Deans Knight Income Corporation
TSX : DNC

Deans Knight Income Corporation

March 31, 2015 21:47 ET

Deans Knight Income Corporation Releases Annual Management Report of Fund Performance and Financial Statements for the Year Ended December 31, 2014

VANCOUVER, BRITISH COLUMBIA--(Marketwired - March 31, 2015) - Deans Knight Income Corporation (the "Company") (TSX:DNC) is pleased to release its annual Management Report of Fund Performance and Financial Statements for the year ended December 31, 2014.

These documents can be found on SEDAR at www.sedar.com or the Company's website: www.dkincomecorp.com.

Annual Management Report of Fund Performance For 2014

This annual management report of fund performance (the "Report") contains financial highlights of Deans Knight Income Corporation (the "Company"). This Report should be read in conjunction with the annual financial statements of the Company for the year ended December 31, 2014 (the "Financial Statements"), which, if not included with this Report, can be obtained at your request, at no cost by emailing info@dkincomecorp.com, visiting our website at www.dkincomecorp.com for contact details or on SEDAR at www.sedar.com. Readers may also contact us to request a free copy of the Company's proxy voting policies and procedures, proxy voting disclosure record or quarterly portfolio disclosure.

A NOTE ON FORWARD-LOOKING STATEMENTS

This Report contains certain forward-looking statements. In particular, this Report contains forward-looking statements in respect of the Company's plans to look for opportunities to sell the Remaining Investments, the Company's anticipation that its business will be limited solely to attending to and pursuing the Modified Business Objectives (as defined in this Report), the anticipated future performance of the Company, the Company's belief that its tax losses and other tax attributes may be used to offset profits generated by the Company, thereby reducing its taxes payable and other matters regarding the CRA Matter (as defined in this Report) including the disposition of the CRA Matter and the anticipated timing thereof. In some cases, forward-looking statements can be identified by terminology such as "may", "will", "should", "expect", "plan", "anticipate", "believe", "estimate", "predict", "potential", "continue" or the negative of these terms or other comparable terminology. Such forward-looking statements reflect the Company's current beliefs and are based on information currently available to the Company. With respect to such forward-looking statements, the Company has made assumptions regarding, among other things, that there will be no change or need for change in the Company's investment portfolio (other than disposition of the Remaining Investments (as described in this Report)), that the Services Agreement (as defined in this Report) will remain in force and not require amendment, current tax laws, regulations and policies and currency, exchange and interest rates. A number of factors could cause actual events or results to differ materially from the results discussed in the forward-looking statements. In evaluating these statements, prospective investors should specifically consider various factors, including global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings and decisions, and catastrophic events and the risks outlined under "Risk Factors" in the Company's annual information form dated March 26, 2015 (the "AIF"), which may cause actual results to differ materially from any forward-looking statement. Although the forward-looking statements contained in this Report are based upon what the Company believes to be reasonable assumptions, the Company cannot assure investors that actual results will be consistent with these forward-looking statements. Forward-looking statements are made as of the date of this Report and, other than as required by applicable law, the Company assumes no obligation to update or revise them to reflect new events or circumstances.

This Report may also contain certain financial and operational information obtained or derived from public sources in respect of certain companies included in the Company's investment portfolio. While management believes this data to be reliable, such information is subject to variations and may not be able to be verified due to limits on the availability and reliability of data inputs, the nature of the data gathering process and other limitations and uncertainties inherent in such information. Accordingly, the accuracy, currency and completeness of this information cannot be guaranteed. The Company has not independently verified any of the data from third party sources referred to in this Report or ascertained the underlying assumptions relied upon by such sources.

Investment Objectives and Strategies

The Company is a closed-end, non-redeemable investment company that, prior to April 30, 2014, was focused on investing in corporate debt securities. The Company's assets are managed by Deans Knight Capital Management Ltd. ("Deans Knight"), a British Columbia-based investment firm focused on managing high income and growth mandates for high net worth individuals, foundations, endowments and pension funds.

Since making a special cash distribution to shareholders of the Company ("Cash Distribution") on April 30, 2014, the Company has ceased all investing and portfolio activities (other than in connection with the Modified Business Objectives). As such, the Company's business now consists of: (i) attending to, and if necessary, litigating, the Canada Revenue Agency ("CRA") tax matter and, if applicable, the related appeal; (ii) divesting of the securities held in the Company's portfolio that were not liquidated prior to the Cash Distribution (the "Remaining Investments"); (iii) attending to any additional distributions to shareholders of any surplus cash and the eventual wind-up and termination of the Company thereafter; and (iv) attending to any ancillary matters related to any of the foregoing (collectively, the "Modified Business Objectives").

Risk

Prior to the reorganization and change in the Company's business that occurred in 2008, as discussed in Note 1 of the Financial Statements, the Company had generated significant tax losses and other tax attributes as a result of its prior business activities. In its tax filings since the reorganization, the Company has taken the position that these losses and other tax attributes could be used to offset taxable income generated by the Company, thereby reducing its taxes payable.

On July 16, 2014, the Company received Notices of Reassessment ("NORAs") from the CRA for the taxation years 2009 to 2012, inclusive. In the NORAs, the CRA denied the use of the losses and other tax attributes by the Company on the basis that an acquisition of control of the Company occurred and on the basis of the General Anti-Avoidance Rule in the Income Tax Act (Canada) (the "CRA Matter"). The Company, in consultation with its legal advisors, remains of the view that its tax filing position is appropriate, and intends to vigorously defend its position.

The NORAs indicate the Company's tax liability for the 2009 to 2012 taxation years to be approximately $22.7 million or $2.15 per Share ("Disputed Amount"), including arrears interest and penalties. Given the Company's financial results for 2013 and 2014, the Company estimates its overall potential net tax liability for the years 2009 through 2014 inclusive to be approximately $21.6 million, or $2.05 per Share ("Potential Tax Liability"). The Company has prepaid the $21.6 million to the CRA to limit any future interest from being incurred.

Should the Company be successful in defending its tax filing position, the amount prepaid to the CRA will be refunded to the Company with interest. However, if the Company is unsuccessful, the recorded amount of the tax assets, if any, as well as such amounts claimed to date would be recorded as a charge to income, and the Potential Tax Liability would be forfeited to the CRA.

In late October, 2014, the Company filed its Notice of Appeal to the Tax Court of Canada, appealing the NORAs and is now attending to normal pre-trial processes, including discovery of documents and examinations for discovery with the Crown.

The Company will continue to keep shareholders apprised of the CRA Matter, as it progresses through the appeal process.

On April 15, 2014, the Voting Shares (as defined herein) ceased trading on the Toronto Stock Exchange ("TSX") and as such, there is no active market through which the shares may be sold. Accordingly, holders of Voting Shares may not be able to resell their shares. This may affect the pricing of the Voting Shares in the secondary market, the transparency and availability of trading prices, the liquidity of the Voting Common Shares and decreased regulation of the Company.

Given the majority of the Company's business is now limited to attending to the CRA Matter, the resolution and disposition of which is uncertain at this time, and the lack of liquidity from the Company's shares no longer being listed on the TSX, an investment in the Company may be considered to be speculative. Therefore, an investment in the Company is only suitable for investors who are looking for potential capital appreciation and are willing to tolerate the speculative risk of the investment.

Results of Operations

On April 30, 2014, the Company executed on its plan to distribute a substantial portion of its assets to holders of voting common shares ("Voting Shares") and non-voting common shares ("Non-Voting Shares" and together with the Voting Shares, the "Common Shares") of the Company through the payment of the Cash Distribution in the aggregate amount of $102.7 million ($9.75 per Common Share). The Cash Distribution aligned with the Company's original business objective of completing a distribution to holders of Common Shares on or about April 30, 2014 while maintaining the necessary reserves to attend to and pursue the Modified Business Objectives. The Cash Distribution was considered a return of capital to holders of Voting Shares for income tax purposes.

In the fourth quarter of 2014, the Company received the expected refund of $1.1 million from monies prepaid to the CRA. After receiving this refund, the Company assessed its cash needs to pursue its Modified Business Objectives. As a result of this exercise, the Company determined it had an excess of cash and declared and paid a dividend of $1.05 million, or $0.10 per Common Share in December 2014. This dividend is considered as an eligible dividend for income tax purposes.

Given the Cash Distribution, the net assets of the Company at December 31, 2014 ($26,374,544 or $2.50 per Common Share) were significantly lower than at December 31, 2013 ($130,367,007 or $12.37 per Common Share).

The net assets of the Company consisted of the following components:

December 31, 2014

$
Per Common Share(1) %
Remaining Investments(2)3,266,854 0.31 12.4
Cash and short-term deposits1,399,985 0.13 5.3
Accrued income155,666 0.01 0.6
Prepaid tax asset (3)21,606,636 2.05 81.9
Accrued liabilities less prepaid assets(54,597)0.00 (0.2)
26,374,544 2.50 100.0
  1. Based on 10,537,263 Common Shares, including 10,191,592 Voting Shares and 345,671 Non-Non-Voting Shares, as outlined in the notes to the Financial Statements.
  2. The details of the Remaining Investments are outlined in the Summary of Investment Portfolio below.
  3. Details of the prepaid tax asset are outlined in the Risk section above. Further, refer to the Taxation note to the Financial Statements for more detail.
December 31, 2013

$
Per Common Share(1) %
Investments(2)65,659,396 6.23 50.4
Cash and short-term deposits64,573,401 6.13 49.5
Accrued income786,745 0.07 0.6
Prepaid expenses41,370 0.00 0.0
Future income tax asset(3)180,000 0.02 0.2
Accounts payable and accrued liabilities(873,905)(0.08)(0.7)
130,367,007 12.37 100.0
  1. Based on 10,537,263 Common Shares, including 10,191,592 Voting Shares and 345,671 Non-Voting Shares, as outlined in the notes to the Financial Statements.
  2. The details of the investments are outlined in detail in the 2013 audited annual financial statements (the "2013 Financial Statements").
  3. Refer to the Taxation note to the 2013 Financial Statements for more detail.

There were no significant developments or changes to report relating to the Remaining Investments other than as disclosed in our June 30, 2014 Interim Management Report of Fund Performance. The Company will continue to look for opportunities to sell the Remaining Investments as prudently as possible. Otherwise, the Company's business will be limited solely to pursuing the Modified Business Objectives.

The Company's net investment income, being dividend and interest for distribution purposes and royalty income less expenses, for the year ended December 31, 2014 was approximately $0.560 million, or $0.05 per share. The comparative figure for the year ended December 31, 2013 was $7.062 million or $0.67 per share. The decrease is the result of the Company liquidating the majority of its income generating investments in anticipation of paying the Cash Distribution. In addition, the Company incurred $3.897 million of realized capital losses in the year ended December 31, 2014 from the sale of all the liquid investments held in the portfolio, the exchange of debt securities for common shares of Mirabela Nickel Ltd., and the settlement of foreign currency contracts. Conversely, the sales resulted in the majority of the change in unrealized appreciation on investments of $3.317 million for the year ended December 31, 2014.

Since the Cash Distribution, the Company's investment income is limited to income it receives from its investments in Skylink Aviation Inc. and the royalty stream it is entitled to from BlackBridge Space Holdings Ltd. (formerly Rapid Eye Canada Inc). For the year ended December 31, 2014, these investments generated approximately $500,000 of investment income.

Recent Developments

Cash Distribution and Extension of Termination Date

On April 4, 2014, shareholders voted in favour of a special resolution authorizing: (i) the reduction in the stated capital of the Voting Shares; (ii) an extension of the termination date of the Company until such time as is reasonably practicable following the conclusion of the CRA Matter (as defined herein) or such other date as the Company deems appropriate on not less than 30 days' notice to shareholders; and (iii) the removal of the restrictions on business that the Company may carry on.

With these shareholder approvals, on April 30, 2014, the Company executed on its plan to distribute a substantial portion of its assets to shareholders through the payment of the Cash Distribution in the amount of $9.75 per Common Share. Further, since that time, the Company has and plans to limit its business activities solely to the Modified Business Objectives. Other than in connection with the Modified Business Objectives, there are no planned reorganizations, mergers or similar transactions.

International Financial Reporting Standards

This reporting period represents the Company's first set of financial statements reported under International Financial Reporting Standards ("IFRS"). The Financial Statements include corresponding comparative financial information for 2013, including an opening statement of financial position as at January 1, 2013.

The Company's transition to IFRS is as outlined in the notes to the Financial Statements. More specifically, Note 11 of the Financial Statements outlines the Company's transition to IFRS and the related impact on the Company's equity and comprehensive loss. This change has resulted in certain comparative figures in this Report being updated to reflect the changes to the Financial Statements.

Composition of the Independent Review Committee

Up to the date of June 25, 2014, the members of the Company's Independent Review Committee were Denyse Chicoyne, Philip Hampson and Alan Ross. Following the Company's annual meeting of shareholders held on June 25, 2014, each of Ms. Chicoyne, Mr. Hampson and Mr. Ross did not stand for re-election as directors of the Company, and Ms. Chicoyne resigned from the Independent Review Committee. The Independent Review Committee is now comprised of Mr. Hampson, Mr. Ross and Robert Rothstein.

Related Party Transactions

The officers and directors of the Company are also employees of Deans Knight, the Company's investment advisor. These officers and directors are not paid by the Company. Deans Knight provides administration, financial reporting and other ancillary services required by a public company, as well as management services related to the Remaining Investments, all as more particularly set forth in the services agreement between the Company and Deans Knight dated May 20, 2014 ("Services Agreement") and available for review on SEDAR at www.sedar.com. Deans Knight is paid a nominal fee of $10 per month, starting May 1, 2014, for the services it provides to the Company under the Services Agreement. Prior to that, and for the period January 1, 2014 to April 30, 2014, Deans Knight was paid a management fee computed quarterly, at an annual rate of 1.5% of the net asset value plus applicable taxes, and adjusted for certain non-investment related assets.

For the year ending December 31, 2014, management fees totaled $554,785 (2013-$2,122,002). At December 31, 2014, $63 (December 31, 2013- $512,138) was owed to Deans Knight, which was unsecured and included in accounts payable and accrued liabilities in the statement of financial position, and is payable immediately.

A former director of the Company, who ceased being a director and therefore a related party in June 2013, is a partner at a law firm that provides legal services to the Company. During the year ending December 31, 2013, the Company incurred $299,969 in legal services and disbursements provided by this law firm. At December 31, 2013, accounts payable included $133,884 due to the law firm for legal fees and disbursements.

Financial Highlights

The following tables show selected key financial information about the Company and are intended to help you understand the Company's financial performance for the past five years.

The Company's Net Assets per Common Share (1)
2014
$
2013
$
2012
$
2011
$
2010
$
Net assets, beginning of year (2)12.37 13.58 13.49 13.65 12.23
Increase from operations(2)
Total revenue0.14 0.96 1.10 1.10 0.94
Total expenses(0.09)(0.29)(0.26)(0.26)(0.24)
Realized (losses) gains(0.37)(0.50)0.44 0.36 1.82
Unrealized gains (losses)0.32 (0.47)(0.25)(0.51)(0.24)
Future income taxes(0.02)(0.21)(0.24)(0.15)(0.16)
Total (decrease) increase from operations (2)(0.02)(0.51)0.79 0.54 2.12
Return of capital(2)(3)(9.75)- - - -
Dividends (2)(3)(4)(0.10)(0.70)(0.70)(0.70)(0.70)
Net assets, end of year (December 31)2.50 12.37 13.58 13.49 13.65
  1. The information is derived from the Company's audited annual financial statements. Common Shares outstanding are 10,537,263, including 10,191,592 Voting Shares and 345,671 Non-Voting Shares.
  2. Net assets, return of capital and dividends are based on the actual number of shares outstanding at the relevant time. The increase/decrease from operations is based on the weighted average number of shares outstanding over the period.
  3. See "Results of Operations" and "Recent Development - Cash Distribution and Extension of Termination Date" for additional information regarding the return of capital.
  4. Dividends were paid in cash.
Ratios and Supplemental Data (1)


2014


2013


2012


2011


2010
Net asset value ($000's)26,375 $130,367 $143,065 $142,178 $143,880
Number of Common Shares outstanding (000's)10,537 10,537 10,537 10,537 10,537
Management expense ratio (2)1.09%2.21%1.96%1.90%1.91%
Portfolio turnover rate (3)(4)159.96%25.23%14.79%79.90%86.60%
Trading expense ratio (5)0.03%0.03%0.01%0.00%0.01%
Net asset value per Common Share$2.50 $12.37 $13.58 $13.49 $13.65
Closing market price - Common Sharen/a(6)$10.01 $12.69 $11.84 $12.54
  1. This information is provided as at December 31 of the years shown.
  2. Management expense ratio is based on total expenses for the year and is expressed as a percentage of weekly average net asset values over the year. See "Related Party Transactions" and "Management Fees" in this Report for a description of and structure of the nominal monthly fee to be paid to Deans Knight under the Services Agreement which was amended on May 20, 2014. As a result of the amendment to the Services Agreement, Deans Knight will be paid a fee of $10.00 per month and will be entitled to be reimbursed for any expenses incurred by it on behalf of the Company.
  3. The Company's portfolio turnover rate indicates how actively the Company manages its portfolio investments. It is calculated as a ratio of investments purchased or sold over the average net asset value. A portfolio turnover rate of 100% is equivalent to the Company buying and selling all of the securities in its portfolio once in the course of the year. The higher a portfolio turnover-rate in a year, the greater the trading costs payable by the Company in the year. There is not necessarily a relationship between a high turnover rate and the performance of the investment portfolio.
  4. 2014's portfolio turnover rate is significantly higher because the Company finished liquidating the majority of its portfolio in 2014 and returned a significant portion of its net asset value to the shareholders.
  5. The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average net asset value during the year. This expense is $28,552 for 2014 (2013- $47,875), as the purchasing and selling of bonds do not generally attract a commission from the buying or selling party.
  6. On April 15, 2014, the Voting Shares were delisted from trading on the Toronto Stock Exchange. As a result, the Company's Voting Shares are no longer traded on a public market, and therefore a closing market value is not available.

Management Fees

Deans Knight provides administration, financial reporting and other ancillary services required by a public company, as well as investment management services related to the Remaining Investments, all as more particularly set forth in the Services Agreement. Deans Knight is paid a nominal fee of $10 per month, starting May 1, 2014, for the services it provides to the Company under the Services Agreement. Prior to that, and for the period January 1, 2014 to April 30, 2014, Deans Knight was paid a management fee computed quarterly, at an annual rate of 1.5% of the net asset value plus applicable taxes, and adjusted for certain non-investment related assets.

Past Performance

This section shows the Company's past performance, since it began operating its business as an investment fund. The past performance information includes changes in net asset value and assumes the reinvestment of all dividends paid to holders of Common Shares. The performance information presented is after the deduction of performance fees and expenses paid or payable by the Company to the investment manager. It is also important to note that the past performance will not necessarily indicate what performance in the future will be.

Following the completion of the Cash Distribution on April 30, 2014, the Company's investment portfolio is comprised solely of the Remaining Investments. Additionally, the Voting Shares were delisted from the Toronto Stock Exchange on April 15, 2014. As a result of these significant changes, it is anticipated that the future performance of the Company will not be reflective of or comparable to the past performance of the Company.

Year-by-year Returns

The accompanying bar chart shows the Company's annual performance for the years shown and illustrates how the Company's performance has changed from year to year. The bar chart shows, in percentage terms, how much an investment made in the Common Shares on the first day of each financial year would have grown or decreased by the last day of each financial year.

To view the graph associated with this release, please visit the following link: http://media3.marketwire.com/docs/999765_graph1.jpg

Annual Compound Returns

The table below summarizes the Company's annual compound total returns for the periods ended December 31 as indicated. As a basis for comparison, we have provided the performance of the Merrill Lynch Canada High Yield Bond Index ("Index"). The Index is a broad based index that tracks the performance of the Canadian high-yield bond market. As the criteria for determining the constituents of the Company's investment portfolio and the Index differ, it is not expected that the Company's performance will mirror that of the Index. Further, the return of the Index is calculated without the deduction of management fees and fund expenses whereas the performance of the Company is calculated after deducting fees and expenses.

Annual Compound ReturnsCompanyIndex
1 Year-0.13%0.93%
2 Years-1.92%3.80%
3 Years0.98%7.43%
5 Years4.85%7.81%
Since Inception8.67%15.03%

Summary of Investment Portfolio

The following is a summary of the Company's investment portfolio as at December 31, 2014. This is a summary only and will change due to ongoing portfolio transactions of the Company. A quarterly update is available at www.dkincomecorp.com.

To view the table associated with this release, please visit the following link: http://media3.marketwire.com/docs/999765_table1.jpg

Deans Knight Income Corporation
Financial Statements
December 31, 2014
Deans Knight Income Corporation
Statements of Financial Position
December 31,
2014
$
December 31,
2013
$
January 1,
2013
$
Assets
Current Assets
Investments* - at fair value 3,266,85465,659,396119,578,722
Cash and cash equivalents (note 9) 1,399,98564,573,40120,091,125
Accrued interest receivable 155,666786,7451,662,373
Prepaid expenses 12,00041,37056,460
Prepaid tax asset (note 6) 21,606,636--
26,441,141131,060,912141,388,680
Non-current Assets
Deferred income tax benefits (note 6) -180,0002,390,000
Total Assets 26,441,141131,240,912143,778,680
Liabilities
Current Liabilities
Accounts payable and accrued liabilities (note 4) 66,597873,905713,711
Net Assets 26,374,544130,367,007143,064,969
Shareholders' Equity
Common shares (note 3) 17,724,18999,366,42999,366,429
Contributed surplus (note 3) 9,904,5049,904,5049,904,504
Retained (deficit) earnings (1,254,149)21,096,07433,794,036
26,374,544130,367,007143,064,969
Number of common shares outstanding (note 3) 10,537,26310,537,26310,537,263
Net assets per common share (note 6) 2.5012.3713.58
*Investments - at average cost 2,513,31668,222,974117,207,284
Contingencies (notes 1 and 6)
Commitments (notes 1 and 8)
Going concern (note 1)
Approved by the Board of Directors
(signed) Wayne DeansDirector(signed) Craig LangdonDirector

The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation
Statements of Comprehensive Loss
For the years ended December 31, 2014 and 2013
2014
$
2013
$
Investment income
Dividend and interest income for distribution purposes1,082,501 9,666,659
Royalty income391,570 399,637
Net realized loss on investments sold (note 5)(3,446,354)(2,572,824)
Net realized loss on foreign currency contracts (note 5)(450,708)(2,670,520)
Change in unrealized appreciation (depreciation) on investments3,317,116 (4,871,217)
Unrealized depreciation on foreign currency contracts- (63,800)
894,125 (112,065)
Expenses
Management fees (note 4)554,785 2,122,002
Public company reporting costs138,414 156,126
Legal fees (note 4)66,993 390,090
Audit, accounting and tax fees46,351 91,087
Director's fees and expenses40,292 136,510
Transaction costs28,552 47,875
Custodial fees22,436 43,688
Independent Review Committee fees16,725 16,650
914,548 3,004,028
Comprehensive loss before tax(20,423)(3,116,093)
Provision for deferred income tax (note 6)(180,000)(2,210,000)
Comprehensive loss(200,423)(5,326,093)
Comprehensive loss per weighted average common share (note 2)(0.02)(0.51)

The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation
Statements of Changes in Equity
For the years ended December 31, 2014 and 2013

Common shares
$

Contributed surplus
$
Retained earnings (deficit)
$
Total shareholders' equity
$
At January 1, 201399,366,429 9,904,50433,794,036 143,064,969
Comprehensive loss- -(5,326,093)(5,326,093)
Dividends paid- -(7,371,869)(7,371,869)
At December 31, 201399,366,429 9,904,50421,096,074 130,367,007

Common shares
$

Contributed surplus
$
Retained earnings (deficit)
$

Total shareholders' equity
$
At January 1, 201499,366,429 9,904,50421,096,074 130,367,007
Comprehensive loss- -(200,423)(200,423)
Dividends paid- -(1,053,726)(1,053,726)
Return of capital (note 3)(81,642,240)-(21,096,074)(102,738,314)
At December 31, 201417,724,189 9,904,504(1,254,149)26,374,544

The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation
Statements of Cash Flows
For the years ended December 31, 2014 and 2013
2014
$
2013
$
Cash flows from operating activities
Comprehensive loss(200,423)(5,326,093)
Items not affecting cash
Net realized loss on investments sold3,446,354 2,572,824
Net realized loss on settlement of foreign currency contracts450,708 2,670,520
Change in unrealized (appreciation) depreciation on investments(3,317,116)4,871,217
Unrealized depreciation on foreign currency contracts- 63,800
Dividend and interest income for distribution purposes(1,082,501)(9,666,659)
Royalty income(391,570)(399,637)
Provision for deferred income tax180,000 2,210,000
(914,548)(3,004,028)
Cost of investments purchased (note 5)(66,382)(26,749,307)
Proceeds from investments sold (note 5)61,878,978 70,490,273
Interest received1,752,656 10,518,891
Royalty received352,494 423,032
Prepaid expenses29,370 15,090
Prepaid tax(21,606,636)-
Change in accounts payable and accrued liabilities(807,308)160,194
40,618,624 51,854,145
Cash flows from financing activities
Return of capital to common shareholders (notes 3 and 8)(102,738,314)-
Dividends to common shareholders (note 8)(1,053,726)(7,371,869)
(103,792,040)(7,371,869)
Net (decrease) increase in cash and cash equivalents during the year(63,173,416)44,482,276
Cash and cash equivalents - Beginning of year64,573,401 20,091,125
Cash and cash equivalents - End of year1,399,985 64,573,401

The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation
Schedule of Investment Portfolio
As at December 31, 2014


Par value1
$


Average cost ²
$


Fair value ²
$
Percentage of total fair
value
3
%
Fixed income
Denominated in Canadian dollars
Skylink Aviation Inc. 12.25% 05-10-2018592,183 592,183 373,075 11.4
Denominated in United States dollars
Mirabela Nickel Ltd. 1.00% 06-30 -2044117,532 124,999 95,444 2.9
Skylink Aviation Inc. 10.00% 03-08-20154965,183 982,991 1,119,709 34.3
1,107,990 1,215,153 37.2
Total fixed income 1,700,173 1,588,228 48.6
Equities - Australia
Mirabela Nickel Ltd. - common shares20,231,470 813,143 556,145 17.0
Total equities 813,143 556,145 17.0
Royalties - Canada
Denominated in Euro
BlackBridge (formerly RapidEye Canada) - 1,122,481 34.4
Total investments 2,513,316 3,266,854 100.0
1 Par values are presented in their source currency
2 All amounts are shown in Canadian dollars
3 Percentages are shown as a percentage of total investments
4 This investment represents a loan receivable, for which lenders agreed to forbear the repayment date of March 8, 2015

The accompanying notes are an integral part of these financial statements.

Deans Knight Income Corporation

Notes to Financial Statements

December 31, 2014

1. Nature of operations and going concern

Deans Knight Income Corporation (the "Company") is a corporation continued under the laws of Canada on April 11, 2001. The Company is a public closed-end, non-redeemable investment company, which prior to April 15, 2014 was listed on the Toronto Stock Exchange. The address of the Company's registered office, and its principal place of business, is 1500 - 999 West Hastings Street, Vancouver, British Columbia.

In April 2014, the Company's shareholders voted in favour of the special resolution authorizing: (i) an extension of the termination date of the Company until such time as reasonably practicable following the conclusion of the Canada Revenue Agency ("CRA") tax matter (note 6); and (ii) the removal of the restrictions on business that the Company can carry on. Going forward, the Company's business will comprise of (i) divesting of any remaining investments held; (ii) attending to, and if necessary, litigating, the CRA audit and related tax appeal (note 6); and, (iii) attending to any distributions to shareholders of surplus cash and the eventual wind-up and termination of the Company thereafter.

Prior to April 30, 2014, the Company's investment objectives were to: (i) maximize the total return for shareholders, consisting of dividend income and capital appreciation; and (ii) provide shareholders with monthly dividends targeted to payout a minimum of 75% of net investment income annually. The Company did this through investing primarily in corporate debt rated BBB or below by recognized credit rating organizations. Prior to its reorganization in May 2008, the Company was a life sciences company involved in the research, development and commercialization of innovative products for the prevention and treatment of life-threatening diseases.

As per the Company's Articles of Incorporation, the common shares of the Company are to be redeemed at such time as is reasonably practicable following the resolution of the CRA tax audit and related tax appeal (note 6), or such other date as the Company deems appropriate, on not less than 30 days' notice to shareholders. The common shares are presented as equity because they meet the criteria in paragraphs 16C - D of International Accounting Standards ("IAS") 32 'Financial Instruments: Presentation' for such classification.

The Company does not anticipate that there will be a resolution to the CRA tax dispute in the next 12 months, and accordingly is not anticipating winding up in that period. Therefore, these financial statements have been prepared on a going concern basis. If a resolution to the CRA tax dispute is achieved, or the Company deems it appropriate to wind up, then the Company would settle all outstanding liabilities, including obtaining a tax clearance certificate, and redeem the common shares of the Company.

2. Summary of significant accounting policies

The following is a summary of significant accounting policies followed by the Company.

Basis of preparation and adoption of IFRS

These financial statements have been prepared in compliance with International Financial Reporting Standards ("IFRS") applicable to the preparation of annual financial statements, including IFRS 1, First-time Adoption of International Financial Reporting Standards. The Company adopted this basis of accounting on January 1, 2014, as required by Canadian securities legislation and the Canadian Accounting Standards Board. Previously, the Company prepared its financial statements in accordance with Canadian generally accepted accounting principles as defined in the Part V of the Chartered Professional Accountants of Canada ("CPA Canada") Handbook ("Canadian GAAP"). The comparative information has been restated from Canadian GAAP to comply with IFRS. The Company has consistently applied the accounting policies used in the preparation of its opening IFRS statement of financial position as at January 1, 2013 and throughout all periods presented, as if these policies had always been in effect. Note 11 discloses the impact of the transition to IFRS on the Company's reported financial position, financial performance and cash flows, including the nature and effect of significant changes in accounting policies from those used in the financial statements for the year ended December 31, 2013 prepared under Canadian GAAP.

These financial statements were authorized for issue by the Board of Directors on March 26, 2015.

Financial instruments

a) Classification

The Company classifies its investments in debt and equity securities, and derivatives, as financial assets or financial liabilities at fair value through profit or loss ("FVTPL"). All other financial assets and liabilities are measured at amortized cost.

The FVTPL category has two sub-categories: financial assets or financial liabilities held for trading; and those designated at FVTPL at inception.

(i) Financial assets and liabilities held for trading

A financial asset or financial liability is classified as held for trading if it is acquired or incurred principally for the purpose of selling or repurchasing in the near term or if on initial recognition is part of a portfolio of identifiable financial investments that are managed together and for which there is evidence of a recent actual pattern of short-term profit taking. Derivatives are also categorized as held for trading. The Company does not classify any derivatives as hedges in a hedging relationship.

(ii) Financial assets and liabilities designated at FVTPL at inception

Financial assets and financial liabilities designated at FVTPL at inception are financial instruments that are not classified as held for trading but are managed, and their performance is evaluated, on a fair value basis in accordance with the Company's documented investment strategy. The Company evaluates the information about these financial assets and liabilities on a fair value basis together with other related financial information.

Unlisted or non-exchange traded investments, or investments where a last bid, sale or close price is unavailable, or investments for which market quotations are, in the Company's opinion, inaccurate, unreliable, or not reflective of all available material information, are valued at their fair value as determined by the Company using appropriate and accepted industry valuation techniques including valuation models. The fair value determined using valuation models requires the use of inputs and assumptions based on observable market data including volatility and other applicable rates or prices. In certain circumstances, the fair value may be determined using valuation techniques that are not supported by observable market data.

The resulting values for investments not traded in an active market may differ from values that would be determined had a ready market existed, and the difference could be significant.

(b) Recognition, de-recognition and measurement

Regular way purchases and sales of investments are recognized on the trade date - the date on which the Company commits to purchase or sell the investment. Financial assets are derecognized when the rights to receive cash flows from the investments have expired or the Company has transferred substantially all risks and rewards of ownership.

Financial assets and financial liabilities at FVTPL are initially recognized at fair value. Transaction costs are expensed as incurred. Subsequent to initial recognition, all financial assets and financial liabilities at FVTPL are measured at fair value. Gains and losses arising from changes in the fair value of the 'financial assets or financial liabilities at FVTPL' category are included in the statements of comprehensive loss in the period in which they arise.

Under the amortized cost method, financial assets and liabilities reflect the amount required to be received or paid, discounted, when appropriate, at the contract's effective interest rate. The calculation includes all fees paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts.

At each reporting date, the Company assesses whether there is objective evidence that a financial asset at amortized cost is impaired. If such evidence exists, the Company recognizes an impairment loss as the difference between the amortized cost of the financial asset and the present value of the estimated future cash flows, discounted using the instrument's original effective interest rate. Impairment losses on financial assets at amortized cost are reversed in subsequent periods if the amount of the loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized.

The interest for distribution purposes shown on the statements of comprehensive loss represents the coupon interest received by the Company accounted for on an accrual basis. The Company does not amortize premiums paid or discounts received on the purchase of fixed income securities except for zero coupon bonds, which are amortized on a straight line basis.

Realized gain/loss on sale of investments and unrealized appreciation/depreciation in investments are determined on an average cost basis. Average cost does not include amortization of premiums or discounts on fixed income securities with the exception of zero coupon bonds. Royalty income is recognized on an accrual basis as earned. Dividend income is recognized at the ex-dividend date.

Transaction costs are any costs that can be directly attributable to the acquisition and disposal of an investment, which include fees and commissions paid to agents, advisors, brokers and dealers; levies by regulatory agencies and securities exchanges; and transfer taxes and duties.

(c) Presentation

Financial assets and liabilities are offset and the net amount reported in the statements of financial position, when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or to realize the asset and settle the liability simultaneously. In the normal course of business, the Company may enter into master netting arrangements or similar agreements that do not meet the criteria for offsetting in the statements of financial position, but still allow for the related amounts to be offset in certain circumstances, such as bankruptcy or termination of the contracts. The Company has not offset any material financial instruments as at December 31, 2014, December 31, 2013 or January 1, 2013.

Fair value measurement

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of financial assets and liabilities traded in active markets (such as publicly traded derivatives and marketable securities) are based on quoted market prices at the close of trading on the reporting date. The Company uses the last traded market price for both financial assets and financial liabilities where the last traded price falls within that day's bid-ask spread. In circumstances where the last traded price is not within the bid-ask spread, management determines the point within the bid-ask spread that is most representative of fair value based on the specific facts and circumstances. The Company's policy is to recognize transfers into and out of the fair value hierarchy levels as of the date of the event or change in circumstances giving rise to the transfer.

The fair value of financial assets and liabilities that are not traded in an active market is determined using valuation techniques. The Company uses a variety of methods and makes assumptions that are based on market conditions existing at each reporting date. Valuation techniques include the use of comparable recent arm's length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, option pricing models and others commonly used by market participants and which make the maximum use of observable inputs. In certain circumstances, the fair value may be determined using valuation techniques that are not supported by observable market data.

The resulting values for investments not traded in an active market may differ from values that would be determined had a ready market existed, and the difference could be significant.

Specifically, financial assets and liabilities that are classified as held for trading are recorded at fair values determined as follows:

Foreign currency contracts

Foreign currency contracts (note 7) entered into by the Company are valued at an amount that is equal to the gain or loss that would be realized if the position were transferred, which is equivalent to the difference between the deliverable asset and the value of the asset to be received.

Warrants

Warrants are recorded at their estimated fair value.

Financial assets and liabilities that are designated at FVTPL at inception are recorded at fair values determined as follows:

Equities

Publicly traded equities are recorded at closing prices as quoted on recognized stock exchanges.

The amounts at which the Company's publicly-traded investments could be disposed of currently may differ from the carrying value based on market quotes, as the value at which significant ownership positions are sold is often different than the quoted market price due to a variety of factors such as premiums paid for large blocks or discounts due to illiquidity.

Fixed income investments and convertible debentures

Fixed income investments traded on a public securities exchange or traded on an over-the-counter market are valued at the closing price. Where no closing price is available, the last sale price is used where, in management's opinion, this provides the best estimate of fair value.

Fixed income investments not traded on a public securities exchange or over-the-counter market are valued by considering data inputs such as the last price the security was traded at, most recent bid/ask information, prices of similar securities with available prices, and comparison of yields of comparable investments.

Royalties

Royalty investments are measured on a discounted cash flow basis, where the value is imputed through forecasting cash flows using an appropriate discount rate.

Foreign exchange

Assets and liabilities denominated in foreign currencies are translated into Canadian dollars, which is also its functional and presentation currency, at the exchange rate applicable on the valuation date. Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates that transactions occur. Foreign currency assets and liabilities denominated in a foreign currency are translated into the functional currency using the exchange rate prevailing at the measurement date. Foreign exchange gains and losses relating to cash are presented as 'Foreign exchange gain (loss) on cash' and those relating to other financial assets and liabilities are presented within 'Net realized loss' and 'Unrealized depreciation' in the statements of comprehensive loss.

Income taxes

The Company follows the liability method of accounting for income taxes. Future income tax assets and liabilities are measured using rates expected to apply to the taxable income in the years in which the temporary differences are expected to be settled. The Company accounts for uncertain tax positions using the contingent liability model, whereby a provision is established only where it is probable that a payment will be required to be made.

Management has estimated the income tax provision and future income tax balances taking into account its expectation of deferred taxable income and an interpretation of the various income tax laws and regulations. It is possible, due to the complexity inherent in estimating income taxes, that the tax provision and deferred tax balances could change (notes 6 and 10), and the change could be significant.

Current income taxes are the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the end of the reporting period, and any adjustment to tax payable in respect of previous years.

Net assets per common share

The net assets per common share are computed by dividing the net assets of the Company by the total number of common shares outstanding on the statements of financial position.

Comprehensive loss per weighted average common share

Comprehensive loss per weighted average common share represents the comprehensive loss divided by the weighted average number of common shares outstanding during the year.

The weighted average number of shares outstanding during the year ended December 31, 2014 was 10,537,263 (2013 - 10,537,263). This weighted average includes both the voting common shares and non-voting common shares of the Company.

3. Capital stock

The Company is authorized to issue an unlimited number of voting common shares without par value, and an unlimited number of non-voting common shares without par value. The holders of the voting common shares have one vote for each share held. The holders of non-voting common shares have no such right to vote.

The holders of both the voting common shares and the non-voting common shares are entitled to receive dividends, which must be declared and paid in an equal amount per share and at the same time without preference or distinction.

In the event of the liquidation, dissolution or winding-up of the Company whether voluntary or involuntary, or any other distribution of the assets of the Company among its shareholders for the purpose of winding up its affairs, the holders of the voting common shares and the holders of the non-voting common shares rank equally and are entitled to share and receive the remaining property of the Company.

There were no changes in the number of voting and non-voting common shares during the years ended December 31, 2014 and 2013. The total shares outstanding at December 31, 2014, December 31, 2013 and January 1, 2013 are summarized as follows:

Number of
shares
Voting common shares10,191,592
Non-voting common shares345,671
Total common shares outstanding10,537,263

On April 30, 2014, the Company paid a return of capital to shareholders of $102,738,314. This was accounted for by first reducing retained earnings, and then reducing common shares by the residual amount. As a result, retained earnings decreased by $21,096,074, the carrying amount of voting common shares was reduced by $79,100,874 and the carrying amount of non-voting common shares was reduced by $2,541,366.

Contributed surplus

The contributed surplus balance did not change during the years ended December 31, 2014 and 2013. The balance at December 31, 2014, December 31, 2013 and January 1, 2013 consists of:

$
Surplus related to stock compensation, warrants and options associated with common shares8,030,295
Surplus relating to warrants associated with previously issued preferred shares1,874,209
9,904,504

4. Related party transactions and balances

Deans Knight Capital Management (the "Investment Advisor"), a corporation with common directors and officers of the Company, provides administration, financial reporting and other ancillary services required by a public company. The Investment Advisor is also providing investment management services related to the disposition of the remaining investments held by the Company. The Investment Advisor is paid a nominal fee of $10 per month, starting May 1, 2014, for the services it provides to the Company under the Services Agreement. Prior to that, and for the period from January 1, 2014 to April 30, 2014, Deans Knight was paid a management fee computed quarterly, at an annual rate of 1.5% of the net asset value plus applicable taxes, and adjusted for certain non-investment related assets.

For the year ending December 31, 2014, management fees totaled $554,785 (2013 - $2,122,002). At December 31, 2014, $63 (December 31, 2013 - $512,138, January 1, 2013 - $589,251) was owed to the Investment Advisor, which was unsecured and included in accounts payable and accrued liabilities in the statements of financial position, and is payable immediately.

A former director of the Company, who ceased being a director and therefore a related party in June 2013, is a partner at a law firm that provides legal services to the Company. During the year ending December 31, 2013, the Company incurred $299,969 in legal services and disbursements provided by this law firm. At December 31, 2013, accounts payable included $133,884 (January 1, 2013 - $226) due to the law firm for legal fees and disbursements.

5. Net realized loss on investments sold and foreign currency contracts

The net realized loss on investments sold and foreign currency contracts for the year ended December 31 was as follows:

2014
$
2013
$
Proceeds from sale of investments61,878,978 70,490,273
Investments at cost - Beginning of year68,222,974 117,207,284
Add: Cost of investments purchased66,382 26,749,307
68,289,356 143,956,591
Less: Investments at cost - End of year2,513,316 68,222,974
Cost of investments sold65,776,040 75,733,617
Net realized loss on investments sold(3,897,062)(5,243,344)
Net realized loss on investments sold and foreign currency contracts consists of:
2014
$
2013
$
Realized loss on investments sold(3,446,354)(2,572,824)
Realized loss on settlement of foreign currency contracts(450,708)(2,670,520)
(3,897,062)(5,243,344)

6. Taxation

Uncertainty of deductibility of tax losses

Prior to the reorganization and change in the Company's business that occurred in 2008, as discussed in Note 1 of the Financial Statements, the Company had generated significant tax losses and other tax attributes as a result of its prior business activities. In its tax filings since the reorganization, the Company has taken the position that these losses and other tax attributes could be used to offset taxable income generated by the Company, thereby reducing its taxes payable.

On July 16, 2014, the Company received Notices of Reassessment ("NORAs") from the CRA for the taxation years 2009 to 2012, inclusive. In the NORAs, the CRA denied the use of the losses and other tax attributes by the Company on the basis that an acquisition of control of the Company occurred and on the basis of the General Anti-Avoidance Rule in the Income Tax Act (Canada) (the "CRA Matter"). The Company, in consultation with its legal advisors, remains of the view that its tax filing position is appropriate, and intends to vigorously defend its position.

The NORAs indicate the Company's tax liability for the 2009 to 2012 taxation years to be approximately $22.7 million or $2.15 per Share ("Disputed Amount"), including arrears interest and penalties. Given the Company's financial results for 2013 and 2014, the Company estimates its overall potential net tax liability for the years 2009 through 2014 inclusive to be approximately $21.6 million, or $2.05 per Share ("Potential Tax Liability"). The Company has prepaid the $21.6 million to the CRA to limit any future interest from being incurred.

Should the Company be successful in defending its tax filing position, the amount prepaid to the CRA will be refunded to the Company with interest. However, if the Company is unsuccessful, the recorded amount of the tax assets, if any, as well as such amounts claimed to date would be recorded as a charge to income, and the Potential Tax Liability would be forfeited to the CRA.

In late October, 2014, the Company filed its Notice of Appeal to the Tax Court of Canada, appealing the NORAs and is now attending to normal pre-trial processes, including discovery of documents and examinations for discovery with the Crown.

Deferred tax asset

The tax effects of temporary differences and tax credits that give rise to significant components of the deferred income tax assets, at the statutory enacted rates when such benefits are expected to be realized, are as follows:

Research and development expenses
$
Share
Issuance
costs
$



Total
$

At January 1, 20132,076,560 313,440 2,390,000
Charged to the statement of comprehensive loss(1,896,560)(313,440)(2,210,000)
At December 31, 2013180,000 - 180,000
At January 1, 2014180,000 - 180,000
Charged to the statement of comprehensive loss(180,000)- (180,000)
At December 31, 2014- - -
Deferred tax assets expected to be realized in:
December 31,
2014
$
December 31, 2013
$
January 1, 2013
$
Less than 12 months- 180,000 1,930,000
Greater than 12 months- - 460,000
Net deferred tax asset- 180,000 2,390,000

The tax balances and income tax expense recognized by the Company are based on management's interpretation of the tax laws. Due to the complexity inherent in tax interpretations, regulations and legislation, and changes in the operations of the Company, there are significant estimates required to compute income tax balances. It is possible that some or all of the Company's significant components of the deferred income tax assets may not be deductible for tax purposes and, accordingly, the amount of future income taxes and provision for income taxes recorded in the financial statements could change by a material amount.

Deferred income tax assets are recognized only to the extent that it is probable that future taxable income will be available against which temporary differences can be utilized. In determining the amount of deferred income tax assets recognized, management assessed the projected taxable income of the Company. Inherent in all forward looking information is uncertainty and actual amounts could differ from these estimates and the difference could be material. In developing the projection, management has assumed full payment of all contractual interest and that investments will be sold at their current value.

Tax pools available to offset future tax expense and payable

As at December 31, 2014, the Company has accumulated non-capital losses of approximately $3,820,000 and the benefit of $3,800,000 of these losses has been recorded as a reduction of the prepaid tax asset. If the Company is successful in defending its tax filing position, these losses would be reinstated for carry forward and will expire in 2033 to 2034. In addition, the Company has scientific research and experimental development ("SR&ED") expenditures of $18,135,000, which do not expire, available to offset future taxable income and $7,097,000 of unclaimed federal investment tax credits ("ITCs"), which expire from 2018 to 2025, available to offset future taxes payable. The benefit of non-capital losses of $20,000 and all of the SR&ED expenditures and ITCs have not been recognized in the financial statements based on management's assessment that it is not probable that these tax attributes will be realized in the future.

Reconciliation of income tax expense

The reconciliation of income tax computed at the statutory tax rate to income tax expense at December 31, using a 26.0% statutory tax rate (2013 - 25.75%), is as follows:

2014
$
2013
$
Decrease in net assets from operations before tax(20,423)(3,116,093)
Statutory tax rate26.00%25.75%
Income tax recovery at statutory rates(5,310)(802,394)
Non-capital loss carry forward5,310 802,394
Reduction of deferred tax asset180,000 2,210,000
Provision for deferred income tax180,000 2,210,000

7. Financial instruments

The following table presents the carrying amounts of the Company's financial instruments by category as at December 31, 2014:

Financial instruments by category
Amortized cost
$
Assets/
liabilities at FVTPL
$

Total
$
Assets as per statements of financial position
Designated as FVTPL:
Investments -3,266,8543,266,854
Loans and receivables:
Cash and accrued interest receivable 1,555,651-1,555,651
1,555,6513,266,8544,822,505
Liabilities as per statements of financial position
Other financial liabilities:
Accounts payable and accrued liabilities 66,597-66,597
66,597-66,597

The following table presents the carrying amounts of the Company's financial instruments by category as at December 31, 2013:

Financial instruments by category
Amortized cost
$
Assets/
liabilities at FVTPL
$

Total
$

Assets as per statements of financial position
Held for trading:
Warrants -106,629106,629
Designated as FVTPL:
Investments -65,616,56765,616,567
Loans and receivables:
Cash and accrued interest receivable 65,360,146-65,360,146
65,360,14665,723,196131,083,342
Liabilities as per statements of financial position
Held for trading:
Foreign currency contracts -63,80063,800
Other financial liabilities:
Accounts payable and accrued liabilities 873,905-873,905
873,90563,800937,705

The following table presents the carrying amounts of the Company's financial instruments by category as at January 1, 2013:

Financial instruments by category
Amortized cost
$
Assets/
liabilities at FVTPL
$

Total
$
Assets as per statements of financial position
Held for trading:
Warrants -677,413677,413
Designated as FVTPL:
Investments -119,197,904119,197,904
Loans and receivables:
Cash and accrued interest receivable 21,753,498-21,753,498
21,753,498119,875,317141,628,815
Liabilities as per statements of financial position
Held for trading:
Foreign currency contracts -296,595296,595
Other financial liabilities:
Accounts payable and accrued liabilities 713,711-713,711
713,711296,5951,010,306

Fair value measurement

Financial instruments are classified in a hierarchy that prioritizes the inputs to fair value measurement. Each level is based on the transparency of the inputs used to measure the fair values of assets and liabilities. The three levels of the fair value hierarchy are:

Level 1 - inputs that reflect unadjusted quoted prices in active markets for identical assets or liabilities;

Level 2 - inputs that reflect other than quoted prices that are observable for the assets or liabilities either directly or indirectly;

Level 3 - inputs that are not based on observable market data.

If inputs of different levels are used to measure an asset's or liability's fair value, the classification within the hierarchy is based on the lowest level input that is significant to the fair value measurement.

The following tables illustrate the classification of the Company's financial instruments within the fair value hierarchy:

Financial assets at fair value - December 31, 2014

Level 1
$

Level 2
$

Level 3
$

Total
$
Corporate debt-- 1,588,2281,588,228
Equity-556,145 -556,145
Royalty-- 1,122,4811,122,481
-556,145 2,710,7093,266,854
Financial assets at fair value - December 31, 2013

Level 1
$

Level 2
$

Level 3
$

Total
$
Corporate debt-50,264,259 6,334,85956,599,118
Convertible debentures-1,060,000 -1,060,000
Equity6,716,216- 106,6296,822,845
Royalty-- 1,241,2331,241,233
Foreign currency contracts-(63,800)-(63,800)
6,716,21651,260,459 7,682,72165,659,396
Financial assets at fair value - January 1, 2013

Level 1
$

Level 2
$

Level 3
$

Total
$
Corporate debt-94,459,352 13,965,857108,425,209
Convertible debentures-2,200,000 -2,200,000
Equity8,696,425- 677,4139,373,838
Royalty-- 1,238,7701,238,770
Other-(1,362,500)-(1,362,500)
Foreign currency contracts-(296,595)-(296,595)
8,696,42595,000,257 15,882,040119,578,722

There were no transfers between Level 1 and Level 2 of the fair value hierarchy.

The following tables reconcile the Company's recurring Level 3 fair value measurements:

Corporate
debt
$

Equities
$

Royalty
$

Total
$
Balance - January 1, 201313,965,857 677,413 1,238,770 15,882,040
Purchases982,991 - - 982,991
Transfers in2,223,464 - - 2,223,464
Sales(10,233,152)(510,000)- (10,743,152)
Realized and unrealized (depreciation) appreciation(604,301)(60,784)2,463 (662,622)
Balance - December 31, 20136,334,859 106,629 1,241,233 7,682,721
Unrealized (depreciation) appreciation(871,596)90,527 2,463 (778,606)
Balance - January 1, 20146,334,859 106,629 1,241,233 7,682,721
Transfers out(813,143)- - (813,143)
Sales(4,000,000)(264,473)- (4,264,473)
Realized and unrealized appreciation (depreciation)66,512 157,844 (118,752)105,604
Balance - December 31, 20141,588,228 - 1,122,481 2,710,709
Unrealized appreciation (depreciation)66,511 - (118,751)(52,240)

The transfer from Level 3 to Level 2 during the period ended December 31, 2014, totalling $813,143, related to corporate debt securities that were exchanged for common shares traded on an active market, as part of a corporate restructuring.

Level 3 fair value measurements have predominantly been valued by considering data inputs such as the last price the security was traded at, most recent bid/ask information, prices of similar securities with available prices, and comparison of yields of comparable investments. Any reasonably possible alternative assumptions, except as noted below, would result in immaterial changes to total net assets.

For royalty investments measured on a discounted cash flow basis, the value is imputed through forecasted cash flows and discount rates. The following summarizes the affect a change in assumptions would have on total net assets at December 31, 2014:

Increase by 5%Decrease by 5%
Cash flow growth rate223,000 (213,000)
Discount rate(185,000)224,000

Management of financial risks

In the normal course of business, the Company is exposed to various financial risks, including credit risk, liquidity risk and market risk (consisting of interest rate risk, currency risk and other price risk). The Company's overall risk management program seeks to minimize potentially adverse effects of these risks on the Company's financial performance by employing a professional, experienced portfolio advisor, monitoring daily the Company's positions and market events, diversifying the investment portfolio within the constraints of the investment guidelines and periodically using derivatives to hedge certain risk exposures. Further, the Company monitors the portfolio to ensure compliance with its investment strategy, investment guidelines and securities regulations.

Fair value risk

The Company's investments are exposed to market price risk and this risk affects the fair value of the investments. All investments have an inherent risk of loss of capital. The maximum risk resulting from investments is determined by their fair value. The Company seeks to manage valuation risks by regular ongoing monitoring of the investment performance of the individual investee companies. A 10% change in the value of the Company's equity investments (excluding warrants) would have a $55,615 (December 31, 2013 - $671,622, January 1, 2013 - $869,643) impact on profit or loss.

Credit risk

Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment that it has entered into with the Company.

All transactions executed by the Company in listed securities are settled/paid for upon delivery using approved brokers. The risk of this settlement not occurring is considered minimal, as delivery of securities sold is only made once the broker has received payment. Payment is made on a purchase once the securities have been received by the broker. The trade will fail if either party fails to meet its obligation. Since the Company invests in high-yield debt instruments and derivatives, this represents the main concentration of credit risk. The fair value of debt securities includes consideration of the creditworthiness of the debt issuer. The maximum credit exposure of these assets is represented by their carrying amounts. However, this maximum exposure is mitigated to varying degrees in each investment, based on the collateral held, if any. Collateral may include such things as a general security agreement over all assets, or specific security over specific assets. It may also entitle the debt holder to take over the overall business through restructuring of the investment.

The Company's credit risk exposure by credit ratings on its investments is listed as follows:

As a % of net assets
December 31,
2014
December 31,
2013
January 1,
2013
Credit rating
BB+-4.44.4
BB--1.8
BB---0.9
B+-2.88.3
B-4.36.0
B--15.210.6
CCC+-11.630.3
CCC--3.1
CCC---2.4
D-0.9-
Not rated*12.411.115.7
12.450.383.5

* Unrated debt securities consist primarily of loans receivable.

Credit ratings are obtained from various credit rating agencies and sources. Where one or more rating is obtained for a security, the lowest rating has been used.

Credit risk associated with the Company's cash and cash equivalents and foreign exchange contracts is not considered significant, as they are held with Tier 1 Canadian Financial Institutions.

The Company's credit risk exposure by sector on its investments is as follows:

As a % of net assets
December 31,
2014
December 31,
2013
January 1,
2013
Sector
Services5.61.00.2
Technology4.31.00.9
Materials and metals2.55.213.7
Consumer goods-6.58.4
Energy-30.349.8
Financial services-2.5-
Forestry-3.86.2
Industrial/manufacturing--4.3
12.450.383.5

Interest rate risk

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows or fair values of financial instruments.

The Company's investments include interest-bearing financial instruments. Accordingly, the Company is exposed to the risk that the value of such financial instruments will fluctuate due to changes in the prevailing levels of market interest rates. The table below summarizes the Company's exposure to interest rate risk by term to maturity on its investments:

Fair value
December 31,
2014
$
December 31,
2013
$
January 1,
2013
$
Maturity
Less than 1 year1,119,709--
1 - 3 years-5,228,44920,543,660
3 - 5 years373,07538,100,24946,527,959
Greater than 5 years1,217,92514,110,99042,639,891
2,710,70957,439,688109,711,510

As at December 31, 2014, if the prevailing interest rates had been raised or lowered by 1%, assuming a parallel shift in the yield curve, with all other factors remaining constant, net assets could possibly have decreased or increased by approximately $104,000 or 0.5% of net assets (December 31, 2013 - $2,100,000, or approximately 1.6% of net assets).

Liquidity risk

As the Company is a closed-end investment company with a fixed number of common shares outstanding, unlike an open-ended mutual fund, it is not exposed to the liquidity risk associated with daily cash redemptions of securities.

The Company's remaining investments may not be able to be liquidated quickly at an amount close to their fair value to respond to specific events such as deterioration in the creditworthiness of any particular issuer. Investments held by the Company may be subject to resale restrictions such as hold periods. The resulting values for the Company's remaining investments may differ from values that would be realized if a ready market exists.

The Company reviews its investment portfolio to assess liquidity risk on its holdings.

Currency risk

Currency risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates. The Company's remaining investments include securities that are denominated in a currency other than the Canadian dollar, which represents the functional currency of the Company. Consequently, the Company is exposed to currency risk as the value of the portfolio securities denominated in currencies other than the Canadian dollar will vary due to changes in foreign currency exchange rates.

Prior to April 30, 2014, being the date the Company returned $102,738,314 of capital to its shareholders (note 3), the Company entered into foreign currency contracts with financial institutions to hedge the value of foreign currency denominated investments. The fair value of these contracts was reflected in investments. Gains or losses arising from these contracts offset the gains or losses from translation of the underlying investments. The unrealized gains or losses were reflected in unrealized appreciation/depreciation on foreign currency contracts on the statements of comprehensive loss. The potential impact to net assets of a 5% change in foreign currency rates against the Canadian dollar, assuming all other variables remain constant, would be $145,200 at December 31, 2014 (December 31, 2013 - $160,000).

8. Capital management

The capital of the Company is divided into voting and non-voting common shares, each having an unlimited authorized amount. The number of voting and non-voting shares outstanding and changes thereto, are outlined in note 3. On April 30, 2014, the Company paid a return of capital of $102,738,314 to voting and non-voting common shareholders, equal to $9.75 per share.

The Company manages its capital in accordance with the Company's amended business objectives, as approved by shareholders at a meeting held April 4, 2014. The objectives include: (i) divesting of any remaining investments held; (ii) attending to, and if necessary, litigating, the CRA audit and related tax appeal (note 6); and, (iii) attending to any distributions to shareholders of surplus cash and the eventual wind-up and termination of the Company thereafter.

The Company discontinued its monthly dividend payment of $0.0583 per voting and non-voting common share after its December 2013 payment. However, the Company made a one off dividend payment of $0.10 per voting and non-voting common share, or $1,053,726, in the year ended December 31, 2014. Total dividends paid in the year ended December 31, 2013 were $7,371,869.

9. Cash and cash equivalents

For the purposes of the statements of financial position and cash flow, cash and cash equivalents comprise the following balances with original maturities of less than 90 days:

December 31,
2014
$
December 31,
2013
$
January 1,
2013
$
Cash at bank1,399,9857,665,2119,110,875
Short-term deposits-56,908,19010,980,250
Total1,399,98564,573,40120,091,125

10. Critical accounting estimates and judgments

The preparation of financial statements requires management to use judgment in applying its accounting policies and to make estimates and assumptions about the future. The following discusses the most significant accounting judgments and estimates that the Company has made in preparing the financial statements:

Fair value measurement of derivatives and securities not quoted in an active market

The Company holds financial instruments that are not quoted in active markets. Fair values of such instruments are determined using valuation techniques and may be determined using reputable pricing sources (such as pricing agencies) or indicative prices from market makers. Broker quotes, as obtained from the pricing sources, may be indicative and not executable or binding. Where no market data is available, the Company may value positions using its own models, which are usually based on valuation methods and techniques generally recognized as standard within the industry. Models use observable data, to the extent practicable. However, areas such as credit risk (both own and counterparty), volatilities and correlations require the Company to make estimates. Changes in assumptions about these factors could affect the reported fair values of financial instruments. The Company considers observable data to be market data that is readily available, regularly distributed and updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market. Refer to note 2 for further information about the fair value measurement of the Company's financial instruments and to note 7 for further information about level 3 investments.

Deferred income taxes

The tax balances and income tax expense recognized by the Company are based on management's interpretation of the tax laws. Due to the complexity inherent in tax interpretations, regulations and legislation, there are significant estimates required to compute income tax balances. It is possible that some or all of the Company's significant components of the deferred income tax assets may not be deductible for tax purposes and, accordingly, the amount of the prepaid tax assets, deferred income taxes, and provision for income taxes recorded in the financial statements could change by a material amount (note 6).

In determining the amount of deferred income tax assets recognized, management assessed the projected taxable income of the Company. Inherent in all forward looking information is uncertainty and actual amounts could differ from these estimates and the difference could be material. In developing the projection, management has assumed full payment of all contractual interest and that investments will be sold at their current value.

11. Transition to IFRS

Transition elections

The only voluntary exemption adopted by the Company was the ability to designate a financial asset or liability at FVTPL upon transition to IFRS. All financial assets designated at FVTPL upon transition were previously carried at fair value under Canadian GAAP as required by Accounting Guideline 18, Investment Companies.

The table below provides a reconciliation of equity and comprehensive income as previously reported under Canadian GAAP to IFRS:

EquityDecember 31,
2013
$
January 1,
2013
$
Equity as reported per Canadian GAAP130,147,580142,275,000
Revaluation of investments at FVTPL219,427789,969
Equity per IFRS130,367,007143,064,969
Comprehensive lossDecember 31,
2013
$
Comprehensive loss as reported per Canadian GAAP(4,755,551)
Revaluation of investments at FVTPL(570,542)
Comprehensive loss per IFRS(5,326,093)

Revaluation of investments at FVTPL

Under Canadian GAAP, the Company measured the fair value of its investments in accordance with Section 3855, Financial Instruments - Recognition and Measurement, which required the use of bid prices for long positions and ask prices for short positions, to the extent such prices were available. Under IFRS, the Company measures the fair values of its investments using the guidance in IFRS 13, 'Fair Value Measurement', which requires that if an asset or a liability has a bid price and an ask price, then its fair value is to be based on a price within the bid-ask spread that is most representative of fair value. It also allows the use of mid-market pricing or other pricing conventions that are used by market participants as a practical expedient for fair value measurements within a bid-ask spread. As a result, upon adoption of IFRS an adjustment was recognized to increase the carrying amount of the Company's investments by $219,427 and $789,969 as at December 31, 2013 and January 1, 2013, respectively. The impact of this adjustment was to increase the Company's comprehensive loss by $570,542 for the year ended December 31, 2013.

Reclassification adjustments

In addition to the adjustments noted above, the Company reclassified certain amounts upon transition in order to conform to its financial statement presentation under IFRS. Under Canadian GAAP, the Company presented investment income on the statement of comprehensive loss; under IFRS the Company presents royalty and interest and other income separately. Further, the statement of cash flows under IFRS requires the Company to provide the royalty and interest and other income accrued separately to the royalty and interest and other income received.

12. Future accounting changes

At December 31, 2014, a number of standards and interpretations, and amendments thereto, had been issued by the International Accounting Standards Board (IASB), which are not effective for these financial statements. Those which are expected to have an effect on the Company's financial statements are discussed below:

IFRS 9, 'Financial instruments', addresses the classification, measurement and recognition of financial assets and financial liabilities. The complete version of IFRS 9 was issued in July 2014. It replaces the guidance in IAS 39 that relates to the classification and measurement of financial instruments. IFRS 9 establishes three primary measurement categories for financial assets: amortized cost, fair value through other comprehensive income and FVTPL. The basis of classification depends on the entity's business model and the contractual cash flow characteristics of the financial asset. Investments in equity instruments are required to be measured at FVTPL with the irrevocable option to recognize changes in fair value with no recycling of gains or loss to the statements of comprehensive loss. IFRS 9 requires credit losses to be recognized on an expected loss basis rather than using an incurred loss model. For financial liabilities there were no changes to classification and measurement except for the recognition of changes in own credit risk in other comprehensive income, for liabilities designated at fair value through profit or loss. The standard is effective for accounting periods beginning on or after 1 January 2018. Early adoption is permitted. The Company is yet to assess IFRS 9's full impact.

IFRS 15, 'Revenue from contracts with customers' deals with revenue recognition and establishes principles for reporting useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity's contracts with customers. Revenue is recognized when a customer obtains control of a good or service and thus has the ability to direct the use and obtain the benefits from the good or service. The standard replaces IAS 18 'Revenue' and IAS 11 'Construction contracts' and related interpretations. The standard is effective for annual periods beginning on or after 1 January 2017 and earlier application is permitted. The Company is yet to assess IFRS 15's full impact.

Contact Information

  • Craig Langdon
    Chief Executive Officer and Director
    Deans Knight Income Corporation
    (604) 669-0212

    Mark Myles
    Chief Financial Officer
    Deans Knight Income Corporation
    (604) 669-0212