A Case Study

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In mid-January 2006. Robert Wight, vice-president (finance) and chief financial officer for Clearwater Seafoods Income Fund (Clearwater), a seafood exporting company based in Nova Scotia, Canada, was preparing for a conference call scheduled in about a week with the financial community on the results for the year ending December 31, 2005.

The main reason for suspension — the first ever since the company’s conversion into an income trust in August 2002 — was that the currencies in which the company was earning income were losing value relative to the Canadian dollar in which the company was incurring expenses. The negative market reaction to the suspension of the distributions had been strong and swift

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The value of the units declined 35 per cent. Now, three months later, the firm’s major stakeholders were seeking assurances that the company had a strategy in place to deal with the exchange rate crisis and other operating challenges so that distributions could be reinstated. Wight wondered, “What is the best strategy with which to turn the tide and change investor sentiment?

For many years, the company had benefited from a weak Canadian dollar which had allowed Clearwater to get more Canadian dollars for its export sales.

But with the dramatic upswing of the Canadian dollar, Clearwater’s earnings from the sale of seafood around the world and from foreign exchange operations were both taking a hit. This was evident in the rapid decrease in EBITDA from 2003 to 2005.

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This had led to suspension of the distribution payments, forcing Clearwater, in turn, to revisit its short-term and long-term business priorities.

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Clearwater was founded in 1976 at Bedford, Nova Scotia as a local lobster distributor, and did an initial public offering (IPO) as an income trust in mid-2002.

Clearwater was the largest publicly traded shellfish company in North America.

Its business consisted of harvesting, processing and selling a variety of shellfish and ground fish species.

Clearwater owned 23 offshore harvesting vessels of which 11 were engaged in processing at sea. The company had seven shore-based processing plants in Atlantic Canada and was working to modernize its fleet and do more offshore processing.

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Two vessels with processing capabilities were located in Argentina. Clearwater had recently invested Cdn$29 million in two new frozen at sea scallop vessels.

The company had also entered into a contract with a shipyard in Taiwan to construct a factory freezer clam vessel at a cost of Cdn$45 million. The financing was obtained from issuing convertible debentures in the Canadian market.

Expected to be operational by mid-2006, the new vessel was meant to increase the volumes and efficiency of the harvest and improve yields. It was an important step in Clearwater’s progression towards diversification of product offerings and improved operational efficiency.

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With 1,600 employees, Clearwater had offices in China, the United States, the United Kingdom, Japan and Argentina. With four distribution hubs in London, Brussels, Louisville and Halifax, it had its own logistics and freight forwarding capability in-house.

Customers: Located across a broad geographic base, Clearwater’s customers comprised retail chains (like Sobeys and Marks & Spencer), food distributors (like Sysco and Gordons) and corporate restaurants (like The Palm and Red Lobster). The top 10 customers contributed about 25 per cent of sales in 2005. No individual customer accounted for more than five per cent of sales. About 80 per cent of customers were doing business with Clearwater for over 10 years.

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Competitors: FPI Limited of Canada and four U.S. companies — American Seafoods Group (ASG), Eastern Fisheries, Seatrade International and Garbo Lobster Company — were some of the leading competitors for the company.

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CURRENT SITUATION The decline in the value of the U.S. dollar

had reduced 2005 sales in Canadian dollar terms, post-hedging, by 7.5 cents for each U.S. dollar of sales, amounting to Cdn$8.4 million during the year. The decline in the value of pound sterling, euro and yen had also had a negative impact on sales to the tune of Cdn$9.2 million

This decrease would have been more if Clearwater did not have an active foreign exchange risk management program

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The foreign exchange risk management program had two components: forward contracts and options. Forward contracts were used to provide certainty in exchange rates going forward 12 months and occasionally longer.

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SEAFOOD INDUSTRY The Canadian seafood harvesting industry

comprised two segments — seasonal inshore and year-round offshore. Seasonal inshore fishery consisted of independent fishermen carrying out small scale harvesting close to the shore and selling their harvest to seafood processors.

Clearwater operated primarily in the latter segment and complemented its own raw materials by purchasing from independent fishing companies.

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Seafood harvesting was a competitive business in which responsible management of the fishery stocks was integral to ensuring future supplies.

The industry was regulated by government agencies, such as the Department of Fishery and Oceans (DFO) in Canada, to ensure the sustainability of the resources. They granted harvesting licenses, set the total allowable catch (TAC) and determined the quotas for each company.

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The seafood business was seasonal in nature. Typically, sales were higher in the second half of the calendar year. Clearwater had been successful in growing its business through the acquisition of new licenses and quotas and the development of new products. It was able to reduce costs and increase product quality as it transitioned its fleet towards factory freezer vessels.

Market size: The global demand for seafood, which stood at 132 million tons in 2003, was forecast to go up to 182 million tons by 2015, representing a compound annual growth rate (CAGR) of 2.2 per cent. The world average per capita demand for seafood was forecast to go up, from 16.3 kg in 2003 to 19.1 kg in

2015, representing a CAGR of 1.1 per cent. Much of the growth in seafood consumption was to come from growth in population. The three largest countries ranked by population (China, India and the United States) accounted for approximately 44 per cent of the world’s total seafood consumption.

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Consumption trends.Almost half of the seafood produced for human consumption worldwide was consumed in three countries: 33 per cent in China, nine per cent in Japan and six per cent in the United States. While it made sense for Clearwater to establish footprints in Asian markets, the competition from local, low-cost producers was formidable, particularly in the individually quick frozen (IQF) scallops and shrimp from aquaculture operations.

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CORPORATE STRATEGY In 2003, Clearwater defined its new growth

strategy as being rooted in the “three pillars of the business” — innovation, vertical integration, and diversity of species and markets.

Innovation was aimed at developing and adopting technologies and practices enhancing growth and ensuring sustainability of the resource base.

Integration was aimed at controlling the value chain — from harvesting, processing and marketing to delivery — to generate cost efficiencies and to control quality

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Diversity was aimed at creating a natural hedge against downturns in the availability and thus the quota of any one species, changes in customer markets to hedge against the value of a specific currency or changes in the demand for Clearwater’s product from a specific region.

Purchasing new vessels, updating production facilities and replacing older boats in its fleet were part of Clearwater’s strategy to establish a premier position in the industry.

Investments in modernized vessels and shore-based processing plants were aimed at securing a strong stewardship of aquatic resources through increased yields, enhanced product quality, reduced costs, and improved environmental responsiveness.

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Traditionally, the company’s strategic intent had been four-fold: focus on previously unexploited species, pursue acquisitions of complementary businesses, foster long-term relationships with customers and take a leadership role in working with the official regulators. They provided the basis for redefining the company’s strategy in 2003.

Clearwater was also well positioned to become a global player. There was a growing international demand for premium shellfish and Clearwater had a diversified worldwide customer base whereas most of the industry was fragmented and consisted of many small enterprises

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The management had little time to strategize and execute an action plan. Restoring distributions was an immediate priority. That, in turn, called for a turnaround strategy that could be executed efficiently.

Wight recognized that:  The strengthening of the Canadian dollar is a trend that

will likely prevail through all of 2006. Equally, restructuring of business operations will dilute earnings in the short term. Continuing the suspension for too long will hurt investor sentiment. It will also weaken Clearwater’s competitive position relative to seafoods companies outside Canada. But it isunlikely Clearwater will be able to reinstate distributions until the restructuring is completed. As earnings continue to fall, leverage ratios will continue to climb, they are currently over three times EBITDA, and the crunch will prevail throughout the restructuring. We can not do both simultaneously - reinstate distributions and restructure operations - while remaining within our bank covenant parameters.

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The exchange management program was supplementing the company’s earnings from the mainline business and also offsetting the decline in earnings due to a strengthening Canadian dollar.

While the Canadian dollar had been falling, the company’s foreign exchange risk management program contributed significantly to the firm’s bottom line. But, as the Canadian dollar started to increase in value, the contribution of the program to the bottom line was decreasing.

There was thus a need to reassess the company’s foreign exchange risk management program.

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As CFO, Wight had to suggest steps to minimize Clearwater’s financial risk. The steps had to be consistent with the company’s overall strategy and improve its long-term profitability. It was thus important to identify Clearwater’s strengths.

. It was then necessary to provide adequate financial resources to leverage them so that the company would generate sufficient profits to reinstate distributions. Even though Clearwater’s founders owned 46 per cent of the units and were most concerned about the long-term viability of the company, they too were interested in the ability of the firm to reinstate its distributions in the near term.

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As Wight prepared for the conference call, he realized that he needed to carefully consider the different alternatives and be prepared to explain how the chosen strategy related to the criteria of interest to the major stakeholders.

“Should we revise the company’s strategy and change, at a fundamental level, the way we do business?” he wondered. ”Or leave the strategy intact and focus on communicating its rationale better to investors.

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If Clearwater was to consider changing its strategy, a clear alternative was to focus more attention on the company’s foreign exchange risk management operations and increase the latter’s ability to both manage risk and generate profit.

Wight realized that increasing Clearwater’s trading in foreign exchange options was one alternative. The profitable foreign exchange trading would help Clearwater mobilize its cash flows in different currencies and put them to better use

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A further alternative was to change Clearwater’s operational strategy. This could be performed in many different ways to either decrease Clearwater’s exposure to foreign currencies or further diversify its operations into other markets. The latter could alleviate some of the need to hedge foreign exchange risk by either decreasing the size of foreign currency exposure or increasing Clearwater’s ability to change prices as exchange rates change.

At the end, the decision required a strategy which would allow distributions to be reinstated while allowing the firm to have sufficient cash flows to sustain growth

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A strategy that focused more on operational hedging and diversification would be long-term and may not allow Clearwater to reinstate its distribution quickly. The company’s operating managers would have to change their traditional commodity mindset to one of differentiated product range.

Instead of competing on low-cost production, as before, they had to compete on the basis of environmental attributes, response to consumer demands, speed of entry, new product launches and alignments with the value chain — all ofwhich would justify premium pricing. A strategy focusing on financial hedging and opportunities in the foreign exchange market would allow for more immediate results and thus a more rapid reinstatement of distributions.

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DILEMMA FACING WIGHT IN JANUARY 2006  In the conference call, Wight had to propose a

method to improve the magnitude and stability of the Canadian dollar value of the company’s global cash flows. Clearwater’s unit holders were expecting a credible strategy and timeline that could, in the near term, stem the decline in the value of units and reinstate distribution. The company’s founders, who were also the largest unit holders, were committed to the long-term viability of the company, but a vast majority of the remaining investors were more interested in short-term results. Wight was thus under pressure to present a viable strategy going forward

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Exhibit1TRENDS IN IMPACT OF HEDGING TRANSACTIONS

2005 2004 2003

Hedge gains (losses) in salesForex gains (losses)- Realized- Unrealized- Total

Total Forex gains (losses) EBITDA

11,0338,1144,43612,55023,58356,956

10,55711,889 (4,407)7,482

18,03974,311

12,73412,4688,95721,42534,15991,243

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Exhibit 3 CLEARWATER — CURRENCY RATE & PERCENTAGE OF SALES

2005 2004 2003 2002

% ofsales

CurrencyRate

% ofsales

CurrencyRate

% ofSales

CurrencyRate

% ofsales

CurrencyRate

US dollarJapanese YenEuroUK PoundCdn $/Others

46.58.219.15.021.2

1.3070.0111.4782.188

-

53.08.215.84.418.6

1.3820.0121.6132.382

-

58.79.49.85.116.9

1.4620.0131.6152.464

-

61.411.27.64.215.6

1.5660.0131.5112.369

-

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Exhibit 4CLEARWATER — SALES BY GEOGRAPHY

2005 2004 2003

$ % $ % $ %

USACanada Europe Japan ChinaAsia (other) Others

95,94060,191

106,39631,5315,713

13,5351,533

30.519.133.810.01.84.30.5

114,71059,264

106,61835,31614,49314,7321,326

33.217.130.610.24.24.30.4

128,22065,60786,08939,95611,58017,306

979

36.718.824.611.43.3

5.000.2

Total 314,839 345,459 349,737

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Exhibit 5CLEARWATER — SALES BY CURRENCY

2005 2004 2003

$ % $ % $ %

US dollarCanadian dollarEuroJapanese Yen British Pound Others

146,00062,00060,00026,00016,0005,000

46.319.719.18.25.11.6

183,40060,00055,00028,00015,0004,000

53.017.315.98.34.31.2

205,00058,00034,00033,00018,0002,000

58.516.69.79.45.20.6

315,000 345,000 350,000

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Exhibit 6

SALES BY SPECIES

2005 2004 2003

Sales % Sales % Sales %

ScallopsLobster Clams Ground fish ShrimpCrabOthers

98,57170,95449,24229,93439,99415,11111,033

31.322.515.69.6

12.74.83.5

114,73566,60359,89844,67931,74117,24610,557

33.219.217.412.99.25.03.1

101,55276,06557,48748,29830,76922,83212,734

29.121.716.513.88.86.53.6

Total 314,839 345,459 349,737

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Exhibit 7

CLEARWATER SEAFOODS — QUOTAS AND TAC 2005

(in MT) Total Allowable Catch 2005

TACQuota

Allocated toClearwater

% of TACownership by

Clearwater

Shellfish- Sea Scallops- Argentine Scallops- Arctic Surf Clams- Lobster- Jonah Crab- Cold Water ShrimpGroundfish- Pollock- Redfish- Flounder- Haddock- Cod

4,2756,000

44,000720720

94,70510,00027,0003,000

19,90022,000

2,0843,000

44,000630630

17,8053,2004,320510

1,393440

48.750.0

100.087.587.518.832.016.017.07.02.0

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Exhibit 8

CLEARWATER SEAFOODS - INCOME STATEMENT

in 000 $ 2005 2004 2003 2002 (six months)

% % % %SalesCost of goods soldGross profitAdd:- Gain on disposal- Other income- Foreign exchange incomeLess:- Administration and selling- Bank interest and charges- Interest on long-term debt- Depreciation- Foreign currency translation- Income taxes- Minority interestNet earnings

314,839242,60172,2384,1021,660

12,55033,594

78611,87515,4001,2363,2213,398

21,040

10022.96.7

345,459253,32292,1375,9765,4757,482

36,759659

10,49016,1453,0064,2762,262

37,473

10026.610.8

349,737252,11197,626

-6,753

21,44334,579

9216,138

15,5401,4432,3382,746

62,117

10027.917.8

156,006105,93550,071

-918

3,36512,007

4462,2095,563

-2,795911

30,423

10032.019.5

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in 000 $ (as on December 31) 2005 2004 2003 2002

ASSETS CashAccounts receivableInventoriesPre-paid and other Other long-term assets Property, plant and equipmentLicenses and license agreementsGoodwillMinority interestLIABILITIESChecks issued in excess of fundsAccounts payable Distributions payable Income taxes payableCurrent portion of long-term debtLong-term debtFuture income taxesDue to joint venture partner Minority interest UNITHOLDERS’ EQUITY Partnership unitsCumulative earningsCumulative distributionsCumulative foreign currency trans a/c

9,72654,91243,4196,458

10,397151,945103,18110,378

-390,416

-36,597

-2,1441,008

192,0247,9582,0232,181

173,133151,053

(162,620) (15,085)

390,416

-61,34445,6614,744

13,497139,305105,08310,378

-380,012

57237,6075,8173,2341,206

167,9927,6931,9951,874

173,133130,013 (135,254)

(15,870)380,012

56452,76347,7499,144

18,500126,749108,443

8,9721,598

374,482-

38,3209,537453

3,515142,28713,0041,995

-172,251

92,540 (80,978) (18,442)

374,482

75951,96745,9545,694

10,266124,50241,8058,972

-289,919

-45,0339,0723,0322,794

107,9759,7191,995

-122,133

30,423 (22,476) (19,781)

289,919

Exhibit 9

CLEARWATER SEAFOODS - BALANCE SHEET

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Thank you

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