canada and Canadian sales to the U.S. as well as recognized financial assets and liabilities denominated in foreign currencies. The Company manages its foreign exchange risk by having geographically diverse manufacturing facilities and purchasing U.S. dollar raw materials in Canada. The Company 90 also monitors forecasted cash flows in foreign currencies and attempts to mitigate the risk by entering into forward foreign exchange contracts. Forward foreign exchange contracts are only entered into for the purposes of managing foreign exchange risk and not for speculative purposes. The following table represents the Group’s balance sheet exposure to currency risk as at December 31, 2021: U.S. Dollars Mexican Pesos Euros Indian Rupees Cash $ 12,855 $ 5,928 2021 2020 2021 2,323 2020 2021 2020 2021 2020 852 € 1,072 € 1,526 10,871 187,323 Accounts receivable 31,109 20,526 17,650 24,377 443 831 223,097 227,817 Long-term lease receivable Bank operating lines of credit – – (1,724) (4,622) – – – – 2,083 2,208 (3,072) (3,074) – – – – Accounts payable (23,226) (13,373) (14,265) (9,612) Lease obligation (5,967) (6,836) Contingent consideration 1,194 – – – – – (18) – – (88) (223,205) (111,871) – (3,504) (6,317) – – – Net exposure $11,853 $ 1,623 5,708 15,617 € 508 € 1,403 7,259 296,952 HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) A one cent ($0.01) decline in the Canadian dollar against the U.S dollar as at December 31, 2021 would have decreased net earnings by $105,000 and increased equity by $149,000. This analysis assumes that all other variables, in particular interest rates, remained constant. Inversely, a one cent ($0.01) increase in the Canadian dollar against the U.S. dollar as at December 31, 2021 would have had an equal but opposite effect. A one cent ($0.01) decline in the Canadian dollar against the Euro as at December 31, 2021 would have decreased net earnings by $46,000 and increased equity by $8,000. Inversely, a one cent ($0.01) increase in the Canadian dollar against the Euro as at December 31, 2021 would have had an equal but opposite effect. A one cent ($0.01) decline in the Canadian dollar against the Indian Rupee as at December 31, 2021 would have increased net earnings and equity by $1,000. Inversely, a one cent ($0.01) increase in the Canadian dollar against the Indian Rupee as at December 31, 2021 would have had an equal but opposite effect. A one cent ($0.01) decline in the Canadian dollar against the Peso as at December 31, 2021 would have decreased net earnings by $4,000 and increased equity by $4,000. Inversely, a one cent ($0.01) increase in the Canadian dollar against the Peso as at December 31, 2021 would have had an equal but opposite effect. Credit risk: Credit risk arises from the possibility that the Group’s customers and counter parties may experience difficulty and be unable to fulfill their contractual obligations. The Group manages this risk by applying credit procedures whereby analyses are performed to control the granting of credit to its customer and counter parties based on their credit rating. As at December 31, 2021, the Group’s accounts receivable are not subject to significant concentrations of credit risk. The long-term lease receivable is subject to credit risk, which is mitigated by the security of the related plant. The Company’s maximum exposure to credit risk associated with the Group’s financial instruments is limited to their carrying amount. The Group’s exposure to customer credit risk is influenced mainly by the individual characteristics of each 91 customer. However, management also considers the factors that may influence the credit risk of its customer base, including the default risk associated with the industry and country in which customers operate. Management has a credit policy under which each new customer is analysed individually for creditworthiness before the Group’s standard payment and delivery terms and conditions are offered. The Group’s review includes external ratings, if they are available, financial statements, credit agency information, industry information and in some cases bank references. Sale limits are established for each customer and reviewed quarterly. Any sales exceeding those limits require approval from Executive management. The Group limits its exposure to credit risk from trade receivables by establishing a reasonable payment period. Many of the Group’s customers have been transacting with the Group for a number of years, and none of these customers’ balances have been written off or are credit-impaired at the reporting date. In monitoring customer credit risk, customers are grouped according to their credit characteristics, including their geographic location, industry, trading history with the Group and existence of previous financial difficulties. An allowance account for accounts receivable is used to record impairment losses unless the Group is satisfied that no recovery of the amount owing is possible; at which point the amounts are considered to be uncollectible and are written off against the specific accounts receivable amount attributable to a customer. The number of days outstanding of an individual receivable balance is the key indicator for determining whether an account is at risk of being impaired. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Expected credit losses are required to be measured through a loss allowance at an amount equal to the 12-month expected credit losses or full lifetime expected credit losses. The Group has used past due information to determine that there have been no significant increases in credit risk since initial recognition. There are balances in excess of 30 days past due but the Group does not presume that credit risk has increased given the characteristics of the Group’s customers, the industries in which they operate, the customer payment track records and the nature of the products the Group sells. During the year, the expected credit losses for trade accounts receivables decreased $218,000 (2020 – decreased $420,000), for which a recovery (2020 – recovery) was recognized in general and administrative expenses. The aging of accounts receivable and the related allowance is as follows: December 31, 2021 December 31, 2020 Gross Allowance Gross Allowance $ 48,820 $ – $ 35,192 $ 18,716 5,963 864 – 10,461 1,495 864 6,405 3,597 $ 74,363 $ 2,359 $ 55,655 $ – – – 2,577 2,577 Not past due Past due 0-30 days Past due 31-120 days Past due more than 120 days Credit risk: The carrying amount of financial assets representing the maximum exposure to credit risk at the reporting 92 date was: Cash and cash equivalents Accounts receivable Lease receivable Carrying Amount December 31, 2021 December 31, 2020 $ $ 20,905 $ 72,004 2,993 95,902 $ 14,795 53,078 3,433 71,306 HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) The maximum exposure to credit risk for accounts receivable at the reporting date by geographic region was: Canada United States Mexico Italy India Interest rate risk: Carrying Amount December 31, 2021 December 31, 2020 $ 25,097 $ 39,546 1,257 334 5,770 19,711 26,297 1,561 268 5,241 $ 72,004 $ 53,078 Interest rate risk is the risk that the future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Financial assets and financial liabilities with variable interest rates expose the Group to cash flow interest rate risk. Changes in market interest rates also directly affect cash flows associated with the Group’s bank operating lines of credit that bear interest at floating interest rates. The Group manages its interest rate risk by minimizing the bank operating lines of credit balances by applying excess funds while maintaining the liquidity necessary to conduct operations on a day-to-day basis as well as actively monitoring interest rates. A 1% increase or decrease in interest rates as at December 31, 2021 would increase or decrease net earnings by approximately $193,000 (2020 – $161,000) respectively. Commodity price risk: A large component of the Group’s cost of sales is comprised of copper and steel, the costs of which can vary 93 significantly with movements in demand for these resources and other macroeconomic factors. To manage its exposure to changes in commodity prices, the Group will enter into supply contracts with certain suppliers, and from time to time will enter into forward commodity purchase contracts. As at December 31, 2021, no forward commodity purchase contracts were outstanding (2020 – none). Liquidity risk: Liquidity risk is the risk that the Group will not be able to meet its obligations as they become due. The Group manages its liquidity risk by forecasting cash flows from operations and anticipated investing and financing activities. Senior Management is also actively involved in the review and approval of planned expenditures. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 The following are the carrying amounts and related anticipated contractual maturities of the Group’s financial liabilities: December 31, 2021 Carrying amount 1 year or less 1-2 years 2-5 years Bank operating lines of credit $ 19,267 $ 19,267 $ – $ Accounts payable and accrued liabilities Contingent consideration Derivative liabilities 75,669 1,509 91 75,669 616 91 – 595 – $ 96,536 $ 95,643 $ 595 $ – – 298 – 298 December 31, 2020 Carrying amount 1 year or less 1-2 years 2-5 years Bank operating lines of credit $ 16,073 $ 16,073 $ – $ Accounts payable and accrued liabilities Derivative liabilities 44,227 1,952 44,227 1,952 – – $ 62,252 $ 62,252 $ – $ – – – – 94 HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)Reconciliation of movements of liabilities to cash flows arising from financing activities: The following is a reconciliation between the opening and closing balances for liabilities arising from financing activities: LIABILITIES EQUITY Bank Operating Lines of Credit Lease Liabilities Contingent Consideration Share Capital Retained Earnings Total Balance January 1, 2021 $ 16,073 $ 9,320 $ - $ 14,491 $ 95,408 $ 135,292 Advances of bank operating lines of credit, net Interest payments Exercise of stock options Cash dividends paid Repayment of lease liability Total changes from financing 3,194 (1,301) - - - – 254 - - (2,724) - - - - – - 329 - - – - - (4,009) - 3,194 (1,047) 329 (4,009) (2,724) cash flows $ 1,893 $ (2,470) $ – $ 329 $ (4,009) $ (4,257) Other changes Liability-related Interest expense Foreign exchange Non-cash additions to lease liabilities Non-cash additions to contingent consideration (note 30) Total liability-related other 1,301 – – – – (65) 1,195 – 8 – – 1,501 – – – – – – – – 1,301 (57) 1,195 1,501 95 changes $ 1,301 $ 1,130 $ 1,509 $ – $ – $ 3,940 Equity-related Exercise of stock options Net income Total equity-related other changes $ – – – Balance December 31, 2021 $ 19,267 – – – 7,980 $ $ $ $ – – – 1,509 66 – – 66 15,176 15,176 $ $ 66 $ 15,176 $ 15,242 14,886 $ 106,575 $ 150,217 For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 LIABILITIES EQUITY Bank Operating Lines of Credit Lease Liabilities Share Capital Retained Earnings Total Balance January 1, 2020 $ 32,697 $ 11,404 $ 14,491 $ 85,339 $ 143,931 Advances of bank operating lines of credit Interest payments Cash dividends paid Repayment of lease liability (16,624) (917) – – – – – (2,650) Total changes from financing cash flows $ (17,541) $ (2,650) $ Other changes: Liability-related Interest expense Foreign exchange Non-cash additions to lease liabilities 917 – – 330 (107) 343 Total liability-related other changes $ 917 $566 $ Equity-related Net income Total equity-related other changes 96 Balance December 31, 2020 28. Capital risk management – – 16,073 $ $ – – 9,320 $ $ $ $ – – - – – – – – – – – 14,491 – – (3,993) – (16,624) (917) (3,993) (2,650) $ (3,993) $ (24,184) – – – – 1,247 (107) 343 $ 1,483 14,062 14,062 14,062 $ 14,062 95,408 $ 135,292 $ $ $ The Group’s objective is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future business development. The Group includes cash, bank operating lines, long- term debt and equity, comprising of share capital, contributed surplus and retained earnings in the definition of capital. The Group is not subject to externally imposed capital requirements and there has been no change with respect to the overall capital risk management strategy during the year ended December 31, 2021. The following table sets out the Group’s capital quantitatively at the following reporting dates: HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts) Cash and cash equivalents Bank operating lines of credit Lease liabilities Contingent consideration Share capital Contributed surplus Retained earnings December 31, 2021 December 31, 2020 $ 20,905 $ (19,267) (7,980) (1,509) 14,886 2,432 106,575 14,795 (16,073) (9,320) – 14,491 2,498 95,408 $ 116,042 $ 101,799 29. Determination of fair values: A number of the Group’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) Derivatives The fair value of forward exchange contracts is based on valuations obtained from third parties, based on observable market inputs. Fair values reflect the credit risk of the instrument and include adjustments to take account of the credit risk of the Group entity and counterparty when appropriate. (b) Non-derivative financial assets The fair value of the lease receivable 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. 97 (c) Share-based payment transactions The fair value of DSUs is determined in accordance with the DSU Plan, which uses the average closing price for HPS shares for the five trading days immediately preceding the relevant date. (d) Investment properties The fair values of the investment properties are based on available market evidence as determined by third party valuators using comparable property sale transactions and is considered to be valued at Level 3 of the fair value hierarchy. 30. Acquisition: On July 23, 2021, Hammond Power Solutions Inc. completed the acquisition of Mesta Electronics Inc. (“Mesta”) in the U.S., acquiring a 100% equity ownership. Mesta is involved in the design and manufacture of standard and custom active filter and induction heating products. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Mesta’ annual revenues for 2019 and 2020 have ranged from approximately $4,178,000 - $6,430,000. The Company will operate as Mesta Electronics Inc., a subsidiary of HPS. Mesta not only expands HPS’ U.S. presence but broadens our product offering and manufacturing capabilities in power quality solutions. Management feels that by building on the strengths of both companies, this acquisition will enhance HPS’ market share, and performance going forward. The purchase price has been allocated as follows: Cash Accounts receivable Inventories and other assets Property, plant and equipment Intangibles (note 14) Goodwill (note 12) Assets Current liabilities Total purchase consideration Satisfied as follows (in thousands of dollars): Cash Accounts payable Contingent consideration 98 $ $ $ $ $ $ 256 90 556 8 5,084 1,422 7,416 (831) 6,585 5,032 52 1,501 6,585 The acquisition was accounted for using the purchase method whereby identified assets acquired and liabilities assumed were recorded at their estimated fair values as of the date of acquisition. The excess of the purchase price over such fair value was recorded as goodwill, which represents the expected synergies to be realized from Mesta’s complementary products. The goodwill recognized is anticipated to be fully deductible for income tax purposes. The transaction includes a contingent liability component for employee performance during the two years following the closing for up to $1,264,000. The liability has been valued at $1,205,000 and is due in quarterly installments of equal amounts payable to the selling shareholders. The transaction includes a second contingent consideration component of up to $1,000,000, payable 45 days after the third anniversary of the closing date. This liability payment is contingent on management achieving certain revenue targets, and has been recognized at $296,000, based on the Company’s assessment of the likelihood of achievement of these targets. Both contingent liabilities have been recorded as a liability as of December 31, 2021. The acquisition costs incurred related to this transaction during the year were $174,000 which were included in general and administrative expense. HAMMOND POWER SOLUTIONS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTSFor the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)Included in the Group’s consolidated results for the twelve months ended December 31, 2021, is revenue of $1,042,000 and net earnings of $81,000 recognized by Mesta from the date of acquisition to December 31, 2021. If the Company had acquired Mesta effective January 1, 2021, the revenue would have been approximately $1,865,000 and there would have been net loss of approximately $8,000. The revenue of the consolidated group would have been approximately $381,025,000 and net income of the consolidated group would have been $15,087,000. 31. Subsequent events Joint Venture Ownership Change As disclosed in note 1, the Company and and National Material L.P. (“National”) have operated the joint venture in Monterrey, Mexico under the name Corefficient S. de R.L. de C.V. Effective February 28, 2022, the Company and National have amicably agreed to divide the operations. In connection with the transaction, HPS will retain certain equipment, employees, obligations, and other financial assets and liabilities, and National will withdraw certain assets and capital in exchange for redeeming their ownership interest. After effecting the transaction, the Company will own 100% of the equity and voting interests of Corefficient and will continue to operate the entity as a wholly owned subsidiary of the Group. The operation will continue to produce transformer cores to supply the Groups’s facilities in Mexico. The Corefficient name will be retained by National. As the Company has acquired control of Corefficient, the transaction constitutes a business combination. Total consideration received by National in connection with this transaction is $10,809,000, comprised of inventory valued at $1,705,000 property, plant and equipment valued at $5,589,000 and a note payable in the amount of $3,515,000 repayable in six equal instalments, due monthly commencing March 2022. The agreement calls for adjustments to the consideration in respect of possible realization of certain tax attributes by March 2023. The initial accounting for the business combination is not yet complete and accordingly a preliminary 99 purchase price allocation has not been included within these consolidated financial statements. The Company is evaluating the recognition and measurement of possible contingent consideration, as well as the fair-value of the Company’s ownership interest immediately prior to the transaction, which may involve the use of third-party valuation specialists. Accordingly, certain disclosures otherwise required under IFRS 3, Business Combinations, have not been included within these financial statements. Dividends On March 4, 2022, the Company declared a dividend of eight and a half cents ($0.085) per Class A subordinate voting shares of HPS and a quarterly cash dividend of eight and a half cents ($0.085) per Class B common shares of HPS payable on March 24, 2022 to shareholders of record at the close of business on March 16, 2022. The ex-dividend date is March 18, 2022. For the years ended December 31, 2021 and 2020 (tabular amounts in thousands of dollars, except share and per share amounts)ANNUAL REPORT 2021 Mexico Corefficient, S. de R.L. de C.V. Ave. Avante #840 Parque Industrial Guadalupe Guadalupe, Nuevo León, México C.P. 67190 United States Hammond Power Solutions, Inc. 1100 Lake Street Baraboo, Wisconsin 53913 17715 Susana Road Compton, California 90224 6550 Longley Lane, Suite 135 Reno, Nevada 89511 Mesta Electronics, Inc. 11020 Parker Drive, North Huntington, Pennsylvania 15642 HPS Offices, Manufacturing Facilities and Warehouse Locations Canada Hammond Power Solutions Inc. Corporate Head Office 595 Southgate Drive Guelph, Ontario N1G 3W6 15 Industrial Road Walkerton, Ontario N0G 2V0 10 Tawse Place Guelph, Ontario N1H 6H9 Delta Transformers Inc. 795 Industriel Boul. Granby, Quebec J2G 9A1 3850 place de Java Suite 200 Brossard, Québec J4Y 0C4 100 India Hammond Power Solutions Private Limited 2nd Floor Icon Plaza, H. No. 5-2/222/IP/B Allwyn X-Roads Miyapur, Hyderabad – 500049 Italy Hammond Power Solutions S.p.A. Via Amedeo Avogadro 26 10121 Torino, Italy at R & P Legal Mexico Hammond Power Solutions S.A. de C.V. Ave. Avante #810 Parque Industrial Guadalupe Guadalupe, Nuevo Leon, C.P. 67190 Monterrey, Mexico Ave. Avante #900 Parque Industrial Guadalupe Guadalupe, Nuevo Leon, C.P. 67190 Monterrey, Mexico Annual General Meeting of Shareholders to be held: Thursday May 12, 2022 1:30 p.m. (EASTERN STANDARD TIME) Via teleconference Audio Conference Details: Calling from Canada or the United States: 1-800-207-0148 United States, Brooklyn and International 1-646-828-8082 Participant Code: 610283 HAMMOND POWER SOLUTIONS Corporate Information Corporate Officers and Directors Stock Exchange Listing Toronto Stock Exchange (TSX) Trading Symbol: HPS.A William G. Hammond * Chairman of the Board and Chief Executive Officer Richard C. Vollering Corporate Secretary and Chief Financial Officer Grant C. Robinson *+ Director David J. FitzGibbon *+ Director Dahra Granovsky *+ Director Fred M. Jaques *+ Director Anne Marie Turnbull *+ Director David M. Wood *+ Director * Corporate Governance Committee + Audit and Compensation Committee Registrar and Transfer Agent Computershare Investor Share Services Inc. 100 University Avenue Toronto, Ontario Canada M5J 2Y1 Auditors KPMG LLP 115 King Street South Waterloo, Ontario N2J 5A3 Legal Representation Dentons Canada LLP 77 King Street West, Suite 400 Toronto Dominion Centre Toronto, Ontario M5K 0A1 Banking Institution JP Morgan Chase Bank N.A. 66 Wellington Street West, Suite 4500 Toronto, Ontario M5K 1E7 Investor Relations Contact: David Feick, Investor Relations Phone: 519.822.2441 x453 Email: ir@hammondpowersolutions.com The Hammond Museum of Radio is one of North America’s 101 premiere wireless museums. It is home to thousands of receivers and transmitters dating back to the turn of the century. The museum is open regular business hours Monday to Friday; evenings and weekends by special appointment. Tours can be arranged by calling: (519) 822-2441 x 590 ANNUAL REPORT 2021 DOLLARS IN THOUSANDS UNLESS OTHERWISE STATED HAMMONDPOWERSOLUTIONS.COMYOU DON’T KNOW WHAT’S GOING TO HAPPEN IN BUSINESS A YEAR FROM NOW... SO YOU HAVE TO BE FLEXIBLE AND ADAPTABLE, AND THAT’S WHAT WE TRY TO DO

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