Unaudited Interim Condensed Consolidated Financial Statements September 30, 2018 and 2017
Notice required under National Instrument 51-102, Continuous Disclosure Obligations, Part 4.3 (3) (a). The accompanying unaudited condensed interim financial statements for Strongco Corporation as at and for the nine-month and three-month periods ended September 30, 2018, together with the accompanying notes have not been reviewed by the Company s auditors
Unaudited Interim Consolidated Statement of Financial Position (in thousands of Canadian dollars, unless otherwise indicated) Assets As at September 30, 2018 As at December 31, 2017 As at September 30, 2017 Current assets Cash $ - $ - $ - Trade and other receivables 47,202 39,479 43,046 Income taxes receivable 471 471 1,508 Inventories [note 3] 196,803 184,007 190,247 Prepaid expenses and other deposits 1,539 1,501 1,831 246,015 225,458 236,632 Non-current assets Property and equipment [note 4] 12,340 11,075 10,467 Other assets 208 1,445 1,492 12,548 12,520 11,959 Total assets $ 258,563 $ 237,978 $ 248,591 Liabilities and shareholders' equity Current liabilities Bank indebtedness [note 5] $ 28,560 $ 28,988 $ 26,944 Trade and other payables 43,909 40,520 51,800 Deferred revenue and customer deposits 152 512 199 Equipment notes payable - non-interest bearing [note 6] 58,838 38,881 58,429 - interest bearing [note 6] 86,708 92,147 73,987 Current portion of finance lease obligations 2,323 2,268 2,151 Lease termination obligation [note 12] 1,200 - - 221,690 203,316 213,510 Non-current liabilities Finance lease obligations 4,853 3,901 3,369 Lease termination obligation [note 12] 800 - - Employee future benefit obligations 4,539 3,788 3,841 10,192 7,689 7,210 Total liabilities 231,882 211,005 220,720 Contingencies, commitments and guarantees [note 7] Shareholders' equity Shareholders' capital [note 8] 65,797 65,497 65,497 Accumulated other comprehensive income 1,147 1,147 1,147 Contributed surplus 1,040 1,006 1,003 Retained earnings (deficit) (41,303) (40,677) (39,776) Total shareholders' equity 26,681 26,973 27,871 Total liabilities and shareholders' equity $ 258,563 $ 237,978 $ 248,591 The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements. 2
Unaudited Interim Consolidated Statement of Income (Loss) and Comprehensive Income (Loss) For the three and nine month periods ended September 30 (in thousands of Canadian dollars, unless otherwise indicated, except share and per share amounts) Three-month period ended Nine-month period ended September 30 September 30 2018 2017 2018 2017 Revenue [note 10] $ 98,984 $ 87,860 $ 309,993 $ 278,504 Cost of sales 80,850 71,244 254,725 228,401 Gross profit 18,134 16,616 55,268 50,103 Selling and administrative expenses 14,897 15,180 46,599 47,201 Other (income) expense 31 (368) (250) (961) Operating income 3,206 1,804 8,919 3,863 Restructuring Costs [note 12] 3,443-3,443 678 Interest expense 2,201 1,561 6,102 4,517 Earnings (loss) before income taxes (2,438) 243 (626) (1,332) Provision for income taxes - - - - Net earnings (loss) and comprehensive income (loss) attributable to shareholders $ (2,438) $ 243 $ (626) $ (1,332) Earnings (loss) per share - basic and diluted Net earnings (loss) attributable to shareholders $ (0.18) $ 0.02 $ (0.05) $ (0.10) Weighted average number of shares [note 9] - basic and diluted 13,371,719 13,221,719 13,272,268 13,221,719 The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements. 3
Unaudited Interim Consolidated Statement of Changes in Shareholders Equity For the nine month periods ended September 30 Number of shares Shareholders' capital Accumulated other comprehensive income Contributed surplus Retained earnings Total Balance - December 31, 2016 13,221,719 $ 65,497 $ 1,147 $ 983 $ (38,444) $ 29,183 Net loss - - - (1,332) (1,332) Total comprehensive income 65,497 1,147 983 (39,776) 27,851 Share-based compensation expense - - 20-20 Balance - September 30, 2017 13,221,719 $ 65,497 $ 1,147 $ 1,003 $ (39,776) $ 27,871 Number of shares Shareholders' capital Accumulated other comprehensive income Contributed surplus Total Balance - December 31, 2017 13,221,719 $ 65,497 $ 1,147 $ 1,006 $ (40,677) $ 26,973 Net earnings - - - (626) (626) Total comprehensive income 65,497 1,147 1,006 (41,303) 26,347 Share-based compensation expense - - 34-34 Issuance of shares [note 8 and 12] 150,000 300 - - - 300 Balance - September 30, 2018 13,371,719 $ 65,797 $ 1,147 $ 1,040 $ (41,303) $ 26,681 The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements. Retained earnings 4
Unaudited Interim Consolidated Statement of Cash Flows For the nine month periods ended September 30 (in thousands of Canadian dollars, unless otherwise indicated) 2018 2017 Cash flows from operating activities Net earnings (loss) for the period $ (626) $ (1,332) Adjustments for Depreciation - property and equipment 1,952 2,295 Depreciation - equipment inventory on rent 11,232 9,031 Depreciation - rental fleet 14 391 Gain on sale of rental fleet - (188) Share-based payment expense 34 20 Interest expense 6,102 4,517 Restructuring costs 3,443 - Employee future benefit expense 1,554 1,263 Changes in non-cash working capital [note 11] (13,474) (5,816) Purchases of rental fleet - (80) Proceeds on sale of rental fleet - 450 Funding of employee future benefit obligations (803) (1,448) Interest paid (6,091) (4,543) Net cash provided by operating activities $ 3,337 $ 4,560 Cash flows from investing activities Purchases of property and equipment (859) (264) Proceeds from sale of business released from escrow - 1,564 Net cash used in investing activities $ (859) $ 1,300 Cash flows from financing activities Increase (decrease) in bank indebtedness (428) (3,757) Repayment of finance lease obligations [note 11] (1,248) (2,103) Payment of lease termination obligation [note 12] (802) - Net cash provided by (used in) financing activities $ (2,478) $ (5,860) Change in cash and cash equivalents during the period $ - $ - Cash and cash equivalents - Beginning of period - - Cash and cash equivalents - End of period $ - $ - The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements. 5
1 General information Strongco Corporation ( Strongco or the Company ) sells and rents new and used equipment and provides after-sale product support (parts, service and warranty recovery from the OEM) to customers that operate in infrastructure, construction, mining, oil and gas exploration, forestry and industrial markets in Canada. The Company is a public entity, incorporated and domiciled in Canada and listed on the Toronto Stock Exchange. The address of its registered office is 1640 Enterprise Road, Mississauga, Ontario L4W 4L4. 2 Basis of presentation These unaudited interim condensed consolidated financial statements have been prepared in accordance with International Accounting Standards ( IAS ) 34, Interim Financial Reporting, as issued by the International Accounting Standards Board ( IASB ). The accounting policies followed in these interim condensed consolidated financial statements are the same as those applied in the Company s consolidated financial statements for the year ended December 31, 2017, except for any new accounting pronouncements which have been adopted, as required, on January 1, 2018. These interim condensed consolidated financial statements do not include all of the information required for full annual financial statements and should be read in conjunction with the Company s annual financial statements for the year ended December 31, 2017, which are available at www.sedar.com and on the Company s website at www.strongco.com. The timely preparation of the interim condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingencies, if any, as at the date of the financial statements and the reported amounts of revenue and expenses during the period. By their nature, estimates are subject to measurement uncertainty and changes in such estimates in future years could require a material change in the interim condensed consolidated financial statements. These interim condensed consolidated financial statements were authorized for issuance by the Board of Directors of the Company on October 31, 2018. New accounting standards adopted during the period The following new standards have been adopted by the Company effective January 1, 2018: IFRS 15 Revenues from Contracts with Customers IFRS 15 applies a single, principles-based five-step model for the recognition of revenue to be applied to goods and services transferred to customers, and requires additional disclosures. The Company elected to apply the retrospective approach, pursuant to which the required comparative reporting periods have been restated. Application of the standard did not change the net earnings of the Company; however certain amounts have been reclassified in the interim consolidated statement of income. Previously, warranty recoveries and costs were recognized as a net amount in selling and administrative expenses. The standard has resulted in the reclassification of warranty recoveries from the OEM to revenues and warranty costs to cost of sales (for the nine months ended September 30, 2017 - $16,090 and $12,449 respectively). Additionally, in some cases the Company provides a guarantee to repurchase equipment at a predetermined residual value at the option of the customer. The standard requires these sales to be 6
recorded as a sale with a right of return. Accordingly, the comparative prior periods of consolidated statement of financial position have been restated to reflect the aggregate value of the predetermined residual values [note 3]. The adoption of the standard did not result in a transitional adjustment through equity at the start of the comparative reporting periods. IFRS 9 Financial Instruments IFRS 9 defines new requirements for the classification and measurement of financial assets and financial liabilities, the impairment of financial assets and the application of hedge accounting. As permitted by the transitional provision of IFRS 9, the Company elected not to restate comparative amounts or note disclosures. Any adjustments to carrying amounts of financial assets and liabilities at the transition date are to be recognized in the opening retained earnings of the current period, however, the Company assessed that no adjustments to the carrying amounts of financial assets and liabilities were required upon adoption of IFRS 9. IFRS 9 eliminates the financial assets of held to maturity, loans and receivables and available for sale previously allowed under IAS 39. Trade and other receivables that were previously classified as loans and receivables under IAS 39 are classified as amortized costs under IFRS 9. The change in classification under IFRS 9 has not resulted in changes in the carrying amounts. The new standard also includes a new expected credit loss model for calculating impairment on financial assets. Due to risk management practices that the Company has in place, this change did not impact the consolidated financial statements. IFRS 9 also introduces new hedge accounting requirements. Since the Company does not apply hedge accounting, there was no impact on the consolidated financial statements. Future changes in accounting standards The standards, amendments, and interpretations issued before 2018 but not yet adopted by the Company have been disclosed in note 2 of the Company s December 31, 2017 annual consolidated financial statements. There are no new standards, amendments, or interpretations issued in the nine months ended September 30, 2018 that are applicable to the Company. Comparative amounts Certain comparative amounts have been reclassified to conform to current period s unaudited interim condensed consolidated financial statements presentation. 7
3 Inventories Inventory components, net of write-downs and provisions are as follows: As at September 30, 2018 December 31, 2017 September 30, 2017 Equipment in-stock $ 105,324 $ 88,049 $ 99,457 Equipment on rental contract with a purchase option 35,733 33,436 36,351 Equipment on a short-term rental contract 20,680 28,397 18,487 Equipment with customer return option 3,258 3,463 3,463 Equipment 164,995 153,345 157,758 Parts 26,042 24,934 26,279 Work-in-process 5,766 5,728 6,210 Total inventory $ 196,803 $ 184,007 $ 190,247 As at September 30, 2018, provisions against inventory totalled $4,751 (December 31, 2017 - $4,099; September 30, 2017 - $3,989). During the nine months ended September 30, 2018, the Company recorded inventory write-downs of $1,078 (nine months ended September 30, 2017 - $389) and reversed inventory provisions of $nil (2017 - $nil). The Company has agreed to buy back equipment from certain customers at the option of the customer for a specified price at future dates. These contracts are subject to certain conditions being met by the customer and range in term from three to 10 years. The aggregate of the future purchase amounts is recorded in inventory as equipment with customer return option and as a liability in trade and other liabilities. The Company's maximum potential losses pursuant to the majority of these buy back contracts are limited, under an agreement with a third party, to 10% of the original sale amounts. A provision of $165 (December 31, 2017 - $42; September 30, 2017 - $70) has been accrued in the Company's accounts with respect to these potential losses. 4 Property and equipment During the nine months ended September 30, 2018, the Company acquired property and equipment of $3,322 (nine months ended September 30, 2017 - $2,555). 5 Bank indebtedness The Company has credit facilities with a bank in Canada that provides an operating line of credit totalling $30.0 million. The bank facilities contain financial covenants that require the Company to maintain certain financial ratios and meet certain financial thresholds. As at September 30, 2018, the Company was in compliance with these covenants. 8
6 Equipment notes payable In addition to its bank credit facilities, the Company has lines of credit available totalling approximately $188 million from various non-bank equipment lenders in Canada and the United States, which are used to finance equipment inventory. As at September 30, 2018, there was approximately $146 million borrowed on these equipment finance lines (December 31, 2017 approximately $131 million; September 30, 2017 approximately $132 million). The equipment notes are payable on demand and therefore have been classified as current liabilities. Typically, these equipment notes are interest-free for periods up to 6 months from the date of financing, after which they bear interest at variable rates based upon 30-day and 90-day Bankers Acceptance rates ( BA ), the prime rate of a Canadian chartered bank, and 30-day and 90-day LIBOR rates plus the financing company s margin. As at September 30, 2018, the rates ranged from 6.20% to 8.20% with an effective weighted average rate of 6.79% (December 31, 2017 6.29%; September 30, 2017 6.19%). As collateral for these equipment notes, the Company has provided liens on the specific inventory financed and any related accounts receivable. In the normal course of business, these liens cover substantially all of the inventories. Monthly principal repayments equal to 3.00% of the original principal balance of the note commence 12 months from the date of financing and the remaining balance is due in full at the earlier of 24 months after financing or when the financed equipment is sold. While financed equipment is out on rent, monthly curtailments are required equal to the greater of 70% of the rental revenue and 2.5% of the original value of the note. Any remaining balance after 24 months, which is due in full, is normally refinanced with the lender over an additional period of up to 24 months. All of the Company s equipment notes facilities are renewable annually. Certain of the Company s equipment finance credit agreements contain restrictive financial covenants, including requiring the Company to remain in compliance with the financial covenants under all of its other lending agreements ( cross default provisions ). As at September 30, 2018, the Company was in compliance with all of the covenants under these agreements. 7 Contingencies, commitments and guarantees In the ordinary course of business activities, the Company may be contingently liable for litigation. On an ongoing basis, the Company assesses the likelihood of any adverse judgments or outcomes, as well as potential ranges of probable costs or losses. A determination of the provision required, if any, is made after analysis of each individual matter. The required provision may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy dealing with these matters. As at September 30, 2018, management has determined that there is no pending or actual litigation requiring a provision. 9
8 Shareholders capital Authorized: Unlimited number of shares Issued: As at September 30, 2018, a total of 13,371,719 shares (December 31, 2017 13,221,719; September 30, 2017 13,221,719) with a stated valued of $65,797 (December 31, 2017 - $65,497; September 30, 2017 - $65,497) were issued and outstanding. On July 1, 2018, the Company issued 150,000 shares as a partial payment towards the facility lease termination cost [note 12]. As at September 30, 2018, stock options totalling 363,502 (December 31, 2017 138,502; September 30, 2017 138,502) had been granted and were outstanding with a weighted average remaining contractual life of 81 months (December 31, 2017 31 months; September 30, 2017 34 months) and the weighted average exercise price was $3.14 (December 31, 2017 - $4.60; September 30, 2017 - $4.60). On June 12, 2018, the Company granted irrevocable options to certain members of senior management to purchase 225,000 shares of the Company. These options have an exercise price of $2.25 per share, which is equivalent to the average trading price of the Company s shares over the five days immediately prior to June 12, 2018. A third of the options vest and become exercisable after 36 months from the grant date, a third of the options vest and become exercisable after 48 months from the grant date and a third of the options vest and become exercisable after 60 months from the grant date. The options expire ten years from the issue date on June 12, 2028. No stock options were cancelled during the period. Stock-based compensation expense resulting from stock options for the period ended September 30, 2018 is $34 (2017 - $20). 9 Weighted average number of shares Three months ended Nine months ended September 30, September 30, 2018 2017 2018 2017 Weighted average number of shares for basic and diluted earnings per share calculation 13,371,719 13,221,719 13,272,279 13,221,719 The computation of dilutive options outstanding only includes those options having exercise prices below the average market price of the shares during the period. There were no dilutive options as at September 30, 2018 and 2017. 10 Segment information Management has determined that the Company has one reportable segment, Equipment Distribution, based on reports reviewed by the Executive Chairman. This business sells and rents new and used equipment and provides after-sale product support (parts, service and warranty recovery from the OEM) to customers that operate in infrastructure, construction, mining, oil and gas exploration, forestry and industrial markets. 10
A breakdown of revenue from the Equipment Distribution segment is as follows: Three months ended September 30, Nine months ended September 30, 2018 2017 2018 2017 Equipment sales $ 58,787 $ 49,634 $ 189,797 $ 165,592 Equipment rentals 4,812 4,691 13,347 11,266 Product support 35,385 33,535 106,849 101,646 Total Equipment Distribution $ 98,984 $ 87,860 $ 309,993 $ 278,504 11 Changes in non-cash working capital The components of the changes in non-cash working capital are detailed below: Nine months ended September 30, 2018 2017 Trade and other receivables $ (7,723) $ (6,022) Inventories (excluding depreciation - equipment inventory on rent) (24,236) (34,625) Prepaid expenses and other deposits (38) (245) Other assets - 265 Trade and other payables 4,365 5,466 Deferred revenue and customer deposits (360) (571) Equipment notes payable 14,518 29,916 $ (13,474) $ (5,816) The changes in liabilities arising from financing activities are detailed below: Equipment Notes Payable Finance Lease Obligations Total financing activities Opening, December 31, 2016 $ 102,463 $ 6,216 $ 108,679 Proceeds 159,919 2,538 162,457 Repayment (129,966) (3,234) (133,200) Closing, September 30, 2017 $ 132,416 $ 5,520 $ 137,936 Opening, December 31, 2017 131,028 6,169 $ 137,197 Proceeds 176,600 2,255 178,855 Repayment (162,082) (1,248) (163,330) Closing, September 30, 2018 $ 145,546 $ 7,176 $ 152,722 11
12 Restructuring Costs Effective July 1, 2018, the Company and the landlord of its Fort McMurray branch terminated the existing lease agreement. The total cost for termination of the existing lease amounted to approximately $3.4 million including a termination fee of approximately $2.7 million plus real estate fees, legal fees, relocation costs and impairment of property and equipment. The termination fee of $2.7 million was satisfied by the issue of 150,000 common shares (with an approximate value of $0.3 million) and cash payment of $0.2 million on closing, followed by 22 equal monthly payments of $0.1 million plus interest at 6%. The Company has moved its sales and product support activities to a smaller and less costly facility in Fort McMurray. 13 Seasonality The Company s interim period revenues and earnings historically follow a weather-related pattern of seasonality. Typically, the first quarter is the weakest quarter as construction and infrastructure activity is constrained in the winter months. This is followed by a strong increase in the second quarter as construction and other contracts begin to be put out for bid and companies begin to prepare for summer activity. The third quarter generally tends to be slower from an equipment sales standpoint, which is partially offset by continued strength in equipment rentals and product support activities. Fourth quarter activity generally strengthens as companies make year-end capital spending decisions in addition to the exercise of purchase options on equipment that has previously gone out on rental contracts. 14 Economic relationship The Company sells and services equipment and related parts. Distribution agreements are maintained with several equipment manufacturers, of which the most significant are with Volvo Construction Equipment North America Inc., Case Corporation and The Manitowoc Company Inc. The distribution and servicing of Volvo, Case and Manitowoc products account for a substantial portion of the Company s operations. The Company has had an ongoing relationship with Volvo since 1991, Case since 1998 and with the Manitowoc group of companies since 1965, together representing approximately 90% of revenues. 12