Hammond Power Solutions Inc. — Management Reports 2021

Mar 25, 2021

Management’s Discussion and Analysis

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Hammond Power Solutions Inc. (“HPS” or the “Company”) is a leader in the design and manufacture of custom electrical engineered magnetics, standard electrical dry-type, cast resin and liquid filled transformers. Advanced engineering capabilities, high quality products and fast responsive service to customers’ needs have established the Company as a technical and innovative manufacturer serving the electrical and electronic industries. The Company has manufacturing plants in Canada, the United States (“U.S.”), Mexico, and India.

The following is Management’s Discussion and Analysis (“MD&A”) of the Company’s consolidated financial position and performance for the years ended December 31, 2020 and 2019, and should be read in conjunction with the accompanying Consolidated Financial Statements of the Company as at December 31, 2020 and 2019, which have been prepared in accordance with International Financial Reporting Standards (“IFRS”). This information is based on Management’s knowledge as at March 25, 2021. All amounts in this report are expressed in thousands of Canadian dollars unless otherwise noted. Additional information relating to the Company may be found on SEDAR’s website at www.sedar.com or on the Company’s website at www. hammondpowersolutions.com.

Caution regarding forward-looking information

This MD&A contains forward-looking statements that involve a number of risks and uncertainties, including statements that relate to among other things, HPS’ strategies, intentions, plans, beliefs, expectations and estimates, and can generally be identified by the use of words such as “may”, “will”, “could”, “should”, “would”, “likely”, “expect”, “intend”, “estimate”, “anticipate”, “believe”, “plan”, “objective” and “continue” and words and expressions of similar import. Although HPS believes that the expectations reflected in such forward-looking statements are reasonable, such statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors or assumptions are applied in making forward-looking statements, and actual results may differ materially from those expressed or implied in such statements. Important factors that could cause actual results to differ materially from expectations include but are not limited to: general business and economic conditions (including but not limited to currency rates); changes in laws and regulations; legal and regulatory proceedings; and the ability to execute strategic plans. HPS does not undertake any obligation to update publicly or to revise any of the forward-looking statements contained in this document, whether as a result of new information, future events or otherwise, except as required by law.

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Additional GAAP and Non-GAAP measures

This document uses the terms “earnings from operations” which represents earnings before finance and other costs/(income) and income taxes. “EBITDA” is also used and is defined as earnings before interest, taxes, depreciation and amortization. Adjusted EBITDA from continuing operations represents EBITDA from continuing operations adjusted for foreign exchange gain or loss. Operating earnings, EBITDA and Adjusted EBITDA are some of the measures the Company uses to evaluate the operational profitability. The Company presents EBITDA to show its performance before interest, taxes and depreciation and amortization. Management believes that HPS shareholders and potential investors in HPS use additional GAAP and non-GAAP financial measures, such as operating earnings, EBITDA and Adjusted EBITDA in making investment decisions about the Company and to measure its operational results. A reconciliation of earnings from operations, EBITDA and Adjusted EBITDA to net earnings for the years ended December 31, 2020 and December 31, 2019 is contained within this MD&A. Earnings from operations, EBITDA and Adjusted EBITDA should not be construed as a substitute for net earnings determined in accordance with IFRS.

“Order bookings” represent confirmed purchase orders for goods or services received from our customers. “Backlog” represents all unshipped customer orders. “Book value per share” is the total shareholders’ equity divided by the average outstanding shares. The terms “earnings from operations”, “EBITDA”, “adjusted EBITDA”, “order bookings”, “backlog” and “book value per share” do not have any standardized meaning prescribed within IFRS and therefore may not be comparable to similar measures presented by other companies.

The Company’s 2020 consolidated financial statements, which comprise the consolidated statements of financial position as at December 31, 2020 and December 31, 2019, the consolidated statements of operations, comprehensive income , changes in equity and cash flows for the years ended December 31, 2020 and December 31, 2019, and Notes thereto, have been prepared under IFRS.

Overview

HPS is a transformer industry leader, providing superior quality, custom engineered and standard product solutions, broad offerings and market access through multiple sales channels which makes us an essential

service business and has allowed us to continue to operate during the global coronavirus (“COVID-19”) pandemic. HPS has continued to produce transformers for our customers throughout the entire pandemic period while also supporting and ensuring employee safety during this time. The pandemic has had a significant impact on our business 2020 and continues to influence our daily operations.

Demand for our product is stable, however sales volumes will be determined primarily by which industries and customers are continuing to operate and in what capacity. Later in the year we saw activity in the project and industrial markets that had stalled when the pandemic gained momentum in North America while other markets continued to struggle. The Canadian lockdown imposed in early 2020 and again in early 2021 continues to impact several of our markets.

HPS’ North American sales volumes experienced a reduction in 2020 as COVID-19 impacted many of our customers’ industries. While our sales dollars have declined, our market share continues to grow thus mitigating some of the decline that many companies in the electrical industry have seen. The Company continued to escalate its North American market share growth, particularly through its North American Electrical Distributor (“NAED”) channel. While our sales volume declined, our financial results were supported in other ways – varied sales mix, achieved price increases, decreased commodity costs, receipt of the Canadian Emergency Wage Subsidy (“CEWS”) benefit and cost reductions.

The Company has incurred significant costs related to COVID-19 to ensure the safety of our employees. HPS has been fortunate that there have been a limited number of cases impacting our employees and their families to date. We continue to ensure our efforts do not waiver as the length of the pandemic continues to extend. HPS’ health and safety practices, including remote work where possible, have allowed the Company to continue to operate during the pandemic ensuring business continuity and supplying our customers with the products they need.

HPS’ history of success has been achieved through its commitment to producing quality, innovative, energy efficient, diverse transformers and related magnetic products. The Company’s alignment of its operational initiatives and strategic vision enhances these competitive differentiators. HPS has a well-established and growing market presence and a focus on continued growth through current and new customers and products.

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The Company has a strong financial footing that allows for continued focus on market share growth. The Company’s increased global footprint provides a gateway to new technologies, customers and markets. These strengths are important to future revenue and earnings growth.

Technology and know how obtained through acquisitions have allowed the Company to accelerate the research and development program of its cast resin transformer technology and product development which are now manufactured in several HPS facilities.

Despite the challenges, 2020 was a successful year financially for HPS. Solid sales and marketing strategies increased organic customer sales and market share growth was realized in markets not as heavily impacted by COVID-19. Increased gross margin rates combined with excellent manufacturing performance as well as effectively managed general and administrative expenses positively impacted HPS’ profitability and financial performance. The financial performance of Corefficient was reasonable as the joint venture experienced decreased revenues due to COVID-19.

Looking forward, in an effort to deliver resilient financial performance, HPS continues to concentrate on sales growth, gross margin generation and operational improvement. Globally in the U.S., Canada and Asia, HPS is well situated for electrical industry market share growth and continues to be a leader in the markets it serves. The Company continues to build market presence through its product capabilities, product quality, cost effectiveness, service and geographical market expansion.

While we experience some sales variability with fluctuations in the markets and those of our customer industries which have a direct impact on our revenue, there are indications that overall market activity will be fairly robust. Booking rates have decreased from 2019 but are still at a healthy level going into 2021. The benefit of the HPS diversified market approach allows for the capitalization of growth in expanding market segments, while counterbalancing the impact of cyclical market declines. A portion of annual sales are derived from major customer projects, for which exact timing continues to be difficult to predict and will influence quarterly sales fluctuations. Order booking rates continue to grow in strategic target markets delivering additional market share penetration, new account development and expansion of organic sales. HPS is consistent in calculating the risks and opportunities that are present and unyielding in the execution of our strategies; there are many opportunities to be recognized.

The industry outlook is very difficult to predict as the

full extent of COVID-19 continues to be unknown. While vaccinations will begin to positively improve the economy, the timing of when the majority of the population will be vaccinated is very unclear given delays in shipments and worldwide ingredient shortages. As always, we expect to see some global economic growth in certain sectors yet declines in others. We are optimistic in continued market improvement later into 2021, particularly in North America. HPS is cognizant of the resource-based commodity cost uncertainty, the variability of foreign currencies and the growing risks to the global economy caused by trade wars and the impacts of tariffs.

HPS remains confident in its ability to generate growth – through our strategic vision merged with our operational strategies. Management is aware of the need to plan and build for the future and is determined to proactively confront the profitability pressures presented in the market. The Company is persistent in identifying and developing new market opportunities which will come from organic and new customer sales expansion, product and technology development, cost effectiveness, competitive lead-times and manufacturing flexibility. Our capabilities are extended through our multi-national operations which provide expanded market opportunities, allowing HPS to deliver results. The Company’s commitment to continuous improvement, cost reduction, improved efficiencies and overall cost effectiveness will assist in reaching these goals. These strategies will improve and build revenue and profitability trends.

The combination of a secure financial foundation, strong business fundamentals and strategic vision positions HPS for growth as well as creating stakeholder value. The future of HPS is not only in its focus on market share and sales growth, but also on improving its cost competitiveness. The Company maintains a strong and stable balance sheet and excellent liquidity supported by a committed credit facility available to implement investment strategies, operational plans and advance growth initiatives. The Company’s current North American credit agreement matures in June 2021. The Company is currently in the process of finalizing a new 5-year agreement.

HPS gained significant momentum in 2019, continued to hold steady in 2020 and is positioned well to continue to grow and execute its vision into 2021.

Sales

Sales from continuing operations in 2020 were $322,097 as compared to sales of $358,782 in 2019, a decrease

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of $36,685 or 10.2%.

U.S. market sales (stated in Canadian dollars) were $198,324, a decrease of $27,385, or 12.1%, compared to 2019 sales of $225,709. U.S. sales, (stated in U.S. dollars), have decreased from $170,073 in 2019 to $147,561 in 2020, a decline of $22,512 or 13.2%. The U.S. market experienced declines in the motor control, private-branding, mining and NAED markets.

Sales were favorably impacted by the strengthening of the U.S. dollar relative to the Canadian dollar. The average U.S. to Canadian exchange rate for 2020 was $1.343 versus $1.327 in 2019, a U.S. dollar strengthening of 1.2%.

Canadian sales were $109,080, a decrease of $7,916 or 6.8% as compared to sales of $116,996 in 2019. The Canadian market suffered declines in the NAED, capital equipment and motor control markets.

Indian sales in 2020 were $14,693, a decrease of $1,384 or 8.6% compared to sales of $16,077 in 2019. The decline in India is largely COVID-19 related as the pandemic dramatically constrained the Indian market, leading to delays in projects because of government imposed lockdowns.

Stated by geographic segment, sales from continuing operations in the U.S. were 61.6% (2019 – 62.9 %), Canadian were 33.9% (2019 – 32.6 %) and India sales accounted for 4.5% (2019 – 4.5 %) of our total sales.

The Company experienced declines in North American sales through its established NAED and OEM channels which were significantly impacted by COVID-19, resulting in an overall drop in demand, project deferrals and cancellations. Despite the pandemic, HPS is growing its market share through distributor conversions and its custom transformer capabilities. The ability to continue to expand these segments is also a result of new customer additions, organic customer diversity, expanded product offerings and geographically diverse manufacturing capabilities. HPS is not single-market or industry dependent and our market diversification strategies provide a natural business hedge.

HPS is committed to its growth strategy through our focus on product development, innovative research and development projects, capital expenditure program to increase capacity, vertical integration strategies, business development activities and its expanded NAED network. The Company will continue to grow market share globally as a result of expanded product offerings, the addition of new customers, geographically diverse manufacturing facilities and market influence. HPS prides itself on providing value to our customers.

The Company is committed to consistent quality, competitive product design, expertise in custom engineered products and product breadth. These factors combined with a strong, effective distribution channel and multi-national manufacturing capabilities will continue to be a competitive advantage for the Company and important to continued revenue growth.

Order bookings and backlog

Overall, 2020 bookings decreased by 14.1% over the prior year. In 2020 direct sales bookings decreased by 22.3% and bookings in the distributor channel decreased by 8.4%. The decrease in both the direct and distributor channels can be directly attributed to the impact of the COVID-19 pandemic on overall business activity which first began in March 2020 and continues to persist. Although bookings were lower across a number of market and geographical segments, the Company still achieved increased market share in the distributor channel due to expansion in the number of distributors carrying the HPS line and late-year strengthening of demand in a broad base of market segments.

The Company’s December 31, 2020 backlog decreased by 4.7% as compared to December 31, 2019, due to lower bookings in both channels but did increase 1% over Quarter 3, 2020. It is expected the combination of the Company’s strategic sales initiatives, service, dominant distributor footprint and new product development will support booking rates.

HPS is sensitive to the volatility and unpredictability of current global economies and the impact that this could have on booking trends. While several markets are seeing positive quotation and order trends, the Company is very cognizant that it may see some volatility and unpredictability in longer term booking rates.

Gross margin

The consolidated gross margin rate from continuing operations in 2020 increased to 27.0% versus 24.5% in 2019, an increase of 2.5% of sales. The improvement in margin rates is attributed to favourable sales mix, selling price increases, receipt of the CEWS benefit and cost reductions.

The CEWS program provides an employee wage subsidy for our Canadian entities for periods where there was a significant decline in Canadian trade sales due to the impact of COVID-19. During 2020, the wage subsidy received for production labour was $5,557 or 1.7% of sales. The Company did incur additional operating

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expenses of $1,902 during 2020 relating to amounts paid for suspended operational employee wages, nonproductive wages support for “at risk” employees, employee transportation, increased cleaning, sanitation and personal protective equipment expenses for the safety of employees. Excluding the wage subsidy and COVID-19 related expenses, the Company still delivered an increase in its gross margin rate of 1.4%.

Demand for our product is stable, however sales volumes will be determined primarily by which industries and customers are continuing to operate and in what capacity. Later in the year we saw activity in some markets that had stagnated when the pandemic originally started in North America while other markets continue to struggle.

HPS continues to focus on price realization strategies and achievement of cost reductions in an effort to maintain or increase margin rates. Fluctuating markets, product mix and the effect of COVID-19 on the current global economy will have a short-term impact on financial results. Looking forward, the unpredictability of the economic, social and industrial impact of the pandemic and the effect on business activity, combined with a slightly decreased backlog provides an indication of predictability caution for 2021. HPS was identified as an essential service in all countries that we operate in, and was able to continue to manufacture with the exception of India where the country was in lockdown at the end of the first quarter and a large portion of the second quarter.

Margin rates can be sensitive to selling price pressures, volatility in commodity costs, customer mix and geographic blend. The Company continues to combat competitor short-sighted pricing strategies through its total value-added engineered solutions. HPS’ focus during the year has been on execution of its selling price realization strategies and achievement of cost reductions in an effort to lift margin rates.

While some growth strategies can have a shorterterm dilutive effect on gross margin rates, the Company continues to focus on the long-term investment to fuel future growth. Gross margin rates are supported by the maintenance of market prices combined with material procurement and engineering cost reduction initiatives. The Company aggressively implemented a number of cost reduction and expense management initiatives to offset the lower absorption of factory overheads from the reduction in manufacturing throughput due to the lower sales. HPS is currently investing in the support of future sales growth and new product development.

Quotation activity, improving bookings and backlog from the end of 2020 as well as an encouraging sales outlook, continue to provide a degree of optimism for the future. Looking ahead, HPS remains cautiously optimistic for the future as growth will be realized in some markets along with a decline in others – underscoring the volatility of markets and sales demand. Over the past few years, to manage the impact of volatility, the Company widened its distributor footprint in North America, expanded its Indian market presence, implemented engineering and material cost reduction initiatives, invested in new product development and broadened manufacturing capabilities. A diversified geographic approach supports anticipated growth from implemented market strategies and subsequent economic improvement.

HPS continues to commit resources to its continuous improvement program, which will result in implementing productivity enhancements, cost reductions and leadtime improvements across the entire organization. HPS is confident that these actions will enhance future margin rates and improve profitability and overall financial performance.

Selling and distribution expense

Total selling and distribution expenses from continuing operations were $40,217 for 2020 versus $41,476 in 2019, a decrease of $1,259 or 3.0%. On a percentageof-continuing-sales basis, total selling and distribution expense increased to 12.5% of sales for 2020 from 11.6% in 2019. The increase in the percentage of sales is due to the reduced sales for 2020. Lower sales value for the year resulted in a lower commission expense of $560 and lower freight expense of $390 which are variable selling expenses that naturally decline with lower sales. Reduced travel expenses and the CEWS benefit of $776 or 0.2% of sales also contributed to the decline in expenses. These declines were partially offset by higher USD exchange rate.

General and administrative expense

General and administrative expenses from continuing operations in 2020 were $24,736 compared to $25,940 for 2019, a decrease of $1,204 or 4.6%. On a percentageof-continuing-sales basis these costs have increased from 7.2% in 2019 to 7.7% in 2020. The increase in the percentage of sales is due to the reduced sales for 2020. During the year there was a reversal of an abnormal expected credit loss provision related to the settlement of the note receivable balance in the amount of $956.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

The CEWS benefit related to general and administrative employees was $1,950 or 0.6% of sales, which was partially offset by a higher USD exchange rate. HPS continues to invest in growth while remaining very cognizant of prudent general and administrative expense management.

Earnings from continuing operations

Earnings from continuing operations surged, finishing at $22,041 in 2020, as compared to earnings of $20,543 in 2019 – an increase of $1,498 or 7.3%. The increase in earnings from operations is due to CEWS wage subsidy support off-setting lower gross margin dollars and increased operating expenses related to the pandemic. Earnings from operations are calculated as outlined in the following table:

in the following table:
		2020		2019
Net earnings from
continuingoperations
for the year	$	14,062	$	13,306
Add:
Income tax expense		6,904		5,882
Finance and other costs		1,075		1,355
Earnings from continued
operations	$	22,041	$	20,543

Net finance and other costs

Net finance and other costs decreased $280 from $1,355 in 2019 to $1,075 in 2020. The decrease from prior year is a result of lower interest expense offset by a decrease in the foreign exchange gain and lower income from the joint venture.

Interest expense from continuing operations for the year-ended December 31, 2020 finished at $1,247 as compared to $1,739 in 2019, a decrease of $492. The decrease in interest expense year-over-year was due to the decrease in operating debt levels throughout the year – a result of lower working capital requirements. Interest expense includes all bank fees.

The foreign exchange gain from continuing operations in 2020 of $123 related primarily to the transactional exchange gain of the Company’s U.S. dollar trade accounts payable in Canada, compared to a foreign exchange gain of $234 in 2019. The decrease of the foreign exchange gain for the year is related to the volatility in the exchange rates during the year – primarily the U.S. dollar which increased 1.2% relative to the Canadian dollar in 2020. As at December 31, 2020, the Company had outstanding foreign exchange contracts in place for 17,500 Euros

(“EUR”), $12,500 USD and 330,000 INR – all of which were implemented as an economic hedge against translation gains and losses on inter-company loans as well as $46,500 USD to economically hedge the U.S. dollar denominated accounts payable in Canadian HPS operations.

The ongoing volatility is managed by HPS’ foreign exchange contract hedging program. Details of the outstanding forward foreign exchange contracts at December 31, 2020 can be found in note 29 in the Notes to Consolidated Financial Statements included in our 2020 Annual Report.

Earnings from continuing operations, before income tax

2020 earnings before income taxes was $20,966 as compared to earnings of $19,188 in 2019, – growing by $1,778 or 9.3%. The main contributors to the higher current year earnings before income tax were gross margin rate improvement, decreases in selling, distribution, general and administration expenses as a result of lower variable selling costs, focused expense management and government wage subsidy support in the current year offset by decreased gross margin dollar contributions.

Income taxes

Income tax expense from continuing operations for 2020 was $6,904 as compared to $5,882 in 2019 – an increase of $1,022 or 17.4%. The consolidated effective tax rate on earnings from continuing operations for 2020 increased to 32.9% versus 30.7% last year – an increase of 2.2%.

The Company’s deferred tax assets and liabilities are related to temporary differences in various tax jurisdictions, primarily reserves and allowances, which are not deductible in the current year. A difference in the carrying value of property, plant and equipment and intangible assets for accounting purposes and for tax purposes is a result of business combination accounting and a different basis of depreciation utilized for tax purposes. The Company’s income tax provision is explained further in note 16 in the Notes to Consolidated Financial Statements included in our 2020 Annual Report.

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Net earnings from continuing operations

Net earnings from continuing operations for 2020 finished at $14,062 compared to net earnings of $13,306 in 2019, an increase of $756 or 5.7%. The increase in the net earnings from continuing operations is a result of gross margin rate improvement, decreases in selling, distribution, general and administration expenses as a result of lower variable selling costs, focused expense management and government wage subsidy support in the current year offset by decreased gross margin dollar contributions.

Discontinued operations and restructuring charges

HPS executed several strategic restructuring plans to advance and expedite profitability improvement and cost competitiveness.

During 2019, the Company continued the closure process of the Italian facility and was successful in selling the machinery and equipment, inventory and certain employee related liabilities to a third party. The Asset Purchase and Sale Agreement closed in late November 2019 for a sale price of 1,086 EUR (approximately $1,583) and resulted in a loss on disposal of 471 EUR (approximately $687). Also, as a result of this transaction, 1,369 EUR (approximately $2,035) of the 2018 restructuring provision for severances that were accrued but not paid was reversed. This recovery was partially offset by additional restructuring charges totaling 897 EUR (approximately $1,307) for cancellation costs, legal fees and additional expected credit losses. These restructuring costs are included in loss from discontinued operations in the Financial Statements. The loss from discontinued operations for 2019 was $1,699.

The 2020 Italy operations consist of investment properties which has been consolidated into continuing operations. During 2020 the cancellation and closure costs of $855 were paid and $92 of the provision was reversed into income. The expected credit loss related to the VAT receivable continues to be provided for and is included in the net accounts receivable value in the amount of $339.

EBITDA

EBITDA from continuing operations for the year-ended December 31, 2020 was $29,482 versus $28,175 in 2019 – an increase of $1,307 or 4.6%. Adjusted for foreign exchange gains, adjusted EBITDA for 2020 was $29,359 versus $27,941 in 2019 – an increase of $1,418 or 5.1%.

EBITDA and adjusted EBITDA is calculated as outlined in the following table:

	2020	2019
Net earnings from continuing operations
Add:	$ 14,062 $	13,306
Interest expense	1,247	1,739
Income tax expense	6,904	5,882
Depreciation and amortization	7,269	7,248
EBITDA from continuingoperations	$ 29,482 $	28,175
Subtract :
Foreign exchangegain	(123)	(234)
Adjusted EBITDA from continuingoperations	$ 29,359 $	27,941

ANNUAL REPORT 2020

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Summary of quarterly financial information (unaudited)

Fiscal 2020 Quarters	Q1	Q2	Q3	Q4	Total
Sales	$ 88,420	$ 75,393	$ 78,115	$ 80,169	$ 322,097
Net earnings	$ 2,148	$ 4,420	$ 3,462	$ 4,032	$ 14,062
Net earnings per share – basic	$ 0.18	$ 0.38	$ 0.30	$ 0.34	$ 1.20
Net earningsper share – diluted	$ 0.18	$ 0.38	$ 0.30	$ 0.34	$ 1.20
Average U.S. to Canadian exchange rate	$ 1.3388	$ 1.3907	$ 1.3346	$ 1.3087	$ 1.3432
Fiscal 2019 Quarters	Q1	Q2	Q3	Q4	Total
Sales	$ 84,690	$ 91,937	$ 91,502	$ 90,653	$ 358,782
Net earnings from continuing operations	$ 2,508	$ 3,352	$ 3,595	$ 3,851	$ 13,306
Net earnings per share from continuing operations – basic	$ 0.21	$ 0.29	$ 0.31	$ 0.32	$ 1.13
Net earnings per share from continuingoperations – diluted	$ 0.21	$ 0.29	$ 0.31	$ 0.32	$ 1.13
Average U.S. to Canadian exchange rate	$ 1.3301	$ 1.3379	$ 1.3198	$ 1.3203	$ 1.3270

Quarterly sales for 2020, with the exception of Quarter 1, decreased from the same quarter in 2019 due to the impact of COVID-19. Quarter 2, 2020 was the first quarter where the company saw sales declines due to the pandemic. While year-over-year there has been a decline the sales volume has increased from Quarter 2 to Quarter 4. There continues to be significant fluctuations of sales volumes in various markets, with some markets being more heavily impacted by COVID-19 than others. Sales for 2020 have been favourably impacted due to small fluctuations in exchange rates.

Gross margin rates for the fourth quarter have increased from the same quarter last year and year-to-date margins have also increased despite a slight decline in the first quarter of the same year. The margin improvement can be attributed to sales mix, market specific pricing, raw material commodity costs and cost reductions and expense containment. HPS Canadian entities received the CEWS government subsidy to partially offset additional costs related to managing COVID-19.

Changing and challenging economic conditions, changes in product mix and competitive pricing pressures have all had an impact on the year-over-year quarterly fluctuations for both sales and income.

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Quarter 4, 2020 financial results

Quarter 4, 2020 fnancial results
	Quarter ended	Quarter ended
	December 31,	December 31,
	2020	2019
Sales	$ 80,169	$ 90,653
Gross margin rate	28.9%	25.7%
Earnings from operations	$ 7,047	$ 5,862
Exchange loss (gain)	$ 401	$ (154)
Net earnings	$ 4,032	$ 3,211
Net earnings from continuing operations	$ 4,032	$ 3,851
Earnings per share – basic	$ 0.34	$ 0.27
Earnings per share – diluted	$ 0.34	$ 0.27
Earnings per share from continuing operations – basic	$ 0.34	$ 0.32
Earnings per share from continuing operations – diluted	$ 0.34	$ 0.32
Cash provided by operations	$ 8,073	$ 16,447

Sales for the quarter ended December 31, 2020 were $80,169, a decrease of $10,484 or 11.6% from the comparative quarter last year, which is reflective of decreased market activity due to the impact of COVID-19.

Quarter 4, 2020 gross margin dollars decreased slightly by $102 compared to Quarter 4, 2019. The gross margin rate increased to 28.9% in Quarter 4, 2020 versus 25.7% in Quarter 4, 2019 as a result of sales mix and the receipt of the CEWS government subsidy.

Total selling and distribution expenses amounted to $10,202 in Quarter 4, 2020 versus $9,924 in Quarter 4, 2019 – an increase of $278 or 2.8%. Selling and distribution expenses as a percentage of sales have increased to 12.7% in 2020 compared to 10.9% in 2019 – a result of the decline in sales.

General and administrative expenses for Quarter 4, 2020 totaled $5,950, a decrease of $1,565 when compared to Quarter 4, 2019 costs of $7,515. The prior year abnormal expected credit loss provisions primarily related to our international operations account for the current year decrease. General and administrative expenses as a percentage of sales have decreased to 7.4% in 2020 compared to 8.3% in 2019.

Quarter 4, 2020 net finance and other costs were $582 compared to $369 for the same quarter in 2019, an

increase of $213 or 57.7%. The Quarter 4, 2020 interest cost decreased from $679 in Quarter 4, 2019 to $296 in Quarter 4, 2020 – a result of lower bank indebtedness levels. Foreign exchange loss in Quarter 4, 2020 was $401 compared to a foreign exchange gain of $154 in Quarter 4, 2019.

Earnings from operations for the quarter were positively impacted by lower general and administrative expenses, offset by decreased sales, less gross margin dollar contribution and higher selling and distribution expenses. Quarter 4, 2020 earnings from operations increased $1,185 from earnings of $5,862 in Quarter 4, 2019 to earnings of $7,047 in Quarter 4, 2020.

Quarter 4, 2020 income tax expense was $2,433 on earnings before income taxes of $6,465 (an effective tax rate of 37.6%) as compared to an income tax expense of $1,642 on income before income taxes of $5,493 (an effective tax rate of 29.9%) in Quarter 4, 2019 – an increase of $791.

Net earnings from continuing operations for Quarter 4, 2020 was $4,032 compared to net income of $3,851 in Quarter 4, 2019 – an improvement of $181.

Cash provided by operations for Quarter 4, 2020 was $8,073 versus $16,447 in Quarter 4, 2019 – a decrease of $8,374. A decrease in the cash generated from operations

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was the main driver of the lower value for the quarter. Quarter 4, 2020 had non-cash working capital usage of $825, compared to Quarter 4, 2019 were non-cash working capital generated by operations was $7,926.

Overall operating debt balance, net of cash, was $1,278 as at December 31 2020, a decrease of $8,048 as compared to a net debt balance of $9,326 as at December 31, 2019, primarily reflecting improved profitability, cash generated from operations and the receipt of the CEWS government subsidy.

Capital resources and liquidity

The Company continued to focus on generating cash from operations, debt management, investment and liquidity.

Cash provided from operating activities during 2020 was $19,683 versus $17,810 in 2019, an increase in cash generated of $1,873. This increase in cash generated from operating activities was due to higher net income. Non-cash working capital used cash of $4,992 in 2020 versus $6,374 in 2019, resulting in a decrease of $1,382 from 2019. The change in non-cash working capital for 2020 was primarily a result of decreases in accounts receivable and inventory, offset by decreases in accounts payable and foreign exchange adjustments.

Accounts receivable finished the year at $53,078 as compared to $64,004 as at December 31, 2019, a decrease of $10,926 – a result of lower sales and higher collections in Quarter 4, 2020 compared to Quarter 4, 2019. HPS’ days sales outstanding ratio remains below industry standards, which can be attributed to effective credit policies and tightly managed accounts receivable administration.

Inventories finished the year at $49,206 as at December 31, 2020, versus $50,926 as at December 31, 2019, a decrease of $1,720. The higher inventory levels in 2019 were attributed to a buildup of inventory to satisfy a predicted increase in 2020 sales volume.

Accounts payable and accrued liabilities, excluding derivative liability, decreased by $10,597 finishing at $44,227 as at December 31, 2020 compared to $54,824 at the end of 2019. The change in accounts payable is related to the timing of purchases from and payments to suppliers.

Net income taxes payable were $454 (income taxes receivable of $488 less income taxes payable of $942) as at December 31, 2020, versus net income taxes receivable of $571 (income taxes receivable of $1,626 less income taxes payable of $1,055) as at December 31, 2019 – a change of $1,025 due to increased Quarter 4, 2020 earnings.

Cash used in financing activities was $24,184 in 2020, compared to cash used of $7,393 in 2019, a change of $16,791. The change in the balance can be attributed to higher repayment of bank operating lines in 2020 compared to 2019 and higher dividend payments.

Cash used in investing activities in 2020 increased $1,779 from $2,968 in 2019 to $4,747 in 2020, a result of the prior year including proceeds on disposal of Italian assets of $1,583 which offset cash outflows in this category. There was an increase in capital spending for property, plant and equipment of $540 over the prior year, totaling $4,222 in 2020 – compared to $3,682 for 2019. The Company continues to invest in the areas of manufacturing processes and capabilities as well as information technology, product and research development.

Bank operating lines of credit finished the year at $16,073 as at December 31, 2020, compared to $32,697 as at December 31, 2019 resulting in a large decrease of $16,624 in the year. The Company had cash and cash equivalent balances of $14,795 as at December 31, 2020 as compared to $23,371 as at December 31, 2019.

Overall operating debt balance, net of cash, was $1,278 as at December 31 2020, an improvement of $8,048 as compared to a net debt balance of $9,326 as at December 31, 2019, primarily reflecting improved profitability and cash generated from operations.

All bank covenants were met as at December 31, 2020, and the Company was in compliance with its covenants throughout the year.

The Company’s liquidity is strong. HPS is well funded, with sufficient cash and debt capacity to fund its operating activities, investments and strategic growth initiatives. The Company has several alternatives to fund future capital requirements, including its existing cash position, credit facility, future operating cash flows and debt financing. The Company continually evaluates these options to ensure that the appropriate mix of capital resources is effectively managed for current and future requirements.

The Company has outstanding capital expenditure commitments of $1,029 primarily for manufacturing efficiency improvement projects and capacity expansion. These ongoing projects are in support of future business development and growth.

Additional details of our change in non-cash working capital can be found in note 27 in the Notes to Consolidated Financial Statements contained in our 2020 Annual Report.

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Credit agreement

The Company’s current credit agreement consists of a $40,000 U.S. revolving credit facility and a $10,000 U.S. delayed draw credit facility. The revolving borrowing can be comprised of U.S. Prime Borrowings, Canadian Prime Borrowings, CDOR Borrowings or LIBOR Borrowings. This agreement aligns our Canadian and U.S. banking requirements, supports our hedging strategies and provides financing for our operational requirements and capital for our strategic initiatives. The Company has access to a 4,070 EUR facility that matures in May 2021, made up of a 3,750 EUR revolver and 250 EUR overdraft facility, as well as a 70 EUR letter of credit line. Hammond Power Solutions Private Limited (“HPS India”) maintains a demand credit facility of 375,000 INR, consisting of a 131,000 INR short-term working capital demand loan facility and a 244,000 INR bank guarantee and letters of credit facility.

Based on exchange rates in effect at December 31, 2020, the combined Canadian dollar equivalent available prior to any utilization of these facilities was $76,477.

The Company’s current North American credit agreement matures in June 2021. The Company is currently in the process of finalizing a new 5-year agreement.

Contractual obligations

The following table outlines payments due for each of the next 5 years and thereafter related to debt, lease, purchase and other long-term obligations.

	2021	2022	2023	2024	2025 & Thereafter	Total
Accounts payable and accrued liabilities	$ 44,227	–	–	–	–	$ 44,227
Capital expenditure purchase commitments	1,029	–	–	–	–	1,029
Operating lines of credit	16,073	–	–	–	–	16,073
Derivative liability	1,952	–	–	–	–	1,952
Lease liabilities	2,719	2,622	1,848	1,675	1,577	10,441
Total	$ 66,000	$ 2,622 $	1,848 $	1,675	$ 1,577	$ 73,722

Hammond Power Solutions S.p.A. – Italy

As part of the VPI asset sale agreement, the lease agreement relating to the Meledo, Italy building includes a put and call sale option related to the leased premises, exercisable within 60 days after September 30, 2023. The call option grants the purchaser an option to purchase the premises from the Company for consideration equal

to 2,225 EUR. The plant purchase price will be reduced by 50% of the monthly rent installments received, to a maximum of 375 EUR (approximately $573). If the purchaser does not execute the call option HPS can exercise its put option which grants HPS an option to sell the plant to the purchaser for consideration equal to the same plant purchase price. If the purchaser rejects the put option, the purchaser will pay 500 EUR (approximately $764) as liquidated damages.

Contingent liabilities

In June 2017, the Corporation received notice of an environmental claim from the owner of a property located nearby to a property that was once partially owned by the Corporation. At this time the Company feels that there is no merit to the claim.

Management is not aware of any further contingent liabilities.

Regular quarterly dividend

The Board of Directors of HPS declared a 21.4% increase in the quarterly cash dividend to eight and a half cents ($0.085) per Class A Subordinate Voting Share of HPS and of eight and a half cents ($0.085) per Class B Common Share of HPS.

The Quarter 1 dividend was paid on March 26, 2020 to shareholders of record at the close of business on March 19, 2020 – the ex-dividend date was March 18, 2020. The Quarter 2 dividend was paid on June 18, 2020 to shareholders of record at the close of business on the 11th day of June 2020 – the ex-dividend date was June 10, 2020. The dividend for Quarter 3 was paid on September 28, 2020 to shareholders of record at the close of business on September 21, 2020 – the ex-dividend date was September 18, 2020. The Quarter 4 dividend was paid on December 9, 2020 to shareholders of record at the close of business on December 2, 2020 – the ex-dividend date was December 1, 2020.

In 2020, the Company has paid a total cash dividend of thirty-four cents ($0.34) per Class A Subordinate Voting Share and thirty-four cents ($0.34) per Class B Common Share compared to 2019, the Company had paid a total cash dividend of twenty-eight cents ($0.28) per Class A Subordinate Voting Share and twenty-eight cents ($0.28) per Class B Common Share.

ANNUAL REPORT 2020

39

MANAGEMENT’S DISCUSSION AND ANALYSIS

Controls and procedures

The Chief Executive Officer and the Chief Financial Officer are responsible for establishing and maintaining disclosure controls and procedures and for establishing and maintaining adequate internal controls over financial reporting. The control framework used in the design of disclosure controls and procedures and internal control over financial reporting is the 2013 Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“2013 COSO Framework”). Our internal control system was designed to provide reasonable assurance to our Management and Board of Directors regarding the preparation and fair presentation of published financial statements in accordance with International Financial Reporting Standards. All internal control systems, no matter how well designed, have inherent limitations, therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

As at December 31, 2020, the Company conducted an evaluation, under the direction and supervision of the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2020 such disclosure controls and procedures were operating effectively.

The Company aggressively bolstered its internal controls of the operation, including the implementation of the Enterprise Resource Planning System (“ERP”) system and additional third party audits.

Internal controls over financial reporting

Management is responsible for establishing and maintaining adequate internal controls over financial reporting. Our internal control system was designed to provide reasonable assurance to our Management and Board of Directors regarding the preparation and fair presentation of published financial statements in accordance with International Financial Reporting Standards. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Canadian Securities Administrators require that companies certify the effectiveness of internal controls

over financial reporting. It also requires a company to use a control framework such as the COSO Framework to design internal controls over financial reporting. As well, the threshold for reporting a weakness of internal controls over financial reporting should be of a “material weakness” rather than “reportable deficiency.” HPS has designed its internal controls in accordance with the COSO Framework and has carried out retesting in 2020, which was completed in the fourth quarter.

As of December 31, 2020 Management, with the supervision and participation of the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting. Based on that assessment, the Chief Executive Officer and Chief Financial Officer have concluded that the internal controls are effective and that there were no material weaknesses in the Company’s internal control over financial reporting as of December 31, 2020.

Changes in internal control over financial reporting and disclosure controls and procedures

During 2020 there were no material changes identified in HPS’ internal controls over financial reporting that had materially affected, or were reasonably likely to materially affect HPS’ internal control over financial reporting. HPS does carry out ongoing improvements to its internal controls over financial reporting but nothing considered at a material level. .

Subsequent events

Dividends

On March 5, 2021, the Company declared a dividend of eight and a half cents ($0.085) per Class A subordinate voting shares of HPS and a quarterly cash dividend of eight and a half cents ($0.085) per Class B common shares of HPS payable on March 25, 2021 to shareholders of record at the close of business on March 18, 2021. The ex-dividend date is March 17, 2021.

Risks and uncertainties

The Company’s goal is to proactively manage risks in a structured approach in conjunction with strategic planning, with the intent to preserve and enhance shareholder value. However, as with most businesses, HPS is subject to a number of marketplace, industry and economic-related business risks, which could cause our results to vary materially from anticipated future results. The Company is acutely cognizant of

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these risks and continually assesses the current and potential impacts that they have on the business. HPS continuously strives to curtail the negative impact of these risks through diversification of its core business, market channel expansion, breadth of product offering, geographic diversity of its operations and business hedging strategies.

Coronavirus (COVID-19 – Business Disruption/ Interruption

Markets, governments and health organizations around the world are working to contain the COVID-19 pandemic. COVID-19 presents a wide range of potential issues or complications for the Company, most of which the Company is not able to know the full extent of.

The following is a summary of what the Company has experienced, or believes may impact their business as a result of COVID-19:

• Disruptions to business operations resulting from quarantines of employees, customers, suppliers and third party service providers in areas affected by the pandemic;

• Disruptions to business operations resulting from travel restrictions;

• Disruptions to business operations resulting from government mandated lockdowns;

• Uncertainty around the duration of the virus’ impact;

• Change in classification of essential services, requiring HPS to shutdown operations; and

• Availability of the COVID-19 vaccine in jurisdictions where HPS operates.

Currently, COVID-19 has been, and will continue to be, a material disruption to the Company’s business. Our operations in Canada, the U.S. and Mexico have been designated as “essential service” businesses. Our Indian operations were not operating from March 24, 2020 to May 2, 2020 as the government had imposed a 100% lockdown of the country, shutting down all businesses. The Company has seen significant reductions in sales in the U.S., Canadian and Indian markets. Due to the uncertainty and unpredictability of the impacts of the COVID-19 pandemic on the business operations, the uncertainty of governmental and health authorities’ legislation, the full negative financial impact of the unprecedented pandemic will be not be fully known until vaccines are widely available and the economy begins to recover.

Other Business Risks

If any of the following risks were to occur they could

materially adversely affect HPS’ financial condition, liquidity or results of operations.

These risks include:

Market supply and demand impact on commodity prices An area that has a definite impact on the Company’s costs and earnings is the cyclical effects and unprecedented market cost pressures of both copper commodity and steel pricing in the global markets. There is a risk in the ability of recouping rapid escalating commodity costs through selling price increases expediently. This risk is mitigated through strategic supply line agreements and alliances in place with major steel suppliers to ensure adequate supply, competitive market pricing and implementing market specific selling price increases.

We may not realize all of the anticipated benefits of our acquisitions, divestitures, joint ventures or strategic initiatives, or these benefits may take longer to realize than expected.

In order to be profitable, the Company must successfully execute upon its strategic initiatives and effectively manage the resulting changes in its operations. The Company’s assumptions underlying its strategic plans may be subjective, the market may react negatively to these plans, and HPS may not be able to successfully execute these plans, and even if successfully executed, its actions may not be effective or may not lead to the anticipated benefits within the expected time frame.

These strategic initiatives can include acquisitions and joint ventures. To be successful, management will conduct due diligence to identify valuation issues and potential loss contingencies, negotiate transaction terms, complete complex transactions and manage post-closing matters such as the integration of acquired startup businesses. Management’s due diligence reviews are subject to the completeness and accuracy of disclosures made by third parties. The Company may incur unanticipated costs or expenses following a completed acquisition, including post-closing asset impairment charges, expenses associated with eliminating duplicate facilities, litigation or other liabilities.

Many of the factors that could have an adverse impact will be outside of management’s control and could result in increased costs and decreases in the amount of expected revenues and diversion of management’s time and attention. Failure to implement an acquisition strategy, including successfully integrating acquired businesses, could have an adverse effect on our business, financial condition and result of operations.

ANNUAL REPORT 2020 41

MANAGEMENT’S DISCUSSION AND ANALYSIS

We sell to customers around the world and have global operations and, therefore, are subject to the risks of doing business in many countries.

We do business in a host of countries around the world. Approximately 70% of our sales were to customers outside of Canada. In addition, a number of our manufacturing operations, suppliers and employees are located in many places around the world. The future success of our business depends in large part on growth in our sales in non-Canadian markets. Our global operations are subject to numerous financial, legal and operating risks, such as political and economic instability; prevalence of corruption in certain countries; enforcement of contract and intellectual property rights and compliance with existing and future laws, regulations and policies, including those related to tariffs, investments, taxation, trade controls, product content and performance, employment and repatriation of earnings.

Our global business translates into conducting business in various currencies, all of which are subject to fluctuations.

HPS’ global footprint exposes the Company to currency fluctuations and volatility and, at times, has had a significant impact on the financial results of the Company. The Company’s functional currency is the Canadian dollar with its operating results reported in Canadian dollars. A significant portion of Company sales and material purchases are denominated in U.S. dollars. There is a natural hedge, as sales denominated in U.S. dollars are partially offset by the cost of raw materials purchased from the U.S., and commodities tied to U.S. dollar pricing. A change in the value of the Canadian dollar against the U.S. dollar will impact earnings, significantly at times. Generally, a lower value for the Canadian dollar compared to the U.S. dollar will have a beneficial impact on the Company’s results, while a higher value for the Canadian dollar compared to the U.S. dollar will have a corresponding negative impact on the Company’s profitability.

HPS has partially reduced the impact of foreign exchange fluctuations by increasing our U.S. dollar driven manufacturing output, periodically instituting price increases to help offset negative changes and entering into forward foreign exchange contracts.

other forms of taxation in numerous tax jurisdictions. Taxation laws and rates, which determine taxation expenses, may vary significantly in different jurisdictions, and legislation governing taxation laws and rates is also subject to change. Therefore, the Company’s earnings may be impacted by changes in the proportion of earnings taxed in different jurisdictions, changes in taxation rates, changes in estimates of liabilities and changes in the amount of other forms of taxation. Tax structures are subject to review by both domestic and foreign taxation authorities. The determination of the consolidated tax provision and liabilities requires significant judgment. Tax filings are subject to audits, which could materially change the amount of current and deferred income tax assets and liabilities.

We face the potential harms of natural disasters, pandemics, acts of war, terrorism, international conflicts or other disruptions to our operations.

Our business depends on the movement of goods around the world. Natural disasters, pandemics, acts or threats of war or terrorism, international conflicts, political instability and the actions taken by governments could cause damage to or disrupt our business operations, our suppliers or our customers and could create economic instability. Although it is not possible to predict such events or their consequences, these events could decrease demand for our products or make it difficult or impossible to deliver our products.

The U.S. political uncertainty and potential for changes in the business environment can lead to legislative changes that could impact business.

The results of the last U.S. election have created a number of geopolitical risks that could be challenging for the Company. The impact of these political changes can be difficult to predict and can have a pervasive impact on the global business climate. Changes in political leaders can impact trade relations as well as taxes and/or duties. HPS’ current structure includes a significant amount of business that crosses borders and any changes in the current trade structure could have a material impact for us. HPS’ global footprint will be critical to mitigating any impact for political changes that would modify the current trade relationships.

Our industry is highly competitive.

Worldwide HPS is subject to, and required to comply with, multiple income and other taxes, regulations and is exposed to uncertain tax liabilities risk. The Company operates and is subject to income tax and

HPS faces competition in all of our market segments. Current and potential competitors may have greater brand name recognition, more established distribution networks, access to larger customer bases and substantially

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greater financial, distribution, technical, sales and market, manufacturing and other resources than HPS does. As a result, those competitors may have advantages relative to HPS; including stronger bargaining power with suppliers that may result in more favourable pricing, the ability to secure supplies at time of shortages, economies of scale in production, the ability to respond more quickly to changing customer demands and the ability to devote great resources to the development, promotion and sales of their products and services. If HPS is unable to compete effectively, it may experience a loss of market share or reduced profitability. We expect the level of competition to remain high in the future.

Our business is highly sensitive to global and regional economic conditions in the industries we serve. Current global economic conditions influence the Company’s focus, direction, strategic initiatives and financial performance. To address the current uncertainty, we are focusing our efforts on projects that will increase our market reach, advance our cost competiveness, expand capacity and improve our manufacturing flexibility.

The Company believes that being an agile organization will hold even greater importance in order to respond quickly to both unexpected opportunities and challenges. HPS’ management believes that the key to expanding our market share during this economic slowdown is growing our access to a variety of domestic and global markets. This will be achieved through our current and new OEM and distributor channels.

The disruption to businesses that can come from unpredictable weather can have an impact on sales volume as customer projects can be delayed or cancelled. Extreme weather conditions such as heavy rains, flooding, snowfall, tornadoes and hurricanes can potentially have a negative impact on the Company’s sales trends and booking rates. When these conditions are present, the Company may see short-term effects of such occurrences due to their unpredictability. This may impact delivery and capacity requirements.

The business practice of extending credit to customers can lead to a risk of uncollectability.

A substantial portion of the Company’s accounts receivable are with customers in manufacturing sectors and are subject to credit risks normal to those industries. The Company’s expansion into emerging markets increases credit risk. This risk is partially mitigated by managements credit policy under which each new customer is analysed

individually for creditworthiness before the Group’s standard payment and delivery terms and conditions are offered. The Group’s review includes external ratings, if they are available, financial statements, credit agency information, industry information and in some cases bank references. Sale limits are established for each customer and reviewed quarterly. Any sales exceeding those limits require approval from Executive management. Although the Company has historically incurred very low bad debt expense, the current economic environment conditions elevate this exposure.

Risk of Cyberattack

Globally there have been increased incidences of outside cyberattacks and viruses on companies’ information infrastructure and technologies. This risk is reduced through a number of initiatives to mitigate exposure.

Off-balance sheet arrangements

The Company has no off-Balance Sheet arrangements, other than capital commitments disclosed in note 15 in the Notes to the Consolidated Financial Statements contained in our 2020 Annual Report.

Transactions with related parties

The Company had transactions with related parties in 2020, as disclosed in note 25 in the Notes to the Consolidated Financial Statements contained in our 2020 Annual Report.

Proposed transactions

The Company had no proposed transactions as at December 31, 2020. The Company continues to evaluate potential business expansion initiatives in accordance with its long-term growth strategy.

Financial instruments

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, long-term lease receivable, note receivable, bank operating lines of credit, accounts payable and accrued liabilities and the following derivative instruments:

At December 31, 2020, the Company had outstanding foreign exchange contracts in place for 17,500 EUR, $12,500 USD and 330,000 INR – which were implemented as an economic hedge against translation gains and losses on inter-company loans and $46,500 USD to economically

ANNUAL REPORT 2020 43

MANAGEMENT’S DISCUSSION AND ANALYSIS

hedge the U.S. dollar denominated accounts payable in the Canadian operations of HPS. The Company had total outstanding foreign exchange contracts in place as at December 31, 2019 for 17,200 EUR and $12,000 USD and 330,000 INR as economic hedges against translation gains and losses on inter-company loans and $52,000 USD to economically hedge the U.S. dollar denominated accounts payable in the Canadian operations.

Further details regarding the Company’s financial instruments and the associated risks are disclosed in note 29 in the Notes to the Consolidated Financial Statements contained in our 2020 Annual Report.

Critical accounting estimates

The preparation of the Company’s consolidated financial statements requires Management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. These estimates are based upon Management’s historical experience and various other assumptions that are believed by Management to be reasonable under the circumstances.

Such assumptions and estimates are evaluated on an ongoing basis and form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates.

The Company conducts its annual impairment assessment of goodwill, intangible assets and property, plant and equipment in the fourth quarter of each year, which corresponds with its annual planning cycle, and whenever events or changes in circumstances indicate that the carrying amount of an asset or Cash Generating Unit (“ CGU”) may not be recoverable. The Company did not identify any triggering events during the course of 2020 indicating that the carrying amount of its assets and CGUs may not be recoverable, which would require the performance of an impairment test for those CGUs which did not contain goodwill.

Outstanding share data

Details of the Company’s outstanding share data as of December 31, 2020, are as follows:

	8,966,624 2,778,300 11,744,924	Class A Shares Class B Common Shares Total Class A and B Shares

There have been no material changes to the outstanding

share data as of the date of this report.

New accounting pronouncements

Definition of a Business (Amendments to IFRS 3)

On October 22, 2018, the International Accounting Standards Board (“IASB”) issued amendments to IFRS 3 Business Combinations that seeks to clarify whether a transaction results in an asset or a business acquisition. The amendments apply to businesses acquired in annual reporting periods beginning on or after January 1, 2020. Earlier application is permitted.

The amendments include an election to use a concentration test. This is a simplified assessment that results in an asset acquisition of substantially all of the fair value of the gross assets is concentrated in a single identifiable asset or as a group of similar identifiable assets. If the preparer chooses not to apply the concentration test, or the test is failed, then the assessment focuses on the existence of a substantive process.

The Company adopted the amendments in its financial statements for the annual period beginning on January 1, 2020. The adoption of the amendments did not have a material impact on the consolidated financial statements.

New accounting pronouncements to be adopted

The IASB has issued the following standards, interpretations and amendments to standards that are not yet effective, have not yet been adopted by the Company and are not expected to have a material impact on the consolidated financial statements.

The Company intends to adopt the following amendments in its financial statements for the annual period beginning on January 1, 2022:

• Property, Plant and Equipment – Proceeds before Intended Use (Amendments to IAS 16)

• Onerous Contracts – Cost of Fulfilling a Contract (Amendments to IAS 37)

• Reference to the Conceptual Framework (Amendments to IFRS 3)

• Annual Improvements to IFRS Standard 2018-2020 The Company intends to adopt the following amendment in its financial statements for the annual period beginning on January 1, 2023:

• Classification of Liabilities as Current or Non-Current (Amendments to IAS 1)

The Company intends to adopt the following amendment once an effective date has been announced:

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• Sale or Contribution of Assets Between an Investor and its Associate or Joint Venture

Strategic direction and outlook

HPS has a rich and extensive history of growth, innovation and resilience. As an essential service HPS has always had to ensure they were ready to respond to their shareholders, customers and employees.

For our shareholders, HPS has provided:

• Escalating growth of the NAED channel;

• New global customers;

• Expanded relationships with existing customers;

• Capital investment in North American manufacturing facilities in Canada, the U.S. and Mexico;

• Establishment of a state-of-the-art core manufacturing facility in Mexico;

• Healthy gross margin rates, strong earnings per share, solid cash generation; and

• Quarterly dividends paid with an attractive yield.

For our customers, HPS has provided:

• Compliance with regulatory changes;

• New product development;

• Expanded product offering using cast resin technology;

• Superior customer service;

• Accurate ship on time; and

• Competitive pricing for our products.

For our employees, HPS has provided:

• The tools to facilitate their best work, which includes development and further implementation of our ERP system to enhance availability of information and streamline processes;

• Space and time for innovation and development;

• Safety in the workplace, especially during COVID-19; and

• Ability for remote work, where able, to help manage school closures and health concerns.

Hammond Power Solutions has a history of strength, perseverance and depth. We have navigated through difficult and fluctuating economic times, increased globalization, adapted to changes in customers and markets and have experienced significant advances in technology. Most recently HPS has steered through the COVID-19 pandemic. HPS has framed these challenges as opportunities and developed strategies to address these rapid changes while continuing to grow and expand.

HPS is aware that the global economy is vital to maintaining competitiveness and market share growth. The international expansion into India has allowed HPS to expand product offerings and opened up additional markets and customers that were previously not accessible. These acquisitions also provided HPS with cast resin technology, which has introduced new markets.

The COVID-19 pandemic continues to have an unprecedented impact on the global economy. The extent of the impact or timeline is still not yet known, but governmental decisions to declare a state of emergency in a number of countries in which we operate had an immediate impact on the economies of such countries. The demand for our transformers particularly in North America continues, but sales volumes have been and are expected to be, tempered due to the economic impact caused by the pandemic. Based on the foregoing, HPS expects to see continued moderation and fluctuation of revenues as well as a continuation of increases in operational costs which had the effect of reducing HPS’ financial performance in 2020 and will continue to have an impact into 2021. Our Canadian entities received a government subsidy for eligible wages in Quarter 2-4, 2020 which offset some additional wages and operational COVID-19 related costs and supported operational and financial performance. The wage subsidy has been extended into 2021 and the Company will continue to monitor eligibility. HPS will remain cognizant of further programs that may be announced.

The Company has implemented robust health and safety precautions dedicated to providing a safe working environment for our employees while continuing to manufacture and serve our customers during this volatile and unpredictable time.

As an essential service, the Company has continued to remain open and producing to ensure our customers have the transformers they need to fulfill the many applications they are purchased for. HPS is committed to managing the impact the pandemic will have on our financial performance. The Company will maintain its liquidity and balance sheet strength.

The implementation of our ERP system has allowed HPS to enhance the availability and quality of information accessible to support operational performance, improve customer service, supplement strategic decision making and audit and control. The ERP system implementation is currently in progress at our operation in Granby Quebec, an implementation project which began in Quarter 1,

ANNUAL REPORT 2020 45

MANAGEMENT’S DISCUSSION AND ANALYSIS

2020 and represents the Company’s final operation that will be converted to our ERP platform. It is expected to be fully implemented by the end of Quarter 2, 2021. The consolidation to the ERP platform is an important step towards providing one global, integrated, consistent source of information and data.

HPS has modern manufacturing facilities throughout the world and this continues to be enhanced through our committed capital investment. HPS continues to focus on customer service and growth – expanding existing relationships as well as exploring new opportunities. Past regulatory requirements to comply with the U.S. Department of Energy (“DOE”) regulations and the Canadian efficiency standard changes (“NRCan”) have created opportunities for us to deliver energy efficient, regulatory compliant transformers fulfilling the needs of our customers. These regulation changes have resulted in new product development and manufacturing techniques.

HPS continues to have a strong reputation of being an industry leader and is both operationally and financially strong. HPS is well positioned to meet the evolving needs of both our traditional markets while becoming a leading player in a growing number of other market sectors. We continue to be focused on escalation of market share, improved sales growth from new product development, geographic diversification, productivity gains, cost reduction and capacity flexibility.

While HPS has experienced a number of successes and challenges, the unpredictable and fluctuating global economic climate has had a pervasive and persistent impact on HPS’ profitability over a number of years. The Company has also experienced the adverse impact of variability of raw material commodity costs, unpredictable foreign currency rates, fluctuating manufacturing throughput and market pricing pressures. Through HPS’ strategic projects and operational plans these deterrents are being prudently managed.

HPS is confronting these challenges and continuously building our competitive and strategic advantage while being cognizant of the importance of our shareholders, customers and employees.

For our shareholders, HPS is focusing on:

• Disciplined cost management initiatives to ensure price competitiveness in the market;

• Cash flow generation;

• Capital investment; and

• Strategic planning.

For our customers, HPS is focusing on:

• Sales development;

• NAED channel expansion;

• Broadened product offering;

• Product development; and

• Bringing quality and value to all that we produce.

For our employees, HPS is focusing on:

• Investing in our employees, through leadership training and development programs;

• Implementing a new Human Resource information system to provide an in-house payroll system, dynamic performance evaluation module, succession planning, personal learning development and people management tool;

• Relaunch of our internal continuous improvement program, Transform, to further foster a culture of innovation; and

• Ongoing support through the CEWS wage subsidy where we qualify.

HPS’ strategic vision and operational initiatives have supported our industry leadership, operational strength and financial stability. The combination of our resilience, drive, decades of experience, commitment, engineering expertise, solid supplier relationships and a broad and unique business perspective gained through our diverse products, customers and markets are all key success factors critical to our success.

As an essential service, HPS will continue to deliver solid financial performance, provide a sustainable return to our shareholders, support employees well-being and growth and deliver long-term value to all stakeholders. U

46

Selected Annual and Quarterly Information

(tabular amounts in thousands of dollars)

Annual Information (1)			2016	2017	2018	2019 2020
Sales		274,793		301,750	314,082	358,792 322,097
Earnings from operations		10,873		14,470	13,779	20,543 22,041
EBITDA		14,356		23,069	17,915	28,175 29,482
Net earnings (loss)			1,793	6,114	(12,917)	11,607 14,062
Total assets		205,177		192,449	205,527	214,953 189,394
Non-current liabilities			4,131	3,641	2,528	11,271 8,329
Total liabilities		84,524		77,438	96,793	105,186 75,478
Total shareholders’ equity attributable
to equity holders of the Company		120,441		114,848	108,734	109,767 113,916
Operating debt, net of cash		(11,318)		(16,983)	(17,056)	(9,326) (1,278)
Cash provided by operations		15,216		1,032	6,474	17,810 19,683
Basic earnings (loss) per share			0.16	0.53	(1.10)	0.99 1.20
Diluted earnings (loss) per share			0.16	0.52	(1.10)	0.99 1.20
Dividends declared and paid			2,808	2,809	2,818	3,287 3,993
Average exchange rate (USD$=CAD$)			1.325	1.298	1.294	1.327 1.343
Book value per share			10.29	9.80	9.26	9.36 9.70
		2019				2020
QuarterlyInformation	Q1	Q2	Q3	Q4	Q1	Q2 Q3 Q4
Sales	84,690	91,937	91,502	90,653	88,420 75,393 78,115 80,169
Earnings from operations	4,479	4,731	5,471	5,862	3,033	6,514 5,447 7,047
EBITDA	6,111	7,111	7,302	7,651	5,678	8,447 7,466 7,891
Net earnings	2,508	3,352	3,595	2,152	2,148	4,420 3,462 4,032
Total assets	206,554	205,059	206,586	214,953	212,929 197,895 203,443 189,394
Non-current liabilities	10,914	10,558	9,947	11,271	9,729	9,039 8,558 8,329
Total liabilities	99,939	99,640	96,870	105,186	97,156 81,375 87,215 75,478
Total shareholders’ equity
attributable to equity
holders of the Company	106,615	105,419	109,716	109,767	115,773 116,520 116,228 113,916
Operating debt, net of cash	(16,588)	(18,582)	(22,678)	(9,326)	(18,356) (12,906) (4,790) (1,278)
Cash (used) provided by operations	2,316	507	(1,460)	16,447	(6,038)	7,229 10,419 8,073
Basic earnings per share	0.20	0.25	0.27	0.27	0.18	0.38 0.30 0.34
Diluted earnings per share	0.20	0.25	0.27	0.27	0.18	0.38 0.30 0.34
Dividends declared and paid	822	821	821	823	998	999 998 998
Average exchange rate (USD$=CAD$)	1.330	1.338	1.320	1.320	1.339	1.391 1.335 1.309
Book value per share	9.09	8.99	9.33	9.36	9.86	9.92 9.90 9.70

(1) Balances for 2016 – 2017 not restated to reflect discontinued operations

ANNUAL REPORT 2020

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