The Westaim Corporation
Annual Report 2012

Plain-text annual report

THE WESTAIM CORPORATION ANNUAL REPORT 2012 THE WESTAIM CORPORATION ANNUAL REPORT 2012 Contents Letter to Shareholders Management’s Discussion and Analysis Management’s Responsibility for Financial Information Independent Auditor’s Report Consolidated Financial Statements Notes to Consolidated Financial Statements Board of Directors Shareholder and Corporate Information All figures are in Canadian dollars, unless otherwise stated. 1 2 16 17 18 22 38 38 LETTER TO SHAREHOLDERS Dear Shareholders: The Board of Directors and the management team of The Westaim Corporation are pleased to have successfully completed the sale of Jevco Insurance Company in September 2012 for a gain of $107 million. Jevco’s operations in 2012 prior to the sale contributed an additional $30 million to the profitability of the Company. As a result, Westaim’s book value per share increased by 23% during the first nine months of the year, from $0.65 per share at December 31, 2011 to $0.80 per share at September 28, 2012. On September 28, 2012, Westaim made a return of capital to its shareholders in the form of a cash distribution of $0.75 per share. At December 31, 2012, book value per share was $0.05. Between the acquisition of Jevco in March 2010 and the sale of Jevco in September 2012, Westaim’s book value per share appreciated by approximately 60%. Your Westaim board and management team continue to look for opportunities to maximize value for our shareholders. On behalf of the Board of Directors, I want to thank all of the Westaim employees and stakeholders for their hard work and support over the past year and look forward to a successful 2013. Sincerely, J. Cameron MacDonald, President and Chief Executive Officer - 1 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 TABLE OF CONTENTS 1. THE COMPANY 2. OVERVIEW OF PERFORMANCE 3. 4. 5. SALE OF JEVCO ANALYSIS OF FINANCIAL RESULTS ANALYSIS OF FINANCIAL POSITION 6. OUTLOOK 7. LIQUIDITY AND CAPITAL RESOURCES 8. RISKS 9. RELATED PARTY TRANSACTIONS 10. DISCLOSURE CONTROLS AND INTERNAL CONTROLS OVER FINANCIAL REPORTING 11. ACCOUNTING ESTIMATES 12. ACCOUNTING POLICIES AND RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS 13. FUTURE ACCOUNTING PRONOUNCEMENTS 14. QUARTERLY FINANCIAL INFORMATION 15. CAUTIONARY NOTE REGARDING FUTURE ORIENTED FINANCIAL INFORMATION “Westaim” or the “Company” in this Management’s Discussion and Analysis (“MD&A”) refers to The Westaim Corporation on a consolidated basis. This MD&A, which has been approved by the Westaim Board of Directors, should be read in conjunction with Westaim’s audited annual consolidated financial statements including notes for the year ended December 31, 2012 and 2011 as set out on pages 18 to 37 of this annual report. Financial data in this MD&A has been derived from the audited annual consolidated financial statements for the year ended December 31, 2012 and 2011 and is intended to enable the reader to assess Westaim’s results of operations for the three months and year ended December 31, 2012 and financial condition as at December 31, 2012. The Company reports its consolidated financial statements using accounting policies consistent with International Financial Reporting Standards (“IFRS”). All amounts are in Canadian dollars unless otherwise indicated. The following commentary is current as of February 28, 2013. Additional information relating to Westaim is available on SEDAR at www.sedar.com. Certain totals, subtotals and percentages may not reconcile due to rounding. Non-GAAP measures Westaim uses both IFRS and non-generally accepted accounting principles (“non-GAAP”) measures to assess performance. The Company cautions readers about non-GAAP measures that do not have a standardized meaning under IFRS and are unlikely to be comparable to similar measures used by other companies. Book value per share represents shareholders’ equity at the end of the period, determined on an IFRS basis, divided by the total number of common shares plus preferred shares outstanding on the same date. Future Oriented Financial Information This MD&A may contain forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ materially from these forward-looking statements as a result of various factors, including those discussed hereinafter or in the Company’s 2012 Annual Information Form. Please refer to the cautionary note in Section 15 of this MD&A. - 2 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 1. THE COMPANY Westaim is a publicly traded Canadian-based holding company that invests directly and indirectly through acquisitions, joint ventures and other arrangements, with the objective of providing its shareholders with capital appreciation and real wealth preservation. Westaim’s strategy is to pursue investment opportunities to grow shareholder value (as measured by book value per share) over the long term. Until September 4, 2012, the Company held all the issued and outstanding shares of Jevco Insurance Company (“Jevco”). Jevco is a leading Canadian property and casualty (“P&C”) insurer that sells P&C products through a distribution network of over 2,000 independent brokers. Section 3, Sale of Jevco of this MD&A provides details of the disposition of Jevco on September 4, 2012. 2. OVERVIEW OF PERFORMANCE Highlights (millions except per share data) Three months ended December 31 2012 2011 Year ended December 31 2011 2012 Continuing operations Revenue Corporate costs excluding share-based compensation Share-based compensation Loss from continuing operations $ $ 0.1 (0.9) (0.2) (1.0) Discontinued operations Post-tax gain on sale of Jevco Post-tax profit of discontinued operations Profit from discontinued operations - - - $ 0.1 (1.3) (3.0) (4.2) - 15.8 15.8 $ 0.3 (13.2) (20.5) (33.4) 106.7 29.7 136.4 Profit or loss $ (1.0) $ 11.6 $ 103.0 $ 2.9 (4.9) (7.5) (9.5) - 49.3 49.3 39.8 Earnings per share – basic and diluted - Loss from continuing operations - Profit from discontinued operations - Profit or loss $ $ $ 0.00 0.00 0.00 $ $ $ (0.01) 0.02 0.02 Book value per share - at December 31 - return of capital to shareholders on September 28, 2012 Consolidated Results – Three months ended December 31, 2012 $ $ $ $ $ (0.05) 0.20 0.15 $ $ $ (0.01) 0.07 0.06 0.05 $ 0.65 0.75 For the three months ended December 31, 2012, the Company reported a consolidated loss of $1.0 million which comprised a loss from continuing operations of $1.0 million, compared to a consolidated profit for the three months ended December 31, 2011 of $11.6 million which comprised a loss from continuing operations of $4.2 million and a profit of discontinued operations of $15.8 million. Consolidated Results – Year ended December 31, 2012 For the year ended December 31, 2012, the Company reported a consolidated profit of $103.0 million which comprised a loss from continuing operations of $33.4 million, a post-tax gain on the sale of Jevco of $106.7 million and a profit of discontinued operations of $29.7 million, compared to a consolidated profit for the year ended December 31, 2011 of $39.8 million which comprised a loss from continuing operations of $9.5 million and a profit of discontinued operations of $49.3 million. - 3 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 3. SALE OF JEVCO On May 2, 2012 the Company announced that it had entered into a definitive agreement (the "Agreement") with Intact Financial Corporation ("Intact") pursuant to which, subject to the terms and conditions of the Agreement, Intact agreed to purchase from the Company all of the issued and outstanding shares in the capital of Jevco for $530.0 million in cash (the "Transaction"). Shareholder approval for the Transaction was received at a special shareholder meeting on June 28, 2012. All regulatory approvals were received and other conditions of the Agreement were met during the third quarter and the Transaction closed on September 4, 2012. The Transaction was reflected in Westaim’s statements of financial position, profit or loss and other comprehensive income, equity and cash flow for the year ended December 31, 2012. For the year ended December 31, 2012, a pre-tax gain of $108.2 million was realized on the sale of Jevco, after deducting the carrying value of Jevco of $414.3 million and costs related to the sale of $7.5 million. The post-tax gain on the sale was $106.7 million. In connection with the Transaction and as approved by the shareholders at a special meeting on June 28, 2012, Westaim completed a cash distribution by way of a return of capital to its common shareholders (the “Cash Distribution”). The Cash Distribution was made on September 28, 2012 to common shareholders of record on September 21, 2012 at $0.75 per common share. The amount was determined by the Board of Directors based on the present and contingent liabilities of Westaim, as well as its future business objectives. The total amount of the Cash Distribution of $521.4 million was recorded as a reduction of stated common share capital. 4. ANALYSIS OF FINANCIAL RESULTS The Company’s operating results include the results from continuing operations, the gain on sale of Jevco and the profit of discontinued insurance operations. 4.1 Continuing Operations Details of continuing operations are as follows: Continuing operations (millions) Revenue Three months ended December 31 2012 2011 Year ended December 31 2011 2012 $ 0.1 $ 0.1 $ 0.3 $ 2.9 Expenses Salaries and benefits Management services Office expenses Professional fees Site restoration provision (recovery) Corporate costs Share-based compensation Total expenses 0.2 - 0.2 0.3 0.2 0.9 0.2 1.1 - 0.6 0.4 0.3 - 1.3 3.0 4.3 0.6 8.4 0.6 3.3 0.3 13.2 20.5 33.7 0.1 3.3 0.9 0.7 (0.1) 4.9 7.5 12.4 Loss from continuing operations $ (1.0) $ (4.2) $ (33.4) $ (9.5) Revenue of Continuing Operations Revenue of continuing operations for the three months and year ended December 31, 2012 was $0.1 and $0.3 million (2011 - $0.1 million and $2.9 million). In the year ended December 31, 2012, interest income of $0.7 million was offset by an investment write-down of $0.4 million. In the year ended December 31, 2011, the Company realized a gain on sale of an investment of $0.5 million, interest income of $0.1 million and an additional gain of $2.3 million in connection with its acquisition of Jevco in 2010. In 2010, the Company paid an amount of $20.0 million to be held in escrow in respect of the claims reserve for Jevco’s insurance business existing at the time of closing. In the event that the related claims reserve development from December 31, 2009 until December 31, 2012 was adverse to Jevco, the purchase price would have been reduced, to a maximum amount of $20.0 million. In March 2011, this escrow amount was released upon agreement between the parties in exchange for a payment of $2.3 million to the Company. - 4 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 4. ANALYSIS OF FINANCIAL RESULTS (continued) Corporate Costs Corporate costs, excluding share-based compensation, for the three months and year ended December 31, 2012 were $0.9 million and $13.2 million (2011 - $1.3 million and $4.9 million). Corporate costs include fees for management services provided by Goodwood Management Inc. (“GMI”), as discussed in Section 9, Related Party Transactions of this MD&A. Corporate costs for the year ended December 31, 2012 included an accounting charge of $5.0 million arising from the extinguishment of the management services contract upon the windup of GMI following the acquisition of GMI by the Company. Corporate costs were $8.3 million higher in the year ended December 31, 2012 compared to the year ended December 31, 2011 mainly due to this $5.0 million charge and $2.6 million in professional fees and other costs incurred to investigate an investment opportunity which Westaim ultimately decided not to pursue. Share-based Compensation Share-based compensation expense for the three months and year ended December 31, 2012 was $0.2 million and $20.5 million (2011 - $3.0 million and $7.5 million). Share-based compensation expense relates to the revaluation of the Company’s outstanding restricted share units (“RSUs”) granted to GMI and outstanding deferred share units (“DSUs”) granted to directors and officers of the Company. Share-based compensation costs were $13.0 million higher in the year ended December 31, 2012 when compared to the year ended December 31, 2011 mainly due to the recognition of an expense of $9.1 million to reflect the value of RSUs which were extinguished as a result of the windup of GMI on September 4, 2012 and from the increase in the Company’s share price. 4.2 Gain on Sale of Discontinued Operations On September 4, 2012, the Company sold its investment in Jevco. Included in the Company’s profit for the year ended December 31, 2012 is the Company’s gain on sale of Jevco. Details of the gain are as follows: Discontinued operations (millions) Proceeds on sale Carrying value of Jevco Transaction costs Pre-tax gain on sale Income tax expense Post-tax gain on sale Year ended December 31, 2012 $ $ 530.0 (414.3) (7.5) 108.2 (1.5) 106.7 The post-tax gain on sale of Jevco is $106.7 million for the year ended December 31, 2012. Cash proceeds of $530.0 million were received on September 4, 2012. The carrying value of Jevco on the date of sale was $414.3 million. Transaction costs of $7.5 million include financial, legal and consulting fees. The Company utilized capital loss carryforwards and non-capital loss carryforwards to offset the taxable income arising from the sale of Jevco. The benefit of these tax loss carryforwards had not previously been recognized in the statement of financial position. Corporate minimum tax of $1.5 million, computed based on income determined under IFRS, has been accrued as a result of the sale. 4.3 Profit of Discontinued Operations The results of Jevco’s operations prior to the sale of Jevco on September 4, 2012 are included in profit of discontinued operations. The profit of discontinued operations is summarized as follows: Discontinued operations (millions) Revenue Expenses Pre-tax profit of discontinued operations Income tax expense Post-tax profit of discontinued operations Three months ended December 31 2012 - - - - - $ $ 2011 86.3 69.1 17.2 1.4 15.8 $ $ $ $ - 5 - $ Year ended December 31 2011 2012 375.5 275.7 312.3 236.9 63.2 38.8 13.9 9.1 49.3 29.7 $ The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 4. ANALYSIS OF FINANCIAL RESULTS (continued) Results for the year ended December 31, 2012 included Jevco’s results to the date of sale on September 4, 2012. Revenue of discontinued operations includes unrealized gains and losses on available-for-sale investments as unrealized gains and losses of a subsidiary are considered realized and included in profit or loss upon the sale of a subsidiary. Income tax expense includes income tax previously deducted to determine profit or loss and income tax on unrealized gains previously included in other comprehensive income. 5. ANALYSIS OF FINANCIAL POSITION The Company’s assets, liabilities and shareholders’ equity comprised the following: (millions) Assets of continuing operations Cash and cash equivalents Other assets Total assets of continuing operations Assets of insurance segment Total assets Liabilities of continuing operations Liabilities of insurance segment Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity 5.1 Cash and Cash Equivalents December 31, 2012 December 31, 2011 $ $ $ $ 39.2 0.2 39.4 - 39.4 4.8 - 4.8 34.6 39.4 $ $ $ $ 14.7 1.9 16.6 1,279.5 1,296.1 14.9 863.9 878.8 417.3 1,296.1 At December 31, 2012, the Company had cash and cash equivalents related to continuing operations of $39.2 million compared to $14.7 million at December 31, 2011. See further discussion in Section 7, Liquidity and Capital Resources of this MD&A. 5.2 Assets of Insurance Segment At December 31, 2011, the Company held $1,279.5 million in assets of the discontinued insurance operations which were sold in 2012. These assets included cash of $9.7 million, investments plus investment income due and accrued of $1,023.6 million, insurance policy related assets of $183.4 million, accounts receivable of $26.0 million, income tax assets of $10.2 million, property and equipment of $22.8 million, and intangible assets of $3.8 million. 5.3 Liabilities of Continuing Operations Liabilities of continuing operations were $4.8 million at December 31, 2012 compared to $14.9 million at December 31, 2011. The decrease of $10.1 million is due to a $10.8 million decrease in share-based compensation liabilities partially offset by additional accruals for other expenses. Included in liabilities of continuing operations at December 31, 2012 is $2.7 million (December 31, 2011 - $2.4 million) related to the provision for site restoration. The provision for site restoration relates to costs associated with soil and groundwater reclamation and remediation costs. The Company conducts periodic reviews of the underlying assumptions supporting the provision, including remediation costs and regulatory requirements. Reimbursements of costs resulting from indemnifications provided by previous owners of the industrial sites have not been recognized in these consolidated financial statements. Future reimbursements will be recorded when received. - 6 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 5. ANALYSIS OF FINANCIAL POSITION (continued) 5.4 Liabilities of Insurance Segment Liabilities of operations sold in 2012 of $863.9 million at December 31, 2011 relate to the discontinued insurance operations and comprised liabilities related to insurance policies of $839.6 million, leasehold inducement of $2.6 million and payables and accruals of $21.7 million. 5.5 Shareholders’ Equity The details of shareholders’ equity are as follows: (millions) Common shares Preferred shares Warrants Contributed surplus Deficit Shareholders’ equity December 31, 2012 $ $ 203.6 - - 12.9 (181.9) 34.6 December 31, 2011 $ 656.6 30.8 1.9 12.9 (284.9) 417.3 $ The decrease in common shares from December 31, 2011 to December 31, 2012 of $453.0 million is due to the return of capital to the common shareholders of $521.4 million, offset by $30.8 million from the conversion of preferred shares outstanding at December 31, 2011 into common shares, $6.9 million from the exercise of all outstanding warrants, $27.4 million for shares issued upon the acquisition of GMI and $3.3 million of proceeds on the issuance of common shares in connection with elections exercised under share-based compensation plans. The changes in share capital are further discussed under Share Capital and Share-based Compensation Plans in Section 7, Liquidity and Capital Resources of this MD&A. The decrease in deficit of $103.0 million from December 31, 2011 to December 31, 2012 is due to the profit for the year ended December 31, 2012. 6. OUTLOOK Westaim completed a positive 2012 year, allowing the Company’s book value per share to appreciate by 23% from $0.65 at December 31, 2011 to $0.80 immediately prior to the cash distribution of $0.75 per share to shareholders on September 28, 2012. At December 31, 2012 the book value per share was $0.05 and the Company’s shareholders’ equity was $34.6 million. Westaim’s management is continuing to pursue the Company’s business strategy, by searching for and investigating potential investment opportunities to grow shareholder value (as measured by book value per share) over the long term. 7. LIQUIDITY AND CAPITAL RESOURCES Capital Management Objectives The Company’s guiding principles for capital management are to maintain the stability and safety of the Company for its stakeholders through optimal capital mix and an adequate level of capital, maintain a strong balance sheet, ensure the return on capital meets the Board of Directors’ expectations relative to the risk taken, and minimize the after-tax cost of capital. Towards achieving these objectives, the Company employs a strong and efficient capital base and manages capital in accordance with policies established by the Board of Directors. These policies relate to capital strength and capital mix. The Company has a capital management process in place to measure, deploy and monitor its available capital to assess its adequacy on a continuous basis. Management develops the capital strategy and oversees the capital management processes of the Company. The Company’s capital consists of its shareholders’ equity. - 7 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 7. LIQUIDITY AND CAPITAL RESOURCES (continued) Share Capital The Company’s authorized share capital consists of an unlimited number of common shares, Class A preferred shares and Class B preferred shares. At December 31, 2012 and February 28, 2013, the Company had 695,209,711 common shares and 372,800 stock options outstanding. At those dates, there were no Class A or Class B preferred shares outstanding. On September 4, 2012, 36,514,902 common shares were issued as partial consideration for the acquisition of GMI. In the year ended December 31, 2012, 27,200 common shares were issued upon the exercise of 27,200 stock options. DSUs vested upon the sale of Jevco, and certain directors of Westaim and Jevco and certain officers of Jevco elected to exercise their right to apply the cash compensation received to purchase common shares of Westaim. The Company issued 4,470,737 common shares as a result of these elected subscriptions. 10,000,000 warrants were exercised for 10,000,000 Series 1 Class A preferred shares and the resulting preferred shares totaling 73,852,912 were converted into common shares on a one for one basis. The Series 1 Class A preferred shares are entitled to dividends as the directors may declare, provided that an equal dividend is declared on the common shares, and rank equally with the common shares with respect to liquidation proceeds. The Series 1 Class A non-voting preferred shares are convertible into common shares, on a one to one basis, subject to any adjustments resulting from subdivision or consolidation of the common shares. As of September 11, 2012, Westaim had 63,852,912 non-voting Series 1 Class A preferred shares issued and outstanding (“Non-Voting Shares”) registered in the name of 1523488 Alberta Ltd., a holding company with an investment portfolio managed by Alberta Investment Management Corporation. 1523488 Alberta Ltd. was also, as of September 11, 2012, the registered and beneficial owner of 232,147,088 common shares of the Company, being 37.4% of the outstanding common shares, and of warrants to acquire an additional 10,000,000 Non-Voting Shares. Any holder of Non-Voting Shares may convert any or all Non-Voting Shares held by such holder into common shares based on the then applicable exercise number (which at the date hereof is one common share for each Non-Voting Share). The terms of the Series 1 Class A preferred shares initially prohibited conversion of such shares if such conversion would result in the holder, together with such holder’s “associates” and “affiliates” (as such terms are defined in the Securities Act (Alberta)), and any person or company acting jointly or in concert with such parties: (i) being the registered holder of; (ii) being the beneficial owner of; and/or (iii) exercising control or direction over, greater than 40% of the issued and outstanding common shares. On September 11, 2012, in order to enable 1523488 Alberta Ltd. to participate in the Cash Distribution in respect of its Non-Voting Shares on the same basis as the common shareholders, Westaim effected an amendment to the terms of the Non-Voting Shares to remove the conversion restrictions, as approved by the common shareholders at the special meeting on June 28, 2012. This allowed 1523488 Alberta Ltd. to convert the Non-Voting Shares held by it (including the Non-Voting Shares acquired pursuant to the exercise of the Warrants) into common shares prior to the Cash Distribution. Cash Distribution and Stated Share Capital Reduction In connection with the Transaction and as approved by the shareholders at the special meeting on June 28, 2012, Westaim completed the Cash Distribution to its common shareholders in the form of a return of capital. The Cash Distribution was made on September 28, 2012 to common shareholders of record on September 21, 2012 at $0.75 per common share. The amount was determined by the Board of Directors based on the present and contingent liabilities of Westaim, as well as its future business objectives. The total amount of the Cash Distribution of $521.4 million was recorded as a reduction of stated common share capital. Dividends No dividends were paid in the years ended December 31, 2012 and 2011. Share-based Compensation Plans On April 12, 2010, the Board of Directors of the Company approved the adoption of a comprehensive long-term equity incentive plan (the “Incentive Plan”), ratified at the Company’s annual general meeting of shareholders held on May 12, 2010, designed to combine the Company’s prior equity incentive plans, being the Employee and Director Stock Option Plan, the Directors and Officers Share Purchase Program, the Restricted Share Unit Plan, and the Deferred Share Unit Plan, collectively, the “Prior Plans”. All awards granted under the Prior Plans remain in full force and effect in accordance with their terms, however, no additional grants will be made under the Prior Plans. See Note 11 to the audited consolidated financial statements for the year ended December 31, 2012. - 8 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 7. LIQUIDITY AND CAPITAL RESOURCES (continued) On September 4, 2012, the Company purchased all the issued and outstanding shares of GMI for $4.2 million cash and 36,514,902 common shares of the Company. GMI was the holder of all of the outstanding RSUs and Westaim had accrued a liability in respect of the RSUs. The share consideration paid for GMI reflected the fair value of the RSUs held by GMI at the time of the acquisition. Immediately following Westaim’s acquisition of GMI, GMI was wound up into Westaim and an additional expense of $9.1 million was recognized to reflect the additional value of the RSUs which were extinguished as a result of the windup of GMI. DSUs are granted at the market value of the Company’s shares at the date of grant to non-executive directors of the Company in lieu of fees, and prior to the sale of Jevco, to non-executive directors, officers and employees of Jevco. Vested DSUs are paid out in cash when the participant ceases to be a director, officer or employee. All DSUs vested and were exercised upon the sale of Jevco. As determined by Westaim’s Board of Directors, in connection with the completion of the sale of Jevco, each holder of DSUs was entitled to receive a cash payment in consideration for relinquishing their rights in respect of each such DSU equal to the “market price” of the common shares (as determined in accordance with the terms of the Incentive Plan) immediately prior to the completion of the sale (being $0.75) less any required withholdings, and could elect to apply all or a part of such cash payment to a subscription for common shares at the same price per share. An aggregate of 4,470,737 common shares were issued to former DSU holders in connection with the entitlements. In July 2012, 27,200 stock options were exercised at $0.22 per share. At December 31, 2012 and February 28, 2013, the Company had 372,800 stock options outstanding. Volatility of Share Price The price of the common shares may be volatile even though there have been no material changes in the Company’s business or finances. In the past, securities class action litigation has often been brought against companies that experience volatility in the market price of their securities. Whether or not meritorious, litigation brought against the Company could result in substantial costs, divert management's attention and resources and harm the Company's financial condition and results of operations. Market for Securities On January 9, 2013, Westaim’s common shares commenced trading on the TSX Venture Exchange (“TSX-V”) under the symbol “WED”. Until January 8, 2013, the common shares of Westaim were listed on the Toronto Stock Exchange (the “TSX”) under the symbol “WED”. The Westaim Board of Directors has determined that a listing with the TSX-V better suits the needs of the Company while providing continued trading liquidity for the Company’s shareholders. The Company received approval of its listing on the TSX-V prior to voluntarily de-listing from the TSX. Normal Course Issuer Bid On August 24, 2011, Westaim announced that the TSX had approved a notice of the Company’s intention to make a normal course issuer bid. In the third and fourth quarters of 2011, pursuant to the terms of the bid, Westaim purchased 6,455,000 of its own common shares for cancellation through the facilities of the TSX at the prevailing market price of the common shares. Cash Flow Objectives The Company manages its liquidity to ensure that there is sufficient cash to meet all financial commitments and obligations as they fall due. The Company believes its liquidity requirements for the next year will be met with the cash and cash equivalents on hand. Although the Company currently does not have any operating assets that generate revenue, the Company has sufficient funds to meet its financial obligations and pursue other opportunities. As part of pursuing one or more new opportunities, the Company may from time to time issue shares from treasury. - 9 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 7. LIQUIDITY AND CAPITAL RESOURCES (continued) The following tables illustrate the duration of the financial assets of the Company compared to its financial obligations: December 31, 2012 (millions) Financial assets: Cash and cash equivalents Other assets Total financial assets Financial obligations: Accounts payable and accrued liabilities Income taxes, due and accrued Site restoration provision Total financial obligations One year or less 1 to 3 years 4 to 5 Years More than 5 years No specific date $ $ 39.2 0.2 39.4 0.6 1.5 - 2.1 - - - - - - - - $ $ - - - - - - - - $ $ - - - - - - - - $ Total 39.2 0.2 39.4 0.6 1.5 2.7 4.8 $ - - - - - 2.7 2.7 Financial assets net of financial obligations $ 37.3 $ $ (2.7) $ 34.6 December 31, 2011 (millions) Financial assets: Cash and cash equivalents Investment income due and accrued Investments available-for-sale Investments held-to-maturity Instalment premiums Accounts receivable and other assets Recoverable from reinsurers Claims recoverable from other insurers Total financial assets Financial obligations: Accounts payable and accrued liabilities Income taxes, due and accrued Unearned premiums Unpaid claims and adjustment expenses Lease commitments Site restoration provision Total financial obligations One year or less 1 to 3 years 4 to 5 years More than 5 years No specific date $ 24.3 5.6 183.6 - 62.8 27.4 11.7 17.6 333.0 25.5 0.8 164.4 231.7 3.0 - 425.4 $ - - 343.6 - - - 12.9 19.4 375.9 5.3 - - 257.5 5.5 - $ $ - - 189.3 - - - 6.0 8.9 204.2 - - - 117.8 5.4 - 268.3 123.2 - - 87.6 97.5 - - 3.4 5.1 193.6 - - - 68.1 24.9 - 93.0 $ - - 116.5 - - 0.5 - - 117.0 2.7 - - - - 2.4 5.1 $ Total 24.3 5.6 920.6 97.5 62.8 27.9 34.0 51.0 1,223.7 33.5 0.8 164.4 675.1 38.8 2.4 915.0 Financial assets net of financial obligations $ (92.4) $ 107.6 $ 81.0 $ 100.6 $ 111.9 $ 308.7 The Company’s investment guidelines stress preservation of capital and market liquidity to support payment of liabilities. The matching of the duration of financial assets and liabilities is monitored to ensure that all obligations will be met. Indemnification In connection with the sale of the operations and assets of a subsidiary, the subsidiary provided an indemnity to the purchaser against certain losses to an aggregate maximum of US$11 million. The Company also agreed to indemnify the directors, officers and employees of the purchaser, for an indefinite period, from certain potential environmental costs relating to premises formerly leased by the subsidiary. - 10 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 8. RISKS Westaim is subject to a number of risks, including the risks described below. The risks and uncertainties described below are those believed to be material, but they may not be the only ones faced by Westaim. If any of these risks, or any other risks and uncertainties that have not yet been identified by Westaim or that Westaim currently considers not to be material, actually occur or become material risks, the business, prospects, financial condition, results of operations and cash flows of Westaim could be materially and adversely affected. The Company has no current business activities from which it earns revenues Following the completion of the sale of Jevco, the Company has no operations which generate revenues and its main assets are cash and cash equivalents. Accordingly, the Company does not anticipate that it will generate any significant earnings until such time as it deploys its cash and cash equivalents through one or more acquisitions, mergers, or other transactions. There is no guarantee that the Company will make such an investment or that any investment made will be profitable and will provide dividends to shareholders. Westaim has no current intention of paying dividends in the near future. There is no assurance that the Company will be able to obtain adequate financing needed for its future business or projects or if the terms of such financing will be favourable. Failure to obtain such additional financing could result in a delay in the future development of the Company. The Company is relying solely on the past business success of its directors and officers to identify acquisitions. The success of the Company is dependent upon the efforts and abilities of its management team. The loss of certain members of the management team could have an adverse effect on the business and prospects of the Company. In such event, the Company will seek satisfactory replacements but there can be no guarantee that appropriate personnel can be found. A single shareholder may be able to exert significant influence over Westaim’s affairs Her Majesty the Queen in Right of the Province of Alberta (“HMQ”), acting for and on behalf of certain Alberta public sector pension plans, endowments and government funds, holds a significant number of common shares of the Company. Accordingly, HMQ has significant influence over the business and affairs of Westaim and has the ability to take shareholder actions irrespective of the vote of any other shareholders, including the ability to prevent certain transactions that it does not believe are in its best interest. This significant influence may discourage transactions involving a change of control of Westaim, including transactions in which minority shareholders of Westaim might otherwise receive a premium for their shares over the then-current market price. Furthermore, HMQ generally has the right (subject to applicable securities laws) at any time to sell the shares of Westaim held by it or to sell its interest in Westaim to a third party without the approval of the minority shareholders and without providing for a purchase of such shareholders’ shares. Accordingly, shares of Westaim held by minority shareholders may be less liquid and worth less than they would be if HMQ did not have the ability to influence matters affecting Westaim. Risks inherent in acquisitions The Company intends to actively pursue the acquisition of companies or businesses in Canada and/or internationally and may seek to acquire securities or other interests in other companies consistent with its investment and growth strategy. Such acquisitions involve inherent risks including but not limited to (a) unanticipated costs; (b) potential loss of key employees of the Company or the business acquired; (c) unanticipated changes in business, industry or general economic conditions that affect the assumptions underlying the acquisition; and (d) decline in the value of the acquired business or assets. Any one or more of these factors could cause the Company to not realize the anticipated benefits of the acquisition in question. In addition, the Company may be required to use available cash, incur debt, issue securities, or a combination of these in order to complete an acquisition. This could affect the Company’s future flexibility and ability to raise capital, operate or develop its business and could dilute its existing shareholders’ holdings as well as decrease the trading price of its common shares. There is no assurance that when evaluating a possible acquisition, the Company will correctly identify and manage the risks and costs inherent in the business or asset to be acquired. Volatile stock price The price of Westaim’s common shares is expected to be highly volatile and will be drastically affected by various factors. Westaim cannot predict the timing of future acquisitions or other developments expected to take place in the future which will likely trigger major changes in the trading price of the common shares. - 11 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 8. RISKS (continued) Liquidity and financing risks As Westaim will have limited interest income from its cash and cash equivalents, its ability to continue its acquisition efforts will be largely reliant on its continued attractiveness to equity investors. Westaim will incur operating losses as it continues to expend funds to explore and develop future business. There is no guarantee that Westaim will be able to develop a profitable business that it may acquire as general economic conditions, regulatory requirements and other factors affect Westaim’s operations and future performance. Many of these factors are beyond Westaim’s control. Additionally, should Westaim require additional capital to continue its activities, failure to raise such capital could result in the Company going out of business. From time to time, Westaim may enter into transactions to acquire assets or the shares of other corporations. These transactions may be financed wholly or partially with debt, which may temporarily increase Westaim’s debt levels above industry standards. Westaim cannot assure investors that it will be able to generate sufficient cash flow to pay the interest on any debt or that future working capital, borrowings or equity financing will be available to pay or refinance such debt. Income taxes The calculation of income taxes requires the use of estimates and judgment. The validity and measurement of tax benefits associated with various tax positions taken or expected to be taken in Westaim’s tax filings are a matter of tax law and are subject to interpretation. The impact of the final determination of tax audits, appeals of decisions of a taxing authority, or tax litigation may be materially different from that reflected in our financial statements. The assessment of additional taxes, interest and penalties could be materially adverse to Westaim’s future results of operations and financial position. 9. RELATED PARTY TRANSACTIONS Management services agreement Prior to September 4, 2012, the Company had a management services agreement (“MSA”) with GMI to manage the day-to-day affairs of the Company and to present strategic investment opportunities for the Board of Directors to consider. GMI was required to provide certain services to the Company including the services of two directors, one of whom was also President and Chief Executive Officer, and a Chief Financial Officer. The MSA provided that GMI was paid an annual service fee designed to compensate GMI for the time and attention of its officers and employees incurred in furtherance of the Company’s business as well as for the office space, equipment, supplies and other facilities made available by GMI to the Company. The amount of the services fee was based on a report prepared by an independent compensation consultant. GMI was also entitled to participate in an annual incentive bonus plan for the purpose of recognizing the contribution of GMI to the Company’s business. Prior to the purchase of GMI by the Company on September 4, 2012, GMI was controlled by corporations controlled by two directors of the Company. For the three months and year ended December 31, 2012, GMI fee expense, inclusive of harmonized sales tax, was $nil and $3.4 million (2011 - $0.6 million and $3.3 million). At December 31, 2012, fees of $nil (December 31, 2011 - $0.2 million) were included in accounts payable and accrued liabilities. Upon the extinguishment of the MSA, an expense of $5.0 million was recognized in the statement of profit or loss and other comprehensive income. All RSUs previously outstanding were held by GMI (details discussed under Share-based Compensation Plans in Section 7, Liquidity and Capital Resources of this MD&A). Acquisition of GMI On September 4, 2012, the Company purchased all the issued and outstanding shares of GMI for $4.2 million in cash and 36,514,902 common shares of the Company. The consideration paid reflected the fair value of the assets and liabilities of GMI. As the fair value of the consideration paid was determined to be equal to the fair value of the assets and liabilities of GMI, no goodwill was recorded. Immediately following the acquisition, GMI was wound up into the Company. Former employees of GMI who are now employees of the Company are considered key management personnel for related party disclosure purposes beginning on September 4, 2012. - 12 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 9. RELATED PARTY TRANSACTIONS (continued) Transactions with key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Company, directly or indirectly, including directors of the Company. Compensation expenses related to key management personnel, including non-executive directors, are as follows: (millions) Salaries and other benefits Share-based payments Three months ended December 31 Year ended December 31 2012 2011 2012 2011 $ $ 0.2 0.2 0.4 $ $ 0.1 0.4 0.5 $ $ 0.6 1.3 1.9 $ $ 0.1 0.3 0.4 10. DISCLOSURE CONTROLS AND INTERNAL CONTROLS OVER FINANCIAL REPORTING Disclosure Controls and Procedures (“DC&P”) DC&P are designed to provide reasonable assurance that information required to be disclosed by the Company in reports filed with or submitted to various securities regulators is recorded, processed, summarized and reported within the time periods specified. This information is gathered and reported to the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), so that timely decisions can be made regarding disclosure. The Company’s management, under the supervision of, and with the participation of, the CEO and CFO, have designed and evaluated the Company’s DC&P, as required in Canada by “National Instrument – 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings”. Based on this evaluation, the CEO and CFO have concluded that, as of December 31, 2012, the Company’s DC&P were effective. Internal Control over Financial Reporting (“ICFR”) Designing, establishing and maintaining adequate ICFR is the responsibility of the Company’s management. ICFR is a process designed by, or under the supervision of, senior management, and affected by the Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and preparation of the Company’s consolidated financial statements in accordance with IFRS. Management is responsible for establishing and maintaining ICFR and has designed such controls to ensure that the required objectives of these internal controls have been met. Management uses the Internal Control – Integrated Framework to evaluate the effectiveness of internal control over financial reporting, which is a recognized and suitable framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company regularly reviews and enhances its systems of controls and procedures. However, because of the inherent limitations in all control systems, management acknowledges that ICFR will not prevent or detect all misstatements due to error or fraud. Prior to its release, this annual report to shareholders was reviewed by the Audit Committee and, on the Audit Committee’s recommendation, approved by the Company’s Board of Directors, similar to prior quarters. There were no changes in the Company’s ICFR that occurred during the year ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, ICFR. As of December 31, 2012, the CEO and the CFO of the Company have evaluated the effectiveness of the Company’s ICFR. Based on those evaluations, the CEO and CFO have concluded that at December 31, 2012, the controls and procedures were operating effectively. There are no material weaknesses that have been identified by management in this regard. 11. ACCOUNTING ESTIMATES Preparation of financial statements in conformity with IFRS requires management to make estimates, some of which relate to matters that are uncertain. As more information becomes known, these estimates and assumptions could change and thus have a material impact on the Company’s financial condition and results of operations in the future. The Company has established detailed policies and control procedures that are intended to ensure that management’s judgments and estimates are well controlled, independently reviewed and consistently applied from period to period. Management believes that its estimates for determining the valuation of the Company's assets and liabilities are appropriate. The Company’s accounting estimates are discussed in Note 2(b) to the audited consolidated financial statements for the year ended December 31, 2012. - 13 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 12. ACCOUNTING POLICIES AND RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS As required for publicly accountable enterprises, the Company reported in accordance with IFRS commencing with the fiscal year beginning on January 1, 2011. Prior to the adoption of IFRS, the Company prepared its financial statements in accordance with Canadian generally accepted accounting principles (“CGAAP”). The Company’s accounting policies are disclosed in Note 2 to the audited consolidated financial statements for the year ended December 31, 2012. 13. FUTURE ACCOUNTING PRONOUNCEMENTS IFRS 9 “Financial Instruments” (“IFRS 9”) was issued in November 2009 and contained requirements for financial assets. This standard addresses classification and measurement of financial assets and replaces the multiple category and measurement models in IAS 39 “Financial Instruments – Recognition and Measurement” (“IAS 39”), for debt instruments with a new mixed measurement model having only two categories: “amortized cost” and “fair value through profit or loss”. IFRS 9 also replaces the models for measuring equity instruments, and such instruments will either be categorized as “fair value through profit or loss” or at “fair value through other comprehensive income”. Requirements for financial liabilities were added to IFRS 9 in October 2010 and largely carried forward existing requirements in IAS 39, except that fair value changes due to credit risk for liabilities designated at fair value through profit and loss will generally be recorded in other comprehensive income. IFRS 9 is effective for annual periods beginning on or after January 1, 2015. The Company has not yet determined the impact of the standard. IFRS 10 “Consolidated Financial Statements” (“IFRS 10”), issued in May 2011, replaces IAS 27 “Consolidated and Separate Financial Statements” and SIC-12 “Consolidation – Special Purpose Entities”. The Company does not currently apply SIC-12 as it does not have special purpose entities. IFRS 10 defines the principle of control and establishes control as the basis for determining which entities are consolidated in the consolidated financial statements. IFRS 10 also sets out the accounting requirements for the preparation of consolidated financial statements. The three elements of control identified in IFRS 10 are power over the investee, exposure or rights to variable returns from involvement with the investee and investor ability to use power over the investee to affect the amount of the investor’s returns. The Company expects that the adoption of IFRS 10 will not have a material impact on its financial statements. IFRS 12 “Disclosure of Interests in Other Entities” (“IFRS 12”) requires a company to disclose information that enables users of financial statements to evaluate the nature of, and risks associated with, its interests in other entities and the effects of those interests on its financial position, financial performance and cash flows. IFRS 12 is required to be applied by an entity that has an interest in subsidiaries. The Company expects that the adoption of IFRS 12 will not have a material impact on its financial statements. IFRS 13 “Fair Value Measurement” (“IFRS 13”), issued in May 2011, establishes a single source of guidance for fair value measurement under IFRS. IFRS 13 defines fair value, provides guidance on its determination and introduces consistent requirements for disclosures on fair value measurements. IFRS 13 does not include requirements on when fair value measurement is required; it prescribes how fair value is to be measured if another IFRS or IAS requires it. IFRS 13 should be applied prospectively from the beginning of the annual period in which it is adopted. The Company expects that the adoption of IFRS 13 will not have a material impact on its financial statements. IFRS 10, IFRS 12 and IFRS 13 are effective for annual periods beginning on or after January 1, 2013. 14. QUARTERLY FINANCIAL INFORMATION (millions) Revenue of continuing operations Expenses of continuing operations Gain on sale of discontinued operations Profit of discontinued operations Profit or loss Q4 2012 $ 0.1 1.1 - - (1.0) Q3 2012 $ 0.1 16.5 108.1 3.7 95.4 Q2 2012 $ 0.1 9.6 (1.4) 12.8 1.9 $ Q1 2012 - 6.5 - 13.2 6.7 Q4 2011 $ 0.1 4.3 - 15.8 11.6 $ Q3 2011 - 2.1 - 15.6 13.5 Q2 2011 $ 0.5 3.1 - 14.1 11.5 Q1 2011 $ 2.3 2.9 - 3.8 3.2 Quarterly revenue from continuing operations includes miscellaneous investment income. In the first quarter of 2011, the Company realized an additional gain of $2.3 million in connection with its acquisition of Jevco in 2010. In the second quarter of 2011, the Company realized a gain on sale of an investment of $0.5 million. Expenses of continuing operations vary from quarter to quarter mainly due to the stock-based compensation expense which varies according to the market price of Westaim’s common shares. In addition, costs of $1.3 million were incurred in each of the first and second quarters of 2012 to investigate an acquisition which Westaim ultimately did not pursue. Gain on sale of discontinued operations is the gain from the sale of Jevco. Expenses of $1.4 million related to the sale were recorded in the second quarter of 2012. - 14 - The Westaim Corporation Management's Discussion and Analysis Year ended December 31, 2012 14. QUARTERLY FINANCIAL INFORMATION (continued) Profit of discontinued operations for the third quarter of 2012 included two months of operating results from the Company’s insurance business to the date of sale of Jevco on September 4, 2012. Profit of discontinued operations in the fourth quarter of 2011 included $2.9 million relating to the recognition of deferred income tax assets for non-capital losses which were expected to be realized following an internal corporate reorganization. 15. CAUTIONARY NOTE REGARDING FUTURE ORIENTED FINANCIAL INFORMATION Certain portions of this MD&A, as well as other public statements by the Company, contain forward-looking statements. In particular, the words "strategy", "may", "will", "continue", "developed", "objective", "potential", "exploring", "could", "expect", "expected", "expects", “tends”, "indicates", and words and expressions of similar import, are intended to identify forward-looking statements. Such forward-looking statements include but are not limited to statements concerning: strategies, alternatives and objectives to maximize value for shareholders; expectations and assumptions relating to the Company’s business plan; the effect of adverse changes in equity markets or the Company’s operations; expectations regarding the Company’s assets and liabilities; the Company’s ability to retain key employees, management’s belief that its estimates for determining the valuation of the Company’s assets and liabilities are appropriate; the Company’s views regarding potential future remediation costs; the effect of changes to interpretations of tax legislation on income tax provisions in future periods; and the Company’s determination that the adoption of new accounting standards will not have a material impact on its consolidated financial statements. These statements are based on current expectations that are subject to risks, uncertainties and assumptions and the Company can give no assurance that these expectations are correct. By their nature, these statements are subject to inherent risks and uncertainties that may be general or specific. A variety of material factors, many of which are beyond the Company’s control, may affect the operations, performance and results of the Company and its business, and could cause actual results to differ materially from the expectations expressed in any of these forward-looking statements. The Company's actual results could differ materially from those anticipated by these forward-looking statements for various reasons generally beyond the Company’s control, including but not limited to: (i) difficult economic conditions or a prolonged economic downturn may adversely affect the Company’s business; (ii) the Company may not be able to realize its investment objectives or its liquid assets may prove to be insufficient to meet future obligations; (iii) the Company may have undisclosed liabilities; (iv) the Company may require significant additional funding; and (v) other risk factors set forth herein or in the Company's Annual Report or the Management Information Circular. The Company disclaims any intention or obligation, except as required by law, to revise forward-looking statements, whether as a result of new information, future developments, or otherwise. All forward-looking statements are expressly qualified in their entirety by this cautionary statement. - 15 - February 28, 2013 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL INFORMATION The accompanying consolidated financial statements including the notes thereto have been prepared by, and are the responsibility of, the management of The Westaim Corporation. This responsibility includes selecting appropriate accounting policies and making estimates and informed judgments based on the anticipated impact of current transactions, events and trends, consistent with International Financial Reporting Standards. The Board of Directors is responsible for ensuring that management fulfills its responsibility for financial reporting and internal control. In meeting our responsibility for the reliability and timeliness of financial information, the Company maintains and relies upon a comprehensive system of internal controls including organizational, procedural and disclosure controls. The Audit Committee, which is comprised of three Directors, a majority of whom are independent, meets with management as well as the external auditors to satisfy itself that management is properly discharging its financial reporting responsibilities and to review the consolidated financial statements and the report of the auditors. It reports its findings to the Board of Directors who approve the consolidated financial statements. The accompanying consolidated financial statements have been audited by Deloitte LLP, the independent auditors, in accordance with generally accepted auditing standards. The auditors have full and unrestricted access to the Audit Committee. J. Cameron MacDonald President and Chief Executive Officer Jeffrey A. Sarfin Chief Financial Officer - 16 - Independent Auditor’s Report TO THE SHAREHOLDERS OF THE WESTAIM CORPORATION We have audited the accompanying consolidated financial statements of The Westaim Corporation, which comprise the consolidated statements of financial position as at December 31, 2012 and December 31, 2011, and the consolidated statements of profit and loss and other comprehensive income, consolidated statements of changes in equity and consolidated statements of cash flows for the years then ended and 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 The Westaim Corporation as at December 31, 2012 and December 31, 2011 and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards. Chartered Professional Accountants, Chartered Accountants Licensed Public Accountants February 28, 2013 Toronto, Ontario - 17 - The Westaim Corporation Consolidated Statements of Financial Position (thousands of Canadian dollars) ASSETS Cash and cash equivalents Investment income due and accrued Investments (note 4) Instalment premiums Income taxes recoverable Accounts receivable and other assets Recoverable from reinsurers Claims recoverable from other insurers Deferred policy acquisition expenses Deferred income taxes (note 13) Property and equipment (note 5) Intangible assets (note 6) LIABILITIES Accounts payable and accrued liabilities Income taxes due and accrued (note 13) Unearned premiums Unpaid claims and adjustment expenses (note 7) Leasehold inducements Site restoration provision (note 8) Commitments and contingent liabilities (note 9) SHAREHOLDERS' EQUITY Share capital (note 10) Warrants (note 10) Contributed surplus (notes 2r and 10) Deficit $ $ $ December 31 2012 December 31 2011 $ 39,164 - - - - 202 - - - - - - 24,347 5,567 1,018,059 62,781 115 27,954 33,970 50,969 35,601 10,108 22,818 3,844 39,366 $ 1,296,133 $ 561 1,530 - - - 2,663 4,754 203,640 - 12,890 (181,918) 34,612 33,523 821 164,437 675,094 2,594 2,401 878,870 687,402 1,900 12,890 (284,929) 417,263 The accompanying notes are an integral part of these consolidated financial statements $ 39,366 $ 1,296,133 Approved on behalf of the Board Ian W. Delaney Director John W. Gildner Director - 18 - The Westaim Corporation Consolidated Statements of Profit or Loss and Other Comprehensive Income (thousands of Canadian dollars except share and per share data) Year Ended December 31 2011 2012 Revenue Investment income Realized gains and losses on sale of investments Other income Expenses Management services Salaries and benefits Office expenses Share-based compensation (note 11) Professional fees Site restoration provision expense (recovery) (note 8) Loss from continuing operations Gain on sale of discontinued operations (note 18) Proceeds on sale of subsidiary Carrying value of subisdiary Transaction costs Gain on sale of discontinued operations Income tax expense (note 13) Post-tax gain on sale of discontinued operations Discontinued operations (note 18) Revenue Expenses Pre-tax profit of discontinued operations Income tax expense Post-tax profit of discontinued operations Profit from discontinued operations Profit or loss and other comprehensive income Earnings per share (note 14) Loss from continuing operations - basic and diluted Profit from discontinued operations - basic and diluted Profit or loss and other comprehensive income - basic and diluted Weighted average number of common and Series 1 Class A preferred shares outstanding (in thousands) Basic Diluted $ $ $ $ $ $ 747 (442) - 305 8,439 564 628 20,467 3,284 262 33,644 (33,339) 530,000 (414,289) (7,498) 108,213 1,530 106,683 275,740 236,903 38,837 9,170 29,667 136,350 116 515 2,250 2,881 3,274 106 871 7,503 743 (95) 12,402 (9,521) - - - - - - 375,522 312,268 63,254 13,917 49,337 49,337 103,011 $ 39,816 (0.05) 0.20 0.15 $ $ $ (0.01) 0.07 0.06 660,500 670,374 646,774 656,893 The accompanying notes are an integral part of these consolidated financial statements - 19 - The Westaim Corporation Consolidated Statements of Changes in Equity Year ended December 31, 2012 (thousands of Canadian dollars) Share Capital Warrants Contributed Surplus Deficit Total Equity Balance at January 1, 2012 $ 687,402 $ 1,900 $ 12,890 $ (284,929) $ 417,263 Profit or loss and other comprehensive income Share capital issued and paid (note 10) Exercise of warrants (note 10) Return of capital (note 10) - 30,745 6,900 (521,407) - - (1,900) - - - - - 103,011 - - - 103,011 30,745 5,000 (521,407) Balance at December 31, 2012 $ 203,640 $ - $ 12,890 $ (181,918) $ 34,612 Year ended December 31, 2011 (thousands of Canadian dollars) Share Capital Warrants Contributed Surplus Deficit Total Equity Balance at January 1, 2011 $ 691,435 $ 1,900 $ 8,734 $ (324,745) $ 377,324 Profit or loss and other comprehensive income Share capital issued and paid (note 10) Repurchase of shares (note 10) - 3,270 (7,303) - - - - - 4,156 39,816 - - 39,816 3,270 (3,147) Balance at December 31, 2011 $ 687,402 $ 1,900 $ 12,890 $ (284,929) $ 417,263 The accompanying notes are an integral part of these consolidated financial statements - 20 - The Westaim Corporation Consolidated Cash Flow Statements (thousands of Canadian dollars) Operating activities Loss from continuing operations Items not affecting cash Net realized loss (gain) on investments Share-based compensation Extinguishment of management contract (note 12) Net change in other non-cash balances Cash used in operating activities of continuing operations Discontinued operations operating activities Cash provided from operating activities Investing activities Purchase of subsidiary, net of cash acquired (note 12) Proceeds from sale of investments Cash (used in) provided from investing activities of continuing operations Proceeds from sale of discontinued operations Cash of discontinued operations Transaction costs incurred upon sale of discontinued operations Discontinued operations investing activities Cash provided from (used in) investing activities Financing activities (note 10) Issuance of share capital, net of cash issuance costs Normal course issuer bid Return of capital to common shareholders Cash (used in) provided from financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Cash and cash equivalents is comprised of: Cash The accompanying notes are an integral part of these consolidated financial statements Year Ended December 31 2011 2012 $ (33,339) $ (9,521) 442 20,467 4,966 (4,185) (11,649) 34,120 22,471 (4,155) - (4,155) 530,000 (22,551) (7,498) 9,598 505,394 8,359 - (521,407) (513,048) 14,817 24,347 39,164 $ (515) 2,967 - (756) (7,825) 19,551 11,726 - 515 515 - - - (20,914) (20,399) 3,270 (3,147) - 123 (8,550) 32,897 24,347 39,164 $ 24,347 $ $ - 21 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 1 Nature of Operations and Basis of Preparation The Westaim Corporation (the “Company”) was incorporated on May 7, 1996 by articles of incorporation under the Business Corporations Act (Alberta). The Company’s registered office is located at 201-212 King Street West, Toronto, Ontario, Canada. These financial statements were authorized for issue by the Board of Directors of the Company on February 28, 2013. On January 9, 2013, the Company’s common shares commenced trading on the TSX Venture Exchange under the symbol WED. Until January 8, 2013, the Company’s common shares were traded on the Toronto Stock Exchange under the symbol WED. Concurrent with the commencement of trading on the TSX Venture Exchange, the Company’s common shares were voluntarily delisted from the Toronto Stock Exchange. Until September 4, 2012, the Company operated in the insurance industry in Canada through its wholly-owned subsidiary, Jevco Insurance Company (“Jevco”). Jevco was sold on September 4, 2012. Note 18 Sale of Subsidiary provides information regarding the sale of the Company’s investment in Jevco and Jevco’s results of operations to the date of sale. These financial statements also include, on a consolidated basis, the accounts of wholly-owned subsidiaries, Westaim Holdings Limited (“WHL”), 1685740 Alberta Ltd., 1685753 Alberta Ltd. and 1686581 Alberta Ltd. The Company amalgamated with WHL, 1685740 Alberta Ltd. and 1685753 Alberta Ltd. on July 1, 2012, and with 1686581 Alberta Ltd. on January 1, 2013. These financial statements are prepared in compliance with International Financial Reporting Standards (“IFRS”). All currency amounts are expressed in thousands of Canadian dollars except earnings per share data, unless otherwise noted. 2 Summary of Significant Accounting Policies The significant accounting policies used to prepare these financial statements are as follows: (a) Principles of consolidation The financial statements of entities which are controlled by the Company through voting equity interests, referred to as subsidiaries, are consolidated. The financial results of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. Intercompany balances and transactions are eliminated upon consolidation. (b) Use of estimates The preparation of financial statements requires management to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and changes in estimates are recorded in the reporting period in which they are determined. Key estimates are discussed in the following accounting policies and applicable notes. (c) Judgments made by management Key areas where management has made difficult, complex or subjective judgments in the process of applying the Company’s accounting policies, often as a result of matters that are inherently uncertain, include: valuation techniques for fair value determination of investments, investment impairment, provision for unpaid claims and adjustment expenses, site restoration provision and income taxes. For additional information on these judgments, see note 4 for investments, note 7 for unpaid claims and adjustment expenses, note 8 for site restoration provision and note 13 for income taxes. (d) Foreign currency translation The Canadian dollar is the functional and presentation currency of the Company. Transactions in foreign currencies are translated into Canadian dollars at rates of exchange prevailing at the time of such transactions. Monetary assets and liabilities are translated at current rates of exchange. Translation differences on available-for-sale investments are classified as relating either to the amortized cost of the investment or to other changes in the carrying value of the investment. (e) Cash and cash equivalents Cash and cash equivalents consist of cash on deposit and highly liquid short-term investments with original maturities of 90 days or less, with the exception of cash equivalents designated as a component of the investment portfolio which are classified as investments. - 22 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 2 Summary of Significant Accounting Policies (continued) Cash and cash equivalents which are not designated as a component of the investment portfolio are classified in the financial instrument category of loans and receivables for purposes of measurement. Cash and cash equivalents are valued at fair value at the issuance date and subsequently at amortized cost using the effective interest method. Carrying value is a reasonable approximation of fair value. (f) Investments and investment income Investments are classified according to four accounting models: available-for-sale, fair value through profit or loss (“FVTPL”), held-to- maturity and cost. The classification depends on the nature and purpose of the financial assets and is determined at the time of initial recognition. Available-for-sale investments are carried at their fair value whereby the unrealized gains and losses are included in accumulated other comprehensive income (“AOCI”) until sale or impairment is recognized, at which time cumulative unrealized gains or losses are transferred to profit or loss. Realized gains and losses on sale, determined on an average cost basis, and write-downs to reflect objective evidence of impairment in value are included in ‘realized gains and losses on sale of investments’. Changes in the fair value of investments designated as FVTPL are charged or credited to investment income for the current reporting period. Held-to-maturity investments are carried at amortized cost using the effective interest method. When a reliable estimate of the fair value of unquoted equity investments cannot be determined, the equity investment is reported at cost. The Company accounts for investments using settlement date accounting. Transaction costs for FVTPL investments are expensed as incurred. Transaction costs for all other categories of investments are capitalized and, when applicable, amortized over the expected life of the investment using the effective interest method. The Company conducts quarterly reviews to identify and evaluate investments that show objective indications of possible impairment. For debt investments, impairment exists when there is objective evidence that, as a result of one or more events occurring after initial recognition, the estimated future cash flows of the investment have been affected. For available-for-sale equity investments, a significant or prolonged decline in the fair value of the security below its cost is considered to be objective evidence of impairment. (g) Instalment premiums The instalment premiums asset represents the premiums related to the unexpired portion of the period of risk. (h) Recoverable from reinsurers Estimates of amounts recoverable from reinsurers on unpaid claims and adjustment expenses are reported separately from related estimated amounts payable to policyholders. Unearned premiums and deferred policy acquisition expenses are also reported before reduction for amounts ceded to reinsurers and the reinsurer’s portion is classified with amounts recoverable from reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with liabilities associated with the reinsured policy. Amounts recoverable from reinsurers are assessed for indicators of impairment at the end of each reporting period. An impairment loss is recognized and the amount recoverable from reinsurers is reduced by the amount by which the carrying value exceeds the expected recoverable amount under the impairment analysis. (i) Claims recoverable from other insurers The expected recoveries from other insurers on claims paid to policyholders are recognized as amounts recoverable at the same time as the related liability is recognized using principles consistent with the Company’s method for establishing the related liability. Claims recoverable from other insurers are assessed for indicators of impairment at the end of each reporting period. An impairment loss is recognized and the amount of claims recoverable from other insurers is reduced by the amount by which the carrying value exceeds the expected recoverable amount under the impairment analysis. (j) Deferred policy acquisition expenses The Company defers brokers’ commissions, premium taxes and other underwriting and marketing expenses relating to premiums written to the extent the expenses are considered recoverable. These costs are expensed as the related premiums are earned. Changes in estimates are reported as expenses in the reporting period in which they are determined. Anticipated future claims, expenses and investment income are considered in determining the recoverability of the carrying value of the deferred policy acquisition expenses. - 23 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 2 Summary of Significant Accounting Policies (continued) (k) Income taxes Income tax expense is recognized in the statement of profit or loss and other comprehensive income. Current tax is based on taxable income which differs from profit or loss and other comprehensive income because of items of income or expense that are taxable or deductible in other years and items that are never taxable or deductible. Deferred tax assets are generally recognized for all deductible temporary income tax differences to the extent that it is probable that taxable profits will be available against which those deductible temporary differences can be utilized. Deferred tax liabilities are generally recognized for all taxable temporary differences. Deferred tax assets and liabilities are determined based on the enacted or substantively enacted tax laws and rates that are anticipated to apply in the year of realization. The measurement of deferred tax assets and liabilities reflects the tax consequences that would follow from the manner in which the Company expects to recover or settle the carrying amount of the related assets and liabilities. The carrying amount of the deferred tax asset is reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered. Income tax assets and liabilities are offset when the Company intends to settle on a net basis and there is a legally enforceable right to offset. (l) Property and equipment Property and equipment are reported at cost less accumulated depreciation. Depreciation of property and equipment is provided using the straight-line method over the estimated useful lives of such assets. The useful lives are 19 to 43 years for buildings, 5 to 15 years for leasehold improvements, 5 to 7 years for furniture and equipment, and 3 to 5 years for computers and automobiles. At the end of each reporting period, management reviews the carrying amounts of property and equipment for indication of impairment. An impairment loss is recognized for the amount by which the carrying amount of the asset exceeds its recoverable amount. The recoverable amount is the higher of fair value less cost to sell and value in use. (m) Intangible assets Intangible assets are reported at amortized cost and consist of purchased software and internally developed software. Amortization of intangible assets is provided using the straight-line method over estimated useful lives of 3 to 5 years. At the end of each reporting period, management reviews the carrying amounts of intangible assets for indication of impairment. An impairment loss is recognized for the amount by which the carrying amount of the asset exceeds its recoverable amount. The recoverable amount is the higher of fair value less cost to sell and value in use. (n) Unearned premiums Unearned premiums reported in the statement of financial position represent the portion of premiums written related to the unexpired risk portion of the policy at the end of the reporting period. The reinsurers’ share of unearned premiums is recognized as amounts recoverable from reinsurers using principles consistent with the Company’s method for determining the unearned premiums liability. (o) Unpaid claims and adjustment expenses The provision for unpaid claims and adjustment expenses includes an estimate of the cost of projected final settlements of insurance claims incurred on or before the statement of financial position date, including claims incurred but not reported (“IBNR”) by policyholders and an estimate of the full amount of all expected expenses. The provision takes into consideration the time value of money using discount rates based on projected investment income from the assets supporting the provisions and includes an explicit provision for adverse deviation. Expected recoveries on unpaid claims and adjustment expenses are recognized as amounts recoverable from other insurers or reinsurers at the same time using principles consistent with the Company’s method for establishing the related liability. These estimates of future claims payments and adjustment expenses are subject to uncertainty and are selected from a wide range of possible outcomes. All provisions are periodically reviewed and evaluated in light of emerging claims experience and changing circumstances. The resulting changes in estimates of the ultimate liability are reported as net claims and adjustment expenses in the reporting period in which they are determined. As the carrying value of the unpaid claims and adjustment expenses is based on the present value of future cash flows with provisions for adverse deviation, it is considered to be an indicator of fair value as there is no ready market for trading insurance policy liabilities. - 24 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 2 Summary of Significant Accounting Policies (continued) (p) Leasehold inducements Leasehold inducements are liabilities associated with the initial benefits received by the Company related to the rental of office premises. Leasehold inducements are amortized over the term of the lease on a straight-line basis. (q) Site restoration provision Future site restoration costs relate to industrial sites previously owned by the Company and are estimated taking into consideration the anticipated method and extent of the remediation consistent with regulatory requirements, industry practices, current technology and possible uses of the site. The estimated amount of future restoration costs is reviewed periodically based on available information. The amount of the provision is the present value of the estimated future restoration costs discounted using the rate of interest of a high quality government bond. Recoveries of costs resulting from indemnifications provided by previous owners of the Company’s industrial sites have not been recognized in these financial statements. Future recoveries of site restoration costs will be recorded when received. (r) Contributed surplus The cost of stock options is recognized over the period from the issue date to the vesting date and recorded as contributed surplus. When share capital of the Company is repurchased by the Company, the amount by which the average carrying value of the shares exceeds the cost to repurchase the shares is removed from share capital and included in contributed surplus. (s) Share-based compensation The Company maintains share-based compensation plans, which are described in note 11. Any consideration paid by stock option holders for the purchase of stock is credited to share capital. The cost of stock options is recognized over the period from the issue date to the vesting date and recorded as a component of equity in contributed surplus. Obligations related to Deferred Share Units (“DSUs”) and Restricted Share Units (”RSUs”) are accrued as liabilities when a change in value occurs and recognized in compensation expense over the applicable vesting period. (t) Discontinued operations Results of discontinued operations are presented in the statement of profit or loss and other comprehensive income as profit from discontinued operations and comprise the revenues and expenses of Jevco and the gain on sale of Jevco, net of related income tax expense. In accordance with IAS 27 “Consolidated and Separate Financial Statements”, gains and losses on available-for-sale investments are included in revenue from discontinued operations as these are considered realized due to the sale of Jevco. Income tax on unrealized gains and losses has been reclassified as income taxes on profit of discontinued operations. In accordance with IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations”, the statement of profit or loss and other comprehensive income for the year ended December 31, 2011 presents the discontinued operations of Jevco reclassified for consistent presentation with the year ended December 31, 2012. (u) Earnings per share Basic earnings per share is calculated by dividing profit or loss by the total of the weighted average number of common shares outstanding during the reporting period plus the weighted average number of preferred shares outstanding during the reporting period. Profit or loss equals profit or loss and other comprehensive income for the years ended December 31, 2012 and 2011. The preferred shares are considered in substance common shares. Diluted earnings per share is calculated on the basis of the weighted average number of shares outstanding during the reporting period plus an estimate of the additional common shares that would have been outstanding if potentially dilutive common shares had been issued using the “treasury stock” method. No adjustments to profit or loss are required for dividends, interest or other changes in income for purposes of calculating diluted earnings per share. - 25 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 3 Accounting Standards Issued But Not Yet Applied IFRS 9 “Financial instruments” (“IFRS 9”) was issued in November 2009 and will replace IAS 39 “Financial Instruments: Recognition and Measurement” (“IAS 39”). IFRS 9 prescribes a single approach to determine whether a financial asset is measured at amortized cost or fair value, replacing the multiple rules permissible under IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments in the context of its business model and the contractual cash flow characteristics of the financial assets. IFRS 9 also requires a single impairment method to be used, replacing the multiple impairment methods permissible under IAS 39. The Company has not yet determined the impact of IFRS 9 on its financial statements. IFRS 9 is effective for years beginning on or after January 1, 2015. IFRS 10 “Consolidated Financial Statements” (“IFRS 10”), issued in May 2011, replaces IAS 27 “Consolidated and Separate Financial Statements” and SIC-12 “Consolidation - Special Purpose Entities”. The Company does not currently apply SIC-12 as it does not have special purpose entities. IFRS 10 defines the principle of control and establishes control as the basis for determining which entities are consolidated in the consolidated financial statements. IFRS 10 also sets out the accounting requirements for the preparation of consolidated financial statements. The three elements of control identified in IFRS 10 are power over the investee, exposure or rights to variable returns from involvement with the investee and investor ability to use power over the investee to affect the amount of the investor’s returns. The Company expects that the adoption of IFRS 10 will not have a material impact on its financial statements. IFRS 12 “Disclosure of Interests in Other Entities” (“IFRS 12”) requires a company to disclose information that enables users of financial statements to evaluate the nature of, and risks associated with, its interests in other entities and the effects of those interests on its financial position, financial performance and cash flows. IFRS 12 is required to be applied by an entity that has an interest in subsidiaries. The Company expects that the adoption of IFRS 12 will not have a material impact on its financial statements. IFRS 13 “Fair Value Measurement” (“IFRS 13”), issued in May 2011, establishes a single source of guidance for fair value measurement under IFRS. IFRS 13 defines fair value, provides guidance on its determination and introduces consistent requirements for disclosures on fair value measurements. IFRS 13 does not include requirements on when fair value measurement is required; it prescribes how fair value is to be measured if another IFRS or IAS requires it. IFRS 13 should be applied prospectively from the beginning of the year in which it is adopted. The Company expects that the adoption of IFRS 13 will not have a material impact on its financial statements. IFRS 10, IFRS 12 and IFRS 13 are effective for years beginning on or after January 1, 2013. 4 Investments The table below provides details of the investments classified by measurement category: Category of investments: Available-for-sale - carried at fair value Held-to-maturity - carried at amortized cost December 31, 2012 $ - - - December 31, 2011 920,591 $ 97,468 1,018,059 $ $ The following table provides details of the amortized cost and fair value of available-for-sale investments, carried at fair value: Short-term investments Canadian bonds - Government Canadian bonds - Corporate Canadian bonds - Mortgage backed Canadian bonds - Other asset backed United States bonds - Corporate Common shares - Canadian Preferred shares - Canadian Amortized cost 84,780 $ 187,681 371,600 40,526 79,615 28,142 792,344 100,605 12,072 905,021 $ Gross unrealized gains $ $ 6 1,463 8,854 937 933 282 12,475 4,918 1,116 18,509 - 26 - Gross unrealized losses $ December 31, 2011 Fair value $ $ 84,786 188,871 380,076 41,456 80,507 28,320 804,016 103,433 13,142 920,591 - 273 378 7 41 104 803 2,090 46 2,939 $ The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 4 Investments (continued) The following table presents the amortized cost and fair value of held-to-maturity investments, carried at amortized cost: Canadian bonds - Government Canadian bonds - Corporate Amortized cost 73,006 $ 24,462 97,468 $ Gross unrealized gains $ $ 7,634 1,679 9,313 $ Gross unrealized losses $ December 31, 2011 Fair value $ $ 80,640 26,141 106,781 - - - The annual coupon rates for the fixed term investments ranged from 1.0% to 12.2% at December 31, 2011. The average effective book yield using amortized cost and the contractual interest rates, adjusted for amortization of premiums and discounts at December 31, 2011, was 2.8%. Fair value determination Fair value amounts represent estimates of the consideration that would currently be agreed upon between knowledgeable, willing parties who are under no compulsion to act and are best evidenced by quoted market prices, if they exist. The calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. The Company uses a fair value hierarchy to categorize the inputs used in valuation techniques to measure fair value. The extent of the Company’s use of quoted market prices (Level 1), internal models using observable market information as inputs (Level 2) and internal models without observable market information (Level 3) in the valuation of the Company’s investments at December 31, 2011 is as follows: December 31, 2011 Available-for-sale investments: Short-term investments Canadian bonds - Government Canadian bonds - Corporate Canadian bonds - Mortgage backed Canadian bonds - Other asset backed United States bonds - Corporate Common shares - Canadian Preferred shares - Canadian Held-to-maturity investments: Canadian bonds - Government Canadian bonds - Corporate Impairment Analysis Fair value Level 1 Level 2 Level 3 $ $ $ $ 84,786 188,871 380,076 41,456 80,507 28,320 103,433 13,142 920,591 80,640 26,141 106,781 $ $ $ $ - - - - - - 103,433 13,142 116,575 - - - $ $ $ $ 84,786 188,871 379,176 41,456 80,507 28,320 - - 803,116 80,640 26,141 106,781 $ $ $ $ - - 900 - - - - - 900 - - - Management performs a quarterly analysis of investment holdings to determine whether there is objective evidence that the estimated cash flows of the investments have been affected. The analysis includes the following procedures as deemed appropriate by management:       assessing whether any credit losses are expected for those investments. This assessment includes consideration of, among other things, all available information and factors having a bearing upon collectability such as changes to credit rating by rating agencies, financial condition of the issuer, expected cash flows and value of any underlying collateral; identifying all security holdings in unrealized loss positions that have existed for at least six months or other circumstances that management believes may impact the recoverability of the investment; obtaining a valuation analysis from third party investment managers regarding the intrinsic value of these holdings based on their knowledge, experience and other market based valuation techniques; reviewing the trading range of certain investments over the preceding year; assessing whether declines in market value for debt investment holdings represent objective evidence of impairment based on their investment grade credit ratings from third party security rating agencies; assessing whether declines in market value for any debt investment holdings with non-investment grade credit rating represent objective evidence of impairment based on the history of its debt service record; and - 27 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 4 Investments (continued)  determining necessary provisions for declines in market values for which there is objective evidence of impairment based on analyses performed. The risks and uncertainties inherent in the assessment methodology utilized to determine whether declines in market value represent objective evidence of impairment include, but may not be limited to, the following:     the opinion of professional investment managers could be incorrect; the past trading patterns of individual investments may not reflect future valuation trends; the credit ratings assigned by independent credit rating agencies may be incorrect due to unforeseen or unknown facts related to a company’s financial situation; and the debt service pattern of non-investment grade investments may not reflect future debt service capabilities and may not reflect unknown underlying financial problems. 5 Property and Equipment Details of cost and accumulated depreciation of property and equipment at December 31, 2011 are as follows: Cost Accumulated depreciation Land Building $ $ 1,283 - 1,283 $ $ 16,584 (963) 15,621 6 Intangible Assets Leasehold improvements $ 3,268 (227) 3,041 $ Furniture and equipment 2,784 $ (847) 1,937 $ Computers 1,663 $ (912) 751 $ Automobiles 286 $ (101) 185 $ Total $ 25,868 (3,050) $ 22,818 Details of cost and accumulated amortization of intangible assets at December 31, 2011 are as follows: Cost Accumulated amortization $ $ 6,049 (2,205) 3,844 7 Unpaid Claims and Adjustment Expenses (a) Nature of unpaid claims and adjustment expenses The establishment of the provision for unpaid claims and adjustment expenses is based on known facts and interpretation of circumstances and is therefore a complex and dynamic process influenced by a large variety of factors. These factors include the Company’s own experience with similar cases and historical trends involving claim payment patterns, loss payments, pending levels of unpaid claims and adjustment expenses, product mix and concentration, claims severity and claim frequency patterns. Other factors include the continually evolving and changing regulatory and legal environment, actuarial studies, professional experience and expertise of the Company’s claim departments’ personnel and independent adjusters retained to handle individual claims, the quality of the data used for projection purposes, existing claims management practices including claims handling and settlement practices, the effect of inflationary trends on future claims settlement costs, investment rates of return, court decisions, economic conditions and public attitudes. In addition, time can be a critical part of the provision determination, since the longer the span between the incidence of a loss and the settlement of the claims, the more variable the ultimate settlement amount can be. Accordingly, short-tailed claims, such as property claims, tend to be more reasonably predictable than long-tailed claims, such as general liability and automobile accident benefit claims. The process of establishing the provision relies on the judgment and opinions of a large number of individuals, on historical precedents and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The provision reflects expectations of the ultimate cost of resolution and administration of claims based on an assessment of facts and circumstances then known together with a review of historical settlement patterns, estimates of trends in claims severity and frequency, legal theories of liability and other factors. - 28 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 7 Unpaid Claims and Adjustment Expenses (continued) Variables affecting the determination of the provision are the receipt of additional claims information and other internal and external factors, such as changes in claims handling procedures, economic inflation, legal and judicial trends, legislative changes, and inclusion of exposures not contemplated at the time of policy inception. The provision for claims and adjustment expenses is reviewed separately by, and must be acceptable to, management of the Company, the Appointed Actuary and an external valuation actuary during the Company’s triennial actuarial examination. (b) Methodologies and assumptions The best estimates of future claims and adjustment expenses have been determined from the projected ultimate claims and adjustment expenses based on the reported / paid claims development method, the Bornhuetter-Ferguson method, the Berquist-Sherman method and the expected claims method. Considerations in the choice of methods to estimate ultimate claims included, among other factors, the line of business, the number of years’ experience and the age of the accident years being developed. A description of each of these methods is as follows: (i) Reported / paid claims development method The distinguishing characteristics of the development method are that ultimate claims for each accident year are produced from recorded values assuming the future claim development is similar to the prior years’ development. The underlying assumption is that claims recorded to date will continue to develop in a similar manner in the future. (ii) Bornhuetter-Ferguson method The key assumption of the Bornhuetter-Ferguson method is that unreported claims will develop based on expected claims. In other words, the claims reported to date contain no informational value as to the amount of claims yet to be reported. It is most frequently used for lines of business with long settlement patterns, and lines of business subject to the occurrence of large claims. (iii) Berquist-Sherman method The adjusted reported development method, also known as the Berquist-Sherman method, is analogous to the reported / paid claims development method except that the reported claims used in the calculation of development factors are first adjusted to a common case reserve adequacy basis. A case reserve is a provision for unpaid claims and adjustment expenses for known claims. Compared to the reported / paid claims method, which relies on consistency in reserving philosophies and procedures to produce reliable results, the Berquist-Sherman method modifies the raw data to restate historical case reserves to the level that the current case reserves would imply, after the consideration of trend. (iv) Expected claims method Using the expected claims method, ultimate claims projections are based upon prior measures of the anticipated claims. An expected claims ratio is applied to the measure of exposure to determine estimated ultimate claims for each year. This method is more commonly used in lines of business with longer emergence and settlement patterns. For each line of business, a roll-forward of the liabilities to September 4, 2012, the date of sale of Jevco, was performed based on the December 31, 2011 analysis. The September 4, 2012 liabilities were based on actuarial assumptions as established in the September 30, 2011 analysis and the December 31, 2011 IBNR reserves and adjusted, as appropriate, based on the actual claims experience. This approach is based on the assumption that the change in reported / paid development factors for the eight months would not be significantly affected by the development of reported claims during the eight months ended September 4, 2012. In addition, this approach is based on the Bornhuetter-Ferguson method principles, where the September 4, 2012 IBNR reserves are calculated based on the September 30, 2011 IBNR reserves projected to December 31, 2011 based on the selected reported / paid development factors, adjusted if necessary, and then added to the actual reported claims valued as of September 4, 2012 to determine the ultimate claims as of September 4, 2012. Claims paid and reported, direct and net of reinsurance recoveries and net of salvage and subrogation, were tracked by lines of business, accident years and development periods. Selected claims development factors were calculated based on the historical development pattern of the reported claims. Judgment was used whenever there was a wide variability in the past development factors due to a small claims sample or due to a new class of business; development factors which seemed abnormal were disregarded in selecting the claims development factors. The Berquist-Sherman method was used to adjust the historical claims information for these variations. - 29 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 7 Unpaid Claims and Adjustment Expenses (continued) Claims data includes external claims adjustment expenses and internal claims adjustment expenses (“IAE”). For the portion of the portfolio which includes IAE, a provision for IAE was determined based on the ratio of paid IAE to paid claims. This method assumes that half of the IAE is required when the claim is first recorded. The remaining half of the IAE is required to maintain the claim. This IAE percentage is applied to the pure IBNR and to half of the case reserves plus IBNR for known claims. The provision for unpaid claims and adjustment expenses is discounted using an interest rate based on the Company’s projected investment income from the assets supporting the unpaid claims and adjustment expense liabilities, and reflecting the estimated timing of payments and recoveries. The discount rate used as at September 4, 2012, the date of sale of Jevco, was 2.89% (December 31, 2011 - 3.1%). Reinsurance recoverable estimates and claims recoverable from other insurers are discounted in a manner consistent with the method used to establish the related liability. 8 Site Restoration Provision The site restoration provision is based on periodic independent estimates of costs associated with soil and groundwater reclamation and remediation of industrial sites formerly owned by the Company. The ultimate environmental costs are uncertain as they are dependent on the future use of the land and future laws and regulations. The change in the site restoration provision for the year ended December 31, 2012 is as follows: Balance at January 1, 2012 Revisions to cash flow estimates Decrease due to inflation Increase due to change in discount rates Changes due to passage of time Balance at December 31, 2012 $ $ 2,401 (632) (474) 1,341 27 2,663 Change in estimates of future expenditures are as a result of periodic reviews of the underlying assumptions supporting the provision, including remediation costs and regulatory requirements. The Company does not expect to settle any portion of the site restoration provision within twelve months after December 31, 2012. Cash flows are estimated to take place over the next 150 years, with the majority to take place later than 50 years after December 31. 2012. To calculate the site restoration provision, the estimated cash flows were adjusted for inflation and discounted to December 31, 2012. For inflation and discounting calculations, all cash flows later than 50 years are treated as if the cash flow would occur at 100 years. Inflation is estimated at 1.2% per annum over the next 100 years. Discount rates are based on risk free rates which range from 1.1% to 2.4% over the next 30 years. The 30-year risk free rate is used for discounting cash flows that are estimated to occur later than 30 years after December 31, 2012. Reimbursements of future costs resulting from indemnifications provided by previous owners of the industrial sites have not been recognized in these financial statements. Future reimbursements will be recorded when received. 9 Commitments and Contingent Liabilities (a) (b) In connection with its operations, the Company is from time to time named as defendant in actions for damages and costs allegedly sustained by the plaintiffs. While it is not possible to estimate the outcome of the various proceedings at this time, such actions have generally been resolved with minimal expenses in excess of amounts provided for. The Company does not believe that it will incur any significant additional expenses in connection with such actions. In connection with the sale of the operations and assets of WHL in 2009, WHL agreed to indemnify the purchaser against certain liabilities or losses as described in the asset purchase agreement to an aggregate maximum of US$11,000, subject to certain exclusions. The Company also agreed to indemnify the purchaser and the purchaser’s directors, officers and employees, for an indefinite period, from certain environmental liabilities and costs relating to the premises formerly leased by WHL in Fort Saskatchewan, Alberta. No claims have been made under, and no amounts have been accrued related to, these indemnities. - 30 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 9 Commitments and Contingent Liabilities (continued) (c) The Company has agreements to indemnify its officers and directors for certain events or occurrences while the officer or director is or was serving at the Company's request in such capacity. The maximum potential amount of future payments is unlimited. However, the Company maintains Director and Officer Liability insurance coverage that enables the Company to recover a portion of any future payments. (d) The Company has provided indemnifications to third parties with respect to future site restoration costs to be incurred on properties previously owned by the Company. These estimated costs have been included in the site restoration provision (note 8). (e) The Company has operating leases in Toronto with remaining lease terms of up to 7 years. At December 31, 2012, the Company had a total commitment of $377 for future minimum lease payments including payments due not later than one year of $99, payments due later than one year and not later than five years of $254, and payments due later than five years of $24. 10 Share Capital, Warrants and Contributed Surplus Share Capital The Company’s authorized share capital consists of an unlimited number of common shares with no par value, Class A preferred shares with no par value and Class B preferred shares with no par value. The Company’s share capital at December 31, 2012 and 2011 is as follows: (thousands) Common shares issued and fully paid Series 1 Class A preferred shares issued and fully paid December 31, 2012 December 31, 2011 Number 695,210 - 695,210 Stated Capital $ 203,640 - $ 203,640 Number 580,344 63,853 644,197 Stated Capital $ 656,618 30,784 $ 687,402 Common shares (thousands) As at January 1 Issued Conversion of Series 1 Class A preferred shares Return of capital Purchased and cancelled Series 1 Class A preferred shares (thousands) As at January 1 Exercise of warrants Conversion to common shares Year ended December 31, 2012 Number 580,344 41,013 73,853 - - 695,210 Stated Capital $ 656,618 30,745 37,684 (521,407) - $ 203,640 Year ended December 31, 2012 Number 63,853 10,000 (73,853) - Stated Capital 30,784 $ 6,900 (37,684) - $ Year ended December 31, 2011 Number 580,565 6,234 - - (6,455) 580,344 Stated Capital $ 660,651 3,270 - - (7,303) $ 656,618 Year ended December 31, 2011 Number 63,853 - - 63,853 $ Stated Capital 30,784 - - 30,784 $ There were no Class B preferred shares outstanding during the years ended December 31, 2012 and 2011. No shares of the Company are held by the Company or by its subsidiaries. At a special meeting of the Company’s shareholders on June 28, 2012, the shareholders voted in favour of a special resolution to reduce the stated capital of the common shares of the Company through a return of capital in the form of a cash distribution. The amount of the cash distribution was determined by the Board of Directors of the Company and the distribution was made on September 28, 2012 at $0.75 per common share for a total of $521,407. The return of capital was recorded as a reduction in the stated capital of the common shares. - 31 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 10 Share Capital, Warrants and Contributed Surplus (continued) The Series 1 Class A preferred shares rank equally with the common shares with respect to liquidation proceeds and are entitled to dividends as the directors may declare, provided that an equal dividend is declared on the common shares. All the issued Series 1 Class A preferred shares previously outstanding were held by one shareholder (the “Holder”). Series 1 Class A preferred shares are non-voting and convertible into common shares, on a one to one basis. The Series 1 Class A preferred shares initially prohibited conversion of such shares where the conversion would result in the Holder exercising control or direction over greater than 40% of the common shares. At the special meeting of the Company’s shareholders on June 28, 2012, an amendment to the Company’s articles was approved by a special resolution which, upon completion of the sale of Jevco, permitted Series 1 Class A preferred shares to be converted to common shares while permitting the Holder to exceed an ownership of 40% of the common shares. In anticipation of this special resolution, the Company and the Holder entered into a voting agreement (“Voting Agreement”) on May 25, 2012 to provide comparable protection to the common shareholders as was provided by the conversion restrictions which were in place prior to the special resolution. Pursuant to the Voting Agreement, the Holder agreed to vote the shares over which it exercises control or discretion and which represent in excess of 40% of the issued and outstanding common shares, in such manner as the Company’s Board of Directors specifies or directs. All Series 1 Class A preferred shares were converted to common shares prior to the cash distribution. Warrants 10,000,000 warrants to purchase an equal number of Series 1 Class A preferred shares of the Company at an exercise price of $0.50 per share were exercised on September 11, 2012 for cash consideration of $5,000. The fair value of the warrants at the time of issuance on February 9, 2010 was $1,900, which was estimated using the Black-Scholes option pricing model assuming a risk-free interest rate of 1.59% and a volatility of 30.0%. This amount was reclassified to share capital upon the exercise of the warrants. Contributed Surplus In August 2011, the Company filed a normal course issuer bid which entitled the Company to acquire up to 30,173,238 common shares between August 30, 2011 and August 29, 2012. In 2012, no shares were purchased under the normal course issuer bid. In 2011, the Company repurchased 6,455,000 common shares on the open market through the normal course issuer bid at an average price per share of $0.4875, for an aggregate consideration of $3,147. The amount by which the average carrying value exceeded the cost of reacquiring the shares of $4,156 was credited to contributed surplus. 11 Share-based Compensation Under the Company’s comprehensive long-term equity incentive plan, as approved by the Board of Directors and ratified by the shareholders, the Company may grant share-based awards for an initial number of 63,858,049 common shares of the Company. Stock Options - Changes to the number of stock options for the years ended December 31, 2012 and 2011 are as follows: Common share stock options Outstanding at January 1 Exercised Expired and forfeited Outstanding at December 31 Year ended December 31, 2012 Number (thousands) 475 (27) (75) 373 Weighted Average Exercise Price in dollars 3.30 0.22 5.60 3.07 $ $ $ $ Year ended December 31, 2011 Number (thousands) 1,072 (70) (527) 475 Weighted Average Exercise Price in dollars 4.03 $ 0.22 $ 5.19 $ 3.30 $ Stock options outstanding are exercisable at prices ranging from $1.23 to $6.18 and have an average remaining contractual life of 2.3 years. Deferred Share Units - DSUs are granted to non-executive directors of the Company and, prior to the sale of Jevco, also to non-executive directors, officers and employees of Jevco, and are issued at the market value of the Company’s shares at the date of grant. Directors may elect to receive DSUs in lieu of fees. Vested DSUs are paid out in cash when the participant ceases to be a director, officer or employee. All DSUs issued prior to the sale of Jevco vested and were paid out upon the sale of Jevco (note 18). - 32 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 11 Share-based Compensation (continued) Changes to the number of DSUs for the years ended December 31, 2012 and 2011 are as follows: DSUs (thousands) Outstanding at January 1 Granted Exercised Cancelled Outstanding at December 31 Year ended December 31 2011 4,609 1,006 - (77) 5,538 2012 5,538 7,232 (7,071) (39) 5,660 For the year ended December 31, 2012, compensation expense relating to DSUs was $1,296 (2011 - $281). At December 31, 2012, a liability of $141 (December 31, 2011 - $2,723) has been accrued with respect to outstanding DSUs. Restricted Share Units - RSUs vest over three years, one third on each of the one year, two year and three year anniversary of the grant date, and are payable in cash when vested. The holder may elect to apply all or part of such cash payment to a subscription for common shares of the Company. Upon a change of control of the Company or the sale of substantially all of the assets of the Company, RSUs vest immediately. Compensation expense with respect to RSUs for the year ended December 31, 2012 was $10,050 (2011 - $7,222). At December 31, 2012, accounts payable and accrued liabilities included an accrued liability related to RSUs of $nil (December 31, 2011 - $8,216). Upon the acquisition of Goodwood Management Inc. (“GMI”) by the Company, an expense of $9,121 was recognized to reflect the value of the RSUs which were extinguished as a result of the subsequent windup of GMI (note 12). Changes to the number of RSUs for the years ended December 31, 2012 and 2011 are as follows: RSUs (thousands) Outstanding at January 1 Granted Extinguished on windup of GMI (note 12) Exercised Outstanding at December 31 Year ended December 31 2011 25,775 9,666 - (8,592) 26,849 2012 26,849 9,666 (36,515) - - 12 Related Party Transactions Management services agreement Prior to September 4, 2012, the Company had a management services agreement (“MSA”) with GMI to manage the day-to-day affairs of the Company and to present strategic investment opportunities for the Board of Directors to consider. GMI was required to provide certain services to the Company including the services of two directors, one of whom was also President and Chief Executive Officer, and a Chief Financial Officer. The MSA provided that GMI was paid an annual service fee designed to compensate GMI for the time and attention of its officers and employees incurred in furtherance of the Company’s business as well as for the office space, equipment, supplies and other facilities made available by GMI to the Company. The amount of the services fee was based on a report prepared by an independent compensation consultant. GMI was also entitled to participate in an annual incentive bonus plan for the purpose of recognizing the contribution of GMI to the Company’s business. Prior to the purchase of GMI by the Company on September 4, 2012, GMI was controlled by corporations controlled by two directors of the Company. For the year ended December 31, 2012, GMI fee expense, inclusive of harmonized sales tax, was $3,473 (2011 - $3,274). At December 31, 2012, fees of $nil (December 31, 2011 - $226) were included in accounts payable and accrued liabilities. Upon the extinguishment of the MSA, an expense of $4,966 was recognized in the statement of profit or loss and other comprehensive income. All RSUs previously outstanding were held by GMI (note 11). - 33 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 12 Related Party Transactions (continued) Acquisition of GMI On September 4, 2012, the Company purchased all the issued and outstanding shares of GMI for $4,190 in cash and 36,514,902 common shares of the Company. The consideration paid reflected the fair value of the assets and liabilities of GMI. As the fair value of the consideration paid was determined to be equal to the fair value of the assets and liabilities of GMI, no goodwill was recorded. Immediately following the acquisition, GMI was wound up into the Company. Former employees of GMI who are now employees of the Company are considered key management personnel for related party disclosure purposes beginning on September 4, 2012. Transactions with key management personnel Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Company, directly or indirectly, including directors of the Company. Compensation expenses related to key management personnel for the years ended December 31, 2012 and 2011 are as follows: Salaries and other short-term employee benefits Share-based compensation 13 Income Taxes Year ended December 31 2011 2012 106 565 $ $ 282 1,296 388 1,861 $ $ Income taxes are recognized for deferred income taxes attributed to estimated differences between the financial statement carrying values of assets and liabilities and their respective income tax bases. The deferred income tax asset consists of deferred taxes related to the following: Non-capital loss carry-forwards Unpaid claims and adjustment expenses Intangible assets, property and equipment Other Deferred income tax asset December 31, 2012 $ December 31, 2011 $ $ $ As the realization of any related tax benefits is not probable, no deferred income tax assets have been recognized for the following: - - - - - 44,404 6,640 6,064 1,530 8,672 2,862 7,653 (1,231) 824 10,108 44,054 96,194 28,333 - 8,672 December 31, 2012 December 31, 2011 $ $ Non-capital loss carry-forwards Capital loss carry-forwards Deductible temporary differences Corporate minimum tax credits Investment tax credits Previously unrecognized capital loss carry-forwards were utilized as a result of the disposition of Jevco. Deductible temporary differences decreased due to the payment and extinguishment of share-based compensation and the reversal of other differences deductible for tax. - 34 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 13 Income Taxes (continued) The unrecognized non-capital losses and investment tax credits will expire at various times to the end of 2031, as follows: Non-capital losses by year of expiry: 2026 2027 2028 2029 2030 2031 $ $ 7,883 6,151 9,048 103 610 20,609 44,404 Investment tax credits by year of expiry: 2017 2018 2019 2020 2021 Beyond 2021 $ $ 3,241 888 961 823 643 2,116 8,672 Temporary differences associated with investments in subsidiaries for which deferred tax liabilities had not been recognized were $99,131 at December 31, 2011. The Company was able to control the timing of the reversal of these temporary differences which were reversed in the year ended December 31, 2012. The following is a reconciliation of income taxes calculated at the statutory income tax rate to the income tax expense included in the statements of profit or loss and other comprehensive income: Loss from continuing operations Gain on sale of discontinued operations Profit or loss before income taxes on continuing operations and gain on sale of discontinued operations Statutory income tax rate Income taxes at statutory income tax rate Variations due to: Non-deductible and non-taxable items Unrecognized temporary differences Utilization of previously unrecognized tax losses Corporate minimum tax Income tax expense on continuing operations and gain on sale of discontinued operations Year ended December 31 $ 2012 (33,339) 108,213 2011 $ (9,521) - 74,874 26.5% 19,842 (9,647) 1,838 (12,033) 1,530 (9,521) 28.0% (2,666) 47 2,619 - - $ 1,530 $ - Income tax expense is recognized in the statements of profit or loss and other comprehensive income as follows: Income tax expense on: Continuing operations Gain on sale of discontinued operations Income tax expense on continuing operations and gain on sale of discontinued operations Income tax expense on profit of discontinued operations Total income tax expense on continuing and discontinued operations Year ended December 31 2011 2012 $ - 1,530 1,530 9,170 $ - - - 13,917 $ 10,700 $ 13,917 14 Earnings per Share The Company uses the treasury stock method to calculate diluted earnings per share. Following the treasury stock method, the numerator for the Company’s diluted earnings per share calculation remains unchanged from the basic earnings per share calculation, as the assumed exercise of the Company’s restricted share units, warrants and stock options does not result in an adjustment to profit or loss. - 35 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 14 Earnings per Share (continued) The reconciliation from the basic number of shares to the diluted number of shares used in the denominators to calculate basic and diluted earnings per share, as presented in the statements of profit or loss and other comprehensive income, is as follows: Number of common shares and Series 1 Class A preferred shares (in thousands) Number of shares for basic earnings per share Effect of dilutive securities: - restricted share units - warrants - stock options Number of shares for diluted earnings per share Year ended December 31 2011 2012 646,774 660,500 9,523 342 9 670,374 9,453 649 17 656,893 The Series 1 Class A preferred shares are considered in substance common shares and are included in the calculation of earnings per share. Stock options to purchase 372,800 common shares were outstanding at December 31, 2012 (December 31, 2011 - 475,000). These stock options were excluded in the calculation of diluted earnings per share because the exercise price of the stock options was greater than the weighted average market value of the common shares in the years ended December 31, 2012 and 2011. 15 Capital Management The Company’s capital consists of its shareholders’ equity. The Company’s objectives when managing capital are to maintain a strong balance sheet and maximize shareholder value. In order to achieve the Company’s capital management objectives, it employs a strong and efficient capital base and manages capital in accordance with policies established by the Board of Directors. These policies relate to capital strength, capital mix, dividends and return on capital. The Company has a capital management process in place to measure, deploy and monitor its available capital to assess its adequacy on a continuous basis. Management develops the capital strategy and oversees the capital management processes. Capital is managed using internal metrics. Prior to the sale of Jevco on September 4, 2012, the funds of the Company were mainly invested in the equity of Jevco. Jevco is regulated by the Office of the Superintendent of Financial Institutions and required to maintain a level of capital sufficient to support the volume and risk profile of Jevco’s business. At the special meeting of the Company’s shareholders on June 28, 2012, the shareholders voted in favour of a special resolution to reduce the stated capital of the common shares of the Company through a return of capital in the form of a cash distribution. The amount of the cash distribution was determined by the Board of Directors of the Company and the distribution was made on September 28, 2012 at $0.75 per common share for a total of $521,407. 16 Risk Management Financial instruments comprised the majority of the Company’s statements of financial position as at December 31, 2012 and 2011. The most significant identified risks which arise from holding financial instruments include credit risk, market risk, liquidity risk and insurance underwriting risk. Market risk exposure is related to changes in interest rates and adverse movement in equity prices. The insurance underwriting risk of the Company was primarily related to pricing risk, concentration of risk and reserving risk. The Investment Committee of the Board of Jevco and senior management monitored the Company’s risk exposures and activities giving rise to these exposures. The Appointed Actuary performed quarterly and annual analyses of the effect of various projected adverse scenarios on the financial condition of the Company which were compared to a base scenario using the Company’s business plan. Management considered the results of these analyses in its risk management procedures. The Company has a comprehensive risk management framework to monitor, evaluate and manage the risks assumed in conducting its business. The sale of Jevco has significantly reduced the Company’s exposure to credit risk, market risk and insurance underwriting risk. The most significant identified risk to the Company at December 31, 2012 is liquidity risk. Liquidity risk is the risk of having insufficient cash resources to meet current financial obligations without raising funds at unfavorable rates or selling assets on a forced basis. Liquidity risk arises from general business activities and in the course of managing assets and liabilities. The purpose of liquidity management is to ensure that there is sufficient cash to meet all financial commitments and obligations as they fall due. To meet these cash requirements, the Company monitors the cash position to ensure that all obligations are fulfilled. The Company’s statement of financial position at December 31, 2012 consists of short-term financial assets and financial liabilities with maturities of less than one year, other than the site restoration provision discussed in note 8. - 36 - The Westaim Corporation Notes to Consolidated Financial Statements For the years ended December 31, 2012 and 2011 (Currency amounts in thousands of Canadian dollars unless otherwise indicated) 17 Operating Segment Prior to the sale of Jevco, the Company had one reportable segment which comprised the Company’s property and casualty insurance business carried on through Jevco. All other revenues, expenses, assets and liabilities are related to corporate activities and include the gain on sale of Jevco. The accounting policies of the reportable segment are the same as the Company’s accounting policies described in note 2. Segment profit or loss and other comprehensive income represents segment profit or loss and other comprehensive income without allocation of certain administration costs. Year ended December 31, 2012 Year ended December 31, 2011 Revenue of continuing operations Profit or loss and other comprehensive income: From continuing operations From discontinued operations Total $ Insurance segment All other 305 - $ Total $ 305 Insurance segment - $ All other 2,881 $ Total $ 2,881 - 29,667 29,667 (33,339) 106,683 73,344 (33,339) 136,350 103,011 - 49,337 49,337 (9,521) - (9,521) (9,521) 49,337 39,816 December 31, 2012 December 31, 2011 Insurance segment All other Total Assets Cash and cash equivalents Investment income due and accrued Investments Instalment premiums Income taxes recoverable Accounts receivable and other assets Recoverable from reinsurers Claims recoverable from other insurers Deferred policy acquisition expenses Deferred income taxes Property and equipment Intangible assets Total assets Liabilities Accounts payable and accrued liabilities Income taxes due and accrued Unearned premiums Unpaid claims and adjustment expenses Leasehold inducements Site restoration provision Total liabilities $ $ $ $ - $ 39,164 - - - - - - - - 202 - - - - - - - - - - - - - - $ 39,366 - $ - - - - - - $ 561 1,530 - - - 2,663 4,754 $ 39,164 - - - - 202 - - - - - - $ 39,366 $ $ 561 1,530 - - - 2,663 4,754 Insurance segment $ 9,685 5,567 1,018,059 62,781 115 26,008 33,970 50,969 35,601 10,108 22,818 3,844 $1,279,525 $ 20,957 821 164,437 675,094 2,594 - $ 863,903 All other Total $ 14,662 - - - - 1,946 - - - - - - $ 16,608 $ 12,566 - - - - 2,401 $ 14,967 $ 24,347 5,567 1,018,059 62,781 115 27,954 33,970 50,969 35,601 10,108 22,818 3,844 $1,296,133 $ 33,523 821 164,437 675,094 2,594 2,401 $ 878,870 18 Sale of Subsidiary On May 2, 2012, the Company announced it had entered into an agreement with an unrelated party to sell all the issued and outstanding shares in the capital of Jevco to the purchaser for $530,000 in cash. On June 28, 2012, at the special meeting of the Company’s shareholders, a special resolution in favour of the agreement was approved by shareholder vote. The sale of Jevco was concluded on September 4, 2012 after all regulatory approvals were received. The insurance segment presented in note 17 Operating Segment consists solely of Jevco, and includes Jevco’s total assets and total liabilities as at December 31, 2011. - 37 - SHAREHOLDER INFORMATION BOARD OF DIRECTORS Ian W. Delaney 3 Non-executive Chairman of the Board, The Westaim Corporation Daniel P. Owen 1, 2, 3 Chairman and Chief Executive Officer, Molin Holdings Limited Chairman, Sherritt International Corporation Chairman, Heli-Lynx Helicopter Services Inc. John Gildner 1, 2, 3 Independent Businessman J. Cameron MacDonald 1 President and Chief Executive Officer, The Westaim Corporation Peter H. Puccetti 2, 3 Chairman, Chief Executive Officer and Chief Investment Officer, Goodwood Inc. Numbers indicate the individual’s committee membership: 1. Member of the Audit Committee 2. Member of the Human Resources and Compensation Committee 3. Member of the Corporate Governance Committee The Westaim Corporation Annual General Meeting of Shareholders Wednesday May 15, 2013 10:00 a.m. Heenan Blaikie LLP 29th Floor Bay Adelaide Centre 333 Bay Street Toronto, Ontario CORPORATE INFORMATION STOCK INFORMATION TRANSFER AGENT J. Cameron MacDonald Traded on the TSX Venture Exchange President and Chief Executive Officer under the symbol WED Computershare Trust Company of Canada 600, 530 – 8th Avenue SW Calgary, Alberta T2P 3S8 Jeffrey A. Sarfin Chief Financial Officer Shares issued and outstanding Tel: 1-800-564-6253 at December 31, 2012 were 695,209,711 E-mail: service@computershare.com Corporate Office 212 King Street West Suite 201 Toronto, Ontario M5H 1K5 Tel: (416) 203-2253 Fax: (416) 203-0734 E-mail: info@westaim.com www.westaim.com - 38 - THIS PAGE INTENTIONALLY LEFT BLANK THIS PAGE INTENTIONALLY LEFT BLANK THIS PAGE INTENTIONALLY LEFT BLANK THE WESTAIM CORPORATION 212 King Street West, Suite 201 Toronto, Ontario, Canada M5H 1K5 www.westaim.com info@westaim.com 

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