NOTES

Robert Wight is the CFO of Cleearwater Seafoods Income Fund

Cleearwater Seafoods is based in Nova Scotia, Canada
Wight is preparing for a conference call with the financial community for
the results concerning the year ending Dec 31, 2005
Clearwater had suspended its monthly distribution payments to its unit
holders from October 2005, the first since the company converted into
an income trust in August 2002
The reason for suspension 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 value of units declined 35%
Now 3 months later major stakeholders are seeking assurances that
Clearwater has a strategy in place to deal with the exchange rate crisis
and operating challenges so that distribution could be reinstated
Its foreign exchange management operations have contributed
significantly to the companys earnings
Rapid decrease in EBITDA from 2003 to 2005, due to dramatic
upswing in the Canadian dollar
Canadian dollar has appreciated relative to the depreciation of the US
dollar since 2001 however the in mid 2004 the Canadian dollar started
to appreciate against the other major currencies in which Clearwater
did business as well

CURRENT SITUATION
- Decline of US dollar 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. The decline of the value of pound sterling, euro, yen
also had a negative impact on sales of Cdn$9.2 million, giving a total of
17.6 million less than what it would have received if there was no
appreciation of the Canadian dollar.
- Foreign exchange risk management program has two components:
forward contracts and options
- Forward contracts: used to provide certainty in exchange rates going
forward 12 months sometimes longer, about 50% of cash flows from
forecasted sales were hedged this way
- Options: The sale of call options was performed on some of the foreign
current dominated sales to generate premium income and if the call
option was exercised the buyer would sell Clearwater Canadian dollars
for in exchange for the foreign currency at the agreed upon rate.
- Forward and option contracts did not fully hedge future foreign
currency revenues, thus Clearwater had not been able to completely
offset the recent currency fluctuations
SEAFOOD INDUSTRY
- Canadian seafood harvesting industry comprised of two segments
seasonal inshore and year-round offshore, Clearwater operates
primarily in the latter

Industry was regulated by the Department of Fishery and Oceans

(DFO) in Canada to ensure sustainability, they granted licenses, set the
total allowable catch (TAC) and determined the quotas for each
company
The quotas and licenses could be transferred, traded and sold
Seafood business is seasonal, higher in second half of the year
Clearwater was successful in growing its business through the
acquisition of new licenses and quotas and development of new
products, and was able to reduce costs and increase product quality
from fleet to factory freezer vessels
Global demand for seafood, 132 million tons in 2003, was forecasted to
go up to 182 million tons in 2015, a compound annual growth rate of
2.2%.
The world average per capita was forecasted to go up from 16.3 kg in
2003 to 19.1 kg in 2015, a compound annual growth rate of 1.1%.
Much of the growth in seafood consumption was to come from growth
in population
The three largest countries ranked by population: China, India and US,
accounted for 44% of global seafood consumption
Even though the US does not fall under the top 20 countries on a per
capita consumption basis and Canada on ranks 16 th, a shift is expected
over the nest few years. The baby boomers in North America are
reaching retirement and are placing more value on health benefits and
nutritional value of seafood
A shift in consumption from lowvalue seafood to high-value seafood,
the latter trend more evident in countries like China
Almost half of seafood produced is consumed in 3 countries: 33%
China, 9% Japan, 6% US.
Competition in from local, low-cost producers was threatening
particularly in individually quick frozen scallops from aquaculture
operations

COMPANY
- Founded in Bedford, Nova Scotia, Canada as a local lobster distributor
- Did an IPO as an income trust in August 2002
- Funds from IPO used to finance a significant growth strategy
- Was largest publicly traded shellfish company in North America
- Consists of harvesting, processing and selling a variety of shellfish and
ground fish species
- Largest holder of offshore rights to harvest premium species in Atlantic
Canada
- Owns 23 offshore harvesting vessels, 11 of which are engaged in
processing at sea
- Has 7 shore based processing plants in Atlantic Canada and was
working to modernize its fleet and do more offshore processing
- Offshore processing improved the freshness of the product for the
consumer and allowed Clearwater to differentiate its product from other
small companies and countries (i.e. US) where regulation limits their
ability to do so, the two vessels are located in Argentina

Clearwater has invested Cdn$29 million in 2 new frozen at sea scallop

vessels and has recently entered into a contract of Cdn$45 million with
a shipyard in Taiwan to construct a factory freezer clam vessel.
Financing was obtained from issuing convertible debentures in the
Canadian market
New vessel expected to be operational by mid 2006 and increase the
volumes and efficiency of the harvest and improve yields
Has 1,600 employees
Also had significant in house research to improve product quality,
longevity and maintenance of the research
Customers are comprised of retail chains, food distributors and
corporate restaurants.
Top 10 customers contributed to 25% of sales on 2005, no customer
accounted for more than 5% of sales, 80% of customers were doing
business for over 10 years
Some of the leading competitors: FPI Limited of Canada and four US
companies
Fragmented nature of industry provided a fertile ground for takeovers
To ensure differentiation across their products each firm was trying to
hold onto a particular skill and build it into a sustainable competitive
advantage
Clearwater has been using product innovation and quality as the
gateway to charge premium pricing
Catch-based fisheries in general faced competition from two sources:
aquaculture and seafood substitutes
Seafood companies had to sharpen their competitive edge by using
tools such as technology, capital assets, quality assurance programs,
research and biodiversity programs and resource management
systems

CORPORATE STRATEGY
- In 2003, new growth strategy was: innovation, vertical integration and
diversity of species and markets
- Clearwater felt that it secured differentiation from its competitors on the
basis of product quality, product innovation, service and niche
marketing
- Purchasing new vessels, updating production facilities and replacing
older boats in its fleet were part of Clearwaters strategy to establish a
premier position in the industry.
-

The companys 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.

A growing international demand for premium shellfish and Clearwater

had a diversified worldwide customer base when most of the industry
was fragmented and consisted of many small enterprises.

CURRENT SITUATION
-

Management had little time to strategize and execute an action plan.

Restoring distributions was an immediate priority. Thus a turnaround
strategy is well needed to be executed efficiently.

Wight recognises: The strengthening of the Canadian dollar is a trend

that will likely continue through all of 2006. At the same time
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 Clearwaters competitive position relative to seafoods
companies outside Canada. But it is unlikely 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.

Clearwaters can not do both simultaneously - reinstate distributions

and restructure operations - while remaining within their bank covenant
parameters.

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

Necessary to provide adequate financial resources to leverage them so

that the company would generate sufficient profits to reinstate
distributions.

Clearwaters 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

Investors did not realize that Clearwater was using option premiums to
supplement its bottom line, and options and forwards to hedge against
exchange rate changes.

Options and forwards could only be classified as effective hedges if

they could be linked to specific forecasted transactions.

Clearwater formally assessed, at inception and on an ongoing basis,

whether the derivatives used in hedging transactions were effective in
offsetting changes in cash flows of hedged items. But it was not always

possible to classify them as effective. Thus, the firm faced a reporting

risk as market conditions changed.
-

Clearwater used forwards to hedge a little less than 50 per cent of its
foreign currency revenues.

For 2006, Clearwater also had US$22.5 million in economic hedges at

a rate of $Cdn1.25/US$ that were accounted for as non-qualifying
hedges. As a result of conditions under which Clearwater could not
account for some hedging activities as effective hedges.

This resulted in frequent disclosure risks for the company as the values
in the financial statements may change as a result of changing market
conditions rather than changes in Clearwaters actual degree of
hedging activities.

ALTERNATIVES
-

If Clearwater was to consider changing its strategy, a clear alternative

was to focus more attention on the companys foreign exchange risk
management operations and increase the latters ability to both
manage risk and generate profit.

The profitable foreign exchange trading would help Clearwater mobilize

its cash flows in different currencies and put them to better use: Selling
call options however the trade-off would be the companys ability to
hedge its future cash flows.

A further alternative was to change Clearwaters operational strategy.

This could be performed in many different ways to either decrease
Clearwaters exposure to foreign currencies or further diversify its
operations into other markets.

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

A strategy that focused more on operational hedging and diversification

would be long-term and may not allow Clearwater to reinstate its
distribution quickly.

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.

SWOT ANALYSIS
Strengths
- Its foreign exchange management operations have contributed
significantly to the companys earnings
- Foreign exchange risk management program has two components:
forward contracts and options
- Forward contracts: used to provide certai46nty in exchange rates going
forward 12 months sometimes longer, about 50% of cash flows from
forecasted sales were hedged this way
- Options: The sale of call options was performed on some of the foreign
current dominated sales to generate premium income.
- Largest holder of offshore rights to harvest premium species in Atlantic
Canada
- Offshore processing improved the freshness of the product for the
consumer and allowed Clearwater to differentiate its product from other
small companies and countries (i.e. US) where regulation limits their
ability to do so
- Also had significant in house research to improve product quality,
longevity and maintenance of the research
- Fragmented nature of industry provided a fertile ground for takeovers
- Corporate strategies were common across firms, however the manner
of execution of strategy differed from one another.
- Clearwater has been using product innovation and quality as the
gateway to charge premium pricing
- Well positioned to become a global player
Weakness
- Clearwater had suspended its monthly distribution payments to its unit
holders from October 2005, the first since the company converted into
an income trust in August 2002
- The value of units declined 35%

Rapid decrease in EBITDA from 2003 to 2005, due to dramatic

upswing in the Canadian dollar
Canadian dollar has appreciated relative to the depreciation of the US
dollar since 2001 however the in mid 2004 the Canadian dollar started
to appreciate against the other major currencies in which Clearwater
did business as well
Received Cdn$17.6 million less than what it would have received if
there were no appreciation of the Canadian dollar.
While the Canadian dollar had been falling, the companys foreign
exchange risk management program contributed significantly to the
firms bottom line. But, as the Canadian dollar started to increase in
value, the contribution of the program to the bottom line was
decreasing.

Opportunities
- The quotas and licenses could be transferred, traded and sold
- Global demand for seafood, 132 million tons in 2003, was forecasted to
go up to 182 million tons in 2015, a compound annual growth rate of
2.2%.
- The three largest countries ranked by population: China, India and US,
accounted for 44% of global seafood consumption
- The baby boomers in North America are reaching retirement and are
placing more value on health benefits and nutritional value of seafood
- A shift in consumption from lowvalue seafood to high-value seafood,
the latter trend more evident in countries like China
- Almost half of seafood produced is consumed in 3 countries: 33%
China, 9% Japan, 6% US.
- Has 7 shore based processing plants in Atlantic Canada and was
working to modernize its fleet and do more offshore processing
- New vessel expected to be operational by mid 2006 and increase the
volumes and efficiency of the harvest and improve yields
- The profitable foreign exchange trading would help Clearwater mobilize
its cash flows in different currencies and put them to better use: Selling
call options
-

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.

Threats
- The currencies in which the company was earning income were losing
value relative to the Canadian dollar in which the company was
incurring expenses - Exchange Rate Crisis
- Operating Challenges

Canadian dollar has appreciated relative to the depreciation of the US

dollar since 2001 however the in mid 2004 the Canadian dollar started
to appreciate against the other major currencies in which Clearwater
did business as well
Forward and option contracts did not fully hedge future foreign
currency revenues, thus Clearwater had not been able to completely
offset the recent currency fluctuations
Competition in from local, low-cost producers was threatening
particularly in individually quick frozen scallops from aquaculture
operations
Some of the leading competitors: FPI Limited of Canada and four US
companies
Fragmented nature of industry provided a fertile ground for takeovers
To ensure differentiation across their products each firm was trying to
hold onto a particular skill and build it into a sustainable competitive
advantage
Catch-based fisheries in general faced competition from two sources:
aquaculture and seafood substitutes
Options and forwards could only be classified as effective hedges if
they could be linked to specific forecasted transactions.
Thus, the firm faced a reporting risk as market conditions changed due
to hedging criteria
Outstanding contracts that were due to expire in 2006 that were
dominated in other currencies whose change exchange rates could
drastically effect the amount of gross profit that Clearwater can receive
Frequent disclosure risks for the company in 2006 as the values in the
financial statements may change as a result of changing market
conditions rather than changes in Clearwaters actual degree of
hedging activities.
A strategy that focused more on operational hedging and diversification
would be long-term and may not allow Clearwater to reinstate its
distribution quickly.