K-Bro Linen
Annual Report 2014

Plain-text annual report

2014 Annual Report Visit the new K-BroLinen.com 1. 2. 6. 12. 34. President’s Message Chairman’s Message Financial Highlights Management’s Discussion and Analysis Consolidated Financial Statements K-Bro is Canada’s healthcare & hospitality laundry & linen processor with facilities all across the country. Vancouver (Two Locations) Victoria Calgary Edmonton Regina Québec City Montréal Toronto Clean Green TRSA Certified President’s Message 2014 was an exciting year for K-Bro as we celebrated our 60th anniversary and completed another record year. We remained focused on providing the best possible laundry and linen services to our valued customers. As a result, we were rewarded with the continuing loyalty and trust of our many existing and new customers. In 2014, we began construction of our 9th plant. This new Regina facility will service all of Saskatchewan and is expected to open in late Q3 2015. As with all new K-Bro facilities, the new Regina plant will include new, modern and highly-automated equipment that will allow us to provide outstanding quality and service to our customers. We remain committed to investments that enable us to provide higher- quality and more efficient service to our customers. 2014 also saw increased operating efficiencies in our Edmonton facility as we continually worked to refine our operating processes to find further savings. At the end of the year we completed a $35 million dollar equity offering strengthening our balance sheet. As a result, we have a capital structure that will support significant future organic and acquisition growth. With all of our new customers and contract renewals from existing customers, we enter 2015 with a substantial portion of our healthcare business under long-term contracts. As a result, we have significant visibility and are able to plan for our future with great confidence. While our new Edmonton and Regina plants receive a lot of attention, we continue to deliver outstanding results by working hard to earn the confidence and trust of existing and new customers every day. Because of their confidence and the tremendous commitment and capabilities of our more than 1,650 employees, 2014 was a year of success: Linda McCurdy President & Chief Executive Officer Ross Smith Chairman • Total shareholder return of 19.4%; • Revenue in excess of $136 million compared with $121 million in 2013; • EBITDA of $26.2 million compared with $23.3 million in 2013; • Earnings per share of $1.72, compared with $1.47 in 2013; and, • $8.5 million in dividends ($1.18/share); • Market capitalization of $367 million and with the debt to total capitalization ratio decreasing to 0.0x. We will always ensure that our business adapts to new and changing customer needs and that we continue to provide the highest quality services to our customers. We will continue to make significant investments in our people and our facilities to ensure that we build upon the many strengths that have made us the leader in our market. For while we take great pride in providing the best possible service to our customers across Canada, we know we must continue to find ways to improve every single day. On behalf of our management team and our 1,650 dedicated employees, thank you for your continued support of K-Bro. Chairman’s Message 2014 was another year of tremendous growth and progress for K-Bro. K-Bro delivered strong financial results, strengthened capital ratios and increased dividend payments. We continued to focus on superior customer service as we believe doing what is best for our customers is also what is best for K-Bro. K-Bro’s Board of Director’s is committed to sound corporate governance. We continually try to balance risk and opportunities, and as a result the Company has continued to deliver strong results. On behalf of K-Bro, I thank all of our customers, employees, shareholders and other stakeholders for your continued confidence and commitment to K-Bro. We will continue to work hard every day to earn your trust. Linda McCurdy President & CEO Ross Smith Chairman 1 2 K-Bro Linen Inc. | 2014 Annual ReportDependable.Officers & Directors K-Bro is the largest healthcare and hospitality laundry and linen processor in Canada. K-Bro operates eight facilities and a distribution center in eight cities, processing hospitality, healthcare and specialty linens. Our core values are central to our reputation, our quality is industry-leading, and our ability to deliver on commitments to customers is second to none. K-Bro provides the vital products and services that help hospitals and extended care centres care for the young, old and vulnerable in environmentally responsible ways. Our responsibility extends to ensuring that we have a safe culture at K-Bro. K-Bro delivers excellence and dependability in providing efficient, environmentally conscious and cost-effective laundry and linen services. By expanding our expertise into new markets and leveraging our operating strengths, we have opportunities to continue the growth of revenue, further enhance operating margins, and ensure consistent and sustainable value creation for stakeholders. Linda McCurdy, President and Chief Executive Officer Our devotion to quality, innovation, and respect for our customers, employees and communities is at the heart of everything K-Bro has accomplished for the past 60 years. K-Bro has been positioned as the preeminent partner of choice by delivering solutions and services to our partners across Canada. Sean Curtis, Senior Vice-President and General Manager K-Bro has a stable business model with strong fundamentals that support our market valuation, reliable shareholder returns, and sustainable growth of our business. Kristie Plaquin, Interim Chief Financial Officer Ross Smith Linda McCurdy Kristie Plaquin Ron Graham Kevin Stephenson Jeff Gannon Jessica Lévesque Sylvain Tremblay Steven Matyas Matthew Hills Sean Curtis Ken Chu Jerry Ostrzyzek 3 4 K-Bro Linen Inc. | 2014 Annual ReportDependable.  As our society grows, we integrate our commitment to responsibility into our new businesses, employees and the communities in which we live and work. Financial Highlights The following unaudited financial data has been derived from K-Bro’s consolidated financial statements, which have been audited by PricewaterhouseCoopers LLP. The information set forth below should be read in conjunction with the Management’s Discussion & Analysis, Consolidated Financial Statements and Notes sections of this Annual Report. Revenue EBITDA 140 130 120 110 100 90 80 70 500 400 300 200 100 30 25 20 18 16 14 12 10 2009 2010 2011 2012 2013 2014 2009 2010 2011 2012 2013 2014 Revenue (In millions of Canadian dollars) Years ended December 31 EBITDA (In millions of Canadian dollars) Years ended December 31 Total Shareholder Return (on a $100 investment in 2009) K-Bro Linen Inc. S&P/TSX Composite Index 149 118 212 107 2010 2011 100 2009 263 115 2012 468 144 344 130 2013 2014 (1) The graph reflects the total cumulative return, assuming reinvestment of all dividends, of $100 invested on December 31, 2009 in each of the Common Shares of the Corporation and the S&P/TSX Composite (TRIV) Index. (2) The year-end values of each investment shown on the graph are based on share price appreciation plus dividend. 5 6 K-Bro Linen Inc. | 2014 Annual ReportDependable.In 2014, K-Bro excelled at discovering and winning new opportunities and clients, building on the successes we’ve had in our decades of experience as leaders in our sector. Sean Curtis Senior VP & General Manager One of our key strategies for growth is to pursue opportunities for expansion through acquisition. We follow a strict set of criteria when evaluating another organization’s potential, examining every facet of a target company – does it open up a new or strategically placed geographic market or market niche for us? Is there a potential for growth in the market it serves? Will we be able to build on relationships the company already has in place? Can we build on an already-existing base of business? Does it enhance our resources overall? Taking advantage of relationships already in place includes maintaining the existing labour and management of a company. The ability and commitment demonstrated by staff members is a factor in our decision-making process for acquisitions. The bottom line is that we want profitable, dependable operations where we can bring our expertise and resources to grow the existing base of business. We continue to review and pursue accretive opportunities in new markets and we believe that such opportunities may be available in the future to further add to our growth. In our industry, we’re dependent on our reputation, resources, and track record as we develop relationships with potential and new clients and compete for contracts. These factors are also critical in maintaining stable, responsive, and loyal relationships with our existing customers. We are the largest healthcare & hospitality laundry & linen processor in Canada. In order to be successful, a company must have a vision. We continue to be committed to remaining as Canada’s premier linen processing company. We focus on businesses that we know and understand – laundry and linen processing – in regions where we have an existing competitive advantage or can develop one. Long-term contracts supported by an experienced workforce and large scale assets are the priority – relationships coupled with assets that provide attractive and sustainable returns. Over the past decade, K-Bro has invested over $95 million in high quality plants, investments that have allowed the company to move forward in achieving its vision. Today, we play a significant role in the provision of high quality healthcare and also in business and leisure travel markets. In aggregate, our eight plants provided services to more than 1,500 customers and employed almost 1650 employees in 2014. At December 31, 2014, total assets were $132.6 million, equity was $109.4 million and market capitalization was $367 million. Diversified and integrated services We provide critical services, support and management of linen requirements that address each and every one of our customers’ needs. Strategically positioned Long-term stable contracts K-Bro has 8 plants and one distribution center located in 8 different cities, which ensures our ability to provide uninterrupted service in the wake of disasters, pandemics or other adversity. By anticipating our customers’ needs, delivering consistently dependable service and acting with integrity, K-Bro has developed long-term relationships with its customers. Committed workforce Single source for customers Our corporate culture enables us to attract and retain quality laundry staff and our national presence provides opportunities for career advancement. Six members of our senior management team commenced their careers with K-Bro and have an average tenure in excess of 20 years. K-Bro is able to deliver total linen management services, including laundering, drying, folding, quota cart development, sterilization, and more that focuses on efficiencies and cost savings. We are one of the largest consumers of linens and textiles in Canada. We leverage our market position to drive savings for our customers. K-Bro works in partnership with our clients to reduce their linen consumption. 7 8 K-Bro Linen Inc. | 2014 Annual ReportDependable. In 2014, K-Bro excelled at discovering and winning new opportunities and clients, building on the successes we’ve had in our decades of experience as leaders in our sector. We obtained significant new business from our competitors in important locations. In British Columbia, we added four major hospitality customers to our base, eight in Quebec, one in Ontario, and in Alberta we added two additional hoteliers and extended agreements with several more. experience contribute to our thinking – our clients talk to us not only about their present needs, but about the directions they see themselves going in. They depend on the knowledge we’ve accumulated over our history. During 2014 we refined our operating processes at the new Edmonton processing facility, completed our third equity offering, began construction of our new Regina processing facility and were able to deliver stronger results to our shareholders. K-Bro’s value-added services provide a ‘one-stop shop’ for linen services, and currently include: • Exchange cart preparation Our new clients include some of the finest hotels in the country. • Delivery of carts to user wards and departments • Reusable OR linen and pack rental (KOR services) Each new customer was a victory for the entire K-Bro team and a reflection of the company as a whole, rather than any individual. The qualities that contribute to our success are the same ones that define us as leaders in customer service – an impeccable and dependable record, comprehensive service programs, financial stability, competitive costs, experience in transitioning large accounts, and having the resources to support growth, including the ability to purchase linen and equipment in anticipation of higher volume. Our policy at K-Bro has always been one of proactive response. In order to meet our goal of being the absolute best laundry and linen services provider in the country, we continually review our service offerings, adding to our menu and providing more comprehensive service capabilities than other linen companies. We watch our industry and think ahead to strategically address the future needs of the markets we serve. Our established relationships and • Distribution and control of uniforms • Personal clothing services • Customer service programs • Linen purchase and supply • Linen inventory management reports and services • Sterilization of operating room linen packs At K-Bro, we will innovate and develop new processes and systems, and further refine business delivery and practices. When we launched our company on the public markets, we stated that we were ready for whatever lay ahead of us. As the events of the next ten years unfolded, our readiness contributed to our success in dependability and growth. The hands-on nature of our management team and established relationships with open lines of communication with our customers is the very source of our advantage. We are Dependable. The following selected unaudited financial data has been derived from K-Bro’s consolidated financial statements, which have been audited by PricewaterhouseCoopers LLP. The information set forth below should be read in conjunction with the Management’s Discussion & Analysis, Consolidated Financial Statements and Notes sections of this Annual Report. ($ Thousands, except per share data and percentages) Years ended December 31(1) 2014 2013 2012 2011 2010 2009 Income Statement Data Revenue EBITDA EBITDA(%) Net earnings Net earnings per share (Diluted) Balance Sheet Data Working Capital Long-Term Debt Other Financial Data Distributable cash per share Payout Ratio(%) Price to earnings multiple (12 month trailing) Price to EBITDA multiple (12 month trailing) Return on shareholders’ equity(ROE)(%) Total Shareholder return, YTD(%) Total Shareholder return, 5 yrs(%) Market capitalization Share price: High Low Close 136,440 26,241 19.2 12,198 1.72 131,202 23,317 17.8 10,336 1.47 126,290 24,517 19.4 11,149 1.59 116,859 19,946 17.1 7,928 1.14 104,051 16,877 16.2 6,953 0.99 87,533 15,547 17.8 7,802 1.11 21,722 0 9,434 19,640 8,064 5,818 7,245 6,095 8,664 10,763 7,896 4,043 2.85 42.0 26.9 12.5 11.1 19.4 182.9 367,023 47.90 36.90 46.11 2.61 44.2 27.0 12.0 14.5 41.2 2.72 41.8 18.1 8.2 16.5 34.9 235.2 253.8 2.40 45.9 19.6 7.8 12.6 27.5 121.1 2.15 51.4 18.5 7.6 11.4 43.9 146.7 1.99 55.1 12.1 6.1 12.0 50.0 87.5 280,976 203,613 155,821 126,866 93,451 40.50 28.38 39.60 30.18 21.20 28.86 22.98 17.28 22.24 19.29 13.02 18.30 13.84 9.70 13.48 (1) K-Bro’s IFRS transition date was January 1, 2010; accordingly 2010 figures have been restated; earlier fiscal periods are presented under Canadian GAAP. 9 10 K-Bro Linen Inc. | 2014 Annual ReportDependable. Management’s Discussion & Analysis 16. 17. 17. 18. 18. 20. 20. 21. 23. 24. 25. 26. 26. 26. 27. 30. 30. 30. 31. 31. Introduction Strategy Fourth Quarter Overview Selected Annual Financial Information Summary of 2014 Results and Events Key Performance Drivers Outlook Results of Operations Liquidity and Capital Resources Dividends Distributable Cash Flow Outstanding Shares Related Party Transactions Critical Accounting Estimates Terminology Changes in Accounting Policies Recent Accounting Pronouncements Financial Instruments Critical Risks and Uncertainties Controls and Procedures Management’s Discussion & Analysis of Financial Condition & Results of Operations The following Management’s Discussion and Analysis (“MD&A”) is supplemental to, and should be read in conjunction with, the audited Consolidated Financial Statements of K-Bro Linen Inc. (“the Corporation”) for the years ended December 31, 2014 and 2013, as well as the unaudited interim condensed Consolidated Financial Statements for the periods ended March 31, 2014, June 30, 2014 and September 30, 2014. The Corporation and its wholly-owned subsidiaries, including K-Bro Linen Systems Inc., are collectively referred to as “K-Bro” in this MD&A. Management is responsible for the information contained in this MD&A and its consistency with information presented to the Audit Committee and Board of Directors. All information in this document has been reviewed and approved by the Audit Committee and Board of Directors. This review was performed by management with information available as of March 11, 2015. In the interest of providing current Shareholders of K-Bro Linen Inc. and potential investors with information regarding current results and future prospects, our public communications often include written or verbal forward-looking statements. Forward-looking statements are disclosures regarding possible events, conditions, or results of operations that are based on assumptions about future economic conditions and courses of action, and include future-oriented financial information. This MD&A contains forward-looking information that represents internal expectations, estimates or beliefs concerning, among other things, future activities or future operating results and various components thereof. The use of any of the words “anticipate”, “continue”, “expect”, “may”, “will”, “project”, “should”, “believe”, and similar expressions suggesting future outcomes or events are intended to identify forward-looking information. Statements regarding such forward-looking information reflect management’s current beliefs and are based on information currently available to management. These statements are not guarantees of future performance and are based on management’s estimates and assumptions that are subject to risks and uncertainties, which could cause K-Bro’s actual performance and financial results in future periods to differ materially from the forward-looking information contained in this MD&A. These risks and uncertainties include, among other things: (i) risks associated with acquisitions, including the possibility of undisclosed material liabilities; (ii) K-Bro’s competitive environment; (iii) utility and labour costs; (iv) K-Bro’s dependence on long- term contracts with the associated renewal risk; (v) increased capital expenditure requirements; (vi) reliance on key personnel; (vii) changing trends in government outsourcing; and (viii) the availability of future financing. Material factors or assumptions that were applied in drawing a conclusion or making an estimate set out in the forward-looking information include: (i) volumes and pricing assumptions; (ii) expected impact of labour cost initiatives; and (iii) the level of capital expenditures. Although the forward-looking information contained in this MD&A is based upon what management believes are reasonable assumptions, there can be no assurance that actual results will be consistent with these forward-looking statements. Certain statements regarding forward-looking information included in this MD&A may be considered “financial outlook” for purposes of applicable securities laws, and such financial outlook may not be appropriate for purposes other than this MD&A. All forward-looking information in this MD&A is qualified by these cautionary statements. Forward-looking information in this MD&A is presented only as of the date made. Except as required by law, K-Bro does not undertake any obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. This MD&A also makes reference to certain measures in this document that do not have any standardized meaning as prescribed by IFRS and, therefore, are considered additional GAAP measures. These measures may not be comparable to similar measures presented by other issuers. Please see “Terminology” for further discussion. As events have unfolded since entering the public market, our readiness has contributed to our success in dependability & growth. 13 14 K-Bro Linen Inc. | 2014 Annual ReportDependable.Quality, innovation and respect for our customers, employees and communities is at the very centre of everything we have done for the past 60 years. Introduction Core Business K-Bro is the largest owner and operator of laundry and linen processing facilities in Canada. K-Bro provides a comprehensive range of general linen and operating room linen processing, management and distribution services to healthcare institutions, hotels and other commercial accounts. K-Bro currently has eight processing facilities and one distribution centre in eight Canadian cities including Victoria, Vancouver, Calgary, Edmonton, Saskatoon, Toronto, Montréal and Québec City. Industry and Market K-Bro provides laundry and linen services to Canadian healthcare, hospitality and other commercial customers. Typical services offered by K-Bro include the processing, management and distribution of general and operating room linens, including sheets, blankets, towels, surgical gowns and drapes and other linen. Other types of processors in K-Bro’s industry in Canada include independent privately-owned facilities (i.e. typically small, single facility companies), public sector central laundries and public and private sector on-premise laundries (known as “OPLs”). Participants in other sectors of the laundry and linen services industry, such as uniform rental companies (which own and launder uniforms worn by their customers’ employees) typically do not offer services that significantly overlap with those offered by K-Bro. Our partnerships with healthcare institutions and hospitality clients across Canada demonstrate K-Bro’s commitment to build relationships that foster continuous improvement, provide flexibility to adjust to changing circumstances as required and which incorporate incentives, penalties and sharing of risks and rewards as circumstances warrant. As a result, clients across the country have entered into long- term relationships with us, with most having renewed their contracts several times. In this competitive industry, K-Bro is distinctive in Canada in its ability to deliver products and services that provide value to our customers. Management believes that the healthcare and hospitality sectors of the laundry and linen services industry represent a stable base of annual recurring business with opportunities for growth as additional healthcare beds and funds are made available to meet the needs of an aging demographic. Industry Characteristics and Trends Management believes that the industry in which K-Bro operates exhibits the following characteristics and trends: Stable Industry with Moderate Cyclicality As evidenced by the stability in the number of approved hospital beds in the healthcare system and hotel rooms in the hospitality industry. The potential for step-changes in volumes and revenues that align with contractual arrangements exists within this industry. Service relationships are generally formalized through contracts in the healthcare sector that are typically long term (from seven to ten years), while contracts in the hospitality sector usually range from two to five years. Outsourcing and Privatization Healthcare institutions and regional authorities are facing funding pressures and must continually evaluate the allocation of scarce resources. Consequently there are often advantages to healthcare institutions in outsourcing the processing of healthcare linen to private sector laundry companies such as K-Bro because of the economies of scale and significant management expertise that can be provided on a more comprehensive and cost-effective basis than customers can achieve in operating their own laundry facilities. Fragmentation Most Canadian cities have at least one and sometimes several private sector competitors operating in the healthcare and hospitality sectors of the laundry and linen services industry. Management believes that the presence of these operators provides consolidation opportunities for larger industry participants with the financial means to complete acquisitions. Customers and Product Mix K-Bro’s customers include some of the largest healthcare institutions and hospitality providers in Canada. Healthcare customers include acute care hospitals and long-term care facilities. Most of K-Bro’s hospitality customers (typically >250 rooms) generate between 500,000 and 3 million pounds of linen per year. Most healthcare customers generate between 500,000 pounds of linen per year for a hospital and up to 30 million pounds of linen per year for a healthcare region. 15 16 K-Bro Linen Inc. | 2014 Annual ReportDependable.Strategy Selected Annual Financial Information K-Bro maintains the following three-part strategic focus: Secure and Maintain Long-Term Contracts with Large Healthcare and Hospitality Customers K-Bro’s core service is providing high quality laundry and linen services at competitive prices to large healthcare and hospitality customers under long-term contracts. K-Bro’s contracts in the healthcare sector typically range from seven to ten years in length. Contracts in the hospitality sector typically range from two to five years. particularly as healthcare and hospitality institutions continue to increase their focus on core services and confront pressures for capital and cost savings. Management may in the future expand its core services to new markets either through acquisitions or by establishing new facilities. Its choice of areas for expansion will depend on the availability of suitable acquisition candidates, the volume of healthcare and hospitality linen to be processed and the policies of applicable governments. Extend Core Services To New Markets Management has demonstrated its ability to successfully expand K-Bro’s business into new markets from its established bases. Since 2005, K-Bro has entered four new geographic markets across Canada. These new markets have contributed significantly to K-Bro’s growth. Management believes that new outsourcing opportunities will continue to arise in the near to medium-term and that K-Bro is well-positioned for continued growth, Introduce Related Services In addition to focusing on its core services, the Corporation also attempts to capitalize on attractive business opportunities by introducing closely-related services that enable it to provide more complete solutions to K-Bro’s healthcare and hospitality customers. These related service offerings include K-Bro Operating Room (“KOR”) services and on-site services. For three major hospitals in Toronto, K-Bro performs the sterilization of operating room linen packs. Fourth Quarter Overview In the fourth quarter of 2014, revenue was $33.8 million which was 4.5% higher than the $32.3 million generated in the comparative quarter of 2013. This year-over-year increase was due to organic growth from existing customers across the plants and additional services provided to the Saskatoon Health Region. EBITDA increased from $5.4 million in Q4, 2013 to $6.3 million in Q4, 2014, this increase was a result of increased efficiencies resulting from the move to the new Edmonton facility, organic growth from existing customers across the plants and additional services provided to the Saskatoon Health Region. ($ Thousands, except share & per share amounts) Revenue Earnings before income taxes Net Earnings Net Earnings per share: Basic Diluted Total Assets Long-term debt Dividends declared to Shareholders Dividends declared to Shareholders per share Number of Shares outstanding: Basic Diluted 2014 136,440 16,663 12,198 1.72 1.72 132,638 - 8,498 1.183 2013 131,202 14,509 10,336 1.47 1.47 112,330 19,640 8,142 1.150 2012 126,290 15,324 11,149 1.60 1.59 94,800 5,818 7,977 1.133 7,090,937 7,111,232 7,022,699 7,054,235 6,981,432 6,993,561 Summary of 2014 Results & Key Events Financial Growth Regina Facility Development Management estimates that the costs to commission a new facility in Regina are expected to be approximately $35.6 million for new equipment, land and building. The expected costs to commission the facility have increased from that previously disclosed as a result of the weakening Canadian dollar. Costs associated with the new facility began to be incurred in Q2, 2014 and will continue to be incurred until Q3, 2015. As at December 31, 2014, K-Bro has incurred $11.2 million of the total expected capital cost. Management expects the new facility to commence processing in late Q3, 2015. K-Bro delivered strong financial results in 2014 driven by the operating results from all eight of its processing plants. Net earnings were $12.2 million or $1.72 per share (basic). Cash flow from operating activities was $23.9 million and distributable cash flow was $20.2 million. Revenue increased in fiscal 2014 to $136.4 million or by 4.0% compared to 2013. This increase was due to a combination of additional services provided to the Saskatoon Health Region and organic growth from existing customers across the plants. EBITDA (see Terminology) increased in the year to $26.2 million from $23.3 million in 2013, which is an increase of 12.5%. The EBITDA margin increased to 19.2% in 2014 compared 17.8% in 2013. Both the EBITDA and EBITDA margin increase were predominantly a result of increased efficiencies as a result of the move to the new Edmonton facility, organic growth from existing customers across the plants, and additional services provided to the Saskatoon Health Region. 17 18 K-Bro Linen Inc. | 2014 Annual ReportDependable. Equity Offering On December 9, 2014, the Corporation issued 839,500 common shares (10.5% of total share capital issued) as a part of an equity offering. The common shares issued have the same rights as the other shares in issue. The fair market value of the shares issued amounted to $34.8 million ($41.50/share). The related transaction costs amounting to $1.3 million have been netted against the deemed proceeds. Effects of Economic Uncertainty K-Bro believes that it is positioned to withstand market volatility and uncertainty given that: • Approximately 70.6% of its revenues in the quarter were from large publicly funded healthcare customers which are geographically diversified across multiple provinces; • At December 31, 2014, K-Bro had unutilized borrowing capacity of $38.4 million or 95.9% of the revolving credit line available and cash of $13.7 million; and, • K-Bro’s prudent approach to managing capital has added cash flow and liquidity to the Corporation, thereby improving its ability to withstand the turmoil in the national and global capital markets. K-Bro is a participant in the temporary foreign worker (“TFW”) program in our facilities where genuine labour shortages exist, predominantly within our Alberta plants. During the year, the federal government reviewed the TFW program and implemented various rule changes. These changes include stricter application requirements, higher application fees, caps on TFW in low wage positions, refusal of applications in regions of high unemployment, reduction to work permit durations, and increased government inspections. The rule changes, if implemented as set out, are not expected to have a material effect on the financial results or operations of the Corporation. Key Performance Drivers K-Bro’s key performance drivers focus on growth, profitability, stability and cost containment in order to maintain dividends and maximize Shareholder value. The following outlines our results on a period-to-period comparative basis in each of these areas: ($ Thousands, except percentages) Category Indicator Q4, 2014 Q4, 2013 YTD 2014 YTD 2013 Growth Profitability Stability Cost Containment EBITDA(1)(%) Adjusted EBITDA(2)(%) Revenue(%) Distributable cash flow(%) EBITDA(1) EBITDA Margin(%) Adjusted EBITDA(2) Adjusted EBITDA margin(2)(%) Net earnings Adjusted net earnings(3) Debt to total capitalization(4)(%) Unutilized line of credit Payout ratio(%) Dividends declared per share Wages and Benefits(%) Utilities(%) Expenses included in EBITDA(%) 16.8 16.8 4.5 3.2 6,333 18.7 6,333 18.7 3,083 3,083 0.0 38,350 45.2 0.300 44.8 6.4 81.3 -6.2 -6.2 2.2 8.1 5,421 16.8 5,421 16.8 2,117 2,117 21.6 19,710 42.8 0.288 46.7 6.6 83.2 12.5 9.2 4.0 9.7 26,241 19.2 26,241 19.2 12,198 12,198 0.0 38,350 42.0 1.183 44.8 6.5 80.8 -4.9 -3.0 3.9 -3.5 23,317 17.8 24,030 18.3 10,336 10,835 21.6 19,710 44.2 1.150 46.4 6.4 82.2 (1) EBITDA is defined as revenue less operating expenses (which equates to net earnings before income tax, gain or loss on disposals, financial charges and depreciation and amortization). See Terminology. (2) Adjusted EBITDA is defined as EBITDA (defined above) plus or minus non-recurring, infrequent and/or unusual transactions which did not occur during the preceding two years and are not expected to recur within the next two years. See Terminology for a complete description of the adjusted items. (3) Adjusted net earnings is defined as net earnings plus or minus non-recurring, infrequent and/or unusual transactions net of corporate income taxes which did not occur during the preceding two years and are not expected to recur within the next two years. See Terminology for a complete description of the adjusted items. (4) Debt to total capitalization is defined as total debt divided by total capital. See Terminology. Outlook K-Bro’s focus is on profitable growth in the years to come as we execute our strategy of expanding geographically and adding new services for our customers. K-Bro is committed to building value for our shareholders, our customers and our employees. K-Bro also has several proposals pending and has entered into discussions with potential new customers. In addition, K-Bro continues to seek potential acquisition candidates. Neither the timing nor the degree of likelihood of success of any of these proposals or acquisitions can be stated with any degree of accuracy. 19 20 K-Bro Linen Inc. | 2014 Annual ReportDependable.Results of Operations Quarterly Financial Information The following table provides certain selected consolidated financial and operating data prepared by K-Bro management for the preceding eight quarters: ($ Thousands) 2014 Q4 Q3 Q2 Q1 2013 Q4 Q3 Q2 Q1 Healthcare revenue Hospitality revenue Total revenue 23,848 9,945 23,068 12,960 23,330 11,018 33,793 36,028 34,348 22,641 9,630 32,271 22,607 9,737 21,874 12,677 22,124 22,288 10,536 9,359 32,344 34,551 32,660 31,647 Expenses included in EBITDA EBITDA(1) EBITDA as a % of revenue(%) Adjusted EBITDA(2) Depreciation and amortization Financial charges Loss (gain) on disposal of equipment Earnings before income taxes Income tax expense Net earnings Net earnings as a % of revenue(%) Basic Earnings per share Diluted earnings per share Adjusted net earnings(3) Basic adjusted earnings per share(3) Diluted adjusted earnings per share(3) 27,460 6,333 18.7 6,333 2,255 103 (30) 4,005 922 3,083 9.1 0.433 0.432 3,083 0.433 0.432 28,411 27,344 26,984 26,923 28,816 26,403 7,617 21.1 7,617 2,273 125 37 5,182 1,431 3,751 10.4 0.533 0.529 3,751 0.533 0.529 7,004 20.4 7,004 2,216 196 12 4,580 1,247 3,333 9.7 0.474 0.471 3,333 0.474 0.471 5,287 16.4 5,287 2,194 169 28 2,896 865 2,031 6.3 0.289 0.287 2,031 0.289 0.287 5,421 16.8 5,421 2,304 176 25 2,916 799 2,117 6.5 0.301 0.300 2,117 0.301 0.300 5,735 16.6 6,448 1,887 169 5 3,674 1,103 2,571 7.4 0.366 0.364 3,070 0.437 0.435 6,257 19.2 6,257 1,940 127 78 4,112 1,226 2,886 8.8 0.411 0.410 2,886 0.411 0.410 Total assets 132,638 117,983 117,984 113,824 112,330 107,911 104,226 Total long-term financial liabilities 5,815 28,267 29,081 25,066 25,619 22,515 20,794 Funds provided by operations Long-term debt Dividends declared per share 9,401 - 0.300 7,787 21,908 0.300 2,705 22,587 0.296 4,016 18,609 0.288 6,399 19,640 0.288 5,106 17,028 0.288 (1,499) 15,338 0.288 25,743 5,904 18.7 5,904 1,974 123 - 3,807 1,045 2,762 8.7 0.393 0.391 2,762 0.393 0.391 99,452 10,442 9,180 5,162 0.288 (1) EBITDA is defined as revenue less operating expenses (which equates to net earnings before income tax, gain or loss on disposals, financial charges and depreciation and amortization). See Terminology. (2) Adjusted EBITDA is defined as EBITDA (defined above) plus or minus non-recurring, infrequent and/or unusual transactions which did not occur during the preceding two years and are not expected to recur within the next two years. See Terminology for a complete description of the adjusted items. (3) Adjusted net earnings is defined as net earnings plus or minus non-recurring, infrequent and/or unusual transactions net of corporate income taxes which did not occur during the preceding two years and are not expected to recur within the next two years. See Terminology for a complete description of the adjusted items. Occupancy costs increased slightly to $4.8 million or 3.5% of revenues compared to $4.7 million and 3.6% in 2013. The increase is mainly attributable to the increased lease costs of the new Edmonton facility offset by the recognition in 2013 of the onerous contract that related to the old Edmonton facility. Corporate costs increased in 2014 by $0.5 million over the comparative period of 2013 and increased as a percentage of revenues to approximately 4.4%. The increase is due to an increase in the management personal to support the company’s growth and business strategies across the plants. Depreciation of property, plant and equipment and amortization of intangible assets represents the expense related to the appropriate matching of certain of K-Bro’s long-term assets to the estimated useful life and period of economic benefit of those assets. Income tax includes current and deferred income taxes based on taxable income and the temporary timing differences between the tax and accounting bases of assets and liabilities. The Corporation’s effective tax rate decreased to approximately 26.8% of net earnings from 28.8% in 2013. This decrease was a result of a decrease in non-deductible expenses. Revenue, EBITDA, Adjusted EBITDA & Earnings For the year ended December 31, 2014, K-Bro’s revenue was $136.4 million, compared to $131.2 million in the prior year. This represents a 4.0% increase in revenue and is due to a combination of organic growth and additional services provided to the Saskatoon Health Region. In 2014 approximately 68.1% of K-Bro’s revenue was generated from healthcare institutions compared to 67.8% in 2013. EBITDA was $26.2 million in 2014, compared to $23.3 million in 2013. This 12.5% increase was predominantly a result of increased efficiencies as a result of the move to the new Edmonton facility, organic growth from existing customers across the plants, additional volume from Saskatoon Health Region, and the recognition of an expense for the remaining lease payments on the former processing facility in Edmonton in Q3, 2013 which was offset by increased lease costs for the new Edmonton facility in 2014. Net earnings increased in 2014 to $12.2 million from $10.3 million in 2013. Net earnings as a percentage of revenue increased to 8.9% compared to 7.9% in 2013. This margin increase is due to a flow through effect of the increase in the EBITDA. Operating Expenses Wages and benefits increased from $60.9 million in 2013 to $61.2 million in 2014 and decreased as a percentage of revenues to 44.8% from 46.4%. This decrease was a result of increased efficiencies as a result of the move to the new Edmonton facility, partially offset by incremental increases in the wage rate provided earlier in the year during Q1, 2014. Linen expenses increased to $14.4 million from $13.8 million and increased to 10.6% from 10.5% as a percentage of revenue. The increase was a result of additional services provided to healthcare customers along with organic growth across the plants. Utility costs slightly increased from 6.4% in 2013 to 6.5% as a percentage of revenue in 2014. This increase was a result of higher commodity costs in early 2014 as compared to 2013 and was partially offset by increased efficiencies as a result of the move to the new Edmonton facility. Delivery costs have increased to $6.2 million compared to $6.0 million in 2013, but remained constant as a percentage of revenues at 4.6%. Materials and supplies and repairs and maintenance remained constant as a percentage of revenue 2014 compared to 2013. 21 22 K-Bro Linen Inc. | 2014 Annual ReportDependable.Liquidity & Capital Resources In 2014 cash generated by operating activities was $23.9 million, compared to cash generated by operating activities of $19.2 million in 2013. The change in cash from operations is due to the increase in earnings and changes in working capital. During 2014, cash generated from financing activities amounted to $5.1 million compared to $5.7 million generated in 2013. Financing activities in 2014 included $33.1 million in net proceeds from issuance of common shares offset by $19.6 million in repayment of long term debt and $8.4 million in dividends paid to Shareholders. The Corporation used cash of $15.2 million in investing activities during 2014 compared to $24.9 million in 2013. The decrease in cash used in investing activities is driven by the purchase of property, plant and equipment for the new Edmonton facility in 2013, offset by the purchase of property, plant and equipment across the plants and purchases associated with the construction of the new Regina facility in 2014. Contractual Obligations At December 31, 2014, payments due under contractual obligations for the next five years and thereafter are as follows: ($ Thousands) Long term debt Operating leases and utility commitments Linen purchase obligations Property, plant and equipment commitments Total - 32,650 4,322 21,741 Payments due by Period 1-3 Years < 1 Year 4-5 Years - 5,740 4,322 21,741 - 10,023 - - - 5,159 - - > 5 Years - 11,728 - - The operating lease obligations are secured by automotive equipment, plants and are more fully described in the audited annual consolidated financial statements. The source of funds for these commitments will be from operating cash flow and, if necessary, the undrawn portion of the revolving credit facility. Financial Position ($ Thousands, except percentages) Long-term debt Shareholders’ equity Total capitalization Debt to total capitalization (see Terminology for definition)(%) 2014 - 109,438 109,438 0.0 2013 19,640 71,116 90,756 21.6 For the year ended December 31, 2014, the Corporation had a payout ratio (see Terminology) of 42.0%, a debt to total capitalization of 0%, an unused revolving credit facility of $38.4 million and has not incurred any events of default under the terms of its credit facility agreement. As at December 31, 2014, the Corporation had net working capital of $21.7 million compared to its working capital position of $9.4 million at December 31, 2013. Management believes that K-Bro has the capital resources and liquidity necessary to meet its commitments, support its operations and finance its growth strategies. In addition to K-Bro’s ability to generate cash from operations and its revolving credit facility, K-Bro may also be able to access equity financing, depending upon pricing and availability, for capital spending to sustain its property, plant and equipment. Dividends Fiscal Period Payment Date # of Shares Outstanding Amount per Share 2014 (1)(2) Total Amount 2013 Amount per Share Total Amount January February 15 February March 15 March April 13 Q1 April May June Q2 May 15 June 15 July 15 July August 15 August September 15 September October 15 Q3 October November 15 November December 14 December January 15 Q4 YTD 7,095,343 7,095,343 7,095,343 7,095,343 7,095,343 7,129,619 7,129,619 7,120,235 7,120,235 7,120,235 7,120,235 7,959,735 0.09580 0.09580 0.09580 0.28740 0.09580 0.10000 0.10000 0.29580 0.10000 0.10000 0.10000 0.30000 0.10000 0.10000 0.10000 0.30000 680 680 680 2,039 680 710 713 2,102 713 712 712 2,137 712 712 796 2,220 0.09580 0.09580 0.09580 0.28741 0.09580 0.09580 0.09580 0.28741 0.09580 0.09580 0.09580 0.28741 0.09580 0.09580 0.09580 0.28741 676 676 676 2,028 676 680 680 2,036 680 680 680 2,039 680 680 680 2,039 1.18320 8,498 1.14964 8,142 (1) The total amount of dividends paid was $0.09580 per share for a total of $679,734 per month for Jan-March 2014; when rounded in thousands, $2,039 of dividends were paid for the quarterly period. (2) The total amount of dividends paid was $0.09580 per share for a total of $679,734 for April, $709,534 for May, and $0.10000 per share for a total of $712,961 for June 2014. When rounded in thousands,$2,102 of dividends were paid for the quarterly period. For the year ended December 31, 2014, the Corporation distributed $1.18 per share compared with $2.85 per diluted share of Distributable Cash (see Terminology). The actual payout ratio was 42.0%. The Corporation’s policy is to pay dividends to Shareholders from its available distributable cash flow while considering requirements for capital expenditures, working capital, growth capital and other reserves considered advisable by the Directors of the Corporation. All such dividends are discretionary. Dividends are declared payable each month in equal amounts to Shareholders on the last business day of each month and are paid by the 15th of the following month. The Corporation designates all dividends paid or deemed to be paid as Eligible Dividends for purposes of subsection 89(14) of the Income Tax Act (Canada), and similar provincial and territorial legislation, unless indicated otherwise. 23 24 K-Bro Linen Inc. | 2014 Annual ReportDependable.Distributable Cash Flow (See Terminology) (All amounts in this section in thousands, except per share amounts and percentages) The Corporation’s source of cash for dividends is distributable cash flow provided by operating activities. Distributable cash flow, reconciled to cash provided by operating activities as calculated under IFRS, is presented as follows: ($ Thousands, except per share amounts & percentages ) 2014 Q4 Q3 Q2 Q1 2013 Q4 Q3 Q2 Q1 Cash provided by operating activities 9,401 7,787 2,705 4,016 6,399 5,106 (1,499) 9,180 Deduct (add): Net Changes in non-cash working capital items(1) Share-based compensation expense Maintenance capital expenditures(2) 3,878 1,544 (2,995) (1,087) 306 309 319 127 102 491 372 315 1,201 261 180 332 279 293 (6,956) 4,049 377 240 320 173 Distributable cash flow 4,908 5,797 5,107 4,416 4,757 4,202 4,840 4,638 Distributable cash flow per weighted average diluted shares outstanding Dividends declared Dividends declared per share Payout ratio(3)(%) Weighted average shares outstanding 0.688 2,220 0.300 45.2 0.817 2,137 0.300 36.7 0.721 2,102 0.296 41.0 0.624 2,039 0.288 46.2 0.673 2,039 0.288 42.8 0.596 2,039 0.288 48.4 0.688 2,036 0.288 41.9 0.657 2,028 0.288 43.9 during the period, basic 7,113 7,042 7,034 7,032 7,031 7,031 7,020 7,019 Weighted average shares outstanding during the period, diluted 7,134 7,096 7,083 7,072 7,065 7,055 7,038 7,054 Trailing-twelve months (“TTM“) Distributable cash flow Dividends Payout ratio(3)(%) 20,228 20,077 18,482 18,215 18,437 18,080 19,158 19,358 8,498 42.0 8,317 41.4 8,219 44.5 8,153 44.8 8,142 44.2 8,131 45.0 8,120 42.5 8,077 41.7 (1) Net changes in non-cash working capital is excluded from the calculation as management believes it would introduce significant cash flow variability and affect underlying cash flow from operating activities. Significant variability can be caused by such things as the timing of receipts (which individually are large because of the nature of K-Bro’s customer base and timing may vary due to the timing of customer approval, vacations of customer personnel, etc.) and the timing of disbursements (such as the payment of large volume rebates done once annually). As well, large increases in working capital are generally required when contracts with new customers are signed as linen is purchased and accounts receivable increase. Management feels that this amount should be excluded from the distributable cash flow calculation. (2) Maintenance capital expenditures includes costs required to maintain or replace assets which do not have a discrete return on investment. (3) The ratio of dividends paid compared to distributable cash flow is periodically reviewed by the Board of Directors to take into account the current and prospective performance of the business and other items considered to be prudent. Payout ratio is calculated on the dividends declared divided by the distributable cash flow. Outstanding Shares At December 31, 2014, the Corporation had 7,959,735 common shares outstanding. Basic and diluted weighted average number of common shares outstanding for 2014 were 7,090,937 and 7,111,232 respectively, (7,022,699 and 7,054,235, respectively for the comparative 2013 periods). In accordance with the LTI plan and in conjunction with the performance of the Corporation in the 2013 fiscal year, on May 8, 2014 the Compensation, Nominating and Corporate Governance Committee of the Board of Directors approved LTI compensation of $1.4 million (2013 – $1.5 million) to be paid as shares issued from treasury. As at December 31, 2014, the market value of the shares held in trust by the LTI trustee was $2.1 million (December 31, 2013 – $2.5 million) which was comprised of 45,368 in unvested common shares (December 31, 2013 – 63,604) with a nil aggregate cost (December 31, 2013 – $nil). As at March 11, 2015, there were 7,959,735 common shares issued and outstanding. Related Party Transactions The Corporation incurred expenses in the normal course of business for advisory consulting services provided by Mr. Matthew Hills, a director of the Corporation. The amounts charged are recorded at their exchange amounts and are subject to normal trade terms. For the year ended December 31, 2014, the Corporation incurred fees totaling $138,000 (2013 – $138,000). K-Bro has continuously refined and documented its management and internal reporting systems to ensure that accurate, timely, internal and external information is gathered and disseminated. Management also regularly evaluates these estimates and assumptions which are based on past experience and other factors that are deemed reasonable under the circumstances. K-Bro has hired individuals and consultants who have the skills required to make such estimates and ensures that individuals or departments with the most knowledge of the activity are responsible for the estimates. Furthermore, past estimates are reviewed and compared to actual results, and actual results are compared to budgets in order to make more informed decisions on future estimates. K-Bro’s leadership team’s mandate includes ongoing development of procedures, standards and systems to allow K-Bro staff to make the best decisions possible and ensuring those decisions are in compliance with the Corporation’s policies. Preparation of the Corporation’s consolidated financial statements requires management to make estimates and assumptions that affect: • volume rebates; • linen in service; • intangible assets; • goodwill; • income taxes; • provisions; and, • allowance for doubtful accounts. Critical Accounting Estimates The Corporation’s summary of significant accounting policies are contained in note 2 to the audited consolidated financial statements. The Corporation’s financial statements include estimates and assumptions made by management in respect of operating results, financial conditions, contingencies, commitments, and related disclosures. Actual results may vary from these estimates. The following are, in the opinion of management, the Corporation’s most critical accounting estimates, being those that involve the most difficult, subjective and complex judgments, and/or requiring estimates that are inherently uncertain and which may change in subsequent reporting periods. The following discusses the most significant accounting judgments and estimates in the Corporation’s consolidated financial statements. Volume Rebates The Corporation earns revenue from linen management and laundry services based on written service agreements whereby K-Bro has agreed to collect, launder, deliver and replenish linens. K-Bro recognizes revenue in the period in which the services are provided. Volume rebates, where applicable, are recorded based on annualized expected volumes when it is reasonable that the criteria are likely to be met. Based on past experience, management believes that volumes utilized for any estimates are reasonable and would not expect a material deviation to the balance of accrued liabilities or revenue. 25 26 K-Bro Linen Inc. | 2014 Annual ReportDependable.Linen in Service Linen in service is recorded at cost. Operating room linen is amortized on a straight-line method over an estimated service life of 24 months. General linen is amortized based on usage which results in an estimated service life of the linen equal to 24 months. Based on past experience, management believes that a service life of 24 months is representative of the average service life of linen and would not expect a material deviation to the balance of linen in service or linen expense. Intangible Assets The Corporation accounts for intangible assets and goodwill in accordance with IFRS 3, Business Combinations and IAS 38, Intangible Assets. In a business combination, K-Bro may acquire the assets and assume certain liabilities of an acquired entity. The allocation of the purchase price for these transactions involves judgment in determining the fair values assigned to the tangible and intangible assets acquired and the liabilities assumed on the acquisition. The determination of these fair values involves a variety of assumptions, including revenue growth rates, expected operating income, discount rates, and earnings multiples. If K-Bro’s estimates or assumptions change prior to finalizing the purchase price allocation for a transaction, a revision to the purchase price allocation or the carrying value of the related assets and liabilities acquired may impact our net income in future periods. At the date of the acquisition, K-Bro must estimate the value of acquired intangible assets that do not have a well defined market value, such as the value of customer lists and relationships and non-competition agreements. Valuing these assets involves estimates of the future net benefit to K-Bro and the useful life of such benefits and is based upon various internal and external factors. A change in those estimates could cause a material change to the value of the intangible assets. Although intangible assets are amortized over their useful life, if the estimated value of an intangible asset has declined below its amortized book value, a write- down would be recorded in the period in which the event causing the decline in value occurred, which would increase amortization expense and decrease the intangible assets balance. At this time, K-Bro does not believe any intangible assets have a book value in excess of their fair market value. Terminology Additional GAAP Measures EBITDA We report on our EBITDA (Earnings before interest, taxes, depreciation and amortization) because it is a key measure used by management to evaluate performance. EBITDA is utilized in measuring compliance with debt covenants and in making decisions relating to dividends to Shareholders. We believe EBITDA assists investors in assessing our performance on a consistent basis as it is an indication of our capacity to generate income from operations before taking into account management’s financing decisions and costs of consuming tangible and intangible capital assets, which vary according to their vintage, technological currency and management’s estimate of their useful life. Accordingly, EBITDA comprises revenues less operating costs before: financing costs, capital asset and intangible asset amortization, loss on disposal and impairment charges, and income taxes. EBITDA is not a calculation based on IFRS and is not considered an alternative to net earnings in measuring K-Bro’s performance. EBITDA does not have a standardized meaning and is therefore not likely to be comparable with similar measures used by other issuers. EBITDA should not be used as an exclusive measure of cash flow since it does not account for the impact of working capital changes, capital expenditures, debt changes and other sources and uses of cash, which are disclosed in the consolidated statements of cash flows. 3 Months ended Dec. 31 Year ended Dec. 31 2014 3,083 922 103 1,725 530 (30) 2013 2,117 799 176 1,774 530 25 2014 12,198 4,465 593 6,817 2,121 47 2013 10,336 4,173 595 5,965 2,140 108 6,333 5,421 26,241 23,317 ($ Thousands) Net Earnings Add Income tax expense Financial charges Depreciation of property, plant and equipment Amortization of intangible assets (Gain) Loss on disposal of property, plant and equipment EBITDA Non- GAAP Measures Adjusted EBITDA Adjusted EBITDA is a measure which has been reported in order to assist in the comparison of historical EBITDA to current results. The calculation of Adjusted EBITDA normalizes the impact of non-recurring infrequent and/or unusual transactions which did not occur during the preceding two years and are not expected to recur within the next two years, and the related impact on EBITDA (as defined above). During the third quarter ended September 30, 2013, a charge equivalent to the remaining lease payments for decommissioned facilities was recognized as occupancy costs. The normalization of this expense from the calculation of EBITDA is considered by Management to be a more accurate representation of continuing operations. ($ Thousands) EBITDA Add 3 Months ended Dec. 31 Year ended Dec. 31 2014 6,333 2013 5,421 2014 26,241 2013 23,317 Occupancy expense of decommissioned facilities - - - 713 Adjusted EBITDA 6,333 5,421 26,241 24,030 Adjusted Net Earnings & Adjusted Net Earnings per Share Adjusted net earnings and adjusted net earnings per share are measures which have been reported in order to assist in the comparison of historical net earnings to current results. The calculation of Adjusted net earnings normalizes the impact of non-recurring infrequent and/or unusual transactions net of corporate income taxes which did not occur during the preceding two years and are not expected to recur within the next two years, and the related impact on net earnings and net earnings per share. The normalization of this net expense in the calculation of adjusted net earnings and adjusted net earnings per share is considered by management to be a more accurate representation of the net earnings from continuing operations. 27 28 K-Bro Linen Inc. | 2014 Annual ReportDependable.($ Thousands) Net Earnings 3 Months ended Dec. 31 Year ended Dec. 31 2014 3,083 2013 2014 2,117 12,198 2013 10,336 Add/(deduct), net of corporate income taxes Occupancy expense of decommissioned facilities - - - 499 Adjusted net earnings 3,083 2,117 12,198 10,835 Adjusted net earnings, per share: Basic Diluted 0.43 0.43 0.30 0.30 1.72 1.72 1.54 1.54 For the year ended December 31, 2014, each of the non-GAAP adjusted measures noted above (adjusted EBITDA, adjusted net earnings and adjusted net earnings per share) are equivalent to their unadjusted measures. Accordingly, no calculations have been presented for these three measures. Distributable Cash Flow Distributable cash flow is a measure used by management to evaluate its performance. While the closest IFRS measure is cash provided by operating activities, distributable cash flow is considered relevant because it provides an indication of how much cash generated by operations is available after capital expenditures. It shall be noted that although we consider this measure to be distributable cash flow, financial and nonfinancial covenants in our credit facilities and dealer agreements may restrict cash from being available for dividends, re-investment in the Corporation, potential acquisitions, or other purposes. Investors should be cautioned that distributable cash flow may not actually be available for growth or distribution from the Corporation. References to “Distributable cash flow” are to cash provided by (used in) operating activities (including the net change in non-cash working capital balances) less capital expenditures. and provide an indication of the sustainability of dividends. The payout ratio depends on the distributable cash and the Corporation’s dividend policy. Debt to Total Capitalization Debt to total capitalization is defined by management as the total long-term debt divided by the Corporation’s total shareholder’s equity. This is a measure used by investors to assess the Corporation’s financial structure. Distributable Cash Flow, Payout Ratio, Debt to Total Capitalization, Adjusted EBITDA, Adjusted net earnings, and Adjusted net earnings per share are not calculations based on IFRS and are not considered an alternative to IFRS measures in measuring K-Bro’s performance. Distributable Cash Flow, Payout Ratio, Adjusted EBITDA, Adjusted net earnings, and Adjusted net earnings per share do not have standardized meanings in IFRS and are therefore not likely to be comparable with similar measures used by other issuers. Payout Ratio Payout ratio is defined by management as the actual cash dividend divided by distributable cash. This is a key measure used by investors to value K-Bro, assess its performance Off Balance Sheet Arrangements As at December 31, 2014, the Corporation has not entered into any off balance sheet arrangements. Changes in Accounting Policies The Corporation has prepared its December 31, 2014 audited Consolidated Financial Statements in accordance with IFRS. See note 2 of the Corporation’s audited Consolidated Financial Statements for more information regarding the significant accounting principles used to prepare the audited Consolidated Financial Statements. The Corporation has adopted the following new and revised standards, along with any consequential amendments, effective January 1, 2014. These changes were made in accordance with the applicable transitional provisions. • IFRS 21, Levies, requires the Corporation to consider certain government imposed payments, or levies, such as property tax to determine whether the obligating event requiring recognition of a liability arises at a point in time or a period of time. As legislation can vary in different jurisdictions this change was applied and considered for each jurisdiction based on the relevant facts and circumstances. The adoption of IFRIC 21 did not result in any change to the method of recognizing liabilities arising from levies for the Corporation. Recent Accounting Pronouncements The following standard has been issued but has not yet been applied in preparing the consolidated financial statements. • IFRS 15, Revenue from Contracts with Customers, was issued in May 2014 by the IASB and supersedes IAS 18, “Revenue”, IAS 11 “Construction Contracts” and other interpretive guidance associated with revenue recognition. IFRS 15 provides a single model to determine how and when an entity should recognize revenue, as well as requiring entities to provide more informative, relevant disclosures in respect of its revenue recognition criteria. IFRS 15 is to be applied prospectively and is effective for annual periods beginning on or after January 1, 2017, with earlier application permitted. The company is in the process of evaluating the impact that IFRS 15 may have on the financial statements. • IFRS 9, Financial Instruments, was issued in July 2014 by the IASB and supersedes IAS 39, “Financial Instruments: Recognition and Measurement”. IFRS 9 addresses the classification, measurement and recognition of financial assets and financial liabilities. IFRS 9 retains but simplifies the mixed measurement model and establishes three primary measurement categories for financial assets: amortized cost, fair value through OCI and fair value through P&L. IFRS 9 is to be applied prospectively and is effective for annual periods beginning on or after January 1, 2018, with earlier application permitted. The company is in the process of evaluating the impact that IFRS 9 may have on the financial statements. Financial Instruments K-Bro’s financial instruments at December 31, 2014 consist of cash and cash equivalents, accounts receivable, accounts payable, dividends payable, and accrued liabilities. The Corporation does not enter into financial instruments for trading or speculative purposes. Financial assets are either classified as available for sale, held to maturity, trading or loans and receivables. Financial liabilities are recorded at amortized cost. Initially, all financial assets and financial liabilities must be recorded on the balance sheet at fair value. Subsequent measurement is determined by the classification of each financial asset and liability. Unrealized gains and losses on financial assets that are held as available for sale are recorded in other comprehensive income until realized, at which time they are recorded in the consolidated statement of earnings. All derivatives, including embedded derivatives that must be separately accounted for, are recorded at fair value in the consolidated balance sheet. Transaction costs related to financial instruments are capitalized and then amortized over the expected life of the financial instrument using the effective interest method. Derivative financial instruments are utilized by the Corporation to manage cashflow risk against the volatility in interest rates on its long-term debt and foreign exchange rates on its equipment purchase commitments. The Corporation typically does not utilize derivative financial instruments for trading or speculative purposes. The Corporation has a floating interest rate debt that gives rise to risks that its earnings and cash flows may be adversely impacted by fluctuations in interest rates. In order to manage these risks, the Corporation may enter into interest rate swaps, forward contracts on foreign currency, utilities and textiles or option contracts. The Corporation has entered into several electrical and natural gas contracts at December 31, 2014. The Corporation has examined the terms of the natural gas and electricity contracts and has determined that these contracts will be physically settled and as such are not considered to be financial instruments. 29 30 K-Bro Linen Inc. | 2014 Annual ReportDependable.Internal Controls over Financial Reporting The CEO and CFO acknowledge responsibility for the design of internal controls over financial reporting (“ICFR”). Consequently the CEO and CFO confirm that the additions to these controls that occurred during the year ended December 31, 2014 did not materially affect, or are reasonably likely to materially affect, the Corporation’s ICFR. Based upon their evaluation of these controls for the year ended December 31, 2014, the CEO and CFO have concluded that these controls were operating effectively. A control system, no matter how well conceived and operated, can provide only reasonable, and not absolute, assurance that the objectives of the control system are met. As a result of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, including instance of fraud, if any, have been detected. These inherent limitations include, amongst other items: (i) that managements’ assumptions and judgments could ultimately prove to be incorrect under varying conditions and circumstances; or, (ii) the impact of isolated errors. Additionally, controls may be circumvented by the unauthorized acts of individuals, by collusion of two or more people, or by management override. The design of any system of controls is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential (future) conditions. Critical Risks & Uncertainties As at December 31, 2014, there are no material changes in the Corporation’s risks or risk management activities since December 31, 2013. The Corporation’s results of operations, business prospects, financial condition, cash dividends to Shareholders and the trading price of the Corporation’s Shares are subject to a number of risks. These risk factors include: dependence on long-term contracts and the associated renewal risk thereof; the effects of market volatility and uncertainty; potential future tax changes; the competitive environment; our ability to acquire and successfully integrate and operate additional businesses; utility costs; the labour markets; the fact that our credit facility imposes numerous covenants and encumbers assets; and, environmental matters. For a discussion of these risks and other risks associated with an investment in Corporation Shares, see Risk Factors – Risks Related to K-Bro and the Laundry and Linen Industry detailed in the Corporation’s Annual Information Form that is available at www.sedar.com. Controls & Procedures In order to ensure that information with regard to reports filed or submitted under securities legislation present fairly in all material respects the financial information of K-Bro, management, including the President and Chief Executive Officer (“CEO”) and the Vice-President and Chief Financial Officer (“CFO”), are responsible for establishing and maintaining disclosure controls and procedures, as well as internal control over financial reporting. During the fourth quarter of 2014, the Corporation adopted the Internal Control-Integrated Framework (2013 COSO Framework) as published by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Disclosure Controls and Procedures The Corporation has established disclosure controls and procedures to ensure that information disclosed in this MD&A and the related financial statements of K-Bro was properly recorded, processed, summarized and reported to the Board of Directors and the Audit Committee. The Corporation’s CEO and CFO have evaluated the effectiveness of these disclosure controls and procedures for the year ended December 31, 2014, and the CEO and CFO have concluded that these controls were operating effectively. Additional information regarding K-Bro including required securities filings are available on our website at www.k-brolinen.com and on the Canadian Securities Administrators’ website at www.sedar.com; the System for Electronic Document Analysis and Retrieval (“SEDAR”). Vous pouvez obtenir des renseignements supplémentaires sur la Société, y compris les documents déposés auprès des autorités de réglementation, sur notre site Web, au www.k-brolinen.com et sur le site Web des autorités canadiennes en valeurs mobilières au www.sedar.com, le site Web du Système électronique de données, d’analyse et de recherche (« SEDAR »). 31 32 K-Bro Linen Inc. | 2014 Annual ReportDependable.Consolidated Financial Statements PricewaterhouseCoopers LLP TD Tower, 10088 102 Avenue NW, Suite 1501, Edmonton, Alberta, Canada T5J 3N5 Phone 1 780 441 6700 | Fax 1 780 441 6776 | Website pwc.com/ca “PwC” refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership. Consolidated Statements of Financial Position ($ Thousands of Canadian dollars) December 31, 2014 December 31, 2013 March 11, 2015 To the Shareholders of K-Bro Linen Inc. Independent Auditor’s Report We have audited the accompanying consolidated financial statements of K-Bro Linen Inc. and its subsidiaries, which comprise the consolidated statements of financial position as at December 31, 2014 and December 31, 2013 and the consolidated statements of earnings and comprehensive income, changes in equity and cash flows for the years then ended, and the related notes, which comprise a summary of significant accounting policies and other explanatory information. Management’s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements 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. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of K-Bro Linen Inc. and its subsidiaries as at December 31, 2014 and December 31, 2013 and their financial performance and their cash flows for the years then ended in accordance with International Financial Reporting Standards. Assets Current assets Cash and cash equivalents Accounts receivable Prepaid expenses and deposits Linen in service (note 6) Total Property, plant and equipment (note 7) Intangible assets (note 8) Goodwill (note 9) Assets Total Liabilities Current liabilities Accounts payable and accrued liabilities (note 10) Income taxes payable Dividends payable to shareholders Total Long-term debt (note 11) Unamortized lease inducements (note 13) Deferred income taxes (note 14) Liabilities Total Shareholders’ Equity Share capital Contributed surplus Retained earnings (deficit) Shareholders’ Total Contingencies and commitments (note 15) The accompanying notes are an integral part of these consolidated financial statements. Approved on behalf of the Corporation. 13,744 14,560 1,009 9,794 39,107 66,319 6,756 20,456 132,638 16,346 243 796 17,385 - 850 4,965 23,200 106,870 1,642 926 109,438 132,638 - 15,465 917 8,647 25,029 57,972 8,873 20,456 112,330 14,824 91 680 15,595 19,640 947 5,032 41,214 72,158 1,732 (2,774) 71,116 112,330 Chartered Accountants Edmonton, Canada 35 Ross Smith Chairman Matthew Hills Director 36 K-Bro Linen Inc. | 2014 Annual ReportDependable.Consolidated Statements of Earnings & Comprehensive Income ($ Thousands of Canadian dollars, except share and per share amounts) Years ended December 31 Revenue Expenses Wages and benefits Linen (note 6) Utilities Delivery Occupancy costs Materials and supplies Repairs and maintenance Corporate Total EBITDA (note 22) Other expenses Depreciation of property, plant and equipment (note 7) Amortization of intangible assets (note 8) Financial charges (note 12) Loss on disposal of property, plant and equipment Total Earning before income taxes Current income tax expense Deferred income tax expense Income tax expense Net earnings and Comprehensive income Net earnings per share: (note 17) Basic Diluted Weighted average number of shares outstanding: Basic Diluted The accompanying notes are an integral part of these consolidated financial statements. 2014 136,440 61,162 14,438 8,898 6,246 4,800 4,474 4,232 5,949 110,199 26,241 6,817 2,121 593 47 9,578 16,663 4,081 384 4,465 12,198 1.72 1.72 2013 131,202 60,858 13,781 8,400 5,979 4,703 4,337 4,398 5,429 107,885 23,317 5,965 2,140 595 108 8,808 14,509 3,931 242 4,173 10,336 1.47 1.47 7,090,937 7,111,232 7,022,699 7,054,235 Consolidated Statements of Changes in Equity ($ Thousands of Canadian dollars) Total Share Capital Contributed Surplus Retained Earnings (deficit) Total Equity As at January 1, 2014 Net earnings Net proceeds from common shares issued (note 16) Dividends declared (note 19) Employee share based compensation expense Cash settled employee share based compensation Shares vested during the year As at December 31, 2014 72,158 - 33,523 - - - 1,189 106,870 1,732 - - - 1 ,136 (37) (1,189) 1,642 (2,774) 12,198 - (8,498) - - - 71,116 12,198 33,523 (8,498) 1,136 (37) - 926 109,438 ($ Thousands of Canadian dollars) Total Share Capital Contributed Surplus Retained Earnings (deficit) Total Equity As at January 1, 2013 Net earnings Dividends declared (note 19) Employee share based compensation expense Shares vested during the year As at December 31, 2013 71,444 - - - 714 72,158 1,209 - - 1,237 (714) 1,732 (4,968) 10,336 (8,142) - - (2,774) 67,685 10,336 (8,142) 1,237 - 71,116 The accompanying notes are an integral part of these consolidated financial statements. 37 38 K-Bro Linen Inc. | 2014 Annual ReportDependable.Consolidated Statements of Cash Flow ($ Thousands of Canadian dollars, except share and per share amounts) Years ended December 31 Operating Activities Net earnings Depreciation of property, plant and equipment (note 7) Amortization of intangible assets (note 8) Lease inducements, net of amortization Cash settled employee share based compensation Employee share based compensation expense Loss on disposal of property, plant and equipment Deferred income taxes Total Change in non-cash working capital items (note 20) Cash provided by operating activities Financing Activities Net proceeds (repayments) of revolving credit facility Net proceeds from issuance of common shares (note 16) Dividends paid to shareholders (note 19) Cash provided by financing activities Investing Activities Purchase of property, plant and equipment (note 7) Proceeds from disposal of property, plant and equipment Purchase of intangible assets (note 8) Cash used in investing activities Change in cash during the year Cash, beginning of year Cash, end of year Supplementary Cash Flow Information Interest paid Income taxes paid The accompanying notes are an integral part of these consolidated financial statements. 2014 12,198 6,817 2,121 (97) (37) 1,136 47 384 22,569 1,340 23,909 (19,640) 33,072 (8,382) 5,050 (15,522) 311 (4) (15,215) 13,744 - 13,744 577 3,929 2013 10,336 5,965 2,140 532 - 1,237 108 242 20,560 (1,374) 19,186 13,822 - (8,138) 5,684 (24,914) 44 - (24,870) - - - 462 6,255 Notes to the Consolidated Statements ($ Thousands of Canadian dollars, except share and per share amounts, years ended December 31, 2014 and 2013) K-Bro Linen Inc. (the “Corporation” or “K-Bro”) is incorporated in Canada under the Business Corporations Act (Alberta). The Corporation and its wholly owned subsidiaries provide a range of linen services to healthcare institutions, hotels and other commercial accounts that include the processing, management and distribution of general linen and operating room linen. The Corporation provides services from eight processing facilities and one distribution centre in eight major cities across Canada from Victoria, British Columbia to Québec City, Québec. The Corporation’s common shares are traded on the Toronto Stock Exchange under the symbol “KBL”. The address of the Corporation’s registered head office is 14903 – 137 Avenue, Edmonton, Alberta, Canada. These audited annual consolidated financial statements (the “consolidated financial statements”) were approved and authorized for issuance by the Board of Directors (“the Board”) on March 11, 2015. 1 Basis of Presentation The consolidated financial statements of the Corporation have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as published in the CPA Handbook. The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgment in the process of applying the Corporation’s accounting policies. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the Consolidated Financial Statements are disclosed in Note 5. 2 Significant accounting policies The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the periods presented, unless otherwise stated. a) Basis of Measurement The consolidated financial statements have been prepared under the historical cost convention, except for the revaluation of certain financial assets and financial liabilities to fair value, including derivative instruments. b) Principles of Consolidation The consolidated financial statements include the Corporation, its wholly owned subsidiaries and the long-term incentive plan trust (notes 2(q) (ii) and (iii)). All intercompany balances and transactions have been eliminated upon consolidation. c) Cash and Cash Equivalents Cash and cash equivalents includes cash on hand, deposits with banks, other short-term highly liquid investments with original maturities of three months or less. Cash and cash equivalents are classified as loans and receivables and are carried at amortized cost, which is equivalent to fair value. d) Linen in Service Linen in service is stated at cost less accumulated depreciation. The cost is based on the expenditures that are directly attributable to the acquisition of linen, with operating room linen amortized across its estimated service life of 24 months and general linen amortized based on usage which results in an estimated average service life of 24 months. e) Revenue Recognition Revenue from linen management and laundry services is primarily based on written service agreements whereby the Corporation agrees to collect, launder, deliver and replenish linens. The Corporation recognizes revenue in the period in which the services are provided. 39 40 K-Bro Linen Inc. | 2014 Annual ReportDependable.f) Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment losses. Cost includes expenditures that are directly attributable to the acquisition of the items. Subsequent costs are included in the asset’s carrying amount or recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Corporation and the cost of the item can be reliably measured. The carrying amount of a replaced part is derecognized. Repairs and maintenance are charged to the income statement during the financial period in which they are incurred. The major categories of property, plant and equipment are depreciated on a straight-line basis to allocate their cost over their estimated useful lives as follows: Asset Buildings Laundry equipment Office equipment Delivery equipment Computer equipment Leasehold improvements Rate 15-25 years 7-20 years 2-5 years 5 years 2 years Lease term Gains and losses on disposals of property, plant and equipment are determined by comparing the proceeds with the carrying amount of the asset and are included as part of other gains and losses in the statement of earnings and comprehensive income. g) Impairment of Financial Assets At each reporting date, the Corporation assesses whether there is objective evidence that a financial asset is impaired. If such evidence exists, the Corporation recognizes an impairment loss equal to the difference between the amortized cost of the loan or receivable and the present value of the estimated future cash flows, discounted using the instrument’s original effective interest rate. The carrying amount of the asset is reduced by this amount either directly or indirectly through the use of an allowance account. of measuring recoverable amounts, assets are grouped at the lowest level for which there are separately identifiable cash flows (cash-generating unit or “CGU”). The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use (being the present value of the expected future cash flows of the relevant asset or CGU). An impairment loss is recognized for the amount by which the asset’s carrying amount exceeds its recoverable amount. The Corporation evaluates impairment losses, other than goodwill impairment, for potential reversals when events or circumstances warrant such consideration. Impairment losses on financial assets carried at amortized cost are reversed in subsequent periods if the amount of the loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized. h) Impairment of Non-Financial Assets Property, plant and equipment and intangible assets are tested for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. Long-lived assets that are not amortized are subject to an annual impairment test. For the purpose i) Intangible Assets Intangible assets are recorded at cost and include customer contracts in progress and related relationships, which are being amortized using the straight-line method over the remaining lives of the related contracts and relationships. Intangible assets which relate to computer software are amortized using the straight-line method over five years when put into service. These estimates are reviewed at least annually and are updated if expectations change as a result of changing client relationships or technological obsolescence. j) Income Taxes The tax expense for the year comprises current and deferred tax. Tax is recognized in statement of earnings, except to the extent that it relates to items recognized in other comprehensive income or directly in equity. In this case, the tax is also recognized in other comprehensive income or directly in equity, respectively. The current income tax provision is calculated on the basis of the tax laws enacted or substantively enacted at the balance sheet date of the taxation authority where the Corporation operates and generates taxable income. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation. It establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities. Deferred income tax is recognized, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the Consolidated Financial Statements. Deferred income tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred income tax asset is realized or the deferred income tax liability is settled. Deferred income tax assets are recognized only to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilized. for impairment annually in the fourth quarter, or more frequently if events or changes in circumstances indicate a potential impairment. Goodwill acquired through a business combination is allocated to each CGU, or group of CGUs, that are expected to benefit from the related business combination. A CGU represents the lowest level within the entity at which the goodwill is monitored for internal management purposes. m) Volume Rebates Certain customers receive a rebate based on specified annual processing volumes. A rebate liability is recorded in the period it is expected that the customer will meet the specified annual volume levels. n) Earnings Per Share Basic earnings per share (“EPS”) is calculated by dividing net earnings for the period attributable to Shareholders of the Corporation by the weighted average number of Common shares outstanding during the period. Diluted EPS is calculated by adjusting the weighted average number of common shares outstanding for dilutive instruments. The number of common shares included within the weighted average is computed using the treasury stock method. The Corporation’s potentially dilutive Common shares are comprised of long-term incentive plan equity compensation granted to officers and key employees (notes 2(q) (ii) and (iii)). k) Business Combinations o) Foreign Currency Translation Business combinations are accounted for using the acquisition method. The acquired identifiable net assets are measured at their fair value at the date of acquisition. The consideration transferred includes the fair value of any asset or liability resulting from a contingent consideration arrangement. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. Any deficiency of the purchase price below the fair value of the net assets acquired is recorded as a gain in net earnings. Associated transaction costs are expensed when incurred. Foreign currency transactions are translated into Canadian dollars using the exchange rates prevailing at the dates of the transactions or valuation where items are re-measured. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognized in the income statement. Foreign exchange gains and losses that relate to borrowings and cash and cash equivalents are presented in the statement of earnings within “financial charges”. l) Goodwill Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the identifiable assets acquired, less liabilities assumed, based on their estimated fair values at the acquisition date. Goodwill is allocated as of the date of the business combination. Goodwill is tested 41 42 K-Bro Linen Inc. | 2014 Annual ReportDependable.p) Lease Inducements Tenant allowances and lease inducements are deferred when credited or received and amortized on a straight- line basis as a reduction of rent expense over the term of the related lease. For lease contracts with escalating lease payments, total rent expense for the lease term is expensed on a straight-line basis over the lease term. The difference between rent expensed and amounts paid is recorded as an increase or deferral in unamortized lease inducements. q) Employee Benefits i) Post-employment benefit obligations The Corporation contributes on behalf of its employees to their individual Registered Retirement Savings Plans subject to an annual maximum of 4% of gross personal earnings. The Corporation accounts for contributions as an expense in the period that they are incurred. The Corporation does not provide any other post-employment or post-retirement benefits. ii) Former equity-based compensation plan The officers and key employees were eligible to participate in a past long-term incentive plan (“LTIP”), which involved equity-settled share-based payments. The Corporation set aside funds each year based on the amount by which distributable cash flow exceeded a base distributable amount for the fiscal year. The LTIP trustee purchased common shares in the open market and held such common shares until ownership vests to each participant. Subject to the Board’s discretion to accelerate vesting, one-quarter of the LTIP grant vested thirty days following the date that the Trustees of the Fund approved the audited Consolidated Financial Statements (the “Determination Date”). The remaining three-quarters vested on the second anniversary of the Determination Date. In most circumstances, unvested grant amounts held by the trustee for an LTIP participant are forfeited if the participant resigns or is terminated for cause prior to the applicable vesting date, and any equity will be sold and the proceeds returned to the Corporation. As of May 1, 2011 no additional compensation will be issued under this LTIP. Any unvested compensation granted under the terms of this plan will vest under the original terms and conditions of issue. All remaining compensation under this LTIP vested during the year ending December 31, 2013. iii) Existing equity-based compensation plan of the Corporation On June 16, 2011, the Shareholders of the Corporation approved a new Long-term Incentive Plan t(“LTI”). Under the LTI, awards are granted annually in respect of the prior fiscal year to the eligible participants based on a percentage of annual salary. The amount of the award (net of withholding obligations) is satisfied by issuing treasury shares to be held in trust by the trustee pursuant to the terms of the LTI. All awards issued under the provisions of the LTI are recorded as compensation expense. Subject to the discretion of the Compensation, Nominating and Corporate Governance Committee of the Board of Directors, one-quarter of a Participant’s grant will vest on the Determination Date (defined as the first May 15th following the date that the Directors of the Corporation approve the audited consolidated financial statements of the Corporation for the prior year). The remaining three- quarters of the Participant’s grant will vest on November 30th following the second anniversary of the Determination Date. If a change of control occurs, all LTI Shares held by the Trustee in respect of unvested grants will vest immediately. LTI participants are entitled to receive dividends on all common shares granted under the LTI whether vested or unvested. In most circumstances, unvested common shares held by the LTI trustee for a participant will be forfeited if the participant resigns or is terminated for cause prior to the applicable vesting date, and those common shares will be disposed of by the trustee to K-Bro for no consideration and such Common shares shall thereupon be cancelled. If a participant is terminated without cause, retires or resigns on a basis which constitutes constructive dismissal, the participant will be entitled to receive his or her unvested common shares on the regular vesting schedule under the LTI. r) Financial Instruments Financial assets and financial liabilities are initially recognized at fair value and are subsequently accounted for based on their classification as described below. The classification depends on the purpose for which the financial instruments were acquired and their characteristics. Except in very limited circumstances, the classification is not changed subsequent to initial recognition. Transaction costs are recognized immediately in income or are capitalized, depending upon the nature of the transaction and the associated instrument. Loans, receivables and other liabilities Loans, receivables and other liabilities are accounted for at amortized cost using the effective interest method. The Corporation has made the following classifications: Asset Financial assets Cash and cash equivalents Accounts receivable Financial liabilities Accounts payable and accrued liabilities Dividends payable Long-term debt Classification Measurement Loans and receivables Loans and receivables Amortized cost Amortized cost Other liabilities Other liabilities Other liabilities Amortized cost Amortized cost Amortized cost Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis or realize the asset and settle the liability simultaneously. 3 Significant accounting policies adopted January 1, 2014 The Corporation has adopted the following new and revised standards, along with any consequential amendments, effective January 1, 2014. These changes were made in accordance with the applicable transitional provisions. • IFRIC 21, Levies, requires the Corporation to consider certain government imposed payments, or levies, such as property tax to determine whether the obligating event requiring recognition of a liability arises at a point in time or a period of time. As legislation can vary in different jurisdictions this change was applied and considered for each jurisdiction based on the relevant facts and circumstances. The adoption of IFRIC 21 did not result in any change to the method of recognizing liabilities arising from levies for the Corporation. 43 44 K-Bro Linen Inc. | 2014 Annual ReportDependable.4 New Standards and interpretations not yet adopted The following standard has been issued but has not yet been applied in preparing the consolidated financial statements. • IFRS 15, Revenue from Contracts with Customers, was issued in May 2014 by the IASB and supersedes IAS 18, “Revenue”, IAS 11 “Construction Contracts” and other interpretive guidance associated with revenue recognition. IFRS 15 provides a single model to determine how and when an entity should recognize revenue, as well as requiring entities to provide more informative, relevant disclosures in respect of its revenue recognition criteria. IFRS 15 is to be applied prospectively and is effective for annual periods beginning on or after January 1, 2017, with earlier application permitted. The company is in the process of evaluating the impact that IFRS 15 may have on the financial statements. • IFRS 9, Financial Instruments, was issued in July 2014 by the IASB and supersedes IAS 39, “Financial Instruments: Recognition and Measurement”. IFRS 9 addresses the classification, measurement and recognition of financial assets and financial liabilities. IFRS 9 retains but simplifies the mixed measurement model and establishes three primary measurement categories for financial assets: amortized cost, fair value through OCI and fair value through P&L. IFRS 9 is to be applied prospectively and is effective for annual periods beginning on or after January 1, 2018, with earlier application permitted. The company is in the process of evaluating the impact that IFRS 9 may have on the financial statements. There are no other IFRSs or IFRIC interpretations that are not yet effective that would be expected to have a material impact on the Corporation. 5 Critical accounting estimates & judgments The preparation of the Corporation’s consolidated financial statements, in conformity with IFRS, requires management of the Corporation to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgments about carrying values of assets and liabilities that are not readily apparent from other sources. These estimates and judgments have been applied in a manner consistent with prior periods. The following discusses the most significant accounting judgments and estimates that the Corporation has made in the preparation of the financial statements: Impairment of goodwill and non-financial assets The Corporation reviews goodwill at least annually and other non-financial assets when there is any indication that the asset might be impaired. The Corporation applies judgment in assessing the likelihood of renewal of significant contracts included in the intangible assets described in note 8. The Corporation has estimated the value in use and fair value of CGUs to which goodwill is allocated using discounted cash flow models that required assumptions about future cash flows, margins, and discount rates. Refer to note 9 for more details about methods and assumptions used in estimating net recoverable amount. Recognition of Rebate Liabilities In applying its accounting policy for volume rebates, the Corporation must determine whether the processing volume thresholds will be achieved. The most difficult and subjective area of judgment is whether a contract will generate satisfactory volume to achieve minimum levels. Management considers all appropriate facts and circumstances in making this assessment including historical experience, current volumetric run-rates, and expected future events. Linen in Service The estimated service lives of linen in service are reviewed at least annually and are updated if expectations change as a result of physical wear and tear, technical or commercial obsolescence and legal or other limits of use. Management regularly evaluates these estimates and judgments. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both current and future periods. 45 6 Linen in Service ($ Thousands of Canadian dollars) Balance, beginning of year Additions Amortization charge Balance, end of year 2014 8,647 15,585 (14,438) 9,794 2013 8,888 13,540 (13,781) 8,647 46 K-Bro Linen Inc. | 2014 Annual ReportDependable.7 Property, Plant & Equipment ($ Thousands of Canadian dollars) Land Buildings(1) Laundry Equipment(2) Office Equipment Delivery Equipment Computer Equipment Leasehold Improvements Spare Parts Total Year ended, December 31, 2013 Opening net book amount Additions Disposals Depreciation charge Closing net book amount At December 31, 2013 Cost Accumulated depreciation Net book amount Year ended, December 31, 2014 Opening net book amount Additions Disposals Transfers Depreciation charge Closing net book amount At December 31, 2014 Cost Accumulated depreciation Net book amount 125 - - - 125 125 - 125 125 2,300 - - - 2,425 2,425 - 2,425 1,140 23 - (89) 1,074 1 ,400 (326) 1,074 1,074 5,692 - - (90) 6,676 7,092 (416) 6,676 31,856 15,247 (100) (4,457) 42,546 73,562 (31,016) 42,546 42,546 6,698 (295) 58 (4,750) 44,257 80,023 (35,766) 44,257 152 154 - (38) 268 771 (503) 268 268 77 - - (71) 274 848 (574) 274 517 100 (52) (74) 491 928 (437) 491 491 69 (63) - (80) 417 934 (517) 417 105 389 - (114) 380 2,025 (1,645) 380 380 178 - - (234) 324 2,203 (1,879) 324 4,507 8,964 - (1,193) 12,278 20,508 (8,230) 12,278 12,278 502 - - (1,592) 11,188 21,010 (9,822) 11,188 773 37 - - 810 810 - 810 810 6 - (58) - 758 758 - 758 39,175 24,914 (152) (5,965) 57,972 100,129 (42,157) 57,972 57,972 15,522 (358) - (6,817) 66,319 115,293 (48,974) 66,319 (1) Included in buildings are assets under development in the amount of $5,683. These assets are not available for service and accordingly are not presently being depreciated. (2) Included in laundry equipment are assets under development in the amount of $3,345. These assets are not available for service and accordingly are not presently being depreciated. 47 48 K-Bro Linen Inc. | 2014 Annual ReportDependable.8 Intangible Assets 9 Goodwill ($ Thousands of Canadian dollars) Healthcare Contracts Hospitality Contracts Computer Software Year ended, December 31, 2013 Opening net book amount Amortization charge Closing net book amount At December 31, 2013 Cost Accumulated amortization Net book amount Year ended, December 31, 2014 Opening net book amount Additions Amortization charge Closing net book amount At December 31, 2014 Cost Accumulated amortization Net book amount 6,769 (1,064) 5,705 19,200 (13,495) 5,705 5,705 - (1,042) 4,663 19,200 (14,537) 4,663 3,870 (891) 2,979 8,366 (5,386) 2,980 2,980 - (892) 2,088 8,366 (6,278) 2,088 374 (185) 189 923 (735) 188 188 4 (187) 5 927 (922) 5 Total 11,013 (2,140) 8,873 28,489 (19,616) 8,873 8,873 4 (2,121) 6,756 28,493 (21,737) 6,756 The Corporation performed its annual assessment for goodwill impairment as at December 31, 2014 in accordance with its policy described in Note 2(l). Goodwill has been allocated to the following CGUs: ($ Thousands of Canadian dollars) Calgary Edmonton Vancouver 2 Victoria Vancouver 1 Montréal Québec Total 2014 5,382 4,346 3,413 3,208 2,630 823 654 20,456 2013 5,382 4,346 3,413 3,208 2,630 823 654 20,456 In assessing goodwill for impairment at December 31, 2014, the Corporation determined that: the assets and liabilities of the Corporation have not changed significantly from the prior year at December 31, 2013; the estimated recoverable amounts of the CGUs exceeded their carrying amounts by a significant amount; no events or circumstances have changed; and the likelihood of an impairment in goodwill is remote. In performing our analysis, estimated recoverable amounts were determined based on the value in use of the CGUs using available cash flow budgets that made maximum use of observable markets for inputs and outputs, including actual historical performance. For periods beyond the budgeted period, cash flows were extrapolated using growth rates that did not exceed the long-term averages for the business. Key assumptions included a weighted average growth rate of 3% and a pre-tax discount rate of 14% for all CGUs. The fair value of each CGU was significantly in excess of its carrying amount. Based on sensitivity analysis, no reasonably possible change in key assumptions would cause the carrying amount of any CGU to exceed its recoverable amount. The total recoverable amount for all CGU’s exceeded their carrying amount by $176,784. The recoverable amount for the CGUs that were in excess of their carrying values was 186% of the carrying value of the applicable CGUs based on a weighted average. Based on sensitivity analysis, no reasonably possible change in growth rate assumptions would cause the recoverable amount of any CGU to have a significant change from its current valuation. A 1% change in the discount rate would not have a significant impact on the recoverable amounts of CGUs. The recoverable amount of each CGU is sensitive to changes in market conditions and could result in material changes in the carrying value of intangible assets in the future. 49 50 K-Bro Linen Inc. | 2014 Annual ReportDependable. 10 Provisions The Corporation has recognized provisions as at December 31, 2014 to recognize estimated obligations resulting from operations. The carrying amount of the provisions is estimated at the end of the reporting period based on best available information. The following table provides a continuity schedule of all recorded provisions: ($ Thousands of Canadian dollars) Balance, beginning of year Additions Payments Balance, end of year 11 Long Term Debt ($ Thousands of Canadian dollars) At January 1, 2013 Net proceeds from debt Closing Balance at December 31, 2013 Current portion of long-term debt Non-current portion of long-term debt At January 1, 2014 Net proceeds from debt Repayment of debt Closing Balance at December 31, 2014 2014 250 350 (338) 262 2013 - 250 - 250 Bankers Acceptances(1) Prime Rate Loan(2) Total Long Term Debt 4,000 - 4,000 - 4,000 4,000 - (4,000) - 1,818 13,822 15,640 - 15,640 15,640 - (15,640) - 5,818 13,822 19,640 - 19,640 19,640 - (19,640) - A general security agreement over all assets, a mortgage against all leasehold interests and real property, insurance policies and an assignment of material agreements have been pledged as collateral. The carrying value of borrowings approximate their fair value as the debt is based on a floating rate, the interest rate risk has not changed, and the impact of discounting is not significant. The Corporation has incurred no events of default under the terms of its credit facility agreement. 12 Financial Charges ($ Thousands of Canadian dollars) Interest on long-term debt Other charges, net Total 2014 578 15 593 2014 1,090 - (97) 993 (143) 850 2013 413 182 595 2013 512 691 (113) 1,090 (143) 947 (1) Bankers’ Acceptances bear interest at 30 day BA rates plus 1.25% depending on certain financial ratios. (2) Prime rate loan, collateralized by a general security agreement, bear interest at prime plus 0.0% depending on certain financial ratios, monthly repayment of interest only, maturing on July 31, 2016. As at December 31, 2014, the interest rate was 3.0%. ($ Thousands of Canadian dollars) 13 Unamortized Lease Inducements The Corporation has a revolving credit facility of up to $40,000 of which $1,650 is drawn (including letters of credit totaling $1,650 per Note 15(a)) as at December 31, 2014. The agreement is a committed facility maturing on July 31, 2016. Interest payments only are due during the term of the facility. The amounts borrowed were repaid on December 9, 2014. Drawings under the revolving credit facility are available by way of Bankers’ Acceptances, Canadian prime rate loans, letters of credit or standby letters of guarantee. Drawings under the revolving credit facility bear interest at a floating rate, plus an applicable margin based on certain financial performance ratios. Balance, beginning of year Lease inducements received Amortization charge Total Less current portion, included in accrued liabilities Total 51 52 K-Bro Linen Inc. | 2014 Annual ReportDependable. 14 Income Taxes A reconciliation of the expected income tax expense to the actual income tax expense is as follows: ($ Thousands of Canadian dollars) Current tax: Current tax on profits for the year Total current tax Deferred tax: Origination and reversal of temporary differences Impact of substantively enacted rates and other Total deferred tax 2014 4,081 4,081 543 (159) 384 2013 3,931 3,931 203 39 242 The tax on the Corporation’s earnings differs from the theoretical amount that would arise using the weighted average tax rate applicable to earnings of the consolidated entities as follows: ($ Thousands of Canadian dollars) Earnings before income taxes Non-deductible expenses Income subject to tax Income tax at statutory rate of 25.6% (2013 - 25.6%) Impact of substantively enacted rates and other Income tax expense 2014 16,663 1,403 18,066 4,624 (159) 4,465 The analysis of the deferred tax assets and deferred tax liabilities is as follows: 2013 14,509 1,573 16,082 4,118 55 4,173 ($ Thousands of Canadian dollars) 2014 2013 Deferred tax assets: Deferred tax asset to be recovered after more than 12 months Deferred tax asset to be recovered within 12 months Total Deferred tax liabilities: Deferred tax liability to be recovered after more than 12 months Deferred tax liability to be recovered within 12 months Total Deferred tax liabilities, net (471) (90) (561) 3,115 2,411 5,526 4,965 (81) (141) (222) 3,101 2,153 5,254 5,032 The movement of deferred income tax assets and liabilities during the year, without taking into consideration the offsetting of balances within the same tax jurisdictions, is as follows: ($ Thousands of Canadian dollars) Deferred tax assets At January 1, 2013 Charged (credited) to the statement of earnings At December 31, 2013 Charged (credited) to the statement of earnings Charged (credited) to the statement of changes in equity At December 31, 2014 Accounts Payable and Accrued Liabilities Offering Costs and Other Total (258) 117 (141) 141 - - (78) (336) (3) (81) 114 (222) (29) 112 (451) (561) (451) (561) ($ Thousands of Canadian dollars) Linen in Service Property, Plant and Equipment Intangible Assets and Goodwill Total Deferred tax liabilities At January 1, 2013 Charged (credited) to the statement of earnings At December 31, 2013 Charged (credited) to the statement of earnings At December 31, 2014 2,160 (7) 2,153 258 2,411 1,142 337 1,479 317 1,796 1,824 5,126 (202) 1,622 128 5,254 (303) 1,319 272 5,526 53 54 K-Bro Linen Inc. | 2014 Annual ReportDependable. 15 Contingencies and Commitments a) Contingencies – Letters of credit The Corporation has standby letters of credit issued as part of normal business operations in the amount of $1,650 (2013 – $650) which will remain outstanding for an indefinite period of time. b) Commitments (i) Operating leases and utility commitments Minimum lease payments for operating leases on buildings and equipment and estimated natural gas and electricity commitments for the next five calendar years are as follows: b) Issued ($ Thousands of Canadian dollars) Balance, beginning of year Common shares issued under LTI Common share issuance under equity offering Balance, end of year Unvested common shares held in trust for LTI 2014 7,095,343 24,892 839,500 7,959,735 45,368 2013 7,055,207 40,136 - 7,095,343 63,604 ($ Thousands of Canadian dollars) 2015 2016 2017 2018 Subsequent Total 5,740 5,355 4,668 3,307 13,580 32,650 The Corporation has examined the terms of the natural gas and electricity contracts and has determined that these contracts will be physically settled and as such are not considered to be financial instruments. (ii) Linen purchase commitments At December 31, 2014, the Corporation was committed to linen expenditure obligations in the amount of $4,322 (2013 – $3,562) to be incurred over the next twelve months. (iii) Capital expenditure commitments At December 31, 2014, the Corporation was committed to capital expenditure obligations in the amount of $21,741 (2013 – $22,066) to be incurred over the next twelve months. 16 Share Capital a) Authorized The Corporation is authorized to issue an unlimited number of common shares and such number of shares of one class designated as preferred shares which number shall not exceed 1/3 of the common shares issued and outstanding from time to time. The Corporation issued 839,500 common shares on December 9, 2014 (10.5% of total share capital issued) as a part of an equity offering. The common shares issued have the same rights as the other shares in issue. The fair market value of the shares issued amounted to $34,839 ($41.50/share). The related transaction costs amounting to $1,316 have been netted against the deemed proceeds. 17 Earnings per Share a) Basic Basic earnings per share is calculated by dividing the net earnings attributable to equity holders of the Corporation by the weighted average number of ordinary shares in issue during the year. ($ Thousands of Canadian dollars) Net earnings Weighted average number of shares outstanding (thousands) Net earnings per share, basic 2014 12,198 7,091 1.72 2013 10,336 7,023 1.47 The basic net earnings per share calculation excludes the unvested Common shares held by the LTIP Trust. 55 56 K-Bro Linen Inc. | 2014 Annual ReportDependable.b) Diluted Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares to assume conversion of all dilutive potential ordinary shares. 20 Net Change in Non-Cash Working Capital Items ($ Thousands of Canadian dollars) Basic weighted average shares for the year Dilutive effect of LTI shares Fully diluted weighted average shares for the year Net earnings Weighted average number of shares outstanding (thousands) Net earnings per share, diluted 18 Long-Term Incentive Plan 2014 7,090,937 20,295 7,111,232 12,198 7,111 1.72 2013 7,022,699 31,536 7,054,235 10,336 7,054 1.47 A trust was formed to hold equity grants issued under the terms of the LTI on behalf of the participants (the “LTIP Trust”). The Corporation is neither a trustee of the LTIP Trust nor a direct participant of the LTI; however, under certain circumstances the Corporation may be the beneficiary of forfeited Common shares held by the LTIP Trust. The Corporation has control over the LTIP Trust as it is exposed, or has rights, to variable returns and has the ability to affect those returns through its power over the LTIP Trust. Therefore the Corporation has consolidated the LTIP Trust. Compensation expense is recorded by the Corporation in the period earned. Dividends paid by the Corporation with respect to unvested Common shares held by the LTIP Trust are paid to LTI participants. Unvested Common shares held by the LTIP Trust are shown as a reduction of shareholders’ equity. ($ Thousands of Canadian dollars) Balance, beginning of year Issued during year Cancelled during year Vested during year Balance, end of year 2014 2013 Unvested Vested Unvested Vested 63,604 24,311 (9,384) (33,163) 45,368 268,351 9,965 - 33,163 311,479 48,191 26,978 - (11,565) 63,604 243,628 13,158 - 11,565 268,351 The cost of the 45,368 (2013 – 63,604) unvested Common shares held by the LTIP Trust at December 31, 2014 was nil (2013 - nil). 19 Dividends to Shareholders During the year ended December 31, 2014, the Corporation declared total dividends to Shareholders of $8,498 or $1.18 per share (2013 - $8,142 or $1.15 per share). The Corporation’s policy is to pay dividends to Shareholders of its available cash to the maximum extent possible consistent with good business practice considering requirements for capital expenditures, working capital, growth capital and other reserves considered advisable by the Directors of the Corporation. All such dividends are discretionary. Dividends are declared payable each month to the Shareholders on the last business day of each month and are paid by the 15th day of the following month. ($ Thousands of Canadian dollars) Accounts receivable Linen in service Prepaid expenses and deposits Accounts payable and accrued liabilities Income taxes payable Total 21 Financial Instruments a) Fair Value 2014 905 (1,147) (92) 1,522 152 1,340 2013 (1,268) 241 154 1,823 (2,324) (1,374) The Corporation’s financial instruments at December 31, 2014 consist of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, and dividends payable. The carrying value of accounts receivable, accounts payable and accrued liabilities, and dividends payable to Shareholders approximate fair value due to the immediate or short-term maturity of these financial instruments. The fair value of the Corporation’s interest-bearing debt approximates the respective carrying amount due to the floating rate nature of the debt. b) Financial risk management The Corporation’s activities are exposed to a variety of financial risks: price risk, credit risk and liquidity risk. The Corporation’s overall risk management program focuses on the unpredictability of financial and economic markets and seeks to minimize potential adverse effects on the Corporation’s financial performance. Risk management is carried out by financial management in conjunction with overall corporate governance. c) Price risk (i) Currency risk Foreign currency risk arises from the fluctuations in foreign exchange rates and the degree of volatility of these rates relative to the Canadian dollar. The Corporation is not significantly exposed to foreign currency risk as all revenues are received in Canadian dollars and minimal expenses are incurred in foreign currencies. For large capital expenditure commitments denominated in a foreign currency, the Corporation will enter into foreign exchange forward contracts if considered prudent to mitigate this risk. (ii) Interest rate risk The Corporation is subject to interest rate risk as its credit facility bears interest at rates that depend on certain financial ratios of the Corporation and vary in accordance with market interest rates. (iii) Other price risk The Corporation’s exposure to other price risk is limited since there are no significant financial instruments which fluctuate as a result of changes in market prices. 57 58 K-Bro Linen Inc. | 2014 Annual ReportDependable.d) Credit risk The Corporation’s financial assets that are exposed to credit risk consist of accounts receivable. The Corporation, in the normal course of business, is exposed to credit risk from its customers. The allowance for doubtful accounts and past due receivables are reviewed by management at each balance sheet reporting date. Any amounts greater than 60 days are considered overdue and all impaired amounts have been fully allowed for as at December 31, 2014. The Corporation updates its estimate of the allowance for doubtful accounts based on the evaluation of the recoverability of accounts receivable balances of each customer taking into account historic collection trends, the contractual relationship with the customer and the nature of the customer which in many cases is a publicly funded health care entity. Management believes that the risks associated with concentrations of credit risk with respect to accounts receivable are limited due to the nature of the customers and the generally short payment terms. The aging of the Corporation’s receivables and related allowance for doubtful accounts are: ($ Thousands of Canadian dollars) Gross Allowance Net December 31, 2013 Current 31-60 days Greater than 60 days Total December 31, 2013 Current 31-60 days Greater than 60 days Total 11,608 3,411 483 15,502 11,636 2,794 161 14,591 - - 37 37 - - 31 31 11,608 3,411 446 15,465 11,636 2,794 130 14,560 While the Corporation evaluates a customer’s credit worthiness before credit is extended, provisions for potential credit losses are also maintained. The change in allowance for doubtful accounts was as follows: ($ Thousands of Canadian dollars) Balance, beginning of year Adjustments made during the year Write-offs Balance, end of year 2014 37 15 (22) 30 2013 30 7 - 37 d) Liquidity risk The Corporation’s accounts payable and dividend payable are due within one year. The Corporation has a credit facility with a maturity date of July 31, 2016 (Note 10). The degree to which the Corporation is leveraged may reduce its ability to obtain additional financing for working capital and to finance investments to maintain and grow the current levels of cash flows from operations. The Corporation may be unable to extend the maturity date of the credit facility. Management, to reduce liquidity risk, has historically renewed the terms of the credit facility in advance of its maturity dates and the Corporation has maintained financial ratios that management believes are conservative compared to financial covenants applicable to the credit facility. A significant portion of the available facility remains undrawn. Management measures liquidity risk through comparisons of current financial ratios with financial covenants contained in the credit facility. 22 Capital Management The Corporation views its capital resources as the aggregate of its debt, shareholders’ equity and amounts available under its credit facility. In general, the overall capital of the Corporation is evaluated and determined in the context of its financial objectives and its strategic plan. The Corporation’s objective in managing capital is to ensure sufficient liquidity to pursue its growth and expansion strategy, while taking a conservative approach towards financial leverage and management of financial risk. The Corporation’s capital is composed of shareholders’ equity and long-term debt. The Corporation’s primary uses of capital are to finance its growth strategies and capital expenditure programs. The Corporation currently funds these requirements from internally-generated cash flows and interest bearing debt. The Corporation pays a dividend which reduces its ability to internally finance growth and expansion. However the availability of the Corporation’s revolving line of credit provides sufficient access to capital to allow K-Bro to take advantage of acquisition opportunities. The merits of the dividend are periodically evaluated by the Board. The primary measures used by the Corporation to monitor its financial leverage are the ratios of Funded Debt to EBITDA (earnings before income taxes, depreciation and amortization) and Fixed Charge Coverage. EBITDA is an additional GAAP measure as prescribed by IFRS and has been presented in the manner in which the chief operating decision maker assesses performance. The Corporation manages a Funded Debt to EBITDA ratio calculated as follows: ($ Thousands of Canadian dollars) Long-term debt, including current portion Issued and outstanding letters of credit Funded debt Net earnings for the trailing twelve months Add: Income tax expense Financial charges Depreciation of property, plant and equipment Amortization of intangible assets Loss on disposal of property, plant and equipment EBITDA Funded debt to EBITDA 2014 - 1,650 1,650 12,198 4,465 593 6,817 2,121 47 26,241 0.06x 2013 19,640 650 20,290 10,336 4,173 595 5,965 2,140 108 23,317 0.87x 59 60 K-Bro Linen Inc. | 2014 Annual ReportDependable.The Corporation manages a Fixed Charge Coverage calculated on a trailing twelve-month basis as follows: ($ Thousands of Canadian dollars) EBITDA Financial charges Dividends to shareholders Total Fixed charged coverage 2014 26,241 593 8,498 9,091 2.9x 2013 23,317 595 8,142 8,737 2.7x 23 Related Party Transactions The Corporation transacts with key individuals from management and with the Board who have authority and responsibility to plan, direct and control the activities of the Corporation. The nature of these dealings were in the form of payments for services rendered in their capacity as Directors (retainers and meeting fees, including share-based payments) and as employees of the Corporation (salaries, benefits, short-term bonuses and share-based payments). Key management personnel are defined as the executive officers of the Corporation including the President and Chief Executive Officer, Senior Vice-President and General Manager, Vice-President and Chief Financial Officer and three employees acting in the capacity of Vice-President and General Manager. During 2014 and 2013, remuneration to directors and key management personnel was as follows: ($ Thousands of Canadian dollars) Salaries and retainer fees Short-term bonus incentives Post-employment benefits Share-based payments Total 2014 1,790 902 57 1,067 3,816 2013 1,708 757 51 1,139 3,655 The Corporation incurred expenses in the normal course of business for advisory consulting services provided by a Director. The amounts charged are included as salaries and retainer fees. For the year ended December 31, 2014, the Corporation incurred such fees totaling $138 (2013 – $138). 24 Expenses by Nature ($ Thousands of Canadian dollars) Wages and benefits Linen Utilities Delivery Materials and supplies Occupancy costs Repairs and maintenance Other expenses Total 25 Segmented information 2014 65,414 14,438 8,898 6,246 5,775 5,002 4,232 194 110,199 2013 64,760 13,781 8,400 5,979 5,553 4,819 4,398 195 107,885 The Chief Executive Officer is the corporation’s chief operating decision-maker. Management has determined the operating segments based on information reviewed by the Chief Executive Officer for the purposes of allocating resources and assessing performance. The Corporation provides laundry and linen services to the healthcare and hospitality sectors through nine operating divisions located in Vancouver, Victoria, Calgary, Edmonton, Saskatchewan, Toronto, Montréal, and Québec City. The services offered and the economic characteristics associated with these divisions are similar, therefore they have been aggregated into one reportable segment which operates exclusively in Canada. In Edmonton, the Corporation is the significant supplier of laundry and linen services to the entity which manages all major healthcare facilities in the region. This contract expires on March 31, 2023. In Calgary, the major customer is contractually committed to February 28, 2018 and in Vancouver the major customer is contractually committed to November 12, 2015. For the year ended December 31, 2014, the Corporation has recorded revenue of $61,489 (2013 – $58,652) from these three major customers, representing 45% (2013 – 45%) of total revenue. ($ Thousands of Canadian dollars) Healthcare Hospitality Total 2014 92,887 43,553 68.1% 31.9% 136,440 100.0% 2013 88,893 42,309 131,202 67.8% 32.2% 100% 26 Subsequent Events The Corporation’s Board of Directors declared an eligible dividend of $0.10 per Common share of the Corporation payable on each of February 13, March 13 and April 15, 2015 to Shareholders of record on January 31, February 28, and March 31, 2015 respectively. 61 62 K-Bro Linen Inc. | 2014 Annual ReportDependable.Corporate Information Board of Directors Corporate Office Vancouver 2 Toronto Dependable. Ross Smith, FCA (Chair) Corporate Director Matthew Hills, MBA Managing Director LLM Capital Partners LLC Steven Matyas, BSc President Staples Canada Inc. Linda McCurdy, MBA President & CEO K-Bro Linen Systems Inc. Executive Officers Linda McCurdy, MBA President & CEO Sean Curtis Senior Vice-President & General Manager (Edmonton) Kristie Plaquin Interim Chief Financial Officer 14903 - 137 Avenue Edmonton, AB T5V 1R9 Phone 780.453.5218 Fax 780.455.6676 4590 Canada Way Burnaby, BC V5G 1J6 Phone 604.681.3291 Fax 604.685.1458 15 Shorncliffe Road Etobicoke, ON M9B 3S4 Phone 416.233.5555 Fax 416.233.4434 Ken Chu General Manager John Truong Operations Manager Jerry Ostrzyzek General Manager Michael Beach Operations Manager Calgary Québec inquiries@k-brolinen.com www.k-brolinen.com Victoria 861 Van Isle Way Victoria, BC V9B 5R8 Phone 250.474.5699 Fax 250.474.5680 Kevin Stephenson General Manager Andrew Mackeen Plant Manager 6969 – 55 Street SE Calgary, AB T2C 4Y9 Phone 403.724.9001 Fax 403.720.2959 Jeff Gannon General Manager Vancouver 1 Edmonton 8035 Enterprise Street Burnaby, BC V5A 1V5 Phone 604.420.2203 Fax 604.420.2313 15223 – 121 A Avenue Edmonton, AB T5V 1N1 Phone 780.451.3131 Fax 780.452.2838 Ron Graham General Manager Kevin McElgunn Operations Manager Sean Curtis Senior Vice-President & General Manager Trevor Rye Operations Manager 367 Boulevard Des Chutes Québec City, QC G1E 3G1 Phone 418.661.6163 Fax 418.661.4000 Jessica Lévesque Directeur Général Fabien Poirier Directeur Opérations Montréal 599, rue Simonds Sud Granby, QC J2J 1C1 Phone 450.378.3187 Fax 450.378.8245 Sylvain Tremblay Directeur Général Transfer Agent & Registrar CST Trust Company Calgary, Alberta Auditors Legal Counsel Principal Bank Stock Exchange Listing PricewaterhouseCoopers LLP Edmonton, Alberta Stikeman Elliott Toronto, Ontario McLennan Ross LLP Edmonton, Alberta TD Bank Edmonton, Alberta TSX: KBL Notice of Annual Meeting The annual meeting of Shareholders will be held at the Sheraton Centre Hotel, Kent Room, 123 Queen Street West, Toronto, Ontario, Canada on June 16, 2015 at 1:00pm EDT 

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