Continental Resources
Annual Report 2018

Plain-text annual report

2018 ANNUAL REPORT Letter from the Chairman of Clearwater Seafoods Incorporated Clearwater’s success is and has always been due to our single greatest resource – our people. It is our people’s character, competence, teamwork and resilience in the face of adversity that has allowed us to turn challenges into opportunities and to grow our company into a proud leader in the global seafood industry. I have always been a proud member of the Clearwater team and never more so than in 2018 with our peoples’ ability to leverage Clearwater’s broad species portfolio in response to a challenging operating environment and their dedication throughout a company-wide reorganization. Our people rose to the challenge and once more will allow the company to grow and prosper. In our four decades, Clearwater has introduced numerous innovative processing and sustainable harvesting practices and technologies in our ongoing efforts to add value to the seafood we harvest and to be responsible stewards of the ocean. We were the first to employ Vessel Monitoring Systems and Geographic Information Systems to derive insights from our harvest data enabling us to improve efficiency of our operations while mitigating the footprint we leave on the natural environment. We have been pioneers in opening and cultivating markets for Canadian seafood globally, now selling to over 50 countries and we continue to create new markets for our products. Our commitment to the responsible and sustainable management of our seafood resources has been recognized globally by our customers generating greater demand for our products. We continue our commitment to independent third-party certification through the world leading Marine Stewardship Council certification. Clearwater is an innovative and entrepreneurial company and I am sincerely proud of the ingenuity, entrepreneurial spirit and unshakeable work ethic of our 2,000 employees globally. Colin MacDonald 2 | P a g e Letter from the Chief Executive Officer of Clearwater Seafoods Incorporated Clearwater 2018 - “Remarkable seafood, Responsible Choice” We began the year in the shadow of challenging 2017 results, a recently completed company-wide reorganization and the announcement of a new entrant in the Arctic surf clam fishery. Despite these challenges, we accomplished what we set out to do – generate significantly more cash, reduce debt and deleverage. With the reversal of the Arctic surf clam decision in early August, we were able to convert our restored harvest access into record sales revenue for clam at lower costs and better margins than in the prior year. In frozen-at-sea shrimp, margins rebounded with improved harvesting conditions and stable pricing. While scallop prices fell globally in response to expanding supply conditions (especially from the United States), higher Canadian total allowable catch, price premiums for our frozen-at-sea quality and improved productivity and cost savings helped deliver another solid year. Sales and margins for our United Kingdom whelk, crab and langoustine products benefited from expanded distribution to Clearwater customers in Asia and North America. Investments in research and development and innovation yielded process and quality improvements as well as significant cost savings across our fleet and land-based operations. Organizationally, our late 2017 restructuring and advancements in sales and operations planning, procurement, financial analysis and reporting processes improved customer service, forecast accuracy and overall profitability. In 2019, we expect balanced and profitable growth across multiple species and regions. Growth will be led by Asia-Pacific where a growing middle class with rising incomes continues to propel seafood consumption to new heights. We will retain full quota access to the Arctic surf clam fishery. This is good news for our company, our customers and for our 2,000 employees from 276 communities in Atlantic Canada and around the world. Clearwater will also take the opportunity to advance our working relationships with our Indigenous partners. We know we can be a leader for our industry and demonstrate that reconciliation can unite and strengthen communities, build trust, secure existing jobs, create new ones and provide greater prosperity for all. We want to thank you, our valued shareholders, for your continued support. When you invest in Clearwater, you are subscribing to one of the most innovative, global and sustainable seafood companies in the world. Ian D. Smith 3 | P a g e Table of Contents Management discussion and analysis Page# Non-IFRS measures Clearwater overview Mission, value proposition and strategies Capability to deliver results Explanation of 2018 results Capital structure and liquidity Outlook Risks and uncertainties Critical accounting policies Related party transactions Summary of quarterly results Non-IFRS measures, definitions and reconciliations Clearwater Seafoods Incorporated - 2018 financial statements Selected annual information Quarterly and share information Corporate information 5 6 7 9 12 23 31 32 35 36 37 38 44 102 101 103 4 | P a g e MANAGEMENT’S DISCUSSION AND ANALYSIS This Management’s Discussion and Analysis (“MD&A”) was prepared effective March 7, 2019. The Audit Committee and the Board of Directors of Clearwater Seafoods Incorporated (“Clearwater”, or the “Company”) have reviewed and approved the contents of this MD&A, the consolidated Financial Statements, the 2018 fourth quarter news release and 2018 Annual Information Form (“AIF”). This MD&A should be read in conjunction with the 2018 annual consolidated Financial Statements prepared in accordance with International Financial Reporting Standards (“IFRS”) and the 2018 AIF, which are available on Sedar at www.sedar.com as well as Clearwater’s website, www.clearwater.ca. COMMENTARY REGARDING FORWARD-LOOKING STATEMENTS This report contains “forward-looking information” as defined under applicable Canadian securities legislation, including but not limited to, statements regarding future plans and objectives of Clearwater. Forward-looking information typically, but not always, contains statements with words such as “anticipate”, “does not anticipate”, “believe”, “estimate”, “forecast”, “intend”, “expect”, “does not expect”, “may”, “will”, “should”, “plan”, or other similar terms that are predictive in nature. Forward-looking information is based on a number of factors and assumptions which have been used to develop such information, but which may prove to be incorrect due to various known and unknown risks, uncertainties, and other factors outside of managements’ control. Examples may include, but are not limited to, total allowable catch levels, resource supply, selling prices, weather, exchange rates, fuel and other input costs. There can be no assurance that such information will prove to be accurate and actual results and future events could differ materially from those anticipated in such forward-looking information. There can be no assurance that such information will prove to be accurate and actual results and future events could differ materially from those anticipated in such forward-looking information. For additional information with respect to risk factors applicable to Clearwater, reference should be made to those factors discussed under the heading “Risks and Uncertainties” in this management discussion and analysis and Clearwater's continuous disclosure materials filed from time to time with securities regulators, including, but not limited to, Clearwater's Annual Information Form. The forward-looking information contained in this report is made as of the date of this release and Clearwater does not undertake to update publicly or revise the forward-looking information contained in this report, whether as a result of new information, future events or otherwise, except as required by applicable securities laws. No regulatory authority has approved or disapproved the adequacy or accuracy of this report. NON-IFRS MEASURES This MD&A makes reference to non-IFRS measures to supplement the analysis of Clearwater’s results. These measures are provided to enhance the reader’s understanding of our current financial performance. They are included to provide investors and management with an alternative method for assessing our operating results in a manner that is focused on the performance of our ongoing operations and to provide a consistent basis for comparison between periods. These non-IFRS measures are not recognized measures under IFRS, and therefore they may not be comparable to similar measures presented by other companies. 5 | P a g e Management believes that in addition to sales, net earnings and cash provided by operating activities, these non-IFRS measures are useful terms from which to determine Clearwater’s ability to generate cash for investment in working capital, capital expenditures, debt service, income tax and dividends. These non-IFRS measures include adjusted EBITDA, adjusted earnings, free cash flows, leverage, and return on assets. Refer to non-IFRS measures reconciliations for further information. CLEARWATER OVERVIEW Clearwater is North America’s largest vertically integrated harvester, processor and distributor of premium shellfish. Clearwater is a leading global provider of wild-caught shellfish with harvesting operations in Canada, Argentina and the UK, Clearwater is recognized for its consistent quality, wide diversity, and reliable delivery of premium, wild, eco-labeled seafood, including scallops, lobster, clams, coldwater shrimp, langoustine, whelk, crab and groundfish with approximately 93 million pounds sold in 2018. Global demand for premium wild-caught seafood among aging boomers and a rising middle class in the Asian-Pacific region is outpacing resource supply creating powerful industry fundamentals. This, in combination with conservatively managing seafood fisheries to protect the long-term health of the industry, is creating new opportunities from the rising demand for high-quality sustainable seafood. Clearwater’s vertical integration creates barriers to entry and sustainable competitive advantage as the largest holder of shellfish quotas and licences within Canada and maintains the widest selection of Marine Stewardship Council (“MSC”)-certified species of any shellfish harvester worldwide. Regulatory authorities strictly control access to quota and rarely grant new licences. Clearwater continues to create competitive advantage through investment in research and development, technology and intellectual property that has resulted in state-of-the-art factory vessels with harvesting and processing capabilities that enable high productivity and frozen-at-sea products that deliver superior taste and quality. Clearwater maintains a global, direct sales force that is capable of interacting with and selling directly to diverse markets worldwide. Our channel mix in food service, retail and other food industries ensures a diverse community of customers and we have no single customer representing more than 7% of total annual sales. The vertical integration of Clearwater’s quotas and licences, sustainable fishing practices, at-sea processing of shellfish, onshore processing and distribution networks, and global sales force combine to make Clearwater the industry leader in shellfish. Clearwater’s proven and experienced leadership team continues to build upon its world class capabilities in quality control and food safety, operations, new product development and leadership. Through its deep industry knowledge and talent, our team will continue to deliver on our operational and financial growth opportunities. 6 | P a g e CLEARWATER’S MISSION, VALUE PROPOSITION AND STRATEGIES Clearwater’s mission is to build the world’s most extraordinary, wild seafood company, dedicated to sustainable seafood excellence. We define:    “extraordinary” as sustainable growth in revenue, margins, adjusted EBITDA, free cash flows and the creation of long-term shareholder value; “wild seafood” as premium wild shellfish, including our core species (scallops, clam, lobster, coldwater shrimp, crab and langoustines); and “sustainable seafood excellence” as delivering best-in-class quality, food safety, traceability and certified sustainability. We believe that the fulfillment of this mission will result in extraordinary value creation for shareholders, customers, employees and the communities in which we work and live. Value Proposition At Clearwater, we have a passion for wild seafood and strive to deliver a highly differentiated and competitively advantaged value proposition to a global customer base. Key elements of Clearwater’s unique value proposition are:  Great tasting, nutritious, highest quality, frozen-at-sea, premium shellfish.  Expertise in premium shellfish science, harvesting, processing and logistics technology to ensure quality and safety from “ocean to plate”.  Marine Stewardship Council certification for sustainability of species to ensure both the traceability and long-term health of our wild resources.  Competitively advantaged global customer service with local market understanding and insight.  Scale in licence and quota ownership guaranteeing exclusive and stable supply to service even the largest global retail and food service customers. Strategies Clearwater’s six core strategies are designed to strengthen our competitive and differentiated value proposition. They are: 1. Expanding Access to Supply – Expanding access to supply of core species and other complementary, high demand, premium, wild and sustainably-harvested seafood through improved utilization and productivity of core licences as well as acquisitions, partnerships, joint ventures and commercial agreements. • Largest Holder of shellfish licences and quotas in Canada Operating from ocean-to-plate, Clearwater holds shellfish licences and quotas in Canada, including Arctic surf clam, offshore lobster, Canadian sea scallops and coldwater shrimp, as well as Argentine scallops in Argentina. Licensing, quotas and strategic procurement provide Clearwater with a consistent and renewable supply of premium, wild-caught, sustainably- harvested seafood for distribution around the globe. 7 | P a g e • Macduff Shellfish Group The acquisition of Macduff in 2015 extended our access to premium, wild-caught, safe and traceable shellfish, including King Scallops, Langoustine, Brown Crab and Whelk. In addition to being a leading harvester, Macduff is one of the largest processors of wild shellfish in the United Kingdom with tremendous opportunity for future growth. 2. Target profitable & growing markets, channels & customers – Clearwater targets growing markets, consumers, channels and customers based on size, profitability, demand for eco-label seafood and ability to win. Our focus is to win in key channels and with customers that are winning with consumers. • Expanding channels and partnerships in key markets Sales to Asia-Pacific reached 41 percent or $65.0 million in the fourth quarter of 2018. Clearwater achieved this growth through market expansion of traditional channels and forging new strategic channels, including ecommerce platforms. Clearwater continues to focus on distribution expansion for clam and all Macduff products. 3. Innovate and position products to deliver superior customer satisfaction and value – We continue to work with customers on new products and formats as we innovate and position our premium seafood to deliver superior satisfaction and value that is differentiated on the dimensions of taste, quality, safety, sustainability, wellness, convenience and fair labour practices. • Increasing product variety and preventing imitation Clearwater continues to innovate products and formats in response to evolving consumer trends and foodservice customers, including utilizing existing processing partnerships to expand our clam sushi offerings and entering the live crab business. 4. Increase margins by improving price realization and cost management – Leverage the scarcity of seafood supply and increasing global demand, in addition to continuing to invest in, innovate and adopt state-of-the-art technology, systems and processes. • Position organization for price realization and cost management Clearwater continues to leverage our state-of-the-art technology and smarter systems to drive margin improvements through cost management. Our fleet and land-based operations continuously improve processes across our diversified species to respond to fluctuations in capacity. In the fourth quarter of 2017, Clearwater completed a company-wide restructuring resulting in year-over-year savings. • Leveraging Intellectual Property (“IP”) and Technology Clearwater continues to leverage and further evolve its proprietary technology to reduce costs, reduce our carbon footprint and maximize the taste and quality of our products. o Ocean floor mapping is utilized on our fleet in combination with fishery-specific innovative gear and geographic positioning technology enabling us to continually increase the productivity of our fleet. o Patented automatic shucking technology and solutions deliver superior tasting and quality products to customers by enabling fresh frozen-at-sea products that are frozen within an hour of the catch. o Our state-of-the-art IP protected clam dredging technology was further refined and implemented on our newest fleet addition, the Anne Risley, providing lower costs and improved productivity while reducing the Company’s carbon footprint. 8 | P a g e 5. Pursue and preserve the long-term sustainability of resources on land on sea – As a leading global supplier of wild-harvested seafood, sustainability remains at the core of our business and our mission. Investing in the long-term health and the responsible harvesting of the oceans is every harvester’s responsibility and the only proven way to ensure access to a reliable, stable, renewable and long-term supply of seafood. Sustainability is not just good business, like innovation it’s in our DNA. That’s why Clearwater has been recognized by the MSC as a leader in sustainable harvesting for wild fisheries and how Clearwater can offer the widest selection of sustainably-certified species of any seafood harvester worldwide. • Commitment to sustainability Clearwater, in collaboration with other industry participants, continues to invest in research to improve the understanding of resource dynamics and harvest strategies that support long-term sustainability. Clearwater undertakes key research initiatives to support long-term sustainability of our fisheries including innovative ocean bottom mapping research and analysis which Clearwater conducts in partnership with the Nova Scotia Community College. Our ocean bottom data is exclusive intellectual property that contributes directly to our increasing harvesting efficiency while reducing impact on the ocean habitat and improving sustainability. On an annual basis, Clearwater, in collaboration with other industry participants, continues to undertake video monitoring research in the Canadian sea scallop fishery adding to our understanding of resource dynamics and informing management for the development of harvest strategies that support long-term sustainability. 6. Build organizational capability, capacity & engagement – We attract, train and retain the best talent to build business system and process excellence company-wide. CAPABILITY TO DELIVER RESULTS Clearwater's revenues and earnings are dependent primarily on its ability to harvest, purchase, and market shellfish. Supply is dependent to a large extent on the annual total allowable catch (“TAC”) for each species. The annual TAC is related to the health of the stock of the species as determined by the relevant government fishery management organizations. All stocks are managed sustainably providing assurance of the long-term availability of the resource, however annual fluctuations in supply of a natural resource are normal. Short term impacts of such fluctuations can normally be offset within Clearwater’s species portfolio and/or by making adjustments within each business unit. See Risk and Uncertainties – Resource Supply Risk and Political Risk for further information regarding Clearwater TAC. The primary shellfish stocks that Clearwater harvests are Canadian sea, Argentine and UK scallops, clam, lobsters and coldwater shrimp, which are harvested in offshore fisheries that have a limited number of participants. Clearwater harvests scallops and clams with its own vessels. Clearwater obtains its lobster and coldwater shrimp through harvesting with its own vessels and through purchases from independent fishermen. Clearwater obtains most of its supply of crab, whelk, and langoustines through purchases from independent fishermen.  The Canadian sea scallop resource typically fluctuates within a stable range. Clearwater anticipates TACs within the normal range in upcoming years. Clearwater lands virtually all its sea scallop quota each year and may from time to time harvest quotas for other industry participants or purchase raw material supply from other industry participants.  Argentine scallop volumes are normally stable. The regulator announced a small reduction in TAC in 2018. Argentina was the first scallop fishery in the world to have earned the rigorous MSC independent certification. 9 | P a g e  UK King Scallop landings are stable. The fishery is managed under a combination of effort days, gear regulation and maximum landing size which vary by area.  The Arctic surf clam resource is stable. Clearwater has quota allocations on both Banquereau Bank and the Grand Banks in Canada.  The offshore Canadian lobster resource is healthy with a consistent offshore TAC. Clearwater harvests all its lobster quota each year. During 2018, Clearwater purchased approximately 80 percent of its lobster from inshore lobster fishermen. The quality of lobster has seen a decline in this fishery resulting in higher raw material costs.  Coldwater shrimp - The Northern shrimp TAC has declined from historic highs over the last five years and is expected to continue to decline as the environment undergoes a regime shift back towards one dominated by groundfish (cod, perch and turbot) rather than shellfish (crab and shrimp). Clearwater holds access to quotas directly through licences and through long-term harvesting agreements. Clearwater procures shrimp from the inshore fresh fishery for its cooked and peeled business and supplements this with frozen raw material from offshore vessels. For the species it harvests, Clearwater maintains the largest, most modern fleet of factory freezer vessels in Canada, as well as vessels used to harvest Clearwater's offshore lobster and to complete research and development. The Company also maintains a fleet of 12 scallop trawlers and one crab vessel in the UK. Clearwater classifies capital expenditures as either return on investment (“ROI”) or maintenance capital. Significant expenditures that are expected to have a return in excess of the cost of capital are classified as ROI, and all refits and expenditures that are expected to return less than the average cost of capital are classified as maintenance. Repairs and maintenance costs are expensed as incurred. Clearwater invested the following on capital expenditures and repairs and maintenance over the last three years: (In 000’s) For the years ended December 31 Vessels Plants and other Return on investment capital Maintenance capital Maintenance capital Repairs and maintenance expense Depreciation/Amortization Maintenance spending as a % of depreciation $ $ $ $ $ $ $ 2018 13,659 5,465 19,124 518 18,606 19,124 18,606 18,281 36,887 44,869 82.2% $ $ $ $ $ $ $ 2017 59,655 25,776 85,431 63,846 21,586 85,432 21,586 21,971 43,557 45,428 95.9% $ $ $ $ $ $ $ 2016 44,343 11,989 56,332 31,913 24,419 56,332 24,419 24,135 48,554 38,634 125.7% $ $ $ $ $ $ $ Total 117,657 43,230 160,887 96,277 64,611 160,888 64,611 64,387 128,998 128,931 100.1% In 2018, Clearwater invested $19.1 million in capital expenditures following the completion of its fleet modernization program in 2017. The majority of capital expenditures related to vessel refits. In 2017, Clearwater invested a record $85.4 million in capital expenditures: $39.2 million of investment capital related to the Anne Risley, a replacement clam vessel, completing Clearwater’s fleet modernization program; $21.6 million of maintenance capital largely related to vessel refits and $19.5 million to improve operational efficiencies in Clearwater’s land-based operations. 10 | P a g e In 2016, Clearwater invested $56.3 million in capital expenditures of which $25.9 million of investment capital related to the Anne Risley and $24.2 million of maintenance capital related to vessel refits and $6.2 million to improve operational efficiencies in our plants and information systems. In addition to the annual amounts capitalized above, over the past three years Clearwater has incurred an average of $21.5 million per annum on repairs and maintenance of its fleet and processing plants. This reflects Clearwater’s commitment to maximizing asset performance, enabling the harvest of allowable catch and efficient processing of harvested and procured species. Clearwater’s largest fleet investments are in its nine factory vessels located within Canada and Argentina. These vessels are used in the harvesting of Canadian scallops, Argentine scallops, shrimp and clams. Of the nine factory vessels: • Four are used to harvest sea and Argentine scallops with the sea scallop vessels being on average 21 years old and the Argentine scallop vessels being on average 23 years old. • Two are used to harvest shrimp and are on average 25 years old. These vessels have the capacity to harvest our shrimp and turbot quota. One of the vessels was built in 1985 and in 2014 Clearwater invested $12.5 million in a late-life refit, thereby extending its useful life. • Three of Clearwater’s vessels are used to harvest clams and are on average 13 years old. In 2017, Clearwater completed the construction of a new clam harvesting vessel, the Anne Risley, which replaced an existing vessel in the fourth quarter of 2017. These vessels have the capacity to harvest the entire clam quota. Clearwater’s fleet also includes 12 mid-shore scallop harvesting vessels and one crab vessel operating within the UK and an offshore lobster vessel within Canada. In 2019, Clearwater expects to invest between $25-$30 million in capital projects relating to vessel refits and land-based supply chain infrastructure. 11 | P a g e EXPLANATION OF FINANCIAL RESULTS Clearwater uses Key Performance Indicators (“KPIs”) and Financial Measures to assess progress against our six core strategies. Key Performance Indicators and Financial Measures In 000's of Canadian dollars As at December 31 Profitability Sales Sales growth Gross margin Gross margin (as a % of sales) Adjusted EBITDA1,2 Adjusted EBITDA1,2 (as a % of sales) Adjusted EBITDA attributable to shareholders1,2 Adjusted EBITDA attributable to shareholders1,2 (as a % of sales) Earnings (loss) attributable to shareholders Basic earnings (loss) per share Diluted earnings (loss) per share Dividends paid on common shares Adjusted earnings attributable to shareholders1 Adjusted earnings attributable to shareholders1 per share Cash flows and leverage Cash from (used in) operating activities Cash from (used in) financing activities Cash from (used in) investing activities Free cash flows1 Leverage1,3 $ $ $ $ $ 2018 2017 2016 592,246 (4.6%) 106,837 18.0% $ $ 621,031 1.5% 110,068 17.7% $ $ 611,551 21.1% 144,621 23.6% 104,391 108,596 120,937 17.6% 17.5% 19.8% 88,175 $ 89,156 $ 98,446 14.9% 14.4% 16.1% $ $ (16,204) (0.25) (0.25) 0.20 15,831 0.25 76,487 (60,617) (16,701) 45,206 4.7 $ $ 15,759 0.25 0.25 0.20 8,690 0.14 58,141 22,665 (85,516) (8,428) 5.0 43,928 0.71 0.71 0.20 23,766 0.38 63,040 (12,666) (55,873) 1,502 4.2 Returns Return on assets1,4 Total assets 1 Refer to discussion on non-IFRS measures, definitions and reconciliations. $ 7.4% 727,423 $ 8.1% 770,880 $ 11.0% 729,735 2 Adjusted earnings before interest, tax, depreciation and amortization. 3 Leverage is calculated as adjusted EBITDA attributable to shareholders to net debt and differs from the calculation of leverage for covenant purposes. 4 Return on assets is calculated as adjusted earnings before interest and taxes to total average quarterly assets. 12 | P a g e 2018 Key Highlights The following are key highlights and developments based on Clearwater’s KPIs and Financial Measures for 2018. Profitability In 2018, gross margin and adjusted EBITDA1 increased as a percentage of sales while sales declined slightly as compared to the prior year. • Improvements in gross margin and adjusted EBITDA as a percentage of sales reflects cost efficiencies, higher sales mix of stronger margin species and favourable net foreign exchange. • Cost efficiencies include the organizational restructuring completed in the fourth quarter of 2017 and benefits from our operational continuous cost improvement initiatives. • Sales to Asia reached 40% as compared to 35% in the prior year following the expansion of distribution channels. • Average foreign exchange rates positively impacted sales by $11.7 million versus 2017. • Gross margin was also impacted by strong sales mix for clam and strong prices for FAS shrimp offset by lower available supply and competitive conditions for scallops. Certain procured species improved despite lower volumes as procurement activities targeted higher margin transactions. • Earnings attributable to shareholders decreased $32.0 million primarily due to unrealized foreign exchange losses on debt. • Adjusted earnings attributable to shareholders increased $7.1 million compared to 2017 due to realized foreign exchange on working capital partially offset by higher depreciation expense in 2018. Cash flows and leverage Record cash from operations of $76.5 million was generated in the year, an increase of $18.3 million compared to the prior year. Free cash flow increased $53.6 million over the prior year. • Leverage improved to 4.7x from reduced debt balances resulting from strong cash generated from operations and a reduction in capital expenditures following the completion of the fleet renewal program in 2017. This was partially offset by higher USD foreign exchange rates on USD denominated debt balances, net of forward foreign exchange contracts on 80% of the notional value of the USD Notes. • Cash from operations was positively impacted by favorable foreign exchange on working capital • and a reduction in cash taxes. Improvements in working capital of $6.6 million also contributed to cash generation in the year, including a reduction of inventory balances by $8.0 million compared to 2017. Returns Return on assets1 declined from 8.1% to 7.4% in 2018 as a reduction in the average asset base was offset by lower earnings before interest and taxes. Developments Effective 2018, the DFO announced the creation of a new surf clam licence representing 25 percent of TAC and awarded the licence to a new entrant in the first quarter of 2018 subject to certain conditions. In the third quarter of 2018, the DFO announced their decision to cancel the process to issue the fourth licence and confirmed that the remaining 25 percent of the clam quota would be issued to Clearwater for 2018 and 2019. See Risk and Uncertainties – Political Risk for further information. 1 – Refer to discussion on non-IFRS measures, definitions and reconciliations 13 | P a g e EXPLANATION OF CHANGES IN EARNINGS The following consolidated statements of earnings (loss) reflects the results of Clearwater for the 13 weeks and years ended December 31, 2018 and 2017. For supplemental non-IFRS measures, refer to discussion on non-IFRS measures in the non-IFRS measures, definitions and reconciliations section of this MD&A. Detailed discussion on the components of consolidated earnings (loss) follows: 13 weeks ended Year ended In 000's of Canadian dollars December 31 December 31 2017 2018 Change December 31 December 31 2017 2018 Change Sales Cost of goods sold $ 159,807 $ 133,340 174,766 $ (14,959) $ 145,315 (11,975) 592,246 $ 485,409 621,031 $ (28,785) (25,554) 510,963 Gross margin Gross margin as a % of sales 26,467 16.6% 29,451 16.9% (2,984) (0.3%) 106,837 18.0% 110,068 17.7% (3,231) 0.3% Operating expenses Administrative and selling Restructuring costs Net finance costs (Gains) losses on contract derivatives Foreign exchange (gains) losses on long-term debt and working capital Other (income) expense Research and development Earnings (loss) before income taxes Income tax expense (recovery) Earnings (loss) Earnings (loss) attributable to: Non-controlling interest Shareholders of Clearwater Adjusted EBITDA attributed to: Non-controlling interest Shareholders of Clearwater Adjusted EBITDA1 $ $ $ $ $ 12,675 - 7,847 14,061 6,677 8,330 1,386 6,677 483 53,509 482 31,966 55,551 6,856 35,280 2,042 6,374 3,314 15,008 2,275 (12,733) 15,798 (4,045) (19,843) 1,681 102 331 37,644 1,231 (1,540) 507 31,541 (450) (1,642) 176 (6,103) 9,061 (3,737) 1,724 108,803 (14,263) (7,576) 2,368 74,171 (23,324) (3,839) 644 (34,632) (11,177) (621) (10,556) $ (2,090) 4,461 (6,551) $ (9,087) 5,082 (4,005) $ (1,966) 1,740 (3,706) $ 35,897 7,658 (37,863) 5,918 28,239 $ (31,945) 1,784 $ (12,340) (10,556) $ 4,405 $ (10,956) (6,551) $ (2,621) $ (1,384) (4,005) $ 12,498 $ (16,204) (3,706) $ 12,480 $ 18 (31,963) 15,759 28,239 $ (31,945) 2,368 $ 21,722 24,090 $ 5,538 $ 22,952 28,490 $ (3,170) $ (1,230) (4,400) $ 16,216 $ 88,175 104,391 $ 19,440 $ 89,156 108,596 $ (3,224) (981) (4,205) 1 – Refer to discussion on non-IFRS measures, definitions and reconciliations 14 | P a g e Sales by species In 000's of Canadian dollars Scallops Clams Lobster Coldwater shrimp Crab Langoustine Whelk Ground fish and other shellfish Sales by region 13 weeks ended Year ended December 31 December 31 $ 2018 43,410 $ 37,349 22,208 14,039 23,665 14,061 1,737 2017 53,857 $ 34,955 24,720 29,963 13,377 14,330 2,197 Change (10,447) 2,394 (2,512) (15,924) 10,288 (269) (460) $ December 31 December 31 2017 200,286 $ 109,170 101,883 77,964 45,468 43,099 24,267 2018 171,373 $ 120,235 88,387 70,951 51,656 42,026 24,291 Change (28,913) 11,065 (13,496) (7,013) 6,188 (1,073) 24 3,338 159,807 $ 1,367 174,766 $ 1,971 (14,959) $ 23,327 592,246 $ 18,894 621,031 $ 4,433 (28,785) $ 13 weeks ended Year ended December 31 December 31 In 000's of Canadian dollars Europe $ 2018 63,747 $ 2017 74,696 $ Change (10,949) December 31 December 31 2017 243,640 $ 2018 205,653 $ $ China Japan Other Asia Asia Canada United States North America Other 44,223 16,265 4,494 64,982 11,825 19,251 31,076 2 $ 159,807 $ 33,840 22,775 4,223 60,838 15,712 23,395 39,107 10,383 (6,510) 271 4,144 (3,887) (4,144) (8,031) 125 174,766 $ (123) (14,959) 130,402 73,325 33,014 236,741 63,892 85,871 149,763 89 $ 592,246 $ 102,315 79,631 34,170 216,116 73,888 86,813 160,701 574 621,031 $ (485) (28,785) Clearwater reported sales for the fourth quarter of 2018 of $159.8 million versus 2017 comparative results of $174.8 million. Annual sales were $592.2 million versus 2017 comparative of $621.0 million. For the year and fourth quarter of 2018, strong sales mix for clams, increased demand for crab and improved harvesting conditions and catch rates for FAS shrimp were offset by lower available supply and competitive conditions for scallops and lower sales of procured species that typically have lower margins. Fourth quarter sales were also lower due to the timing of FAS shrimp landings that were partially offset by higher turbot sales. Clam sales reached a record high following targeted efforts to increase customer and channel penetration and geographic distribution, including expansion in Asia-Pacific, further reducing inventory from peak levels. In other species, purchase and production plans were adjusted to achieve a more profitable product mix. This reduced sales while improving investments in working capital and maintaining overall adjusted profitability. 1 – Refer to discussion on non-IFRS measures, definitions and reconciliations 15 | P a g e Change (37,987) 28,087 (6,306) (1,156) 20,625 (9,996) (942) (10,938) Average foreign exchange rates realized on sales for the fourth quarter and full year of 2018 had a net positive impact to sales of $3.8 million and $11.7 million, respectively, as compared to the same period of the prior year. The impact of foreign exchange is partially offset through Clearwater’s foreign exchange risk management program with net realized gains and losses on contract derivatives recognized below gross margin, within adjusted EBITDA. Scallops • Competitive conditions associated mainly with US scallop landings and lower available supply resulted in lower sales volumes and prices for scallops in 2018. • Sales were impacted by lower sales prices and volumes in the fourth quarter and a shift in regional sales. Clams • Sales for the fourth quarter and full year 2018 increased following targeted efforts to increase volumes through customer and channel penetration and geographic distribution, including expansion in China. • Sales mix was favourable in 2018 compared to the prior year. • Sales volumes have been supported by favourable harvesting conditions and available supply in inventory. Lobster • Lobster sales volumes declined in the fourth quarter and year to date 2018 due to difficult harvest conditions in the first quarter of 2018 that led to reduced supply availability and high raw material costs. This resulted in higher selling prices with lower volumes. This reduced sales while improving investments in working capital and maintaining profitability. • Strong pricing in home currencies partially offset lower sales volumes. Coldwater shrimp • Coldwater shrimp sales decreased in the fourth quarter due to timing of landings of FAS shrimp. • Sales in 2018 decreased due to the lack of inshore shrimp supply offset by improved harvesting conditions for FAS shrimp as compared to the same period in 2017. • Selling prices in home currencies remain strong with improved demand in Asia and Europe. Crab • Sales increased in the fourth quarter as procurement was expanded in the UK, increasing the available supply. • The crab harvest season in Canada was delayed in 2018 due to poor weather conditions resulting in lower availability of supply. Overall Canadian harvest volumes were down resulting in lower sales volumes and higher prices. Europe Clearwater’s largest scallop market and a key market for coldwater shrimp, langoustines, crab and lobster products. Sales for the fourth quarter and full year 2018 declined $10.9 million and $38.0 million to $63.7 million and $205.7 million, respectively, as compared to the same periods of 2017. The decline in sales for both periods was a result of lower available supply of scallops and a shift to markets where demand was stronger. Overall, scallop prices were lower due to increased market supply. Langoustine volumes were lower due to lack of available supply. The decline in sales was partially offset by favourable foreign exchange rates. The Euro, GBP and DKK continued to strengthen in the fourth quarter and full year of 2018 as compared to the prior year, resulting in a net positive impact of $0.4 million and $7.1 million respectively. 1 – Refer to discussion on risks and uncertainties 16 | P a g e China Key market for clams, coldwater shrimp, lobster and turbot. Sales for the fourth quarter and full year 2018 increased $10.4 million and $28.1 million to $44.2 million and $130.4 million, respectively, compared to the same period of 2017 as a result of higher clam sales with favourable product mix weighted towards higher sales prices, increased crab sales including the launch of live crab and higher FAS shrimp sales that were supported by strong sales prices. Sales in China are almost exclusively transacted in US dollars. The fourth quarter and full year sales were positivity impacted by average foreign exchange rates as compared to the same periods of the prior year by $1.7 million and $1.3 million respectively. Japan Primary species are clams, lobster, coldwater shrimp and turbot. Sales for the fourth quarter and full year 2018 decreased $6.5 million and $6.3 million to $16.3 million and $73.3 million, respectively, as compared to the same period in 2017. The decrease was primarily the result of unfavorable sales mix for FAS shrimp and lower available supply of lobster. Decrease in sales for full year 2018 was offset increased turbot volumes. Sales in Japan are typically transacted in Yen. The Yen continued to strengthen in the fourth quarter and year-to-date as compared to the prior year resulting in a net positive impact of $0.6 million and $1.2 million respectively. Other Asia Region includes Korea, Taiwan, Singapore and other Asian countries. Whelk, clams, sea scallops and lobster are key products for these markets. Sales increased in the fourth quarter by $0.3 million primarily as a result of higher clam sales and decreased in 2018 by $1.2 million as compared to prior period primarily as a result of lower available supply of whelk. United States Primary species are scallops, lobster and clams. Sales for the fourth quarter decreased $4.1 million to $19.3 million as compared to the same period in 2017 as a result of lower available supply and competitive price pressures for scallops. Sales for the year decreased $0.9 million to $85.9 million as compared to the prior year following lower available supply of lobster. Higher sales volumes for langoustines partially offset the decline in sales in both periods. Sales for the fourth quarter were positively impacted by $0.8 million and fully year by $0.6 million by favourable average foreign exchange as compared to the prior year. Canada Large market for lobster, scallops, snow crab, clams and coldwater shrimp. Sales for the fourth quarter 2018 declined $3.9 million as compared to the prior year due to lower scallop sales offset by timing of snow crab sales. Sales for the year declined $10.0 million to $63.9 million primarily the result of a lower availability of supply of scallops and lower sales volumes for snow crab. 1 – Refer to discussion on risks and uncertainties 17 | P a g e Average Foreign Exchange Rates Realized on Sales For the fourth quarter of 2018, favourable foreign exchange rates for the USD, YEN and Euro, as compared to the same period of 2017, positively impacted sales by $3.8 million. In 2018, favourable average foreign exchange rates for the Euro and USD positively impacted sales by $11.7 million as compared to 2017. The impact of foreign exchange on sales was partially offset through Clearwater’s foreign exchange risk management program with net realized gains and losses on contract derivatives recognized below gross margin, within adjusted EBITDA. December 31 2018 Average rate realized 1 % sales 13 weeks ended December 31 2017 Average rate realized1 % sales 44.2% 30.7% 8.3% 7.3% 7.8% 1.7% 100.0% 1.326 1.508 1.698 0.012 0.203 40.5% 27.9% 10.1% 8.2% 11.0% 2.3% 100.0% 1.273 1.498 1.692 0.011 0.201 Currency US dollars Euros Canadian dollar and other UK pounds Japanese yen Danish kroner 1 Refer to discussion on risks and uncertainties. Cost of Goods Sold December 31 2018 Average rate realized1 % sales Year ended December 31 2017 Average rate realized1 % sales 44.8% 24.9% 9.1% 8.8% 8.6% 3.8% 100.0% 1.303 1.525 1.732 0.012 0.207 40.0% 26.3% 11.5% 9.9% 10.1% 2.2% 100.0% 1.292 1.470 1.672 0.012 0.197 Cost of goods sold includes harvesting and procurement costs, manufacturing costs, depreciation, transportation and administration. Cost of goods sold decreased in the fourth quarter and year by $12.0 million and $25.6 million as compared to the same periods of 2017. The decrease is primarily due to sales mix weighted towards species with lower variable costs, reduced overheads following cost savings programs and lower sales volumes. Harvesting and procurement include all costs incurred in the operation of the vessels including labour, fuel, repairs and maintenance, fishing gear, supplies, other costs and fees plus procured raw material costs for lobster, shrimp, scallops, crab, langoustine and whelk. Gross margin Gross margin as a percentage of sales decreased in the fourth quarter of 2018 to 16.6% compared to 16.9% in the prior year and increased to 18.0% for the year as compared to 17.7% in the prior year. Gross margin for the fourth quarter decreased $3.0 million to $26.5 million as compared to 2017 due to timing of landings of FAS shrimp offset by favourable clam sales mix. In 2018, gross margin decreased $3.2 million to $106.8 million as compared to 2017 due to competitive conditions and lower available supply for scallops, a harvested species that typically has higher gross margins offset by higher clam sales and strong landings for FAS shrimp. Gross margin also improved for certain procured species despite lower volumes as sales and purchases were targeted to profitable transactions. In the fourth quarter and full year, average foreign exchange rates realized on sales had a net positive impact to gross margin of $3.8 million and $11.7 million, respectively. 18 | P a g e Operating expenses In 000's of Canadian dollars Salaries and benefits 13 weeks ended Year ended December 31 December 31 2017 10,064 $ 2018 10,493 $ $ Change 429 $ December 31 December 31 2017 40,197 $ 2018 41,308 $ Change 1,111 Share-based compensation Employee compensation 495 10,988 116 10,180 379 808 1,289 42,597 409 40,606 880 1,991 Consulting and professional fees Other1 Allocation to cost of goods sold2 Administrative and selling 3,189 2,029 3,397 3,859 (208) (1,830) 12,827 11,524 14,238 14,078 (3,531) 12,675 $ (3,375) 14,061 $ (156) (1,386) $ (13,439) 53,509 $ (13,371) 55,551 $ $ Restructuring costs Operating expenses 1 Other includes, but is not limited to, selling costs, travel and occupancy, depreciation and donations. 2 Allocated to cost of goods sold reflects costs that are attributable to the production of goods and are included in the cost of inventory. (6,677) (8,063) $ 6,677 20,738 $ 482 53,991 $ 6,856 62,407 $ 12,675 $ - $ (1,411) (2,554) (68) (2,042) (6,374) (8,416) Operating expenses decreased $8.1 million and $8.4 million for the fourth quarter and year ended December 31, 2018 primarily due to the targeted restructuring of the Company’s employee base and distribution infrastructure in the fourth quarter of 2017 and cost saving initiatives in 2018. These decreases were partially offset by higher share-based compensation and incentive-based employee costs. Net Finance costs In 000's of Canadian dollars Interest and bank charges Amortization of deferred financing charges 13 weeks ended Year ended December 31 December 31 2017 7,426 $ 2018 7,061 $ $ Change (365) December 31 December 31 2017 28,205 $ 2018 28,551 $ $ 435 7,496 405 7,831 30 (335) 1,695 30,246 1,555 29,760 Change 346 140 486 Accretion on deferred consideration Debt settlement and refinancing costs1 351 - 351 486 (135) 1,720 2,166 (446) 13 499 (13) (148) - 1,720 3,354 5,520 (3,354) (3,800) $ 7,847 $ 8,330 $ (483) $ 31,966 $ 35,280 $ (3,314) 1 Debt settlement and refinancing costs reflects the net loss on settlement of existing interest rate swaps and cross currency swaps and caps, forward foreign exchange contracts, remaining unamortized deferred financing costs and accretion offset by unrealized gains on interest rate swaps and caps. Net finance costs decreased $0.5 million and $3.3 million in the fourth quarter and year ended December 31, 2018 largely due to the debt settlement and refinancing costs in the second quarter of 2017. Interest and bank charges decreased in the fourth quarter compared to the same period in 2017 due to lower average revolving debt balance partially offset by the USD strengthening relative to the CDN dollar impacting interest on the USD senior unsecured notes. 19 | P a g e (Gains) losses on contract derivatives In 000's of Canadian dollars Realized (gain) loss Forward foreign exchange contracts Unrealized (gain) loss Forward foreign exchange contracts 13 weeks ended Year ended December 31 December 31 2017 2018 Change December 31 December 31 2017 2018 Change $ 1,565 $ 2,461 $ (896) $ 1,321 $ (3,065)$ 4,386 13,443 15,008 $ $ (186) 2,275 $ 13,629 12,733 $ 14,477 15,798 $ (980) (4,045)$ 15,457 19,843 Clearwater is primarily an export company with more than 85% of our sales taking place outside Canada in foreign currencies. As part of our risk management strategy we enter into short-term forward contracts to provide greater certainty regarding exchange rates and cash flows for a period of time. We recognize any realized gains and losses on these instruments as they mature and are settled. Clearwater also recognizes unrealized non-cash gains and losses on these instruments resulting from the change in fair value. Clearwater estimates the fair value of the financial derivative instruments based on forward prices and converts them to Canadian dollars at each balance sheet date. The unrealized non- cash gains or losses are excluded when calculating adjusted EBITDA and adjusted earnings attributable to shareholders of Clearwater. Realized losses on settled forward contract derivatives decreased $0.9 million and increased $4.4 million in the fourth quarter and full year 2018 versus the same comparative periods in 2017. The unrealized loss is due to average contracted rates for most currency pairs being unfavourable compared to the spot rate on the date of settlement in 2018. The increase in unrealized loss of $13.6 million and $15.5 million in the fourth quarter and full year 2018 as compared to the same period in 2017 is dependent on average contracted rates as compared to the forward rates based on maturity. The unrealized loss in the fourth quarter and full year 2018 is primarily due to average contracted rates for USD, YEN and Euro being unfavourable compared to current projected forward rates at maturity. Foreign exchange (gains) losses on long-term debt and working capital In 000's of Canadian dollars Realized (gain) loss Long-term debt and working capital Unrealized (gain) loss Long-term debt and working capital Forward exchange contracts, cross currency swaps and cap related to long-term debt 13 weeks ended Year ended December 31 December 31 2017 2018 Change December 31 December 31 2017 2018 Change $ (660) $ (565) $ (95) $ (5,514) $ 3,547 $ (9,061) 15,381 3,400 11,981 30,798 (23,693) 54,491 (13,040) 2,341 1,681 $ $ (1,604) 1,796 1,231 $ (11,436) 545 450 (16,223) 14,575 $ 9,061 $ 5,883 (17,810) (14,263) $ (22,106) 32,385 23,324 1 – Refer to discussion on risks and uncertainties 20 | P a g e Realized foreign exchange gains on long-term debt and working capital increased $9.1 million to a gain of $5.5 million for the year in 2018 as compared to the same period of 2017 as average foreign exchange rates on working capital settlement were favourable. Unrealized foreign exchange losses on long-term debt and working capital for the fourth quarter was $15.4 million and $30.8 million year to date 2018. The unrealized losses are primarily due to long-term debt denominated in USD which are translated into Canadian dollars as at the period-end spot rates. Partially offsetting unrealized losses on long-term debt and working capital, were unrealized gains related to forward foreign exchange contracts to hedge approximately 80% of the notional amount of the USD senior unsecured notes. The unrealized loss in year to date 2017 included the $75 million cross currency swap. Other (income) expense In 000's of Canadian dollars December 31 December 31 2017 2018 Change December 31 December 31 2017 2018 Change 13 weeks ended Year ended Share of earnings of equity- accounted investee Fair value adjustment on earn-out liability1 Other (income) fees Royalties, interest income and other income Acquisition related costs Export rebate income $ (178) $ 754 $ 932 $ (2,923) $ (2,656)$ 267 91 494 (2,103) (354) (2,194) (848) (623) 170 (2,769) (994) (2,146) (1,164) 314 (43) 80 385 (1,190) (179) (3,839) (1,540) 1 Relates to the Macduff acquisition in 2015. The earn-out liability is an unsecured additional consideration to be paid dependent on the future financial performance of Macduff and is recognized at fair value, with changes in fair value recognized in the statement of earnings (loss). (431) 464 (1,190) (7,576)$ (408) 103 - 102 $ 365 282 (179) (1,642) (745) 384 - (3,737) $ $ $ Other income decreased by $1.6 million and $3.8 million in the fourth quarter and year ended December 31, 2018 primarily due to fair value adjustments on the earn-out liability and changes to export rebate regulations in Argentina. Export rebate income related to incentives accrued by our Argentine subsidiary for exports from certain economic zones in Argentina. Effective January 1, 2018, the Argentina government announced a change to the export rebate program in response to changes made by the World Customs Organization. Clearwater and other exporters are working with the Argentine government to determine rebate qualifications under the new regulations. 1 – Refer to discussion on risks and uncertainties 21 | P a g e Research and Development Research and development relates to new harvesting, processing and storage technology and research into ocean habitats and fishing grounds. Research and development can vary year to year depending on the scope, timing and volume of research completed. Income taxes Income taxes primarily relate to taxable subsidiaries in Argentina, the United States, the United Kingdom and Canada. Deferred tax assets are being recognized based on management’s estimate that it is more likely than not that Clearwater will earn sufficient taxable profit to utilize these losses. The decrease in income tax expense in the fourth quarter and full year 2018 of $5.1 million and $5.9 million respectively, as compared to the same period for 2017 was primarily due to changes in income in foreign tax jurisdictions. Earnings (loss) attributable to non-controlling interest Non-controlling interest relates to minority share of earnings from Clearwater’s majority investments in a shrimp/turbot joint venture and subsidiaries in Argentina and Newfoundland and Labrador. The decrease in earnings attributable to non-controlling interest of $2.6 million in the fourth quarter of 2018 relates primarily to lower available supply and competitive sales conditions for scallops. On an annual basis, the decrease was offset by strong landings for FAS shrimp. It is important to note that the earnings attributable to non-controlling interest relates to the portion of Clearwater’s partnerships owned by other parties. Income taxes are included in earnings attributable to shareholders for Clearwater’s share of partnership earnings, whereas the earnings attributable to non- controlling interest are not tax affected. Earnings (loss) attributable to shareholders Earnings attributable to shareholders decreased $1.4 million and $32.0 million in the fourth quarter and full year 2018 as compared to the same periods of 2017. The decline was primarily a result of higher unrealized foreign exchange losses on long-term debt and working capital. Adjusted Earnings attributable to shareholders To assist readers in understanding our earnings we have included a calculation of adjusted earnings with Non-IFRS Measures, Definitions and Reconciliations. Management believes that in addition to earnings and cash provided by operating activities, adjusted earnings is a useful supplemental measure from which to determine Clearwater’s earnings from operations and ability to generate cash available for debt service, working capital, capital expenditures, income taxes and dividends. Adjusted earnings attributable to shareholders1 increased in the fourth quarter of 2018 as compared to 2017 primarily due to lower depreciation expense and increased in 2018 by $7.1 million due to realized foreign exchange on working capital partially offset by higher depreciation expense in 2018. Refer to the section entitled “Non-IFRS measures, definitions and reconciliations” for the definition of adjusted earnings and a reconciliation of adjusted earnings to net earnings. 22 | P a g e CAPITAL STRUCTURE AND LIQUIDITY Clearwater’s overall approach is to have a cost-effective capital structure that supports growth, while maintaining flexibility, reducing interest rate risk and reducing foreign exchange risk by borrowing in currencies other than the Canadian dollar, when appropriate. Clearwater maintains flexibility in its capital structure by regularly reviewing forecasts and multi-year business plans and modifying its debt and equity facilities on a proactive basis. These changes can include early repayment of debt, issuing or repurchasing shares, issuing new debt, utilizing surplus cash, extending the term of or amending existing debt facilities and, selling surplus assets to repay debt. The following are key elements of our capital strategy: • Maintain sufficient liquidity to enable continued access to capital to finance operations, including investments in innovation and technology and to fund growth; • Target a long-term leverage ratio of 3.0x; • Limit potential foreign exchange volatility in cash flows; and • Generate strong cash flows from operations to fund scheduled loan payments, capital expenditures and distributions to non-controlling interest and to provide for sufficient free cash flow to fund growth-investments and pay a sustainable dividend to its shareholders. Management continuously evaluates its capital structure in light of these policies and strategies. Capital Structure Clearwater’s capital structure includes a combination of equity and various types of debt facilities. Clearwater uses leverage, in particular USD senior unsecured notes, revolving and term debt to lower its cost of capital. The amount of debt available to Clearwater under certain lending facilities is a function of adjusted EBITDA1 attributable to shareholders. Adjusted EBITDA can be impacted by known and unknown risks, uncertainties, and other factors outside Clearwater’s control including, but not limited to, total allowable catch levels, selling prices, weather, exchange rates, fuel and other input costs. 23 | P a g e Clearwater’s capital structure was as follows as at December 31, 2018 and December 31, 2017: In 000's of Canadian dollars As at December 31 Equity Share capital Contributed surplus Deficit Accumulated other comprehensive income (loss) $ 2018 2017 215,506 $ 4,218 (38,848) (36,053) 144,823 18,397 163,220 333,955 58,019 13,637 3,500 409,111 34,177 112 34,289 16,504 3,513 463,417 210,860 3,021 (8,722) (39,730) 165,429 17,109 182,538 306,684 87,682 12,215 3,500 410,081 34,466 167 34,633 23,181 5,278 473,173 Non-controlling interest Long-term debt Senior debt, non-amortizing USD senior unsecured notes, due 20251 Revolving debt, due in 20222 Term loan, due in 2019 Term loan, due in 2091 Senior debt, amortizing Term Loan B, due 20223 Other loans Deferred obligation4 Earnout liability4 Total long-term debt Total capital $ 626,637 $ 655,711 1. USD senior unsecured notes is net of unamortized deferred financing charges of $7 million with a US dollar coupon rate of 6.875%. This resulted in an effective interest rate of approximately 7.2%. 2. The revolving debt is net of unamortized deferred financing charges of $2 million resulting in an effective interest rate of approximately 4.53%. As of December 31, 2018, subject to financial covenants, Clearwater may borrow up to an additional CDN $90.3 million on the undrawn facility. The availability on this loan is reduced by the amount outstanding on a USD $10 million non- amortizing term loan. 3. Term Loan B is net of unamortized deferred financing charges of $0.2 million. As of December 31, 2018, this resulted in an effective interest rate of approximately 4.46%. 4. The Deferred Obligation and Earnout Liability relate to the acquisition of Macduff in 2015. Equity In 2018, Clearwater issued 21,185 common shares under its share-based compensation plans and 886,110 common shares under the dividend reinvestment plan (“DRIP”) See Dividends within the section titled Review of Cashflows for information regarding the DRIP initiated in 2018. Clearwater reserved 2.5 million common shares (December 31, 2018 - 2.5 million remaining) for issuance under the share-based compensation plans and 3.0 million (December 31, 2018 - 2.1 million remaining) under the DRIP. There are 64,841,993 shares outstanding as of December 31, 2018 (December 31, 2017 - 63,934,698). 24 | P a g e Long-term debt As at December 31, 2018 long-term debt includes: • USD $250 million senior unsecured notes, due 2025 with a US dollar coupon rate of 6.875% (“the USD Notes”). Forward foreign exchange contracts are in place to hedge approximately 80% of the notional value of the USD Notes at an average rate of 1.2844 and approximately 80% of the coupon payments at an average rate of 1.2830 through to 2022. Clearwater has applied hedge accounting to these forward foreign exchange contracts that hedge coupon payments; • Senior secured credit facilities consisting of a CDN $200 million revolving credit facility and a CDN $35 million amortizing secured term loan, each maturing in 2022 (the “Senior Secured Credit Facilities”). The Senior Secured Credit Facilities bear interest ranging from banker’s acceptance rate (“BA rate”) plus 1.50% to 2.25% for the revolving credit facility and BA rate plus 2.50% to 3.25% for the secured term loan. The range is determined quarterly based on a ratio of Senior Secured indebtedness to EBITDA, with EBITDA calculated on a trailing twelve-month basis. The revolver and Term Loan B are secured by a first charge on cash and cash equivalents, accounts receivable, licences and quotas, and Clearwater’s investments in certain subsidiaries; and inventory, marine vessels, • Other term loans: The term loan maturing in 2019 is for USD $10 million, for a term of 1-year and the borrower is a subsidiary in Argentina; this loan is supported by a secured letter of credit. The term loan maturing in 2091 has recourse limited to the asset financed. Also included in Clearwater’s long-term debt is deferred consideration related to the acquisition of Macduff in 2015 comprised of a deferred obligation and an earnout liability. • The Deferred Obligation consists of deferred payments for 33.75% of the shares of Macduff acquired by Clearwater (the "Earn Out Shares") in 2015. The principal balance outstanding as at December 31, 2018 was £10.5 million (CDN $18.3 million) (December 31, 2017 - £15.7 million (CDN $26.5 million)) and does not bear interest. The Deferred Obligation is recorded at the discounted amount based on estimated timing of payment and is being accreted to the principal amount over the estimated term using the effective interest method with an effective average interest rate of 7.44%. On October 30th of each year, the holders of the Earn Out Shares can elect to be paid up to 20% of the original Deferred Obligation amount. Beginning in 2017, Clearwater had the right to exercise the payout of 20% of the Deferred Obligation annually. • The holders of the Earn Out Shares elected to be paid 20% of the Deferred Obligation in both 2018 and 2017 resulting in payments of £5.2 million (CDN - $8.9 million) and £5.2 million (CDN - $8.8 million) in November 2018 and November 2017, respectively. • The Earnout liability is unsecured additional consideration to be paid dependent upon the financial performance of Macduff and the percentage of Deferred Obligation remaining unpaid at the time of payment. The estimated fair value of the Earnout liability at December 31, 2018 was £2.0 million (CDN - $3.5 million) (December 31, 2017 - £3.1 million, CDN - $5.3 million). The Earnout liability is recorded at fair value on the consolidated statement of financial position. See the consolidated financial statements for terms and valuation of the Earnout liability. Excluding deferred consideration and the related earnout liability, Clearwater has effectively fixed the interest rate on 76% percent of its debt as at December 31, 2018. Clearwater’s debt facilities are subject to certain financial and non-financial covenants. Clearwater is in compliance with all covenants associated with its debt facilities. 25 | P a g e Liquidity Capital Requirements Clearwater’s business experiences a predictable seasonal pattern in which sales, margins and adjusted EBITDA are lower in the first half of the year and higher in the second half, while investments in capital expenditures and working capital are typically higher in the first half of the year and lower in the second half. This typically results in lower cash flows, higher debt balances and higher leverage in the first half of the year and higher cash flows, lower debt balances and lower leverage in the second half. We schedule ongoing capital expenditure programs to maintain the operating capacity of our assets at existing levels, which we refer to as maintenance capital, which are typically funded by operating cash flows. Sources of Liquidity Our primary sources of liquidity to fund current operations, seasonal operations, seasonal working capital demands, capital expenditures, and other commitments consists of: • Cash flow from operating activities; • Cash on deposit; and • $200 million revolving loan. As of December 31, 2018, Clearwater had $35.9 million in cash, and $90.3 million available to draw down on its revolving facility. In 000's of Canadian dollars As at December 31 Cash Availability on revolving credit facility Sources of liquidity Leverage1 $ 2018 35,887 $ 90,254 126,141 2017 35,514 $ 55,806 91,320 2016 39,514 63,159 102,673 Leverage as at December 31, 2018 was 4.7x as compared to 5.0x as at December 31, 2017. Strong generation of cash from operations and a reduction in capital expenditures following the completion of the fleet renewal program in 2017, enabled at $28.3 million reduction in net debt which more than offset the decrease in adjusted EBITDA attributable to shareholders. In 000's of Canadian dollars As at December 31 Adjusted EBITDA1 attributable to shareholders Net Debt2,3,4 (excluding non-controlling interest) Leverage 1 Refer to discussion on non-IFRS measures, definitions and reconciliations 2018 2017 2016 $ 88,175 $ 89,156 $ 98,446 418,455 4.7 446,771 5.0 411,724 4.2 2 Debt as at December 31 and December 31, 2017 has been adjusted to include USD $200 million forward foreign exchange contracts at an average contracted rate of 1.2844. (December 31, 2016 - USD $75 million cross-currency swap at contracted rates of 1.3235). 3 Debt is net of unamortized deferred financing charges of $9.2 million (December 31, 2017 - $10.0 million; December 31, 2016 - $2.0 million). 4 Net debt is adjusted for cash attributable to shareholders. Clearwater’s leverage measure is based on the ratio of adjusted EBITDA attributable to shareholders to its outstanding debt, net of cash balances. Clearwater’s longer-term goal is a leverage ratio of 3.0x. 26 | P a g e Leverage is not a recognized measure under IFRS, and therefore is unlikely to be comparable to similar measures presented by other companies. Management believes leverage to be a useful term when discussing liquidity and as a measure frequently analyzed for public companies, Clearwater has calculated the amount to assist readers in this review. Leverage should not be construed as a measure of cash flows. Foreign Exchange Management Clearwater has a foreign exchange risk management program which limits cash flow volatility arising from foreign currency cash flows. Clearwater currently uses forward contracts to lock-in foreign exchange rates up to 18 months for anticipated sales and long-term debt related hedges extend through to 2022. A reduction in volatility from currency exposures improves earnings predictability. As of December 31, 2018, Clearwater had forward exchange contracts outstanding: Currency USD to CDN Yen to CDN Euro to CDN Euro to GBP CDN to USD Forecasted transaction Sales Sales Sales Sales Debt Notional (millions) 121.7 3,324.7 38.6 32.4 248.1 Average rate 1.2975 0.0120 1.5637 0.9007 1.2841 Refer to the section entitled Risks and Uncertainties for a comprehensive discussion of Clearwater’s foreign exchange exposure and strategy to manage foreign exchange risk. 27 | P a g e REVIEW OF CASHFLOWS Clearwater endeavors to generate strong cash flows from operations to fund scheduled loan payments, capital expenditures and distributions to non-controlling interests and to provide sufficient free cash flow to fund growth investments and pay a sustainable dividend to its shareholders. The following table summarizes information about Clearwater’s cash flows: In 000's of Canadian dollars 13 weeks ended December 31 2017 2018 2018 Year Ended December 31 2016 2017 Cash from (used in) operating activities Cash from (used in) financing activities Cash from (used in) investing activities Free cash flow1,2 $ 45,836 $ (32,705) (4,360) 42,664 $ (27,734) (22,691) 76,487 $ (60,617) (16,701) 58,141 $ 22,665 (85,516) 63,040 (12,666) (55,873) $ 32,651 $ 22,252 $ 45,206 $ (8,428)$ 1,502 Supplemental cash flow information $ 3,057 $ Changes in working capital3 Decrease (increase) in inventory (Decrease) increase in accounts payable Decrease (increase) in accounts receivable Decrease (increase) in prepaids (Decrease) increase in income tax payable Purchase of property, plant and equipment Cash dividends paid on common shares4 1 Refer to discussion on non-IFRS measures, definitions and reconciliations. 2 Free cash flow is defined as cash flows from operating activities, less planned capital expenditures (net of debt designated to fund such expenditures), scheduled payments on long-term debt and distributions to non-controlling interests. Discretionary items such as debt refinancing and repayments, changes in the revolving loan and discretionary financing and investing activities are excluded from free cash flow. 3 Changes in working capital have been restated to align with the change in presentation of cash interest and cash income taxes paid in the consolidated statement of cash flows. This change had no impact on cash from operations. 31,139 $ 35,206 (8,948) 7,067 (2,179) (7) (2,638) (1,849)$ 12,615 9,369 (22,043) 188 2,928 (85,431) (12,787)$ 34,715 $ 48,116 (2,487) (11,177) 1,838 (1,575) (25,350) 9,699 $ 8,021 (8,252) 18,574 (3,108) (5,536) (19,124) (16,547) (22,030) (7,785) 3,775 4,953 4,540 (56,332) (12,388) (8,299)$ (3,197)$ $ 4 Net of the dividend reinvestment plan. Cash flow from Operating Activities For 2018, cash generated from operations of $76.5 million was a record for the Company increasing $18.3 million from the prior year driven by a lower investment in working capital, including net foreign exchange gains on working capital, and lower income tax expense, partially offset by one-time restructuring costs paid in 2018. The fourth quarter of 2018 generated strong cash from operations of $45.8 million driven by operating performance and reduction in working capital investment of $31.1 million in the quarter. Working capital improvements resulted from timing of sales, improved collection periods compared to prior year and lower inventory levels, due to less procurement of species with lower margins and reductions in clam inventory from peak levels. Cash flow from Financing Activities For 2018, cash was used in financing activities to repay $30.2 million of the revolving credit facility, fund distributions to non-controlling interests and dividends paid on common shares. In 2017 financing was raised to support capital expenditure programs. 28 | P a g e Cash Flow from Investing Activities Cash used in investing activities decreased in 2018 with declines in capital expenditures following the completion of the fleet renewal program in 2017. Free Cash Flow1 Free cash flows of $45.2 million for the year and $32.7 million in the fourth quarter of 2018 increased $53.6 million and $10.4 million respectively, compared to the same periods in 2017 primarily due to significant reductions in capital expenditures following the fleet renewal program completed in 2017 and strong cash from operations. Certain large investments in longer term assets such as vessel conversion and acquisitions are funded with long-term capital including amortizing term loans. As a result, Clearwater adds the funding on those capital expenditures in the determination of free cash flows and deducts the related debt borrowings. Changes in working capital Clearwater is manages working capital within cash from operations and free cash flow. Clearwater manages trade receivables through a combination of tight collection terms and, when appropriate, discounting. Clearwater has a policy of utilizing a combination of credit reporting agencies, credit insurance, letters of credit and secured forms of payment to mitigate customer and country specific credit risk. As a result, Clearwater does not have any significant concentration of credit risk. Clearwater manages its investment in inventories through detailed review of supply and production plans versus sales forecasts, and through continuous improvements in the integration of its fleet and sales plans. From time-to-time, Clearwater enters into transactions to sell selected accounts receivables to a commercial partner without recourse. Sale of receivables during the period represented less than 5 percent of consolidated sales. Purchase of Property Plant and Equipment Clearwater manages capital spending within cash from investing activities and free cash flow. Clearwater evaluates investments in property, plant, equipment and licences as either return on investment or maintenance capital and tracks each project accordingly. Significant expenditures that are expected to have a return in excess of the cost of capital are classified as ROI, and all refits and expenditures that are expected to return less than the average cost of capital are classified as maintenance. On average, Clearwater expects to invest approximately $20-25 million a year in maintaining its fixed assets with repairs and maintenance capital. In 2019, Clearwater expects to invest between $25-$30 million in capital projects relating to vessel refits and land-based supply chain infrastructure. Dividends On March 7, 2019 the Board of Directors approved and declared a dividend of $0.05 per share payable on April 1, 2019 to shareholders of record as of March 18, 2019. On February 15, 2018 the Board approved a DRIP effective February 23, 2018 to provide shareholders of Clearwater who are resident in Canada with the option to have the cash dividends declared on the common shares of Clearwater reinvested automatically back into additional shares, without the payment of brokerage commissions or service charges. The DRIP program was effective for the payment of the fourth quarter 2017 dividend paid on April 2, 2018 and expects to continue until further notice. 29 | P a g e In making the determination of dividend levels Clearwater's Board gives consideration to several key principles including: • expected future earnings; • • • free cash flows that should be retained to reinvest in the business; the assurance that all obligations can be met with respect to existing loan agreements; and the desire to increase the dividend in the future as the business continues to grow and expand. The Board will continue to review Clearwater’s dividend policy on a regular basis to ensure the dividend level remains consistent with the policy. These dividends are eligible dividends as defined for the purposes of the Income Tax Act (Canada) and applicable provincial legislation and, therefore, qualify for the favorable tax treatment applicable to such dividends. Commitments In the normal course of business, Clearwater is obligated to make future payments, including contractual obligations for non-derivative and derivative financial instruments, operating leases and other commitments. The table includes undiscounted cash flows of financial liabilities, operating leases and other commitments, interest and principal cash flows based on the earliest date on which Clearwater is required to pay. December 31, 2018 Interest - long-term debt Principal repayments - long-term debt Carrying Amount Total Contractual Cash Flow $ - $ 182,056 $ 2020 2019 27,951 $ 27,561 $ 2022 2021 27,545 $ 24,989 $ 2023 23,719 $ >2024 50,291 463,417 463,417 23,269 10,080 1,467 91,146 - 337,455 Total long-term debt 463,417 645,473 51,220 37,641 29,012 116,135 23,719 387,746 Trade and other payables Operating leases and other Capital and maintenance projects Derivative financial instruments - liabilities 70,507 - - 70,507 10,501 262 70,507 4,882 262 - 2,874 - - 1,258 - - 687 - - 270 - 10,463 10,463 9,966 497 - - - - 530 - - $ 544,387 $ 737,206 $ 136,837 $ 41,012 $ 30,270 $ 116,822 $ 23,989 $ 388,276 Included in the above commitments for “operating leases and other” are amounts to which Clearwater is committed directly - and indirectly through its partnerships - for various licences and lease agreements, office, machinery and vehicle leases, and vessel and equipment commitments. These commitments require approximate minimum annual payments in each of the next five years as shown above. Also included in commitments for operating leases and other, are (i) amounts to be paid to a company controlled by a director of Clearwater over a period of years ending in 2020 for vehicle and office leases, which aggregate approximately $0.04 million (2017 - $0.07 million). 30 | P a g e OUTLOOK In 2019, we expect balanced growth across multiple species and regions led by Asia-Pacific and driven by increased volume and significant new product introductions including new products in clam, sea cucumber and whelk as well as a full year offering of live crab. Continued innovation throughout our global supply chain on land and sea will reduce cost and increase the productivity of our asset base while continuing to enable product diversification in response to changing consumer trends. Clearwater will continue de-leveraging activities in 2019, prioritizing cash generation, cost savings, margin improvement, further inventory reductions and lower capital expenditures. The resulting cash generation will be used to reduce debt and leverage throughout 2019. Clearwater’s access to the full clam total allowable catch (“TAC”) for 2019 and a FAS shrimp harvest unrestricted by vessel refits will be met with the continuing competitive conditions for scallop associated with higher worldwide supply. In 2017, with full access to the clam quota and three harvesting vessels, Clearwater harvested 100% of the TAC and reported clam sales of $109.2 million. Clearwater’s core fisheries are managed for long-term sustainability. We have taken and will continue to pursue timely and carefully considered measures in response to near-term challenges including; adjustments to harvest plans, pricing and distribution strategies, and cost and working capital reductions. These measures will generate strong cash flows from operations, reduce debt and leverage, yield a higher return on assets and generate positive returns to shareholder value. Global demand for seafood is being driven by growing worldwide population, shifting consumer tastes towards healthier diets, and rising purchasing power of middle-class consumers in emerging economies. The supply of wild seafood is limited and is expected to continue to lag behind the growing global demand. This supply-demand imbalance has created a marketplace in which purchasers of seafood are increasingly willing to pay a premium to suppliers that can provide consistent quality and food safety, wide diversity and reliable delivery of premium, wild, sustainably harvested seafood. Clearwater is well positioned to take advantage of this opportunity with its proprietary licences, premium product quality, diversity of species, global sales footprint and year-round harvest and delivery capability. 31 | P a g e RISKS AND UNCERTAINTIES The performance of Clearwater’s business is susceptible to a number of risks which affect income, liquidity and cash flow, including risks related to resource supply, food processing and product liability, suppliers, customers, competition and foreign exchange exposure and lawsuits in the normal course of business. For further disclosure of additional risk factors please refer to the Annual Information Form, which is available on Sedar at www.sedar.com as well as Clearwater’s website at www.clearwater.ca. Foreign exchange risk Clearwater’s financial results are subject to volatility as a result of foreign exchange rate fluctuations. The majority of Clearwater’s sales are to locations outside Canada and are transacted in currencies other than the Canadian dollar whereas the majority of its expenses are in Canadian dollars. As a result, fluctuations in the foreign exchange rates of these currencies can have a material impact on the financial condition and operating results. In addition, Clearwater has subsidiaries which operate in the offshore scallop fishery in Argentina and in the UK which exposes Clearwater to changes in the value of the Argentine Peso and GBP. Risks associated with foreign exchange are partially mitigated by the following strategies: (1) Diversify sales internationally which reduces the impact of any country-specific economic risks. (2) Execute on pricing strategies so as to offset the impact of exchange rates. (3) Limit the amount of long-term sales contracts – Clearwater has very few long-term sales contracts with any customers. Contracts are typically less than 6 months and are based on list prices that provide a margin for exchange rate fluctuations. (4) Plan conservatively - Clearwater regularly reviews economist estimates of future exchange rates and uses conservative estimates when managing its business, and (5) Foreign exchange hedging program – a portfolio of forward contracts enables Clearwater to lock in exchange rates for up to 18 months for key sales currencies (the US dollar, Euro, Yen and GBP) thereby lowering the potential volatility in cash flows through derivative contracts. In 2018 approximately 44.8% of Clearwater’s sales and 75% of long-term debt were denominated in US dollars. Based on 2018 sales and excluding the impact of its hedging program, • a change of 0.01 in the US dollar rate converted to Canadian dollars would result in a $2.0 million change in sales; • a change of 0.01 in the GBP rate converted to Canadian dollars would result in a $0.3 million change in sales; • a change of 0.01 in the Euro rate as converted to Canadian dollars would result in a $1.0 million change in sales; and • a change of 0.0005 in the Yen rate as converted to Canadian dollars would result in a $2.2 million change in sales. 32 | P a g e Political risk Our operations and investments are subject to economic and political risks, which could materially and adversely affect our business. These risks include fluctuations in foreign exchange rates, expropriation of our assets, nationalization, renegotiation, forced divestiture, modification or nullification of our contracts and changes in foreign laws or other regulatory policies of foreign or domestic governments and having to submit to the jurisdiction of a foreign court or arbitration panel or having to enforce the judgment of a foreign court or arbitration panel against a sovereign nation within its own territory. Specific risks by country are described below. Canada Clearwater was a pioneer in the development of the clam fishery, which began in 1986. Clearwater purchased its licences and quota with the consent of the DFO and has invested hundreds of millions of dollars to develop the fishery and the market, including $156 million from 2015 through 2017. On September 6, 2017, the DFO announced the introduction of a fourth Arctic Surf Clam licence representing 25 percent of the existing TAC to be awarded to a new entrant effective 2018. The announcement of the introduction of a fourth Arctic Surf Clam licence represented a departure from historical Canadian policy. On August 10, 2018, the DFO canceled the process to issue the fourth licence and confirmed that the remaining 25 percent of the clam quota would be issued to Clearwater for 2018 and 2019. The DFO also signalled their intent to initiate a new process in the spring of 2019 whereby an independent third party would be employed to assess and evaluate expressions of interest with the objective of identifying a new Indigenous licence holder. Clearwater intends to participate in the new process in partnership with Indigenous communities. Argentina Our operations in Argentina may be negatively affected by foreign exchange and restrictions on the repatriation of dividends as well as the increased cost and risks of doing business in developing markets. There are currently no restrictions on our ability to pay dividends. We mitigate these risks through maintaining a policy of repatriating our share of earnings from Argentina through dividends and we do not maintain any material financial assets that are surplus to our needs to operate the business outside of Canada. In addition, we have structured our operations in Argentina with an Argentine partner who owns 14% and is active in managing the business. United Kingdom On June 23, 2016, the United Kingdom (“UK”) voted to leave the European Union (“EU”). On March 29, 2017, the Prime Minister of the UK filed notice of intention to leave the EU triggering the process to negotiate the terms of the withdrawal and the country’s future relationship with the EU. Under the Lisbon Treaty, the negotiations of the terms of departure are required to be concluded within two years from giving notice. Full discussions related to the future economic partnership agreements began in July 2018. The UK Parliament has yet to accept the Withdrawal Agreement between the EU and the UK Government. Ongoing negotiations are likely to result in a transition period which will provide stability and status quo during an implementation period concluding on December 31, 2020. Any impacts to Clearwater are not yet known although the UK Government white paper proposes a mechanism for free and frictionless trade of goods between the UK and EU, as well as outlining government plans for establishing free trade agreements with the rest of the world. 33 | P a g e The UK is clear that access to waters should be decided at annual fisheries negotiations and not linked to trade arrangements. Sustainability, industry leadership and cost recovery form the basis of the fisheries white paper, which indicates that the UK acknowledges the reciprocal access to waters is important for both the UK and EU. for shellfisheries and processing; As a business, we are taking a fully participative, active and advisory role in all preparatory government working groups fisheries access and immigration/labour related matters. Furthermore, the removal of EU fisheries legislation provides an opportunity to redesign fisheries management systems in the UK over the longer term. The Company is engaging with the UK and devolved governments to engage in policy discussion for future management measures for shellfish fisheries focusing on conservation science, sustainability, quality, health and safety and fair labour practices. The Company expects to be able to assess, manage and plan for any impacts to the business through our involvement in the negotiations and their outputs. looking at trade, United States NAFTA was a comprehensive trade agreement that set the rules of trade and investment between Canada, the United States, and Mexico. The agreement entered into force on January 1, 1994 and systematically eliminated most tariff and non-tariff barriers to free trade and investment between the three NAFTA countries. On September 30, 2018, NAFTA was replaced with a new tentative agreement named the United States- Mexico-Canada Agreement (“USMCA”) which must be ratified by the member countries before coming into effect. Clearwater is not expected to be impacted by the changes under the USMCA. Approximately 14.5% of total sales for 2018 were in the United States. Management will continue to review, assess and monitor for any changes to USMCA that could significantly impact Clearwater until the agreement is ratified. Asia Pacific On March 8, 2018 the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (“CPTPP”) was signed. The CPTPP has created an eleven country trading block including Canada, and representing 495 million people, with a combined gross domestic product of $13.5 trillion or 13.5% of global GDP. Resource supply risk A material change in the population and biomass of scallop, lobster, clam, langoustine, crab, whelk or coldwater shrimp stocks in the fisheries in which we operate would materially and adversely affect our business. Clearwater’s business is dependent on the state of the targeted shellfish stocks, with limitations on catch levels determined by annual TAC, effort restrictions and other technical measures. The annual TACs are generally related to the health of the stock of the particular species as measured by a scientific survey of the resources. The population and biomass of shellfish stocks are subject to natural fluctuations some of which are beyond our control and which may be exacerbated by factors such as water temperatures, food availability, the presence of predators, disease, disruption in the food chain, reproductive problems or other biological issues. Supply and quality of supply can also be influenced by man-made factors such as oil spills and pollution. We are unable to fully predict the timing and extent of fluctuations in the population and biomass of the shellfish stocks we harvest and process, and we therefore may not be able to engage in effective measures to alleviate the adverse effects of these fluctuations. In addition, the population models utilized by scientists evaluating the fisheries in which we operate are constantly evolving. Certain 34 | P a g e changes in the population models could negatively impact future biomass estimates. Any material reduction in the population and biomass or TAC of the stocks from which we source seafood would materially and adversely affect our business. Any material increase in the population and biomass or TAC could dramatically reduce the market price of any of our products. The source of all Clearwater’s supply of products comes from fisheries in Canada, the United Kingdom and Argentina. The governments of Canada, the UK and EU and Argentina set the annual TAC and/or define fishing regulations for each species by reviewing scientific studies of the resource and then consulting with key stakeholders including Clearwater and its competitors to determine acceptable catch levels. The potentially differing interests of our competitors may result in conflicting positions on issues around resource management, including the establishment of TACs and other management measures potentially limiting our ability to grow, to fully capitalize on our investments in harvesting capacity, or to achieve targeted yields from the resource, which may adversely affect our financial condition and results of operations. Resource supply risk is managed through adherence with government policies and regulations related to fishing in Canada, Argentina and the UK and Clearwater’s investment in science and technology, which enables Clearwater to understand the species that it harvests. Clearwater has invested in projects with the scientific community, such as ocean floor mapping and the resource assessment surveys to ensure access to the best available science information. Resource management plans, developed by DFO, are developed through an open and transparent process with strong input from industry participants. Clearwater engages in these processes to promote best in class, robust, and sustainable management of the resource. The MSC certification of all our core species demonstrates that the resources that Clearwater harvests meet the leading global standard for sustainable fisheries management practice. Clearwater further mitigates the risk associated with resource supply and competition through the diversification across species. Contingent Liabilities From time to time Clearwater is subject to claims and lawsuits arising in the ordinary course of operations. In the opinion of management, the ultimate resolution of such pending legal proceedings will not have a material effect on Clearwater’s consolidated financial position. Other risks For further disclosure of additional risk factors please refer to the Annual Information Form. CRITICAL ACCOUNTING POLICIES Clearwater’s critical accounting policies are those that are important to the portrayal of Clearwater’s financial position and operations and may require management to make judgments based on underlying estimates and assumptions about future events and their effects. These estimates can include but are not limited to estimates regarding inventory valuation, accounts receivable valuation allowances, estimates of expected useful lives of vessels and plant facilities, and estimates of future cash flows for impairment tests. Underlying estimates and assumptions are based on historical experience and other factors that are believed by management to be reasonable under the circumstances. These estimates and assumptions are subject to change as new events occur, as more experience is acquired, as additional information is obtained, and as the operating environment changes. Clearwater has considered recent market conditions including changes to its cost of capital in making these estimates. Refer to the notes to the annual financial statements for a complete listing of critical accounting policies and estimates used in the preparation of the consolidated financial statements. 35 | P a g e Disclosure Controls and Internal Controls Over Financial Reporting The Management of Clearwater, with the participation of the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) (collectively “Management”), is responsible for establishing and maintaining disclosure controls and procedures (“DC&P”) and internal controls over financial reporting (“ICFR”), as those terms are defined in National Instrument 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings. Based on management’s evaluation, the CEO and the CFO have concluded that DC&P and ICFR were effective as of December 31, 2018. There have been no changes to controls during the quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, Clearwater’s ICFR. Adoption of new and revised standards The IASB has issued the following standard that has not been applied in preparing these consolidated financial statements as its effective date falls within annual periods beginning subsequent to the current reporting period. IFRS 16 Leases On January 13, 2016, the IASB issued IFRS 16 Leases. This standard introduces a single lessee accounting model and requires a lessee to recognize assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is required to recognize a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. This standard substantially carries forward the lessor accounting requirements of IAS 17, while requiring enhanced disclosures to be provided by lessors. Other areas of the lease accounting model have been impacted, including the definition of a lease. Transitional provisions have been provided. The Company will adopt IFRS 16 beginning on January 1, 2019 and has elected to apply the modified retrospective approach on transition. Clearwater currently leases office space, machinery, wharves, equipment and vehicles. Clearwater will not see a material impact on net income as a result of the new lease standard and interest and depreciation will largely offset the amounts previously reported as operating expense. The standard will have an impact on its key performance measures, including earnings before interest, tax, depreciation and amortization, leverage and return on assets. Related Party Transactions Clearwater transacts in the normal course of business with related parties. The details are as follows for the year ended December 31, 2018 and 2017: Clearwater rents office space to and provides computer support network services to CFFI Ventures Inc. (“CVI”), a related party. The net amount due from CVI in respect of these transactions was nil (December 31, 2017 – $0.04 million). Any amounts outstanding are unsecured and due on demand. For the year ended December 31, 2018, Clearwater recorded net expense of approximately $0.2 million for providing computer support network services to and receiving goods and services from companies related to CVI (December 31, 2017 - net revenue of $0.06 million). The transactions are recorded at the exchange amount and the balance due from these companies was $0.1 million as at December 31, 2018 (December 31, 2017 - $0.07 million due to). 36 | P a g e SUMMARY OF QUARTERLY RESULTS The following table provides historical data for the ten most recently completed quarters. In 000's of Canadian dollars $ Fiscal 2018 Sales Adjusted EBITDA Adjusted EBITDA attributable to shareholders1 Earnings (loss) attributable to shareholders Earnings (loss) per share Diluted earnings (loss) per share2 Weighted average shares outstanding3 Fiscal 2017 Sales Adjusted EBITDA Adjusted EBITDA attributable to shareholders1 Earnings (loss) attributable to shareholders Earnings (loss) per share Diluted earnings (loss) per share Weighted average shares outstanding $ First Quarter Second Quarter Third Quarter Fourth Quarter 120,072 $ 19,114 14,933 (13,758) (0.22) (0.22) 63,935,153 148,142 $ 30,501 26,147 (923) (0.01) (0.01) 64,154,263 164,225 $ 30,686 25,373 10,818 0.17 0.17 64,417,905 159,807 24,090 21,722 (12,340) (0.19) (0.19) 64,676,360 128,367 $ 19,767 15,798 2,172 0.03 0.03 63,934,698 154,302 $ 27,542 23,550 9,489 0.15 0.15 63,934,698 163,597 $ 32,797 26,961 15,054 0.24 0.24 63,934,698 174,766 28,490 22,846 (10,956) (0.17) (0.17) 63,934,698 $ Fiscal 2016 Sales Adjusted EBITDA Adjusted EBITDA attributable to shareholders1 Earnings (loss) attributable to shareholders Earnings (loss) per share Diluted earnings (loss) per share Weighted average shares outstanding 1 Refer to discussion on non-IFRS measures, definitions and reconciliations 3 In 2018, Clearwater implemented a Dividend Reinvestment Plan and issued shares under the share-based compensation plans. 189,457 $ 45,158 36,795 10,847 0.17 0.17 63,934,698 140,180 $ 27,454 21,811 9,962 0.16 0.16 60,439,577 116,225 $ 18,864 14,761 14,507 0.24 0.24 59,958,998 165,690 29,461 25,079 8,611 0.14 0.14 63,934,698 For a more detailed analysis of each quarter’s results, please refer to our quarterly reports and annual reports. Due to seasonality, sales generally increase with each successive quarter with the highest revenues in the second half of each year. Volatility in exchange rates can have a significant impact on earnings. The volatility is partially offset by Clearwater’s foreign exchange management program. 37 | P a g e NON- IFRS MEASURES, DEFINITIONS AND RECONCILIATIONS Adjusted earnings before interest, tax, depreciation and amortization (“adjusted EBITDA”) Adjusted EBITDA is not a recognized measure under IFRS, and therefore is unlikely to be comparable to similar measures presented by other companies. Management believes that in addition to net earnings and cash provided by operating activities, adjusted EBITDA is a useful supplemental measure from which to determine Clearwater’s ability to generate cash available for debt service, working capital, capital expenditures, income taxes and dividends. In addition, as adjusted EBITDA is a measure frequently analyzed for public companies, Clearwater has calculated adjusted EBITDA to assist readers in this review. Adjusted EBITDA should not be construed as an alternative to net earnings determined in accordance with IFRS as a measure of liquidity, or as a measure of cash flows. Adjusted EBITDA is defined as EBITDA excluding extraordinary, non-operating, non-recurring or non- routine items that are unusual and are deemed not to be a part of normal operations of the business. Items that are excluded from adjusted EBITDA include restructuring and reorganization expenses, gains and losses on investment activities, costs associated with acquisitions to the extent not capitalized, financing and refinancing costs, net gains on insurance claims and share-based compensation. In addition, recurring accounting gains and losses on foreign exchange (other than realized gains and losses on forward exchange contracts), have been excluded from the calculation of Adjusted EBITDA. Unrealized gains and losses on forward exchange contracts relate to economic hedging on future operational transactions and by adjusting for them, the results more closely reflect the economic effect of the hedging relationships in the period to which they relate. 38 | P a g e Reconciliation of net earnings (loss) to adjusted EBITDA for the 13 weeks and year ended December 31, 2018, December 31, 2017 and December 31, 2016. Earnings (loss) Add (deduct): Income taxes $ Taxes and depreciation for equity investment Depreciation and amortization Interest on long-term debt and bank charges Earnings before interest, taxes, depreciation and amortization $ Add (deduct) other items: Unrealized foreign exchange and derivative loss (gain) Fair market value on long-term debt Realized foreign exchange loss (gain) on working capital Restructuring and refinancing costs 13 weeks ended December 31 December 31 December 31 2018 (3,706) $ 2018 (10,556) $ 2017 (6,551) $ Year Ended December 31 2017 28,239 $ December 31 2016 59,596 (621) (874) 12,479 7,496 4,461 (57) 15,850 7,831 1,740 476 48,843 30,246 7,659 2,112 45,252 29,759 16,446 960 33,501 26,889 7,924 $ 21,534 $ 77,599 $ 113,021 $ 137,392 15,786 442 (660) 103 1,609 (1,617) (564) 7,412 29,052 1,097 (5,512) 866 (23,136) (1,307) 3,547 16,062 (31,753) 2,211 7,805 2,380 Share-based compensation (recovery) expense Adjusted EBITDA $ 495 24,090 $ 116 28,490 $ 1,289 104,391 $ 409 108,596 $ 2,902 120,937 Adjusted EBITDA attributed to: Non-controlling interests Shareholders of Clearwater $ $ 2,368 $ 21,722 24,090 $ 5,538 $ 22,952 28,490 $ 16,216 $ 88,175 104,391 $ 19,440 89,156 108,596 $ 22,491 98,446 120,937 39 | P a g e Adjusted earnings attributable to shareholders To assist readers in estimating our earnings we have included a calculation of adjusted earnings. Management believes that in addition to earnings and cash provided by operating activities, adjusted earnings is a useful supplemental measure from which to determine Clearwater’s earnings from operations and ability to generate cash available for debt service, working capital, capital expenditures, income taxes and dividends. Reconciliation of net earnings to adjusted earnings for the 13 weeks and year ended December 31, 2018, December 31, 2017 and December 2016 is as follows: 13 weeks ended Year ended December 31 December 31 December 31 December 31 December 31 2016 2017 2018 2017 2018 Reconciliation of net earnings to adjusted earnings Earnings (loss) $ (10,556) $ Restructuring and refinancing costs Acquisition related costs Share-based compensation cost (recovery) Unrealized foreign exchange and derivative (gain) loss Devaluation of Peso on working capital Fair value on long-term debt 103 - 495 15,786 - 442 16,826 (6,551) $ 7,412 - 116 1,609 - (1,617) 7,520 (3,706) $ 866 - 1,288 29,052 - 1,097 32,303 28,239 $ 16,059 - 409 (23,136) - (1,307) (7,975) 59,596 (182) 1,159 2,902 (31,753) 5,199 2,211 (20,464) Adjusted earnings $ 6,270 $ 969 $ 28,597 $ 20,264 $ 39,132 Adjusted earnings attributable to: Non-controlling interests Shareholders Adjusted earnings per share: 1,480 4,790 6,270 $ 2,554 (1,585) 969 $ 12,766 15,831 28,597 $ 11,574 8,690 20,264 $ 15,366 23,766 39,132 $ Weighted average of shares outstanding Adjusted earnings per share for shareholders 64,676 0.07 63,935 (0.02) 64,299 0.25 63,935 0.14 62,051 0.38 Reconciliation of adjusted earnings to adjusted EBITDA Adjusted earnings $ 6,270 $ 969 $ 28,597 $ 20,264 $ 39,132 Add (subtract) Income tax expense Depreciation and amortization Interest on long-term debt and bank charges Taxes and depreciation on equity investment Realized foreign exchange on working capital Other reorganizational costs (621) 12,479 7,496 (874) (660) - 17,820 4,461 15,850 7,831 (57) (564) - 27,521 1,740 48,843 30,246 476 (5,511) - 75,794 7,659 45,252 29,759 2,112 3,550 - 88,332 16,446 33,501 26,889 960 2,608 1,403 81,807 Adjusted EBITDA1 $ 24,090 $ 28,490 $ 104,391 $ 108,596 $ 120,939 40 | P a g e Leverage Leverage is not a recognized measure under IFRS, and therefore is unlikely to be comparable to similar measures presented by other companies. Management believes leverage to be a useful term when discussing liquidity and does monitor and manage leverage. In addition, as leverage is a measure frequently analyzed for public companies, Clearwater has calculated the amount to assist readers in this review. Leverage should not be construed as a measure of liquidity or as a measure of cash flows. Leverage for banking purposes differs from the below calculations as agreements require the exclusion of certain cash from the calculation and EBITDA excludes non-controlling interests and most significant non- cash and non-recurring items. Clearwater is in compliance with all of the non-financial and financial covenants associated with its debt facilities. The calculation of adjusted EBITDA attributable to shareholders to debt (net of unamortized deferred financing charges) for the year ended December 31, 2018, December 31, 2017 and December 31, 2016 is as follows: In 000's of Canadian dollars As at December 31 Adjusted EBITDA1 attributable to shareholders Debt2,3 (excluding non-controlling interest) Less cash (excluding non-controlling interest) Net debt 2018 2017 88,175 $ 89,156 $ 447,551 (29,096) 418,455 $ 478,747 (31,976) 446,771 $ 2016 98,446 436,834 (25,110) 411,724 $ $ Leverage 1. Refer to discussion on non-IFRS measures, definitions and reconciliations 4.7 5.0 4.2 2. Debt as at December 31, 2018 and 2017 has been adjusted to include USD $200 million forward foreign exchange contracts at an average contracted rate of 1.2844. (December 31, 2016 - USD $75 million cross-currency swap at contracted rates of 1.3235). 3. Debt is net of unamortized deferred financing charges of $9.2 million (December 31, 2017 - $10.0 million; December 31, 2016 - $2.0 million). Free cash flows Free cash flow is not a recognized measure under IFRS, and therefore is unlikely to be comparable to similar measures presented by other companies. Management believes that in addition to net earnings and cash provided by operating activities, free cash flow is a useful supplemental measure from which to determine Clearwater’s ability to generate cash available for debt service, working capital, capital expenditures and distributions. Free cash flow should not be construed as an alternative to net earnings determined in accordance with IFRS, as a measure of liquidity, or as a measure of cash flows. Free cash flow is defined as cash flows from operating activities, less planned capital expenditures (net of any borrowings of debt designated to fund such expenditures), scheduled payments on long-term debt and distributions to non-controlling interests. Items excluded from the free cash flow include discretionary items such as debt refinancing and repayments changes in the revolving loan and discretionary financing and investing activities. 41 | P a g e Reconciliation for the 13 weeks and year ended December 31, 2018, December 31, 2017 and December 31, 2016 is as follows: Adjusted EBITDA1 Less: Interest and bank charges Current income tax expense Other income and expense items 13 weeks ended December 31 2017 2018 2018 2017 Year Ended December 31 2016 $ 24,090 $ 28,490 $ 104,391 $ 108,596 $ 120,937 (7,061) (1,260) (1,071) (7,426) (657) (12,458) (28,551) (6,318) (2,734) (28,204) (12,376) (12,932) (24,776) (7,078) (9,496) Operating cash flow before changes in working capital 14,698 7,949 66,788 55,084 79,587 Changes in working capital2 Cash flows from operating activities 31,138 45,836 34,714 42,663 9,699 76,487 3,057 58,141 (16,547) 63,040 Sources (uses) of cash: Purchase of property, plant, equipment, quota and other assets Disposal of fixed assets Less: Designated borrowings3 Scheduled payments on long-term debt4 Payments on long-term incentive plans Distribution to non-controlling interests Dividends received from joint venture Non-routine project costs Free cash flows1 Reconciliation of change in cash flows for the period Add/(less): Other debt borrowings (repayments) of debt, use of cash3 Issuance of equity Payments on long-term incentive plans Other investing activities Other financing activities Change in cash flows for the period (2,638) - - (8,992) - (1,853) - 298 (25,350) 2,400 14,513 (8,901) 177 (6,642) - 3,392 (19,124) - 1,106 (10,650) 1,084 (11,353) 3,228 4,428 (85,431) 2,408 39,206 (11,948) 1,618 (19,154) 3,340 3,392 (56,332) 1,131 25,883 (15,215) 5,670 (24,560) - 1,885 $ 32,651 $ 22,252 $ 45,206 $ (8,428)$ 1,502 (20,000) 1,381 - (1,724) (2,383) 9,925 $ (24,574) - (177) 259 (5,159) (7,399)$ (31,356) 4,548 (1,084) (805) (16,136) 27,792 - (1,618) (5,832) (15,914) 373 $ (4,000)$ (37,566) 53,024 (5,670) (2,513) (20,369) (11,592) $ 1. Refer to discussion on non-IFRS measures, definitions and reconciliations. 2. Changes in working capital have been restated to align with the change in presentation of cash interest and cash income taxes paid in the consolidated statement of cash flows. This change had no impact on cash from operations. 3. Designated borrowings relate to capital projects for which there is long-term financing and therefore they will not be financed with operating cash flows. For the purpose of free cash flow calculations, the amount invested (up to the total amount of the related financing) during the period on these projects is backed out of the calculation of free cash flows regardless of the timing of the related borrowing. 4. Scheduled payments on long-term debt for 2017 have been updated to include the Deferred Consideration payment made in the fourth quarter 2017 of $8.9 million (fourth quarter 2016 of $8.7 million) and the Earnout payment in the second quarter 2017 of $1.3 million. 42 | P a g e Return on Assets Return on assets is not a recognized measure under IFRS, and therefore is unlikely to be comparable to similar measures presented by other companies. Management believes that return on assets measures the efficiency of the use of total assets to generate income. Return on assets should not be construed as an alternative to net earnings determined in accordance with IFRS. Return on assets is defined as the ratio of rolling 12 month adjusted earnings before interest and taxes (“EBIT”) to average total quarterly assets including all working capital assets. The calculation of adjusted earnings before interest and taxes to total assets for the years ended December 31, 2018, December 31, 2017 and December 31, 2016 is as follows: In (000's) of Canadian dollars Adjusted EBITDA1 Depreciation and amortization Adjusted earnings before interest and taxes Average quarterly total assets December 31 2018 December 31 2017 December 31 2016 $ $ 104,391 $ 108,596 $ 120,937 48,843 55,548 45,428 63,168 38,634 82,303 752,007 $ 775,783 $ 746,896 7.4% 8.1% 11.0% (1) Refer to discussion on non-IFRS measures, definitions and reconciliations. 43 | P a g e Clearwater Seafoods Incorporated Management’s Statement of Responsibility for Financial Reporting The consolidated financial statements and all related financial information contained in the annual report, including Management’s Discussion and Analysis, are the responsibility of the management of Clearwater Seafoods Incorporated. The statements have been prepared in accordance with generally accepted accounting principles, using management's best estimates and judgments, where appropriate. Management is responsible for the reliability and integrity of the consolidated financial statements, the notes to the consolidated financial statements, and other financial information contained in the annual report. In the preparation of these statements, estimates are sometimes necessary because a precise determination of certain assets and liabilities is dependent on future events. Management believes such estimates have been based on careful judgments and have been properly reflected in the accompanying consolidated financial statements. Management is also responsible for maintaining a system of internal control designed to provide reasonable assurance that assets are safeguarded and that accounting systems provide timely, accurate and reliable financial information. The Board of Directors of Clearwater Seafoods Incorporated (“the Board”) is responsible for ensuring that management fulfills its responsibilities for financial reporting and internal control. The Board is assisted in exercising its responsibilities through the Audit Committee of the Board, which is composed of non- management directors. The Audit Committee meets periodically with management and the auditors to satisfy itself that management's responsibilities are properly discharged, to review the consolidated financial statements and to recommend approval of the consolidated financial statements to the Board. KPMG LLP, the independent auditors appointed by the Board, have audited Clearwater Seafoods Incorporated’s consolidated financial statements in accordance with generally accepted auditing standards and their report follows. The independent auditors have full and unrestricted access to the Audit Committee to discuss their audit and their related findings. March 7, 2019 Ian Smith Chief Executive Officer Teresa Fortney Vice-President, Finance and Chief Financial Officer 44 | P a g e KPMG LLP Purdy's Wharf Tower One 1959 Upper Water Street, Suite 1500 Halifax Nova Scotia B3J 3N2 Canada Telephone (902) 492-6000 Fax (902) 429-1307 INDEPENDENT AUDITORS’ REPORT To Shareholders of Clearwater Seafoods Incorporated Opinion We have audited the consolidated financial statements of Clearwater Seafoods Incorporated (the “Company”), which comprise: the consolidated statements of financial position as at December 31, 2018 and December 31, 2017 the consolidated statements of earnings (loss) and comprehensive income for the years then ended • • • • • and notes to the consolidated financial statements, including a summary of significant accounting the consolidated statements of changes in equity for the years then ended the consolidated statements of cash flows for the years then ended policies (Hereinafter referred to as the “financial statements”). In our opinion, the accompanying financial statements present fairly, in all material respects, the consolidated financial position of the Company as at December 31, 2018 and December 31, 2017, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards (IFRS). Basis for Opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the “Auditors’ Responsibilities for the Audit of the Financial Statements” section of our auditors’ report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in Canada and we have fulfilled our other responsibilities in accordance with these requirements. 45 | P a g e We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Other Information Management is responsible for the other information. Other information comprises: • • the information included in Management’s Discussion and Analysis filed with the relevant Canadian Securities Commissions. the information, other than the financial statements and the auditors’ report thereon, included in a document likely to be entitled “Annual Report”. Our opinion on the financial statements does not cover the other information and we do not and will not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, and remain alert for indications that the other information appears to be materially misstated. We obtained the information included in Management’s Discussion and Analysis filed with the relevant Canadian Securities Commissions as at the date of this auditors’ report. If, based on the work we have performed on this other information, we conclude that there is a material misstatement of this other information, we are required to report that fact in the auditors’ report. We have nothing to report in this regard. The information, other than the financial statements and the auditors’ report thereon, included in a document likely to be entitled “Annual Report” is expected to be made available to us after the date of this auditors’ report. If, based on the work we will perform on this other information, we conclude that there is a material misstatement of this other information, we are required to report that fact to those charged with governance. Responsibilities of Management and Those Charged with Governance for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with IFRS, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. 46 | P a g e Those charged with governance are responsible for overseeing the Company’s financial reporting process. Auditors’ Responsibilities for the Audit of the Financial Statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors’ report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: • Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. • Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. • Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. • Conclude on the appropriateness of management's use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company's ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditors’ report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditors’ report. However, future events or conditions may cause the Company to cease to continue as a going concern. 47 | P a g e • Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation. • Communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. • Provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group Entity to express an opinion on the financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. Chartered Professional Accountants, Licensed Public Accountants The engagement partner on the audit resulting in this auditors’ report is Douglas W. Reid. Halifax, Canada March 7, 2019 48 | P a g e CLEARWATER SEAFOODS INCORPORATED Consolidated Statements of Financial Position (In thousands of Canadian dollars) As at December 31 ASSETS Current assets Cash Trade and other receivables (Note 5) Inventories (Note 6) Prepaids and other Derivative financial instruments (Note 7(a)) Non-current assets Long-term receivables (Note 8) Derivative financial instruments (Note 7(a)) Other assets Property, plant and equipment (Note 9) Investment in equity investee (Note 11) Deferred tax assets (Note 12(c)) Intangible assets (Note 10) Goodwill (Note 10) TOTAL ASSETS LIABILITIES Current liabilities Trade and other payables Income taxes payable (Note 12) Current portion of long-term debt (Note 13) Derivative financial instruments (Note 7(a)) Non-current liabilities Long-term debt (Note 13) Derivative financial instruments (Note 7(a)) Other long-term liabilities Deferred tax liabilities (Note 12(c)) SHAREHOLDERS' EQUITY Share capital (Note 14) Contributed surplus Retained earnings (deficit) Accumulated comprehensive loss ("ACL") Non-controlling interest (Note 16) 2018 2017 $ $ 35,887 85,244 70,115 7,357 1,222 199,825 4,970 12,671 147 246,117 9,382 14,266 191,422 48,623 527,598 $ 727,423 $ $ $ $ $ 70,507 1,661 23,269 9,966 105,403 440,148 497 323 17,832 458,800 215,506 4,218 (38,848) (36,053) 144,823 18,397 163,220 35,514 103,096 79,124 4,781 5,797 228,312 5,077 141 102 272,071 9,817 11,349 193,815 50,196 542,568 770,880 80,411 7,182 21,025 1,978 110,596 452,148 7,142 616 17,840 477,746 210,860 3,021 (8,722) (39,730) 165,429 17,109 182,538 770,880 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 727,423 $ See the accompanying notes to the consolidated financial statements Approved by the Board: John Risley Director Colin MacDonald Chairman 49 | P a g e  CLEARWATER SEAFOODS INCORPORATED Consolidated Statements of Earnings (Loss) (In thousands of Canadian dollars) Year ended December 31 Sales (Note 15) Cost of goods sold Gross margin Operating expenses (Note 17) Administrative and selling costs Restructuring costs Net finance costs (Note 13 (e)) Foreign exchange (gains) losses on long-term debt and working capital (Note 7 (c)) (Gains) losses on contract derivatives (Note 7 (d)) Other (income) expense (Note 18) Research and development Earnings (loss) before income taxes Income tax expense (Note 12) Earnings (loss) for the year Earnings (loss) attributable to: Non-controlling interest (Note 16) Shareholders of Clearwater 2018 2017 $ $ 592,246 485,409 106,837 621,031 510,963 110,068 53,509 482 31,966 9,061 15,798 (3,737) 1,724 108,803 55,551 6,856 35,280 (14,263) (4,045) (7,576) 2,368 74,171 (1,966) 35,897 1,740 7,658 $ (3,706) $ 28,239 $ $ 12,498 $ (16,204) (3,706) $ 12,480 15,759 28,239 Basic earnings (loss) per share (Note 20) Diluted earnings (loss) per share (Note 20) $ $ See the accompanying notes to the consolidated financial statements (0.25) $ (0.25) $ 0.25 0.25 50 | P a g e CLEARWATER SEAFOODS INCORPORATED Consolidated Statements of Comprehensive Income (In thousands of Canadian dollars) Year ended December 31 Earnings (loss) for the year Comprehensive income (loss) Items that may be reclassified subsequently to income (loss): Foreign currency translation differences of foreign operations Cash flow hedges - effective portion of change in fair value, net of tax Cash flow hedges - reclassified to earnings, net of tax Comprehensive income (loss) for the year Comprehensive income (loss) attributable to: Non-controlling interest (Note 16) Shareholders of Clearwater 2018 2017 $ (3,706) $ 28,239 312 3,377 (169) 3,520 255 (1,238) 49 (934) (186) $ 27,305 12,250 (12,436) $ 12,077 15,228 (186) $ 27,305 $ $ $ See the accompanying notes to the consolidated financial statements 51 | P a g e CLEARWATER SEAFOODS INCORPORATED Consolidated Statements of Changes in Equity Accumulated Comprehensive Loss Cash Cumulative Retained Non- (In thousands of Canadian dollars) shares surplus hedge adjustment (deficit) interest Total Balance at January 1, 2017 $ 210,860 $ 1,419 $ - $ (38,931) $ (4,793) $ 19,930 $ 188,485 Common Contributed flow translation earnings controlling Comprehensive (loss) income for the year Transactions recorded directly in equity Share-based compensation (Note 21) Distributions to non-controlling interest Dividends declared on common shares (Note 14) Acquisition of non-controlling interest (Note 16) Total transactions with owners - - - - - - (1,189) 658 15,759 12,077 27,305 1,602 - - 1,602 - - - - - - - - (268) (268) - - (12,787) (6,901) (19,688) - (15,343) - 445 1,602 (15,343) (12,787) (6,724) (14,898) (33,252) Balance at December 31, 2017 $ 210,860 $ 3,021 $ (1,189) $ (38,541) $ (8,722) $ 17,109 $ 182,538 Comprehensive income (loss) for the year Transactions recorded directly in equity Share-based compensation (Note 21) Distributions to non-controlling interest Dividends declared on common shares (Note 14) Common shares issued under DRIP Acquisition of non-controlling interest (Note 16) Total transactions with owners - 98 - - 4,548 - 4,646 - 3,208 560 (16,204) 12,250 (186) 1,197 - - - - 1,197 - - - - - - - - - - (91) (91) - - (12,847) - (1,075) (13,922) - (10,816) - - (146) 1,295 (10,816) (12,847) 4,548 (1,312) (10,962) (19,132) Balance at December 31, 2018 $ 215,506 $ 4,218 $ 2,019 $ (38,072) $ (38,848) $ 18,397 $ 163,220 See the accompanying notes to the consolidated financial statements 52 | P a g e CLEARWATER SEAFOODS INCORPORATED Consolidated Statements of Cash Flows (In thousands of Canadian dollars) Year ended December 31 Operating Earnings (loss) for the year Adjustments for: Depreciation and amortization Accretion on long-term debt (Note 13 (e)) Amortization of deferred financing costs (Note 13 (e)) Net unrealized foreign exchange (gains) losses on financial assets and liabilities Loss on debt refinancing Fair value adjustments to financial instruments Deferred tax expense (recovery) (Note 12) Share-based compensation (Gain) loss on disposal of property, plant, and equipment and other assets (Earnings) loss from equity investee (Note 11) Foreign exchange and other Cash from operating activities before changes in working capital Change in non-cash operating working capital (Note 26) Cash from (used in) operating activities Financing Repayment of long-term debt (Note 13) Proceeds from long-term debt Net (repayment of) proceeds from revolving credit facility Settlement of derivative contracts on refinancing Distributions paid to non-controlling interest Repayments from (advances to) minority partners Dividends paid on common shares, net of dividends reinvested Cash from (used in) financing activities Investing Purchase of property, plant and equipment, and other Proceeds on disposal of property, plant and equipment Dividends received from equity investee (Note 11) Acquisition of non-controlling interest (Note 16) Proceeds from sale (purchase) of other assets Payments received (net advances) on long-term receivables Cash from (used in) investing activities Effect of foreign exchange rate changes on cash Increase (decrease) in cash Cash, beginning of period Cash, end of period Supplemental disclosure of operating cash flows Cash interest paid Cash income taxes paid See the accompanying notes to the consolidated financial statements 2018 2017 $ (3,706) $ 28,239 44,869 1,720 1,695 30,558 - - (4,578) 1,283 (254) (2,923) (1,876) 66,788 9,699 76,487 $ (10,652) - (30,248) - (11,353) (65) (8,299) (60,617) $ (19,124) - 3,228 (1,312) 181 326 (16,701) $ 1,204 $ 373 35,514 35,887 $ 45,428 2,166 1,555 (14,156) 3,787 (694) (4,717) 232 (216) (2,656) (3,884) 55,084 3,057 58,141 (425,949) 364,916 116,082 (4,209) (19,154) 3,766 (12,787) 22,665 (85,431) 2,407 3,340 (6,724) (44) 936 (85,516) 710 (4,000) 39,514 35,514 (28,817) (11,853) (25,518) (9,447) 53 | P a g e $ $ $ $ $ CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 1. DESCRIPTION OF THE BUSINESS Clearwater Seafoods Incorporated (“Clearwater” or the “Company”) was incorporated on July 7, 2011 and is domiciled at 757 Bedford Highway, Bedford, Nova Scotia, Canada. Clearwater’s sole investment is the ownership of 100% of the partnership units of Clearwater Seafoods Limited Partnership (“CSLP”), which holds the underlying investments in subsidiaries and a joint venture. The consolidated financial statements of Clearwater as at and for the years ended December 31, 2018 and 2017 comprise the Company, its subsidiaries and a joint venture (see Note 23). Clearwater’s business includes the ownership and operation of assets and property in connection with the harvesting, processing, distribution and marketing of seafood. 2. BASIS OF PREPARATION (a) Statement of Compliance These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRSs”). The financial statements were authorized for issue by Clearwater’s Board of Directors on March 7, 2019. (b) Basis of Measurement The consolidated financial statements have been prepared on the historical cost basis except for the following material items measured at fair value through profit or loss: • Derivative financial instruments • Earnout liability entered into as part of a business combination • Liabilities for cash settled share-based compensation arrangements • Embedded derivative liability within long-term debt extinguished in 2017 The fair value measurements have been described in the notes. (c) Functional and presentation currency These consolidated financial statements are presented in Canadian dollars, which is the functional currency of Clearwater and its Canadian subsidiaries. Clearwater’s subsidiary in the United Kingdom has a functional currency of Pounds Sterling and the Argentine operations have a functional currency of the US dollar. All tabular financial information presented in Canadian dollars has been rounded to the nearest thousands, except per share amounts or as otherwise noted. Change in functional currency On July 1, 2018, Clearwater changed the functional currency of a subsidiary from the Argentinean Peso to the US dollar to reflect that the US dollar has become the predominate currency. Key factors considered in this assessment include the currency in which sales are denominated, the underlying currency in which operating costs are determined and the Company’s intra-group funding arrangements. The Company has accounted for the change prospectively in accordance with IAS 21 The Effects of Changes in Foreign Exchange Rates. 54 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (d) Critical judgments and estimates in applying accounting policies The preparation of financial statements requires management to make estimates, judgments and assumptions that materially affect the amounts reported in the consolidated financial statements and accompanying notes. Management bases assumptions, estimates and judgments on historical experience, current trends and events, and all available information that management believes is relevant at the time it prepares the consolidated financial statements. Actual results may differ materially from these estimates. The following are the accounting policies that are subject to judgments and estimates that Clearwater believes could have the most significant impact on the reported results and financial position. The information in this note is grouped by accounting policy to include: • Key sources of estimation uncertainty • Judgments management made in the process of applying Clearwater’s accounting policies (where applicable) i. Income taxes Key sources of estimation uncertainty Accounting for income taxes is based upon evaluation of income tax rules in all jurisdictions where Clearwater operates. In determining the provision for current and deferred income taxes, Clearwater makes assumptions about temporary and permanent differences between accounting and taxable income. Changes in tax law and the level and geographical mix of earnings will impact the effective tax rate. With respect to deferred taxes, Clearwater makes assumptions about when deferred tax assets are likely to reverse, the extent to which it is probable that temporary differences will reverse and whether or not there will be sufficient taxable profits available to offset the tax assets when they do reverse. Clearwater recognizes deferred tax assets only to the extent that it considers it probable that those assets will be recoverable. Judgments made in relation to accounting policies applied Clearwater makes judgments about whether to recognize the benefit of deferred tax assets. In making this judgment Clearwater continually evaluates the magnitude and duration of any past losses, current profitability and whether it is sustainable, and earnings forecasts. For further discussion on deferred income taxes refer to Note 12. ii. Goodwill and intangible assets Key sources of estimation uncertainty Clearwater conducts impairment testing on its goodwill and intangible assets annually in the fourth quarter and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Clearwater determines the fair value of each cash-generating unit (“CGU”) to which goodwill and intangible assets are allocated using the value in use method, which estimates fair value using a discounted five-year forecasted cash flow estimate with a terminal value. The determination of the recoverable amount involves estimates and assumptions of future sales, product margins, market conditions, allowable catch rates, and appropriate discount rates. 55 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Judgments made in relation to accounting policies applied In performing its impairment testing, Clearwater makes judgments in determining its CGUs, and the allocation of working capital assets and liabilities and corporate assets to these CGUs. For further discussion on goodwill and intangible assets, refer to Note 10. iii. Share-based compensation Key sources of estimation uncertainty Clearwater determines compensation expense for share-based compensation using market-based valuation techniques. Clearwater determines the fair value of performance-based non-vested share awards at the date of grant using Black-Scholes and Monte Carlo simulation valuation models. Certain performance-based share awards require Clearwater to make estimates of the likelihood of achieving company and corporate peer group performance goals or internal performance metrics. Clearwater makes assumptions in applying valuation techniques including estimating the future volatility of the stock price, expected dividend yield, future employee turnover rates and corporate performance. For further discussion on share-based compensation, refer to Note 21. iv. Derivative financial instruments Key sources of estimation uncertainty Clearwater records the fair value of certain financial assets and liabilities using valuation techniques where the fair value cannot be observed in active markets. The inputs used in the fair value models contain inherent uncertainties, estimates and use of judgment. Fair value is taken from observable markets where possible and estimated as necessary. Assumptions underlying the valuations require estimation of discount rates, inflation rates, defaults and other relevant variables such as foreign exchange volatility. For further discussion on derivative financial instruments, refer to Note 7. v. Earnout liability Key sources of estimation uncertainty Clearwater determines the fair value measurement of the Earnout liability based on significant inputs not observable in the market. The inputs used in the fair value model contain inherent uncertainties, estimates and use of judgment. Inputs are taken from observable markets where possible and estimated as necessary. Assumptions include forecasted earnings and probability assessments. For further discussion on the fair value measurement of the Earnout liability, refer to Note 7(l). 56 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 3. SIGNIFICANT ACCOUNTING POLICIES The principal accounting policies set out below have been applied consistently to all periods presented in these consolidated financial statements. (a) Basis of consolidation i) Business Combinations and Goodwill Clearwater measures goodwill in business combinations as the excess of the fair value of the consideration transferred, the amount of any non-controlling interest in the acquiree, less the net recognized amount (generally fair value) of the identifiable assets acquired and liabilities assumed, all measured as of the acquisition date. When the excess is negative, a bargain purchase gain is recognized immediately in consolidated earnings (loss). Goodwill is subsequently measured at cost less accumulated impairment losses. Goodwill is not amortized and is tested for impairment annually in the fourth quarter and as required if events occur that indicate that its carrying amount may not be recoverable. Goodwill is tested for impairment at the CGU level by comparing the carrying amount to its recoverable amount, consistent with the methodology outlined in Note 3 (h). Clearwater elects on a transaction-by-transaction basis whether to measure non-controlling interest at its fair value, or at its proportionate share of the recognized amount of the identifiable net assets, at the acquisition date. Any contingent consideration payable is measured at fair value at the acquisition date. Subsequent changes in the fair value of the contingent consideration are recognized in consolidated earnings (loss). When the initial accounting for a business combination has not been finalized by the end of the reporting period in which the combination occurs, the Company reports provisional amounts for the items for which the accounting has not been finalized. These provisional amounts are adjusted during the measurement period, which does not exceed one year from the acquisition date, or additional assets or liabilities are recognized, to reflect new information obtained about facts and circumstances that existed at the acquisition date that, if known, would have affected the amounts recognized at that date. Transaction costs, other than those associated with the issue of debt or equity securities, that Clearwater incurs in connection with a business combination are expensed as incurred and included in other (income) expense in the consolidated statement of earnings (loss). ii) Subsidiaries Subsidiaries are entities controlled by Clearwater. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. 57 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) iii) Joint venture A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the joint arrangement. Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require unanimous consent of the parties sharing control. The earnings (loss) and assets and liabilities of the joint venture are incorporated into these consolidated financial statements using the equity method of accounting. Under the equity method, a joint venture is initially recognized in the consolidated statement of financial position at cost and adjusted thereafter to recognize Clearwater’s share of net earnings (loss) and comprehensive income (loss) of the joint venture. iv) Transactions eliminated on consolidation Intercompany balances and transactions are eliminated in preparing the consolidated financial statements. Unrealized losses are eliminated in the same way as unrealized gains, but only to the extent that there is no evidence of impairment. (b) Inventories Inventories consist primarily of raw materials and finished goods and are stated at the lower of cost and net realizable value. Cost includes the cost of materials plus direct labour applied to the product and the applicable share of manufacturing overheads, administration and depreciation, determined on a first-in, first-out basis. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. (c) Property, plant and equipment Property, plant and equipment is measured at cost, less government assistance received, accumulated depreciation and accumulated impairment losses. Cost includes expenditures that are directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials and direct labour, any other costs directly attributable to bringing the assets to a working condition for their intended use and location, and borrowing costs. Depreciation on property, plant and equipment commences in the month the assets are available for use. Vessel refits are capitalized when incurred and amortized over the period between scheduled refits. Construction in progress assets are capitalized during the construction period and depreciation commences when the asset is available for use. Depreciation is recognized on a straight-line basis to depreciate the cost of each of the components of an item of property, plant and equipment over its estimated useful life. When parts of an item of property, plant and equipment have different useful lives, they are accounted for as separate items (major components). Estimated useful lives are the following: Asset Component Buildings and wharves Plant and equipment Vessels Vessels equipment Rate 10 to 50 years 5 to 15 years 15 to 25 years 1 to 10 years The cost of replacing a part of an item of property, plant and equipment is recognized in the carrying amount of the item if it is probable that the future economic benefits embodied within the part will flow to Clearwater and its cost can be measured reliably. The carrying amount of the replaced part is derecognized. The costs of the day-to-day servicing of property, plant and equipment are recognized in consolidated earnings (loss) as incurred. 58 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Gains and losses on disposal of an item of property, plant and equipment are determined as the difference between the proceeds from disposal and the carrying amount of the item, and are recognized net within administrative and selling costs in the consolidated statement of earnings (loss). Depreciation methods, useful lives and residual values are reviewed at each financial year-end and changes to estimates are adjusted prospectively. (d) Intangible Assets Intangible assets include licences, brand names, patents, fishing rights and computer software. Definite life intangible assets are measured at cost less accumulated amortization and any net accumulated impairment losses. Amortization is recognized in the consolidated statements of earnings (loss) on a straight-line basis over their estimated useful lives as follows: Intangible Asset Fishing rights Computer software Rate 10 to 15 years 3 to 8 years i) Licences, brand names, patents and fishing rights Licences and brand names represent intangible assets acquired directly or in a business combination that meet the specified criteria for recognition apart from goodwill and are recorded at their fair values at the date of acquisition and are subsequently carried at cost. Indefinite life intangible assets, including licences, brand names and patents, are not amortized and are tested for impairment annually in the fourth quarter or more frequently if events or changes in circumstances indicate that the asset may be impaired. Fishing rights arise from contractual rights to fish quotas; they have definite lives and are amortized over the term of the related operating agreement. ii) Computer software Computer software represents intangible assets developed during the enterprise resource planning (“ERP”) system conversion including all costs directly attributable to bringing the asset to the location and condition necessary for its intended use. The computer software has a definite life and is amortized over its estimated useful life. (e) Revenue from contracts with customers Clearwater sells seafood in a fresh or frozen state to customers. These sales are evidenced by purchase orders or invoices, which set out the terms of the sale, including pricing and shipping terms. Revenue is recognized when control of the product transfers to the customer. Control transfers to the customer at the point of delivery, which is dependent on the shipping term. Revenue from the sale of seafood products is recognized based on the price specified in the contract, less any customer discounts. No element of financing is recognized as sales are generally made with normal credit terms ranging from 14 days from delivery to 60 days from the date of invoice. When customers pay before product is shipped, revenue is not recognized until control transfers to the customer. 59 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Clearwater has elected to apply the practical expedient related to contract costs therefore contract costs with an amortization period of less than one year have been expensed as incurred. Clearwater may also provide services after control of the product has transferred to the customer, including, freight, storage, customs clearing and cleaning. These services represent separate performance obligations for which revenue is recognized over the time that the service is performed for freight, storage and cleaning and at a point in time for customs clearing, being when the goods have cleared customs. The transaction price is allocated to these services based on an expected cost-plus margin approach. (f) Government assistance Government assistance received by Clearwater relates to items of property, plant and equipment or research and development expenses. Government assistance related to property, plant and equipment is deducted from the carrying amount of the related asset and amortized over the same estimated useful life of the asset to which it relates. Government assistance related to expenses are presented in Other (income) expense. Clearwater does not have any government assistance that is required to be repaid, nor any forgivable loans. (g) Financial instruments Classification Clearwater classifies its financial assets and financial liabilities into three categories being subsequently measured at 1) fair value through profit or loss (“FVTPL”); 2) amortized cost; or 3) fair value through other comprehensive income (“FVTOCI”). The classification for financial assets depends on the Company’s business model, management of the financial asset and the contractual terms of the cash flows. Financial assets are classified as amortized cost only if both the following criteria are met: (1) the financial asset is held within a business model with the objective of collecting the contractual cash flows; and (2) the contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding. Derivatives are classified as FVTPL unless they are designated as hedges. Clearwater has not designated any financial liabilities to be recognized as FVTPL. Clearwater’s financial assets and liabilities have been classified as follows: Financial instrument Cash Trade and other receivables Long-term receivables Trade and other payables Long-term debt Earnout liability Derivative financial instruments Derivative financial instruments (hedge accounting) Classification FVTPL Amortized cost Amortized cost Amortized cost Amortized cost Measurement Fair value Initial: Fair Value Subsequent: Amortized cost FVTPL FVTPL FV - hedging instrument Fair value Fair value Fair value 60 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Measurement (1) Financial assets and liabilities at amortized cost or FVTPL On initial recognition, a financial asset or financial liability carried at amortized cost is measured at its fair value plus transaction costs that are directly attributable to the acquisition of the financial asset or liability. Transaction costs of financial assets and liabilities carried at FVTPL are recognized in the Consolidated Statement of Earnings (Loss). (2) Derivative instruments Derivatives are initially recognized at fair value and subsequently re-measured to their fair value either through profit or loss or other comprehensive income depending on whether the derivative has been designated as a hedging instrument. When a derivative is designated as a cash flow hedging instrument, the effective portion of the changes in fair value of the derivative is recognized in the Consolidated Statement of Comprehensive Income (Loss) and accumulated within equity. The amount recorded in equity is reclassified to the Consolidated Statement of Earnings (Loss) in the same period during which the hedged item is recognized in the Consolidated Statement of Earnings (Loss). The ineffective portion of the change in fair value of the derivative is recognized as Net finance costs in the Consolidated Statement of Earnings (Loss). If the forecasted transaction is no longer expected to occur, the hedge no longer meets the criteria for hedge accounting, the hedging instrument expires or is sold, terminated or expired, or Clearwater elects to discontinue hedge accounting for the derivative, then hedge accounting is discontinued prospectively. If the forecasted transaction is no longer expected to occur, then the amount accumulated in equity is reclassified to the Consolidated Statement of Earnings (Loss). If hedge accounting is discontinued but the forecasted transaction is still expected to occur, the amount accumulated in equity will be reclassified to the Consolidated Statement of Earnings (Loss) at the same time as the original hedged item. Derecognition From time-to-time, Clearwater enters into transactions to sell selected accounts receivables to a commercial partner without recourse. The amount of receivables sold are removed from the Consolidated Statement of Financial Position at the time of the sale. The difference between the carrying amount and the proceeds on sale of the receivables is recorded in Net Finance Costs in the Consolidated Statement of Earnings (Loss). Sale of receivables during the year represent less than 5 percent of consolidated sales. (h) Impairment i) Financial assets The Company assesses expected credit losses on financial assets carried at amortized cost on a forward- looking basis. For trade receivables, Clearwater applies the simplified approach which requires lifetime expected credit losses to be recognized from initial recognition of the receivables. 61 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Clearwater considers the probability of default on a specific account basis, which involves assessing whether there was a significant increase in credit risk. Indicators include actual or expected changes in the debtor’s ability to pay based on information that is available each reporting period; monitoring past due accounts and other external factors. Refer to Note 7(e) for discussion on credit risk and the provision for impairment losses related to trade receivables. ii) Non-financial assets Clearwater reviews non-financial assets at each reporting date to determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated. In addition, for goodwill and intangible assets that have indefinite useful lives an annual impairment test is performed. The recoverable amount of an asset or CGU is the greater of its value in use (“VIU”) and its fair value less costs of disposal. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generate cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets or CGU. Goodwill and the intangible assets acquired in a business combination are allocated to the CGU, or the group of CGUs, that are expected to benefit from the synergies of the combination. This allocation is subject to an operating segment ceiling test and reflects the lowest level at which that asset is monitored for internal reporting purposes. An impairment loss is recognized if the carrying amount of an asset or its CGU exceeds its estimated recoverable amount. Impairment losses are recognized in earnings (loss). Impairment losses recognized in respect of CGUs are allocated first to reduce the carrying amount of any goodwill allocated to the CGUs, and then to reduce the carrying amounts of the other assets in the unit on a pro rata basis. An impairment loss in respect of goodwill is not reversed. In respect of other assets, impairment losses recognized in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates and assumptions used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized. (h) Translation of foreign currency i) Foreign currency transactions Transactions in foreign currencies are translated into the respective functional currency of the Company and its’ subsidiaries at the exchange rate at the date of the transactions. Monetary assets and liabilities denominated in foreign currencies are retranslated to the Company’s functional currency at the exchange rate as at the reporting date. Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. 62 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) ii) Foreign operations The assets and liabilities of foreign operations with a functional currency different from Clearwater’s presentation currency, including goodwill, intangible assets and fair value adjustments arising on acquisition, are translated into Canadian dollars at exchange rates at the reporting date. Foreign currency differences resulting from this translation are recognized in comprehensive income in the cumulative translation adjustment account. The income and expenses of foreign operations are translated to Canadian dollars at average exchange rates. When a foreign operation is disposed of, all relevant amounts in the cumulative translation adjustment account are transferred to earnings (loss) as part of the gain or loss on disposal. On the partial disposal of a subsidiary that does not result in loss of control the relevant proportion of such cumulative translation adjustment account is reattributed to non-controlling interest and not recognized in profit or loss. (i) Income taxes Income tax expense is comprised of current and deferred income tax. Current tax and deferred income tax are recognized in earnings (loss) except to the extent that they relate to a business combination, or items recognized directly in equity or in other comprehensive income. Current tax is the expected tax payable on the taxable income or loss for the period, using tax rates enacted or substantively enacted at the reporting date, and any adjustments to tax payable in respect of previous years. Taxable earnings differs from earnings as reported in the consolidated statement of earnings (loss) because of items of income or expense that are taxable or deductible in years other than the current reporting period or items that are never taxable or deductible. Deferred tax is recognized in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax is not recognized for the temporary differences relating to investments in subsidiaries and joint venture to the extent that it is probable that they will not reverse in the foreseeable future. In addition, deferred tax is not recognized for taxable temporary differences arising on the initial recognition of goodwill. Deferred tax is measured at the tax rates that are expected to be applied to temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets, and they relate to income taxes levied by the same tax authority on the same taxable entity, or on different tax entities, but they intend to settle current tax liabilities and assets on a net basis or their tax assets and liabilities will be realized simultaneously. A deferred tax asset is recognized for unused tax losses, and deductible temporary differences, to the extent that it is probable that future taxable profits will be available against which it can be utilized. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. (j) Borrowing costs Clearwater capitalizes borrowing costs attributable to the acquisition or construction of its qualifying assets which are assets that take a substantial period of time to ready for their intended use, as they are being constructed. Other borrowing costs are recognized as an expense in the period in which they are incurred. 63 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (k) Finance costs Finance costs comprises interest expense on borrowings, gains and losses on financial instruments related to long-term debt or interest recognized in earnings (loss), accretion on deferred consideration and refinancing and settlement fees. Borrowing costs determined to be period costs or the amortization of such costs are recorded through earnings (loss). (l) Share-based compensation Clearwater has three share-based compensation plans including share appreciation rights (“SARs”), deferred share units (“DSUs”) and performance share units (“PSUs”). Refer to Note 21 for a description of the plans. In accordance with the PSU plan document, vested units may be settled in cash or common shares or by a combination thereof as determined by the Company. Grants settled under the PSU plan up to 2017 were cash-settled and all future grants under the PSU plan will be settled by the issuance of common shares. In 2018, PSUs were settled in common shares. Cash-settled PSU awards were recorded as liabilities at fair market value at each reporting period with changes in fair value recorded to earnings (loss). Equity-settled PSU awards are measured at fair market value on the grant date of the awards. The fair value of PSU’s are calculated using a Monte Carlo simulation model or the share price on the grant date where the performance factor is a non-market condition. Compensation expense is recognized based on the fair value of the awards that are expected to vest and remain outstanding at the end of the reporting period. Clearwater estimates the expected forfeiture rate for each plan and adjusts for actual forfeitures in the period. The share-based compensation liability related to cash-settled PSU’s was recorded in trade and other payables in the consolidated statement of financial position. The cumulative compensation expense related to the equity-settled PSU’s is recorded as contributed surplus in equity. The related compensation expense for both cash-settled and equity-settled PSU’s is recorded in administrative and selling costs in the consolidated statement of earnings (loss) over the vesting period. (m) Earnings (loss) per share Basic earnings (loss) per share is calculated by dividing earnings (loss) for the year attributable to the shareholders of Clearwater by the weighted average number of common shares outstanding during the year. Diluted earnings (loss) per share is calculated by dividing earnings (loss) for the year attributable to the shareholders of Clearwater, adjusted for the change in the fair market value of the cash-settled PSU’s, by the weighted average number of common shares outstanding and the voting rights attributable to the PSU’s outstanding during the year. The calculation of the potential dilutive common shares assumes all outstanding PSU’s are contingently issuable shares. 64 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 4. CHANGES IN ACCOUNTING POLICIES Clearwater has adopted the following new and revised standards, along with any consequential amendments, effective January 1, 2018. These changes were made in accordance with the applicable transitional provisions. IFRS 15 – Revenue from Contracts with Customers IFRS 15 contains a single model that applies to contracts with customers and two approaches to recognizing revenue: at a point in time or over time. The model features a contract-based five-step analysis of transactions to determine whether, how much, and when revenue is recognized. The Company adopted IFRS 15 in its financial statements for the annual period beginning on January 1, 2018. The Company has elected to apply the modified retrospective method on transition, which means that comparative periods have not been restated. On transition, cumulative impacts related to adoption are required to be recognized in opening retained earnings; however, no adjustments were required for Clearwater. Under the new standard, the Company is required to disclose information related to the disaggregation of revenues, performance obligations, significant judgements, contract balances and costs to obtain contracts. Refer to accounting policies and Note 9 in the Consolidated Financial Statements for these disclosures. IFRS 9 – Financial Instruments IFRS 9 introduces new requirements for the classification and measurement of financial assets. Under IFRS 9, financial assets are classified and measured based on the business model in which they are held and the characteristics of their contractual cash flows. The standard introduces additional changes relating to financial liabilities and amends the impairment model by introducing a new ‘expected credit loss’ model for calculating impairment. IFRS 9 also includes a new general hedge accounting standard which aligns hedge accounting more closely with risk management. The Company adopted IFRS 9 in its financial statements for the annual period beginning on January 1, 2018. The adoption of this standard had no financial impact to Clearwater. Refer to accounting policies and Note 7 in the Consolidated Financial Statements. New accounting standards not yet adopted The IASB has issued the following standard that has not been applied in preparing these consolidated financial statements as its effective date falls within annual periods beginning subsequent to the current reporting period. IFRS 16 Leases On January 13, 2016, the IASB issued IFRS 16 Leases. This standard introduces a single lessee accounting model and requires a lessee to recognize assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. A lessee is required to recognize a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make lease payments. This standard substantially carries forward the lessor accounting requirements of IAS 17, while requiring enhanced disclosures to be provided by lessors. Other areas of the lease accounting model have been impacted, including the definition of a lease. Transitional provisions have been provided. 65 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) The Company will adopt IFRS 16 beginning on January 1, 2019 and has elected to apply the modified retrospective approach on transition. Clearwater currently leases office space, machinery, wharves, equipment and vehicles. Clearwater will not see a material impact on net income as a result of the new lease standard and interest and depreciation will largely offset the amounts previously reported as operating expense. The standard will have an impact on its key performance measures, including earnings before interest, tax, depreciation and amortization, leverage and return on assets. 5. TRADE AND OTHER RECEIVABLES As at December 31 Trade receivables Other receivables $ $ 2018 68,952 16,292 85,244 $ $ 2017 86,636 16,460 103,096 Included in other receivables is $9.3 million (December 31, 2017 - $9.2 million) of value added tax and commodity tax receivables and $7.0 million (December 31, 2017 - $7.3 million) of other receivables. 6. INVENTORIES As at December 31 Seafood inventory Supplies and other $ $ 2018 60,414 9,701 70,115 $ $ 2017 68,696 10,428 79,124 In 2018 inventory costs of $450.1 million (2017 - $467.7 million) were recognized in cost of goods sold. Clearwater incurred $1.2 million (2017 - $1.8 million) in inventory write-downs which was recognized in cost of goods sold. For inventories pledged as security for long-term debt, refer to Note 13. 7. FINANCIAL INSTRUMENTS The Company periodically uses derivative instruments as part of an active risk management program. The Company designated certain forward foreign exchange contracts related to USD denominated interest payments as hedging instruments in a hedging accounting, qualifying hedging relationship (cash flow hedge). Changes in the fair value of derivatives in a qualifying hedging relationship are recognized in comprehensive income until the hedged risk affects income. The Company has elected not to use hedge accounting on the remaining derivative instruments and consequently, changes in their fair value are recorded in the consolidated statement of earnings (loss). Summary of fair value of derivative financial instrument positions: As at December 31 2018 2017 Derivative financial assets Contracts in a current asset position Contracts in a non-current asset position Derivative financial liabilities Contracts in a current liability position Contracts in a non-current liability position $ $ 1,222 12,671 13,893 $ $ (9,966) (497) $ (10,463) $ 5,797 141 5,938 (1,978) (7,142) (9,120) 66 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (a) Forward Foreign Exchange Contracts Clearwater has forward contracts maturing each month until June 2020 and forward contracts related to the USD Notes maturing May 2022 (Note 13). At December 31, 2018 Clearwater had outstanding forward contracts as follows: Average Weighted average contract Currency Foreign currency notional amount (in 000's) exchange months rate to maturity Fair value asset (liability) Contracts in a current asset position Derivatives designated as hedging instruments USD 13,750 1.284 7 $ 1,003 Derivatives not designated as hedging instruments Euro Euro - GBP 8,950 13,540 1.594 0.911 5 8 $ 126 93 1,222 Contracts in a non-current asset position Derivatives designated as hedging instruments USD Derivatives not designated as hedging instruments USD Euro - GBP Total contracts in an asset position 34,375 1.283 28 $ 2,075 200,000 2,120 1.284 0.918 40 15 Contracts in a current liability position Derivatives not designated as hedging instruments Euro USD Yen Euro - GBP 24,060 121,723 2,928,300 14,890 1.550 1.298 0.0120 0.889 Contracts in a non-current liability position Derivatives not designated as hedging instruments Euro Yen Euro - GBP 5,620 396,400 1,870 1.574 0.0121 0.900 Total contracts in a liability position $ 6 6 6 5 $ 15 14 15 $ 10,584 12 12,671 13,893 (770) (7,204) (1,631) (361) (9,966) (207) (242) (48) (497) (10,463) 67 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) At December 31, 2017, Clearwater had outstanding forward contracts as follows: Average Weighted average contract Currency Foreign currency notional amount (in 000's) exchange rate months to maturity Fair value asset (liability) Contracts in a current asset position Derivatives designated as hedging instruments USD 6,875 1.237 7 $ 122 Derivatives not designated as hedging instruments Euro USD Yen Euro - GBP USD - GBP 4,700 62,600 1,461,000 9,500 5,220 1.560 1.323 0.0120 0.904 0.766 12 6 6 8 5 $ Contracts in a non-current asset position Derivatives designated as hedging instruments USD 17,188 1.243 28 $ Total contracts in an asset position $ 84 4,178 1,012 134 267 5,797 141 141 5,938 Contracts in a current liability position Derivatives designated as hedging instruments USD 6,875 1.336 7 $ (541) Derivatives not designated as hedging instruments Euro USD Yen Euro - GBP 27,700 27,400 715,000 9,400 1.497 1.245 0.0113 0.866 6 9 9 4 $ (750) (270) (21) (395) (1,978) Contracts in a non-current liability position Derivatives designated as hedging instruments USD Derivatives not designated as hedging instruments 30,938 1.305 38 $ (1,504) USD 200,000 1.284 52 Total contracts in a liability position (5,639) (7,142) (9,120) $ 68 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (b) Derivatives designated as Hedging Instruments Clearwater entered into USD forward foreign exchange contracts to hedge a portion of its USD interest payments, payable semi-annually in May and November each year. The following table summarizes amounts recognized in the Consolidated Statements of Comprehensive Income (Loss), the amounts reclassified from Accumulated Comprehensive Income (Loss) (“ACL”) within equity and the amount recorded in the Consolidated Statements of Earnings (Loss): Gain (loss) recognized in ACL Year ended December (Gain) loss reclassified from ACL to Net Finance Costs Year ended December December 31 2018 31 December 31 2018 2017 Ineffectiveness recognized in Net Finance Costs Year ended December 31 2017 31 December 31 2018 2017 4,859 (1,482) 3,377 (1,781) 543 (1,238) (243) 74 (169) 71 (22) 49 - - - - - - Derivatives in cash flow hedging relationship Forward foreign exchange contracts Income tax recovery (expense) Net gain (loss) $ (c) Foreign exchange (gains) losses on long-term debt and working capital Year ended December 31 Realized (gain) loss Long-term debt and working capital $ 2018 (5,514) $ 2017 3,547 Unrealized (gain) loss Long term debt and working capital Forward foreign exchange contracts, cross currency swaps and cap on long-term debt Total unrealized (gain) loss (d) Losses (gains) on contract derivatives Year ended December 31 Realized (gain) loss Forward foreign exchange contracts Unrealized (gain) loss Forward foreign exchange contracts 30,798 (23,693) (16,223) 14,575 9,061 $ 5,883 (17,810) (14,263) $ 2018 2017 1,321 $ (3,065) 14,477 15,798 $ (980) (4,045) $ $ 69 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (e) Credit risk Credit risk refers to the risk of losses due to failure of Clearwater’s customers or other counterparties to meet their contractual obligations. Clearwater is exposed to credit risk in the event of non-performance by counter parties to its derivative financial instruments but does not anticipate non-performance of any of the counter parties as Clearwater only deals with highly rated financial institutions. Clearwater has significant accounts receivable from customers operating in Canada, the United States, Europe and Asia. Significant portions of Clearwater’s customers from a sales dollar perspective have been transacting with Clearwater in excess of five years and bad debt losses have been minimal. Clearwater has a policy of using a combination of credit reporting agencies, credit insurance, letters of credit and secured forms of payment to mitigate customer specific credit risk and country specific credit risk. No single customer of Clearwater represented more than 7% of total sales for the year ended December 31, 2018. As a result, Clearwater does not have any significant concentration of credit risk. Clearwater’s trade accounts receivable aging based on the invoice due date was as follows: As at December 31 0-30 days 31-60 days over 60 days 2018 93.8% 4.6% 1.6% 100.0% 2017 92.8% 5.7% 1.5% 100.0% The carrying amount of accounts receivable is reduced by an allowance for doubtful accounts of $0.3 million (2017 - $0.1 million). Clearwater considers the probability of default on a specific account basis, which involves assessing whether there was a significant increase in credit risk. Indicators include actual or expected changes in the debtor’s ability to pay based on information that is available each reporting period; monitoring past due accounts and other external factors. Changes in the allowance for doubtful accounts are summarized in the table below: As at Balance at January 1 Allowance recognized Amounts recovered Amounts written off as uncollectible Foreign exchange Balance at December 31 (f) Foreign currency exchange rate risk December 31 2018 December 31 2017 $ $ $ 147 120 (10) - 8 265 $ 424 263 (12) (247) (281) 147 Foreign currency exchange rate risk refers to the risk that the value of financial instruments or cash flows associated with the instruments will fluctuate due to changes in foreign exchange rates. Approximately 91% (2017 - 88%) of Clearwater's sales are in currencies other than Canadian dollars, whereas the majority of expenses are in Canadian dollars. As a result, fluctuations in foreign exchange rates may have a material impact on Clearwater's financial condition and operating results. In addition, Clearwater has subsidiaries that operate in the offshore scallop fishery in Argentina and Scotland which exposes Clearwater to changes in the value of the Argentine Peso and GBP. 70 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Risks associated with foreign exchange are partially mitigated by the following strategies: (1) Diversify sales internationally which reduces the impact of any country-specific economic risks. (2) Execute on pricing strategies so as to offset the impact of exchange rates. (3) Limit the amount of long-term sales contracts – Clearwater has very few long-term sales contracts with any customers. Contracts are typically less than 6 months and are based on list prices that provide a margin for exchange rate fluctuations. (4) Plan conservatively – Clearwater regularly reviews economist estimates of future exchange rates and uses conservative estimates when managing its business, and (5) Foreign exchange hedging program – a portfolio of forward contracts enables Clearwater to lock in exchange rates for up to 18 months for key sales currencies (the US dollar, Euro, Yen and GBP) thereby lowering the potential volatility in cash flows through derivative contracts. On April 26, 2017, Clearwater completed an offering of USD $250 million senior unsecured notes, due 2025 with a US dollar coupon rate of 6.875% (“the Notes”). In 2017, Clearwater entered into forward foreign exchange contracts to hedge approximately 80% of the notional value of the Notes at an average rate of 1.2844 and approximately 80% of the coupon payments at an average rate of 1.2830 through to 2022. The carrying amounts of Clearwater’s foreign currency denominated monetary assets and monetary liabilities (excluding derivative financial instruments) as at December 31, 2018 and December 31, 2017 were as follows (presented in Canadian dollars): As at December 31 Cash Trade receivables Other receivables Long-term receivables Trade and other payables Long-term debt Other long-term liabilities Net exposure to foreign currency monetary items 2018 2017 $ $ $ 28,392 58,583 16,442 3,151 (24,982) (367,593) (308) (286,315) $ 9,685 78,075 9,618 3,672 (31,506) (347,026) (616) (278,098) The components of this net exposure by currency are as follows (in foreign currency ‘000’s) at December 31, 2018: Argentine December 31, 2018 GBP USD Yen Euros RMB DKK Peso Cash Trade receivables Other receivables Long term receivables Trade and other payables Long-term debt Other long-term liabilities 8,018 3,442 1,169 425 1,508 41,805 2,302 10,555 446,079 21,003 1,861 1,400 1,070 (40) - - 6,501 - - - - 267 316 7,500 2,516 28,190 - 21,266 (7,680) (6,525) (13,531) (582) 6,272 (719) (75,455) (11,470) (254,965) (177) - - - 40 - - - - - - - Net exposure to foreign currency monetary items (5,746) (246,463) 433,717 27,387 7,780 51,102 (25,416) 71 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) The components of this net exposure by currency are as follows (in foreign currency ‘000’s) at December 31, 2017: Argentine December 31, 2017 GBP USD Yen Euros RMB DKK Peso Cash Trade receivables Other receivables Long term receivables Trade and other payables Long-term debt Other long term liabilities 285 475 2,032 1,400 2,517 13,949 414 1,551 24,583 20,610 567,467 29,313 1,333 660 2,547 - - - - - - 7,950 (3,432) 21,873 - 19,958 212 154 (11,023) (1,745) (14,702) (2,588) 2,290 (2,595) (100,333) (16,835) (253,879) (365) - - - 40 - - - - - - - Net exposure to foreign currency monetary items (24,031) (231,164) 567,374 29,726 3,841 26,506 (58,136) The following table details Clearwater’s sensitivity to a 10% change in the exchange rates against the Canadian dollar. The sensitivity analysis includes outstanding foreign currency denominated monetary items and adjusts their translation at the period end for a 10% change in foreign currency exchange rates. The change below is calculated based on the net exposure to foreign currency monetary items. (In '000 of Canadian dollars) GBP USD Yen Euros RMB DKK Argentine Peso (g) Interest rate risk 2018 (1,000) (33,610) 540 4,282 154 1,070 (92) 2017 (4,059) (28,968) 630 4,459 74 534 (381) Interest rate risk refers to the risk that the value of a financial instrument or cash flow associated with the instrument will fluctuate due to changes in market interest rates. Clearwater’s interest rate risk arises from long-term borrowings issued at fixed rates which create fair value interest rate risk. Clearwater’s variable rate borrowings create cash flow interest rate risk. Clearwater’s long-term debt is carried at amortized cost. In 2017, prior to the refinancing on April 26, 2017, the embedded interest rate floor in Term Loan B was recorded at fair value through earnings (loss). Clearwater manages its interest rate risk exposure by using a mix of fixed and variable rate debt. In 2017, Clearwater replaced its long-term debt with fixed rate USD Notes and a variable rate Revolving Credit facility and Term Loan B facility (Note 13). As at December 31, 2018, approximately 76% (2017 – 68%) of Clearwater’s debt of $463.4 million (2017 - $473.2 million) was fixed rate debt with a weighted average interest rate of 6.3% (2017 – 5.8%). A 1% change in interest rates for variable rate borrowings would result in a $0.9 million increase (or decrease) in interest expense. 72 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (h) Liquidity risk Liquidity risk is the risk that Clearwater will encounter difficulty in meeting obligations associated with financial liabilities. Clearwater manages liquidity risk by monitoring forecasted and actual cash flows, minimizing reliance on any single source of credit, maintaining sufficient undrawn committed credit facilities and matching the maturity profiles of financial assets and financial liabilities. Clearwater’s debt facilities are subject to certain financial and non-financial covenants. Clearwater is in compliance with all covenants associated with its debt facilities as of December 31, 2018. Clearwater’s financing needs follow a seasonal pattern with working capital and debt increasing in the second and third quarter of the year as inventories are built up over the primary fishing seasons with sales typically increasing in the third and fourth quarters of the year, reducing leverage over those periods. Management has structured its financing facilities reflecting this pattern and works with its lenders to set financial covenants which consider seasonal liquidity requirements. The following are the contractual maturities of non-derivative financial liabilities, derivative financial instruments, operating leases and other commitments. The table includes undiscounted cash flows of financial liabilities, operating leases and other commitments, interest and principal cash flows based on the earliest date on which Clearwater is required to pay. December 31, 2018 Interest - long-term debt Principal repayments - long-term debt Carrying Amount Total Contractual Cash Flow $ - $ 182,056 $ 2020 2019 27,951 $ 27,561 $ 2022 2021 27,545 $ 24,989 $ 2023 23,719 $ >2024 50,291 463,417 463,417 23,269 10,080 1,467 91,146 - 337,455 Total long-term debt 463,417 645,473 51,220 37,641 29,012 116,135 23,719 387,746 Trade and other payables Operating leases and other Capital and maintenance projects Derivative financial instruments - liabilities 70,507 - - 70,507 10,501 262 70,507 4,882 262 - 2,874 - - 1,258 - - 687 - - 270 - 10,463 10,463 9,966 497 - - - - 530 - - $ 544,387 $ 737,206 $ 136,837 $ 41,012 $ 30,270 $ 116,822 $ 23,989 $ 388,276 Included in the above commitments for “operating leases and other” are amounts to which Clearwater is committed directly - and indirectly through its partnerships - for various licences and lease agreements, office, machinery and vehicle leases, and vessel and equipment commitments. These commitments require approximate minimum annual payments in each of the next five years as shown above. Also included in commitments for operating leases and other, are (i) amounts to be paid to a company controlled by a director of Clearwater over a period of years ending in 2020 for vehicle and office leases, which aggregate approximately $0.04 million (2017 - $0.07 million). 73 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (i) Fair value of financial instruments The following tables set out Clearwater’s classification and carrying amount, together with fair value, for each type of non-derivative and derivative financial asset and liability: December 31, 2018 Assets: Cash Trade and other receivables Long-term receivables Forward foreign exchange contracts Liabilities: Trade and other payables1 Long-term debt2 Forward foreign exchange contracts $ $ $ $ 35,887 $ - - 10,815 46,702 $ - $ (3,513) (10,463) (13,976) $ FVTPL FV Hedging Amortized cost Total Carrying amount - $ - - 3,078 3,078 $ - $ 85,244 4,970 - 90,214 $ 35,887 $ 85,244 4,970 13,893 139,994 $ Fair value 35,887 85,244 4,970 13,893 139,994 - $ - - - $ (70,507) $ (459,904) - (530,411) $ (70,507) $ (463,417) (10,463) (544,387) $ (70,507) (450,098) (10,463) (531,068) 1 Trade and other payables includes share-based compensation of $3.5 million which is not recorded at amortized cost. Refer to Note 21. 2 Earnout liability is recorded at fair value through profit or loss. December 31, 2017 Assets: Cash Trade and other receivables Long-term receivables Forward foreign exchange contracts Liabilities: Trade and other payables1 Long-term debt2 Forward foreign exchange contracts $ $ $ $ FVTPL FV Hedging Amortized cost 35,514 $ - - 5,675 41,189 $ - $ - - 263 263 $ - $ 103,096 5,077 - 108,173 $ Total Carrying amount 35,514 $ 103,096 5,077 5,938 149,625 $ Fair value 35,514 103,096 5,077 5,938 149,625 - $ (5,278) (7,075) (12,354) $ - $ - (2,045) (2,045) $ (80,411) $ (467,895) - (548,306) $ (80,411) $ (473,173) (9,120) (562,704) $ (80,411) (491,079) (9,120) (580,610) 1 Trade and other payables includes share-based compensation of $4.7 million which is not recorded at amortized cost. Refer to Note 21. 2 Earnout liability is recorded at fair value through profit or loss. Fair value of financial instruments carried at amortized cost: Except as detailed above, Clearwater considers the carrying amounts of financial assets and financial liabilities recognized in the consolidated financial statements to approximate their fair values. For cash, trade and other receivables, and trade and other payables, the carrying value approximates their fair values due to the short-term maturity of these instruments. The fair values of the long-term receivables are not materially different from their carrying values. The estimated fair value of Clearwater’s long-term debt for which carrying value did not approximate fair value at December 31, 2018 was $354.3 million (December 31, 2017 - $363.5 million) and the carrying value was $367.7 million (December 31, 2017 – $345.7 million). The fair value of long-term debt has been classified as Level 2 in the fair value hierarchy (described below) and was estimated based on discounted cash flows using current rates for similar financial instruments subject to similar risks and maturities. 74 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (j) Fair value hierarchy Assets and liabilities carried at fair value are classified using a three-level hierarchy that reflects the significance of the inputs used in making the fair value measurements. The levels are defined as follows: • Level 1: Fair value measurements derived from quoted prices (unadjusted) in active markets for identical assets or liabilities • Level 2: Fair value measurements derived from inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices) • Level 3: Fair value measurements derived from valuation techniques that include inputs for the asset or liability that are not based on observable market data (unobservable inputs) The table below sets out fair value measurements of financial instruments carried at fair value through profit and loss and fair value hedging instruments using the fair value hierarchy: December 31, 2018 Recurring measurements Financial Assets: Cash Forward foreign exchange contracts Financial Liabilities: Forward foreign exchange contracts Earnout liability December 31, 2017 Recurring measurements Financial Assets: Cash Forward foreign exchange contracts Financial Liabilities: Forward foreign exchange contracts Earnout liability Level 1 Level 2 Level 3 $ $ $ $ $ $ 35,887 $ - $ - 13,893 35,887 $ 13,893 $ - - - $ 10,463 - 10,463 $ - - - - 3,513 3,513 Level 1 Level 2 Level 3 35,514 $ - $ 5,938 35,514 $ 5,938 $ - - - - 9,120 - - $ 9,120 $ - 5,278 5,278 There were no transfers between levels during the periods ended December 31, 2018 and December 31, 2017. 75 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Clearwater used the following techniques to value financial instruments categorized in Level 2: • Forward foreign exchange contracts are measured using present value techniques. Future cash flows are estimated based on forward exchange rates (from observable exchange rates at the end of the reporting period) and contract forward rates, discounted at a rate that reflects the credit risk of Clearwater and the various counterparties. The Earnout liability relating to the Macduff acquisition is a financial liability categorized as Level 3 as the fair value measurement of this financial liability is based on significant inputs not observable in the market. To determine the fair value of the Earnout liability three primary sources of risk are assessed (i) the risk associated with the underlying performance of Macduff’s Earnings before interest, taxes, depreciation and amortization (“EBITDA”); (ii) the risk associated with the functional form of the Earnout liability payments; and (iii) the credit risk associated with the future Earnout liability payments. The fair value of the Earnout liability payments is estimated based on a Monte Carlo simulation under a risk-neutral framework. The fair value of the Earnout liability is estimated based on discounted expected future EBITDA cash flows for Macduff for the remaining period ending December 31, 2020. The following inputs and assumptions were used in calculating the fair value of the Earnout liability including: • Payment dates: The Earnout liability is be payable for the periods ending December 31, 2018 through December 31, 2020, based on the expected pattern of the Deferred Obligation and the expected outstanding amount of Deferred Obligation at the end of each year. • Forecasted EBITDA: Management’s forecast for the remaining period; • Risk adjusted discount rate: 7.5% • Asset volatility: The estimated asset volatility of Macduff is based on its observable historical EBITDA volatility. In the context of calculating the asset volatility, the following inputs to derive the asset volatility were used: o Debt value: 1.8x EBITDA o Enterprise Value: 7.5x EBITDA o EBITDA volatility: 26% A risk adjusted payout is calculated at each time period and discounted at the risk-adjusted rate to the valuation date. This process is simulated 100,000 times and the expected value of the Earnout liability is retrieved. Based on the method stated above, the fair value of the Earnout liability was determined to be £2.0 million (CDN $3.5 million) as at December 31, 2018. The change in the fair value of the Earnout liability for the Year ended December 31, 2018 was a decrease of £0.4 million (CDN $0.6 million) (2017 - decrease of £1.6 million (CDN $2.7 million)). The fair value estimates are not necessarily indicative of the amounts that Clearwater will receive or pay at the settlement of the contracts. 76 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 8. LONG-TERM RECEIVABLES As at December 31 Advances to fishermen Other $ $ 2018 4,930 40 4,970 $ 2017 5,077 - 5,077 Certain advances to fishermen are made for a fixed term, secured by an assignment of catch and are non-interest bearing unless there is no supply for 6 weeks, at which time the loans become repayable in installments and are interest bearing. Other advances to fishermen bear interest at prime plus 1% - 3% (2017 - prime plus 2% - 3%) are due on demand, and are secured by an assignment of catch, a marine mortgage on the related vessels, equipment and licences. Advances to fishermen are presented as non-current as the entire balances are not expected to be repaid in the current year and it is not Clearwater’s intention to demand payment unless the terms of the advance agreements are not met. Certain advances to fishermen are denominated in Pounds Sterling (see Note 7 (h)). There is no material expected loss provision on long-term receivables. 9. PROPERTY, PLANT AND EQUIPMENT Land and land improvements Building and wharves Equipment Vessels and vessel equipment Construction in progress Total PPE Deferred Gov't Assistance Total Cost Balance at January 1, 2018 Additions Disposals Reclassifications and other adjustments Effect of movements in exchange rates Balance at December 31, 2018 Accumulated depreciation Balance at January 1, 2018 Depreciation for the year Disposals Reclassifications and other adjustments Effect of movements in exchange rates Balance at December 31, 2018 Carrying amounts At January 1, 2018 At December 31, 2018 $ $ $ $ $ $ 2,877 $ - - 69,212 $ 87,878 $ 312,449 $ 12 (899) - (4,381) - (369) 85,875 $ 558,291 $ (10,122) $ 548,169 19,124 19,112 (5,649) - 19,124 (5,649) - - - 3,035 14,112 78,912 (96,190) (131) - (131) (3) 2,874 $ (132) 588 71,746 $ 101,691 $ 382,300 $ (4,680) 75 (4,152) 8,872 $ 567,483 $ (10,122) $ 557,361 (4,152) - 1,035 $ 19 - 52,223 $ 65,543 $ 165,902 $ 6,850 2,552 (720) (369) 32,099 (3,954) - $ 284,703 $ - - 41,520 (5,043) (8,605) $ 276,098 41,216 (5,043) (304) - - (43) 45 - - 2 - 2 - 1,054 $ 47 347 54,410 $ 72,065 $ 192,595 $ (1,452) (1,058) - - $ 320,124 $ 29 (1,029) (8,880) $ 311,244 1,842 $ 1,820 $ 16,989 $ 22,335 $ 146,547 $ 17,336 $ 29,626 $ 189,705 $ 85,875 $ 273,588 $ 8,872 $ 247,359 $ (1,517) $ 272,071 (1,242) $ 246,117 77 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Land and land improvements Building and wharves Equipment Vessels and vessel equipment Construction in progress Total PPE Deferred Gov't Assistance Total Cost Balance at January 1, 2017 Additions Disposals Reclassification and other adjustments Effect of movements in exchange rates Balance at December 31, 2017 Accumulated depreciation Balance at January 1, 2017 Depreciation for the year Disposals Reclassifications and other adjustments Effect of movements in exchange rates Balance at December 31, 2017 Carrying amounts At January 1, 2017 At December 31, 2017 $ $ $ $ $ $ 2,819 $ - - 67,102 $ 47 (11) 73,024 $ 325,083 $ 254 (15) 6,428 (26,952) 36,043 $ 504,071 $ 78,702 - 85,431 (26,978) (8,962) $ 495,109 85,431 (26,978) - - 62 2,293 14,407 12,923 (28,998) 687 (1,160) (473) (4) 2,877 $ (219) 69,212 $ 208 (5,033) 87,878 $ 312,449 $ 128 (4,920) 85,875 $ 558,291 $ (10,122) $ 548,169 (4,920) - 1,005 $ 30 - 49,695 $ 2,532 (11) 60,320 $ 158,515 $ 5,082 (15) 33,037 (24,760) 7 $ 269,542 $ 40,681 - (24,786) - (8,240) $ 261,302 40,304 (24,786) (377) - - - 1,035 $ - 7 (7) 630 (7) 616 - 616 163 (1,520) 52,223 $ 65,543 $ 165,902 $ (1,350) - - $ 284,703 $ 12 (1,338) (8,605) $ 276,098 1,814 $ 1,842 $ 17,407 $ 16,989 $ 12,704 $ 166,568 $ 22,335 $ 146,547 $ 36,036 $ 234,529 $ 85,875 $ 273,588 $ (722) $ 233,807 (1,517) $ 272,071 Total depreciation and amortization expense related to property, plant and equipment and definite-life intangible assets for 2018 was $44.9 million (2017 - $45.4 million). In 2018, $46.4 million (2017 - $42.3 million) of depreciation and amortization expense for assets used in the harvesting and production of goods was included in the cost of inventory and cost of goods sold and $2.5 million (2017 – $3.0 million) was recorded in administrative and selling costs for assets used in administrative activities. For property, plant and equipment pledged as security for long-term debt, refer to Note 13. 78 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 10. INTANGIBLE ASSETS AND GOODWILL Intangible assets Goodwill Brand names Computer software Indefinite life assets Fishing rights Total Goodwill and intangible asset total Cost Balance at January 1, 2017 Additions Foreign currency exchange translation Balance at December 31, 2017 Additions Disposal Foreign currency exchange translation Balance at December 31, 2018 Accumulated amortization Balance at January 1, 2017 Amortization Foreign currency exchange translation Balance at December 31, 2017 Amortization Disposal Foreign currency exchange translation Balance at December 31, 2018 Carrying amounts As at December 31, 2017 As at December 31, 2018 $ $ $ $ $ $ 49,781 $ 10,216 $ - 415 50,196 - 186 10,402 21,078 $ 996 - 22,074 153,726 $ 25,664 $ - 727 154,453 - (356) 25,308 210,684 $ 996 557 212,237 - - (1,573) 48,623 $ - - 315 10,717 $ - (197) - 21,877 $ 119 (596) 1,777 155,753 $ - - (340) 24,968 $ 119 (793) 1,752 213,315 $ - $ - - - - - - - $ - $ - - - - - - - $ 2,392 $ 3,224 - 5,616 3,137 (107) - 8,646 $ - $ - - - - - - - $ 10,971 $ 1,900 (65) 12,806 516 - (75) 13,247 13,363 $ 5,124 (65) 18,422 3,653 (107) (75) 21,893 $ 260,465 996 972 262,433 119 (793) 179 261,938 13,363 5,124 (65) 18,422 3,653 (107) (75) 21,893 50,196 $ 48,623 $ 10,402 $ 10,717 $ 16,458 $ 13,231 $ 154,453 $ 155,753 $ 12,502 11,721 193,815 $ 191,422 $ 244,011 240,045 Clearwater maintains fishing licences and rights to ensure continued access to the underlying resource. Fishing licences have an indefinite life as they have nominal annual renewal fees, which are expensed as incurred, and the underlying stocks of the species are healthy. The licences and goodwill are tested for impairment annually and when circumstances indicate the carrying value may be impaired. Indefinite life licences, brand names, patents and goodwill Annual impairment testing for each CGU was performed using a VIU approach as of December 31, 2018. The recoverable amount is the higher of the VIU and fair value less cost of disposal. The VIU for all CGU’s were determined to be higher than their carrying amounts and therefore no impairments were recorded during 2018. The value in use was determined by discounting the projected future cash flows generated from operations for the applicable CGU. Unless otherwise indicated in notes i – iii, the assumptions used in the goodwill and indefinite life intangible assets value in use for 2018 were determined similarly to those used in 2017. 79 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) The carrying value of Clearwater’s significant CGU’s are as follows: As at December 31 Scallops Indefinite life assets MacDuff Goodwill Indefinite life assets Brand names Brand names Goodwill Indefinite life assets December 31 2018 December 31 2017 $ 53,541 $ 54,456 42,985 76,652 10,717 5,638 25,560 215,093 $ 44,558 74,886 10,402 5,638 25,111 215,051 $ The discounted cash flows used in determining the recoverable amounts were based on the following key assumptions: i) Cash flows from operations were projected for a period of five years based on a combination of past experience, actual operating results and forecasted earnings. Terminal values and forecasts for future periods were extrapolated using inflation rates of 2% - 2.5% (2017: 2% - 2.5%). ii) Pre-tax discount rates ranging from 9% - 13% (2017: 9% - 13%) were applied in determining the recoverable amount of the CGU’s. The discount rates were estimated based upon weighted average cost of capital, and associated risk for the CGU. iii) Cash flow adjustments for capital expenditures were based upon a management approved capital expenditure forecast, and terminal year capital expenditures were based on required refits over the period of the fishing licence. The following assumptions were used for each individual CGU: Argentine scallops Clams Turbot CDN scallops FAS shrimp Lobster MacDuff Other Terminal growth rate Pre-tax discount rates 2018 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.5% 2.0% 2017 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.5% 2.0% 2018 13.0% 9.5% 9.5% 9.5% 9.5% 10.0% 11.0% 9.0% 2017 13.0% 9.5% 9.5% 9.5% 9.5% 10.0% 11.0% 9.0% The values assigned to the key assumptions represent management’s assessment of future trends in the industry and are based on both internal and external sources. Definite life fishing rights Amortization relates to fishing rights. Amortization is allocated to the cost of inventory and is recognized in cost of goods sold as inventory is sold. Refer to Note 13 for assets pledged as security for long-term debt. 80 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Computer software Clearwater implemented a new enterprise resource planning system (“ERP”) in 2016 and began amortizing on a straight-line basis over 3 - 8 years, beginning in the second quarter of 2016. 11. INVESTMENT IN EQUITY INVESTEE The following table summarizes the financial information of Adams and Knickle Limited, a joint venture in which Clearwater owns 50% and is accounted for using the equity method: Year ended December 31 2018 2017 Carrying amount of interest in joint venture $ 9,382 $ 9,817 Share of: Earnings for the year Dividends from joint venture 12. INCOME TAXES (a) Reconciliation of income tax expense 2,923 3,228 2,656 3,340 The effective rate on Clearwater's earnings before income taxes differs from the expected amount that would arise using the combined Canadian federal and provincial statutory income tax rates. A reconciliation of the difference is as follows: Year ended December 31 Earnings (loss) before income taxes Combined tax rates Income tax provision at statutory rates Add (deduct): Income of partnerships taxed in the hands of the partners Permanent differences Benefit of non-capital loss not recognized Benefit of capital loss not recognized Recognition of previously unrecognized deferred tax assets Effect of rate differences Income of foreign subsidiary not subject to tax Other Actual provision (b) Income tax expense $ $ $ $ 2018 (1,966) $ 30.5% (600) $ (3,618) $ 4,452 - 4,099 (2,636) (22) 1,153 (1,088) 1,740 $ 2017 35,897 30.5% 10,949 (2,458) (2,565) 5,451 - (2,970) 639 (50) (1,338) 7,658 The components of the income tax expense (recovery) for the year are as follows: Year ended December 31 Current income tax expense Deferred tax expense (recovery) (c) Deferred tax assets and liabilities $ $ 2018 6,318 (4,578) 1,740 $ $ 2017 12,375 (4,717) 7,658 81 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Deferred tax assets and liabilities are attributable to the following: Year ended December 31 Deferred tax assets: Non-capital loss carry-forwards Unrealized foreign exchange Share issuance costs Reserve for unpaid share-based compensation Capital losses Other Deferred tax liabilities: Licences and intangibles Unrealized foreign exchange Property, plant and equipment Long-term debt Classified in the consolidated statement of financial position as: Deferred tax asset Deferred tax liability 2018 2017 $ $ $ 20,770 - 418 798 - 2,371 (22,422) (1,215) (3,235) (1,051) (3,566) $ 14,266 (17,832) $ (3,566) $ 18,198 1,472 805 1,094 3,590 656 (22,932) - (5,227) (4,147) (6,491) 11,349 (17,840) (6,491) The net change in deferred income taxes is reflected in deferred income tax recovery of $4.6 million (2017 - $4.7 million), plus $1.4 million (2017 – recovery $0.5 million) of deferred tax expense recorded through other comprehensive loss (Note 7 (b)), less the foreign exchange effect of deferred taxes of foreign subsidiaries totaling $0.3 million (2017 – $0.1 million), the effect of which was recorded through foreign exchange. The deferred tax asset recorded for non-capital loss carry-forwards is recognized based on Clearwater's estimate that it is more likely than not than it will earn sufficient taxable profits to utilize these losses before they expire. Unrecognized deferred tax assets Clearwater has the following deductible temporary differences, unused tax losses and unused tax credits for which no deferred tax asset is recognized in the consolidated statements of financial position. Clearwater Seafoods Inc. - 20,244 68,089 - Non-capital losses Investment tax credits Capital losses Accounts receivable Subsidiary Corporations 6,665 930 380 13,750 6,665 2026 - 2037 21,174 2023 - 2038 68,469 13,750 No expiry N/A Expiry Total $ $ $ Unrecognized deferred tax liabilities Deferred tax is not recognized on the unremitted earnings of subsidiaries and other investments as the Company is in a position to control the reversal of the temporary difference and it is probable that such differences will not reverse in the foreseeable future. The unrecognized temporary difference at December 31, 2018 for the Company's subsidiaries was $95.3 million (December 31, 2017 - $84.2 million). 82 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 13. LONG-TERM DEBT As at December 31 Senior debt (a): 2018 2017 USD senior unsecured notes, due May 2025 (USD $250,000) $ 333,955 $ 306,684 Term loan B, due May 2022 Revolving credit facility, due May 2022 Deferred obligation (b) Earnout liability (b) Term loan, due June 2019 (c) Term loan, due in 2091 (d) Other loans Total debt Less: current portion 1 34,177 58,019 16,504 3,513 13,637 3,500 112 463,417 (23,269) 34,466 87,682 23,181 5,278 12,215 3,500 167 473,173 (21,025) Total long-term debt 1 Current portion of long-term debt includes scheduled payments related to the Senior debt, Deferred Obligation $ 440,148 $ 452,148 payments, less accretion during the period and minimum payment related to the Earnout Liability. (a) Senior debt In April 2017, Clearwater refinanced its senior debt facilities. The Company issued USD $250 million of 6.875% Senior Notes due May 2025 (the “Senior Notes”). Concurrent with issuing the Senior Notes, Clearwater entered into new senior secured credit facilities in an aggregate availability of CDN $335 million, consisting of a CDN $300 million revolving credit facility and a CDN $35 million amortizing secured term loan (“Term Loan B”), each maturing in 2022 (the “Senior Secured Credit Facilities”). Clearwater used the net proceeds from the sale of the Senior Notes, together with the new borrowings under the Senior Secured Credit Facilities, to refinance existing senior secured credit facilities (Term Loan A, Term Loan B that were due in June 2018 and June 2019 and senior revolving credit facility) and for general corporate purposes. The refinancing was accounted for as a settlement of the prior facilities and consequently $4.2 million of unamortized deferred financing costs and refinancing costs were recorded within Net Finance Costs (refer to Note 13 (e)). Financing costs related to the Senior Notes and Senior Secured Credit Facilities of $12.0 million had been deferred and amortized into interest using the effective interest method over the term of the debt. On March 29, 2018, Clearwater amended the terms of the secured credit facility agreement to temporarily increase the secured indebtedness to EBITDA covenant requirement for the duration of 2018 and obtained a reduction in the availability on the revolving credit facility from $300 million to $200 million. The transaction costs of $0.2 million were added to deferred financing costs and will be amortized over the remaining term of the credit facility using the effective interest rate. As at December 31, 2018, Senior debt consists of Senior Notes, a Term Loan B facility and revolving credit facility. Senior Notes, due 2025 – The USD $250.0 million (CDN $340.9 million) Senior Notes have a coupon rate of 6.875%, with coupon payments payable in semi-annual installments of USD $8.6 million (CDN $11.7 million) in May and November each year. The balance is shown net of unamortized deferred financing charges of USD $5.1 million (CDN $7.0 million) which resulted in an effective interest rate of 7.20%. Refer to Note 7 for details on forward foreign exchange contracts used to economically hedge a portion of the foreign exchange risk related to the notional and coupon payments for the Senior Notes. 83 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Term Loan B facility, due 2022 – The Term Loan B consists of an initial term loan of CDN $35.0 million. The principal outstanding as at December 31, 2018 was CDN $34.4 million. The loan is repayable in quarterly installments totalling $0.35 million per year, with the balance due at maturity in May 2022. The facility bears interest ranging from banker’s acceptance rate (“BA rate”) plus 2.50% to 3.25%. The range is determined quarterly based on a ratio of Senior Secured Indebtedness to EBITDA, with EBITDA calculated on a trailing twelve-month basis. The balance is shown net of deferred financing charges of CDN $0.2 million resulting in an effective interest rate of 4.46%. Revolving credit facility, due 2022 – The CDN $200 million revolving credit facility can be drawn in CDN, USD, EUR, YEN or GBP. As at December 31, 2018 the balances were drawn in CDN and bear interest at the BA rate plus 1.50% to 2.25%. The range is determined quarterly based on a ratio of Senior Secured Indebtedness to EBITDA, with EBITDA calculated on a trailing twelve-month basis. The balance is shown net of deferred financing charges of CDN $2.0 million, resulting in effective rates of 4.53% for CDN balances. The availability of this facility, subject to financial covenants, is further reduced by the term loan outstanding in note (c), as such the availability as at December 31, 2018 was approximately CDN $90.3 million. The facility has standby fees ranging from 0.25% to 0.30% based upon the Senior Secured Indebtedness to EBITDA ratio as of the last day of the immediately preceding fiscal quarter. The Revolving Credit Facility and Term Loan B, due 2022, are secured by a first charge on cash, trade and other receivables, inventories, marine vessels, licences and quotas, and Clearwater’s investments in certain subsidiaries. In addition to the minimum principal payments for Term Loan B, the loan agreement requires that between 0% and 50% of excess cash flow (defined in the loan agreement as EBITDA, excluding non- controlling interest in EBITDA less principal debt repayments (excluding revolver payments), less interest expense, less capital expenditures funded through operating cash flows, less certain tax expenses), be used to repay the principal based on the previous fiscal year’s results upon approval of the annual consolidated financial statements. No principal repayment was required under this condition in 2017 or 2018. (b) Deferred Obligation and Earnout Liability In connection with the 2015 acquisition of MacDuff, there are two components of the purchase price that are to be paid in future periods as discussed below: (i) Deferred obligation The Deferred Obligation relates to deferred payments for 33.75% of the shares of Macduff acquired by Clearwater (the "Earn Out Shares") in 2015. Excluding the fair value adjustment on acquisition, the principal balance outstanding as at December 31, 2018 is £10.5 million (CDN $18.3 million) (December 31, 2017 - £15.7 million (CDN $26.5 million)) and does not bear interest. The Deferred Obligation is recorded at the discounted amount based on estimated timing of payment and is being accreted to the principal amount over the estimated term using the effective interest method with an effective average interest rate of 7.44%. 84 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) The following is a reconciliation of the Deferred Obligation: Balance - at acquisition Accretion Principal repayments Effect of movement in foreign exchange Balance - December 31, 2017 Accretion - Year ended December 31, 2018 Principal repayment Effect of movement in foreign exchange Balance - December 31, 2018 $ GBP 20,925 3,262 (10,462) - 13,725 $ 991 (5,231) - 9,485 $ £ £ £ CDN 42,388 5,722 (17,539) (7,390) 23,181 1,720 (8,903) 506 16,504 On October 30th of each year, the holders of the Earn Out Shares can elect to be paid up to 20% of the original Deferred Obligation amount. Beginning in 2017, Clearwater had the right to exercise the payout of 20% of the Deferred Obligation annually. The percentage of the Deferred Obligation remaining unpaid will impact the fair value of the future performance component of the additional consideration, the Earnout liability. On October 30, 2018 and 2017, the holders of the Earn Out Shares elected to be paid 20% of the outstanding Deferred Obligation. As a result, a payment of £5.2 million (CDN - $8.9 million) was made in November 2018 and £5.2 million (CDN - $8.8 million) in November 2017. (ii) Earnout liability The Earnout liability is unsecured additional consideration to be paid dependent upon the financial performance of Macduff and the percentage of Deferred Obligation remaining unpaid at the time of payment (refer to Deferred Obligation above). The estimated fair value of the Earnout liability at December 31, 2018 is £2.0 million (CDN - $3.5 million) (December 31, 2017 - £3.1 million, CDN - $5.3 million) based on forecast earnings and probability assessments. The actual Earnout payments will be paid over a five-year period ending 2021. The amount of the total Earnout liability is calculated as follows: The greater of: (i) (ii) £3.8 million; or up to 33.75% (dependent upon the percentage of Deferred Obligation remaining unpaid each year) of the increase in equity value of the business over five years calculated as 7.5x adjusted EBITDA of Macduff less the outstanding debt of Macduff; and 10% of adjusted EBITDA of Macduff above £10 million (dependent upon the percentage of Deferred Obligation remaining unpaid each year). (iii) 85 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) The Earnout liability is recorded at fair value on the consolidated statement of financial position at each reporting period until paid, with changes in the estimated fair value being recorded as a component of other expense on the Consolidated Statement of Earnings (Loss). Balance - at acquisition Fair value adjustment Payment Effect of movement in foreign exchange Balance - December 31, 2017 Fair value adjustment Payment Effect of movement in foreign exchange Balance - December 31, 2018 GBP 6,100 (2,238) (737) $ 3,125 $ (350) (756) - 2,019 $ CDN 12,357 (3,841) (1,333) (1,905) 5,278 (623) (1,354) 212 3,513 £ £ £ Term Loan, due 2019 (c) The principal outstanding as at December 31, 2018 was USD $10.0 million (CDN $13.6 million) (December 31, 2017 - USD$10.0 million; CDN $12.2 million). The loan is held through a Clearwater subsidiary. The loan was renewed in June 2018, is non-amortizing, repayable at maturity in June 2019 and bears interest payable monthly at 5.5% per annum. Term Loan, due 2091 (d) In connection with this term loan, Clearwater makes a royalty payment of CDN $0.3 million per annum in lieu of interest. This equates to an effective interest rate of approximately 8.0% per annum. (e) Net finance costs Year ended December 31 Interest expense on financial liabilities Amortization of deferred financing charges and accretion Accretion on deferred consideration (Note 13 (b)) Fair value adjustment on embedded derivative (Note 13 (a)) Interest rate swaps and caps (1) Debt settlement (2) & refinancing fees $ 2018 28,551 1,695 30,246 1,720 - - - 1,720 31,966 $ 2017 28,205 1,555 29,760 2,166 (703) (4,347) 8,404 5,520 35,280 $ $ (1) Interest rate swaps and caps represents unrealized (gains) losses as a result of the change in fair value during the year. Realized gains and losses are reflected in interest expense and bank charges and debt settlement and refinancing fees. (2) Debt settlement includes loss on settlement of existing interest rate swaps and cross currency swaps and cap, forward foreign exchange contracts, remaining unamortized deferred financing costs and accretion. 86 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 14. SHARE CAPITAL Authorized: Clearwater is authorized to issue an unlimited number of common shares. Share capital movement: As at December 31 Share capital: Balance at January 1 Shares issued under share-based compensation plans Shares issued under dividend reinvestment plan Balance at December 31 # 63,934,698 21,185 886,110 64,841,993 2018 $ 210,860 98 4,548 215,506 # 63,934,698 - - 63,934,698 2017 $ 210,860 - - 210,860 On February 15, 2018, Clearwater approved a Dividend Reinvestment Plan (“DRIP”) effective February 23, 2018 to provide shareholders with the option to have the cash dividends declared on the common shares of Clearwater reinvested automatically back into additional shares. Shares may be either newly issued from treasury or purchased on the open market. Clearwater may from time to time, in its sole discretion, offer a discount of up to 5% of the average market price for shares purchased from treasury. Clearwater will provide a discount of 3% from the average market price for shares purchased under the DRIP until further notice. Clearwater has 2.5 million common shares (December 31, 2018 – 2.5 million remaining) reserved for issuance under the share-based compensation plans and 3.0 million (December 31, 2018 – 2.1 million remaining) under the DRIP. During the year ended 2018, dividends of $12.8 million were declared and paid as follows: Payment Date April 2, 2018 June 1, 2018 September 4, 2018 December 3, 2018 # of Shares Outstanding 63,955,169 64,060,448 64,345,020 64,600,116 Dividends per Share $ $ $ $ 0.05 0.05 0.05 0.05 During the year ended 2017, dividends of $12.8 million were declared and paid as follows: Payment Date April 3, 2017 June 2, 2017 September 1, 2017 December 1, 2017 # of Shares Outstanding 63,934,698 63,934,698 63,934,698 63,934,698 $ $ $ $ 0.05 0.05 0.05 0.05 Dividends per Share Subsequent to the end of the year, on March 7, 2019 the Board of Directors declared a quarterly dividend of $0.05 per share payable on April 1, 2019 to shareholders of record as of March 18, 2019 for a total of $3,242,100. 87 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 15. REVENUE Clearwater recognized the following revenue from customers: Year ended December 31 Revenue from contracts with customers 2018 592,246 $ 2017 621,031 $ Disaggregation of revenue from contracts with customers Clearwater’s revenue from contracts with customers is primarily generated through the sale of seafood product in a fresh or frozen state to customers. Clearwater recognizes revenue on the sale of seafood product at a point-in-time. Clearwater may provide additional services after control of seafood product has transferred to the customer, including freight, storage, customs clearing and cleaning. These services are recognized over time except from customs clearing which is recognized at a point-in-time. These services are each considered separate performance obligations. The timing of revenue recognition related to seafood product is dependent on shipping terms, in which Clearwater uses International Commercial terms (“Incoterms”) as agreed upon with each customer. These internationally recognized shipping terms specify when control of the goods have transferred to the customer and therefore when revenue should be recognized. Refer to Note 22 for revenue disaggregated by species and region. Refer to Note 5 for trade receivables from contracts with customers. 16. NON-CONTROLLING INTEREST On October 26, 2018, Clearwater acquired an additional 1% interest in its Argentina subsidiary for USD $1 million (CDN $1.3 million) increasing Clearwater’s ownership from 85% to 86%. On May 29, 2017, Clearwater acquired an additional 5% interest for USD $5.0 million (CDN $6.7 million) increasing Clearwater’s ownership from 80% to 85%. The carrying value of the subsidiary's net liabilities in the consolidated financial statements on the date of acquisition was $12.3 million (2017 - $8.9 million), including the cumulative translation adjustment account. The acquisition resulted in a reduction to retained earnings attributable to shareholders of Clearwater of $1.4 million (2017 - $7.2 million). Year ended December 31 2018 2017 Carrying amount of net deficit $ (12,259) $ (8,895) Non-controlling interest acquired (deficit) Consideration paid to non-controlling interest (119) 1,312 (445) 6,725 Decrease in retained earnings attributable to shareholders of Clearwater $ 1,431 $ 7,170 88 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Summarized financial information in respect of Clearwater’s subsidiaries that have non-controlling interests (“NCI”) is set out below. (a) Summarized statements of financial position As at December 31 NCI Percentage Current assets Current liabilities Non-current assets Net assets Coldwater shrimp 2018 2017 46.34% 46.34% $ $ 25,258 (10,499) 14,759 21,763 (11,359) 10,404 14,613 17,192 29,372 27,596 Accumulated non-controlling interests $ 18,784 $ 17,473 As at December 31 NCI Percentage Current assets Current liabilities Non-current assets Non-current liabilities Net assets Argentine Scallops 2018 14.0% $ $ 15,255 (17,625) (2,370) 10,112 (88) 10,024 2017 15.0% 10,961 (25,404) (14,443) 18,203 (391) 17,812 7,654 3,369 Accumulated non-controlling interests $ (2,118) $ (1,801) 89 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) (b) Summarized statements of earnings Year ended December 31 Sales Earnings and comprehensive income for the year $ Earnings allocated to non-controlling interest Dividends paid to non-controlling interest Year ended December 31 Sales Earnings for the year Other comprehensive income Total comprehensive income Earnings allocated to non-controlling interest Dividends paid to non-controlling interest (c) Summarized statements of cash flows Year ended December 31 Cash flow from operating activities Cash flow used in financing activities Cash flow used in investing activities Net increase (decrease) in cash Year ended December 31 Cash flow from operating activities Cash flow used in financing activities Cash flow used in investing activities Net increase (decrease) in cash Coldwater shrimp 2018 2017 82,434 $ 26,281 12,665 11,353 74,199 19,004 10,605 18,073 Argentine Scallops 2018 2017 $ 38,534 5,506 (1,222) 4,284 77 - 60,850 18,231 (2,119) 16,112 2,632 1,962 Coldwater shrimp 2018 2017 $ 35,032 (24,500) (4,825) 5,707 Argentine Scallops $ 2018 8 - (12) (4) 19,957 (39,000) (4,142) (23,185) 2017 13,522 (10,977) (2,666) (121) $ $ $ 90 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 17. OPERATING EXPENSES Year ended December 31 Salaries and benefits Share-based incentive compensation Employee compensation Consulting and professional fees Other Selling costs Travel Occupancy Donations Total administrative and selling costs before allocation Allocation to cost of goods sold Total administrative and selling costs $ 2018 41,308 1,289 42,597 $ 12,827 3,559 2,319 2,770 1,578 1,298 24,351 (13,439) 53,509 Restructuring costs Operating expenses 482 53,991 $ $ 2017 40,197 409 40,606 14,238 4,977 2,816 3,089 1,548 1,648 28,316 (13,371) 55,551 6,856 62,407 Restructuring costs consisted of severance costs associated with the targeted restructuring of the Company’s employee base and changes to Clearwater’s distribution infrastructure initiated in the fourth quarter of 2017. 18. OTHER (INCOME) EXPENSE Year ended December 31 Acquisition related costs Share of earnings of equity-accounted investee Royalties, interest income and other fees Other (income) fees Fair value adjustment on earn-out liability Export rebates Other (income) expense 19. EMPLOYEE COMPENSATION $ 2018 384 (2,923) (745) 170 (623) - (3,737) $ 2017 464 (2,656) (431) (994) (2,769) (1,190) (7,576) $ $ Employee compensation is classified in the consolidated statement of earnings (loss) based on the related function. The following table reconciles Clearwater's compensation expense items to the functions where the amounts are presented on the consolidated statement of earnings (loss): Year ended December 31 Salaries and benefits Share-based compensation Cost of goods sold Administrative and selling costs 2018 146,105 1,289 147,394 113,570 33,824 147,394 $ $ $ $ 2017 151,410 409 151,819 120,511 31,308 151,819 $ $ $ $ 91 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 20. EARNINGS (LOSS) PER SHARE The earnings and weighted average number of shares used in the calculation of basic and diluted earnings (loss) per share is as follows: In thousands except number of shares and per share data Earnings (loss) attributable to shareholders - basic and diluted Weighted average number of shares outstanding - basic Adjustment for stock-based compensation plan shares Weighted average number of shares outstanding - diluted Earnings (loss) per share Basic Diluted 2018 (16,204) $ 2017 15,759 64,298,784 - 64,298,784 63,934,698 60,344 63,995,042 (0.25) $ (0.25) $ 0.25 0.25 $ $ $ Diluted earnings (loss) for the period is calculated based on earnings attributable to the shareholders of Clearwater after the adjustment for any potentially dilutive cash-settled share-based payments. There was no revaluation adjustment related to cash-settled share-based payments for the year ended December 31, 2018. Diluted weighted average number of shares outstanding are adjusted for the dilutive effect of share-based compensation. For the year ended December 31, 2018, 123,833 (2017 – nil) potentially dilutive shares were excluded from the calculation of diluted (loss) earnings per share as they were anti-dilutive. 21. SHARE-BASED COMPENSATION Clearwater’s share-based compensation plans are disclosed in Note 3 (l). An aggregate amount of 2.5 million Common Shares of Clearwater are issuable under the deferred share unit and performance share unit plans. Clearwater has the following share-based compensation plans: Share appreciation rights (“SARs”) The share appreciation rights plan is a phantom share plan that provides the holder a cash payment equal to the fair market value of Clearwater’s shares, less the grant price. SARs vest over a three-year period and have no expiry. Deferred share units (“DSU”) There are two deferred share unit plans that provide the holder a cash payment equal to the fair market value of Clearwater’s common shares on the date of settlement or equity-settlement. The retention DSU plan awards vest once the holder reaches the age of 65 with continued employment by Clearwater, or death. The director DSU plan allows non-employee directors to receive, in the form of deferred share units, all or a percentage of director’s fees, which would be otherwise payable in cash. Each director DSU vests at the grant date. 92 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Performance share units (“PSU”) Performance share units are issued to both employees and directors. Prior to 2018, holders of PSUs received settlement amounts measured based upon the relative performance of Clearwater shares to its pre-defined peer group. Performance was based on the total return to shareholders over the defined period. Beginning in 2018, the performance measure is based on Clearwater’s performance relative to specific internal targets. Vested units will be settled in cash or shares or by a combination thereof as determined by the Company. All outstanding grants under the PSU plan will be settled by the issuance of common shares. The number of share-based awards outstanding and vested as of December 31, 2018 and 2017 were as follows: As at December 31, 2018 (in thousands) SARs PSU - Tranche 5 PSU - Tranche 6 PSU - Tranche 7 DSU Total As at December 31, 2017 (in thousands) SARS PSU - Tranche 4 PSU - Tranche 5 PSU - Tranche 6 DSU Total $ $ Grant price 0.80 1.00 N/A N/A N/A N/A Grant price 0.80 1.00 N/A N/A N/A N/A Number outstanding 83 67 79 103 409 403 1,144 Number outstanding 83 67 61 85 110 465 871 Number vested 83 67 79 - - 403 632 Number vested 83 67 61 - - 465 676 Grant Date May 2010 May 2010 April 2016 May 2017 May 2018 June 2012 - December 2018 Grant Date May 2010 May 2010 April 2015 April 2016 May 2017 June 2012 - December 2017 The following reconciles the share-based awards outstanding for the year ended December 31, 2018: (In thousands of share units) Outstanding at January 1, 2018 Granted Granted from dividends Exercised Outstanding at December 31, 2018 PSU - Tranche 4 61 - - (61) - PSU - Tranche 5 85 - 3 (9) 79 PSU - Tranche 6 110 - 4 (11) 103 PSU - Tranche 7 DSU - 407 11 (9) 409 465 111 12 (185) 403 Vested at January 1, 2018 Vested Exercised Vested at December 31, 2018 61 - (61) - - 88 (9) 79 - 11 (11) - - 9 (9) - 465 123 (185) 403 SARS Total 150 - - - 150 150 - - 150 871 518 30 (275) 1,144 676 231 (275) 632 93 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) The following reconciles the number of share-based awards outstanding for the year ended December 31, 2017: (In thousands of share units) Outstanding at January 1, 2017 Granted Granted from dividends Exercised Outstanding at December 31, 2017 PSU - Tranche 3 141 - - (141) - PSU - Tranche 4 79 - 2 (20) 61 PSU - Tranche 5 124 - 2 (41) 85 PSU - Tranche 6 DSU - 157 2 (49) 110 390 69 6 - 465 Vested at January 1 2017 Vested Exercised Vested at December 31, 2017 141 - (141) - - 81 (20) 61 - 41 (41) - - 49 (49) - 313 152 - 465 SARS Total 150 - - - 150 150 - - 150 884 226 12 (251) 871 604 323 (251) 676 The following units were settled in the year ended December 31, 2018: As at December 31, 2018 PSU - Tranche 4 PSU - Tranche 5 PSU - Tranche 6 PSU - Tranche 7 Total Grant price N/A N/A N/A N/A Number exercised In thousands 61 9 11 9 90 Exercise date March 2018 June 2018 June 2018 June 2018 Share price at exercise date $4.63 $5.04 $5.04 $5.04 These awards were equity settled during 2018. Refer to Note 14 for the number of shares issued after taking into consideration the performance factor as described in Note 3 (l). The following units were settled in the year ended December 31, 2017: As at December 31,2017 PSU - Tranche 3 PSU - Tranche 4 PSU - Tranche 5 PSU - Tranche 6 Total Grant price N/A N/A N/A N/A Number exercised In thousands 141 20 41 49 251 Exercise date April 2017 November 2017 November 2017 November 2017 Share price at exercise date $10.37 7.14 7.14 7.14 These awards were cash settled during 2017 for $1.7 million, after taking into consideration the performance factor as described in Note 3 (m). The PSU Tranche 5 awards are fully vested as of December 31, 2018 and the total expense recorded over the vesting period was $1.7 million recognized within contributed surplus. These awards will be equity settled in the first quarter of 2019. The retention DSUs awards are fully vested as of December 31, 2018 and will be settled in cash in the first quarter of 2019. 94 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Dividend equivalents When cash dividends are paid to shareholders of Clearwater, dividend equivalent PSUs and DSUs are granted to the Participants which are equal to the greatest number of whole share units having a market value, as of the payment date of the dividend, equal to the product of the cash dividend paid per share multiplied by the number of PSUs and DSUs outstanding. The additional PSUs and DSUs granted are subject to the same terms and conditions as the corresponding PSU or DSU Grant. Fair value of share-based awards The SARs issued and outstanding are fully vested and are expected to be cash settled on the exercise date; therefore, vested awards are recorded as liabilities at the intrinsic value of the SARs. Retention DSU awards have fully vested. Awards may be redeemed up to one year following retirement and therefore recorded at the share price at the end of the reporting period. Awards for which redemption notices have been received but are still outstanding as of December 31, 2018, are recorded at the share price at the time of the election. Measurement inputs for the remaining plans include the fair value of Clearwater’s shares, exercise price of the instrument, expected volatility (based on weighted average historic volatility adjusted for changes expected due to publicly available information), weighted average expected remaining life of the instruments (based on historical experience and general option holder behaviour), expected dividends, and the risk-free interest rate (based on government bonds), as follows: Weighted average fair value per award Weighted average risk-free interest rate Weighted average expected volatility Expected life of awards (years) $ PSU Tranche 6 11.85 $ 1.11% - 2.31% 16.60% - 33.83% 3 PSU Tranche 7 4.95 $ N/A N/A N/A Weighted average fair value per award Weighted average risk-free interest rate Weighted average expected volatility Expected life of awards (years) PSU Tranche 5 PSU Tranche 6 $ 17.78 $ 11.85 $ 1.01% - 2.28% 18.66% - 43.43% 3 1.11% - 2.31% 16.60% - 33.83% 3 2018 DSU 5.89 N/A N/A N/A 2017 DSU 9.05 N/A N/A N/A Share-based compensation expense included in the Consolidated Statements of Earnings (Loss) for the year ended December 31, 2018 is $1.3 million (December 31, 2017 - $0.4 million). The liability for share-based compensation is $3.5 million at December 31, 2018 (December 31, 2017 - $4.7 million). The vested portion of the liability for share-based compensation is $3.5 million at December 31, 2018 (December 31, 2017 - $4.7 million). 95 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 22. SEGMENT INFORMATION Clearwater has one reportable segment which includes its integrated operations for harvesting, processing, marketing and the distribution of seafood products. (a) Sales by Species Year ended December 31 Scallops Clams Lobster Coldwater shrimp Crab Langoustine Whelk Groundfish and other shellfish (b) Sales by Geographic Region of the Customer Year ended December 31 France Scandinavia UK Other Europe China Japan Other Asia United States Canada North America Other $ $ $ $ $ $ 2018 171,373 120,235 88,387 70,951 51,656 42,026 24,291 23,327 592,246 2018 94,422 27,381 25,059 58,791 205,653 130,402 73,325 33,014 236,741 85,871 63,892 149,763 89 592,246 $ $ 2017 200,286 109,170 101,883 77,964 45,468 43,099 24,267 18,894 621,031 2017 108,650 28,606 14,921 91,463 243,640 102,315 79,631 34,170 216,116 86,813 73,888 160,701 574 621,031 (c) Non-current Assets by Geographic Region As at December 31 2018 2017 Property, plant and equipment, licences, fishing rights and goodwill Canada Argentina Scotland Other $ $ 306,565 $ 10,844 168,653 100 486,162 $ 327,432 18,984 169,362 304 516,082 96 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 23. RELATED PARTY TRANSACTIONS (a) Subsidiaries, partnerships, and joint venture Clearwater’s consolidated financial statements include the accounts of the Corporation and its material subsidiaries and a joint venture, as follows: Entity Adams and Knickle Limited Clearwater Fine Foods (Europe) Limited Clearwater Fine Foods (USA) Incorporated Clearwater Ocean Prawns Venture Clearwater Seafoods Holdings Incorporated Clearwater Seafoods Limited Partnership Glaciar Pesquera S.A. Macduff Shellfish Group Limited St. Anthony Seafoods Limited Partnership (b) Key management personnel Ownership % 50% 100% 100% 53.66% 100% 100% 86% 100% 75% Accounts Equity method Consolidated Consolidated Consolidated Consolidated Consolidated Consolidated Consolidated Consolidated Clearwater has defined key management personnel as senior executive officers, as well as the Board of Directors, as they have the collective authority and responsibility for planning, directing and controlling the activities of the Corporation. The following table outlines the total compensation expense for key management personnel for the years ended December 31, 2018 and 2017. Year ended December 31 Wages and salaries Share-based compensation Severance Other benefits $ $ 2018 2,835 966 - 198 3,999 $ $ 2017 3,623 (108) 1,624 364 5,503 (c) Transactions with other related parties Clearwater rents office space to and provides computer support network services to CFFI Ventures Inc. (“CVI”), a related party. The net amount due from CVI in respect of these transactions was nil (December 31, 2017 – $0.04 million). Any amounts outstanding are unsecured and due on demand. For the year ended December 31, 2018, Clearwater recorded net expense of approximately $0.2 million for providing computer support network services to and receiving goods and services from companies related to CVI (December 31, 2017 - net revenue of $0.06 million). The transactions are recorded at the exchange amount and the balance due from these companies was $0.1 million as at December 31, 2018 (December 31, 2017 - $0.07 million due to). 97 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 24. CAPITAL MANAGEMENT Clearwater’s objectives when managing capital are as follows: • Ensure liquidity • Minimize cost of capital • Support business functions and corporate strategy Clearwater’s capital structure includes a combination of equity and various types of debt facilities. Clearwater’s goal is to have a cost effective capital structure that supports its growth plans, while maintaining flexibility, reducing interest rate risk and reducing exchange risk by borrowing in currencies other than the Canadian dollar when appropriate. Clearwater uses leverage, in particular USD senior unsecured notes, revolving and term debt to lower its cost of capital. The amount of debt available to Clearwater under its lending facilities is a function of Net Adjusted EBITDA attributable to shareholders, as defined in the credit agreement. Net Adjusted EBITDA attributable to shareholders can be impacted by known and unknown risks, uncertainties, and other factors outside Clearwater’s control including, but not limited to, total allowable catch levels, selling prices, weather, exchange rates, fuel and other input costs. Clearwater maintains flexibility in its capital structure by regularly reviewing forecasts and multi-year business plans and making any required changes to its debt and equity facilities on a proactive basis. These changes can include early repayment of debt, issuing or repurchasing shares, issuing new debt, utilizing surplus cash, extending the term of existing debt facilities and, selling surplus assets to repay debt. 98 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) Clearwater’s capital structure was as follows as at December 31, 2018 and December 31, 2017: In 000's of Canadian dollars As at December 31 Equity Share capital Contributed surplus Deficit Accumulated other comprehensive income (loss) $ 2018 2017 215,506 $ 4,218 (38,848) (36,053) 144,823 18,397 163,220 333,955 58,019 13,637 3,500 409,111 34,177 112 34,289 16,504 3,513 463,417 210,860 3,021 (8,722) (39,730) 165,429 17,109 182,538 306,684 87,682 12,215 3,500 410,081 34,466 167 34,633 23,181 5,278 473,173 Non-controlling interest Long-term debt Senior debt, non-amortizing USD senior unsecured notes, due 20251 Revolving debt, due in 20222 Term loan, due in 2019 Term loan, due in 2091 Senior debt, amortizing Term Loan B, due 20223 Other loans Deferred obligation4 Earnout liability4 Total long-term debt Total capital $ 626,637 $ 655,711 1. USD senior unsecured notes is net of unamortized deferred financing charges of $7 million with a US dollar coupon rate of 6.875%. This resulted in an effective interest rate of approximately 7.2%. 2. The revolving debt is net of unamortized deferred financing charges of $2 million resulting in an effective interest rate of approximately 4.53%. As of December 31, 2018, subject to financial covenants, Clearwater may borrow up to an additional CDN $90.3 million on the undrawn facility. The availability on this loan is reduced by the amount outstanding on a USD $10 million non- amortizing term loan. 3. Term Loan B is net of unamortized deferred financing charges of $0.2 million. As of December 31, 2018, this resulted in an effective interest rate of approximately 4.46%. 4. The Deferred Obligation and Earnout Liability relate to the acquisition of Macduff in 2015. The Company’s share capital is discussed in Note 14 and long-term debt, including the Deferred Obligation and Earnout liability in Note 13. 25. CONTINGENT LIABILITIES From time to time Clearwater is subject to claims and lawsuits arising in the ordinary course of operations. In the opinion of management, the ultimate resolution of such pending legal proceedings will not have a material effect on Clearwater’s consolidated financial position. 99 | P a g e CLEARWATER SEAFOODS INCORPORATED Notes to the Consolidated Financial Statements (Tabular amounts are in thousands of Canadian dollars) 26. ADDITIONAL CASH FLOW INFORMATION Changes in non-cash operating working capital (excludes change in accrued interest) Decrease (increase) in inventory (Decrease) increase in accounts payable Decrease (increase) in accounts receivable Decrease (increase) in prepaids (Decrease) increase in income tax payable Changes in liabilities arising from financing activities Current and long-term debt - beginning of period Scheduled repayments of long-term debt Repayment of long-term credit facilities Repayment of revolving credit facility Net proceeds from long-term debt, net of financing costs Net proceeds from long-term credit facilities, net of financing costs Net proceeds from revolving credit facility, net of financing costs Realized foreign exchange on settlement of long-term debt Non-cash changes in long-term debt: Accretion of Term Loan B and Deferred Obligation Fair market value adjustment on embedded derivative Fair market value adjustment on earnout liability Amortization of deferred financing costs Write-off unamortized deferred financing costs Foreign exchange gain on long-term debt Current and long-term debt - end of period 2018 2017 8,021 (8,252) 18,574 (3,108) (5,536) 9,699 $ $ 2018 473,173 $ (10,652) - - - - (30,248) - - 1,720 - (623) 1,695 - 28,352 463,417 $ 12,615 9,369 (22,043) 188 2,928 3,057 2017 436,414 (11,953) (361,519) (52,400) 330,015 34,901 116,082 4,172 - (1,352) (694) (2,736) 7,384 1,477 (26,618) 473,173 $ $ $ $ 100 | P a g e Quarterly and share information Clearwater Seafoods Incorporated ($000's except per share amounts) Sales Earnings attributable to: Non-controlling interests Shareholders of Clearwater Per share data Basic net earnings (loss) Diluted net earnings (loss) Adjusted earnings (loss) Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 2018 2017 159,807 164,225 148,142 120,072 174,765 163,597 154,302 128,367 1,784 (12,340) (10,557) 4,440 10,818 15,258 (0.19) (0.19) 0.07 0.17 0.17 0.06 2,715 (924) 1,792 (0.01) (0.01) 0.11 3,559 (13,758) (10,199) 4,405 (10,957) (6,552) 4,526 15,055 19,581 2,503 9,489 11,992 (0.22) (0.22) 0.01 (0.17) (0.17) (0.02) 0.24 0.24 0.13 0.15 0.15 0.00 1,046 2,172 3,218 0.03 0.03 0.03 Trading information, Clearwater Seafoods Incorporated, symbol CLR Trading price range of shares (board lots) High Low Close Trading volumes (000's) Total Average daily Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 6.40 5.06 5.75 6.24 4.82 5.80 5.61 4.40 5.06 5.04 3.94 4.58 2,715 44 4,948 80 5,581 87 10,207 170 9.43 6.90 7.33 6,759 109 12.03 8.93 8.99 4,738 80 11.95 10.15 11.42 5,554 88 11.80 9.85 10.48 7,837 124 Shares outstanding at end of quarter 64,841,993 64,600,116 64,345,020 63,955,169 63,934,698 63,934,698 63,934,698 63,934,698 101 | P a g e Selected Annual Information Sales Costs of goods sold Gross margin Operating expenses Administrative and selling Restructuring Net finance costs Foreign exchange (gains) losses on long-term debt and working capital (Gains) losses on forward contracts Other income Research and development Gain on change of control of joint venture 2018 (Audited) 2017 (Audited) 2016 (Audited) 2015 (Audited) 2014 (Audited) $ 592,246 $ 485,409 621,031 $ 510,963 611,551 $ 466,930 504,945 $ 372,757 444,742 341,908 106,837 110,068 144,621 132,188 102,834 47,135 6,856 31,967 61,421 986 35,617 9,062 (14,262) 15,798 (3,739) 1,724 - (4,382) (7,576) 2,368 - 55,342 3,150 (5,209) 2,922 - - 68,579 49,480 1,883 444 1,981 - - 148,472 48,178 74 (5,031) 1,991 - - 87,088 Earnings before income taxes (1,966) 35,897 19,837 (70,072) (29,466) Income taxes expense (recovery) 1,740 28,238 59,596 (20,671) 9,797 Earnings before non-controlling interest (3,706) 28,238 59,596 (20,671) 9,797 Non-controlling interest 12,498 12,480 15,668 16,937 12,702 Earnings attributable to shareholders $ (16,204) $ 15,759 $ 43,928 $ (37,608) $ (2,905) 102 | P a g e CORPORATE INFORMATION HEAD OFFICE OF CLEARWATER SEAFOODS INCORPORATED 757 Bedford Highway Bedford, Nova Scotia B4A 3Z7 902-443-0550 DIRECTORS Colin E. MacDonald, Chairman of the Board John C. Risley Chairman and CEO, CFFI Ventures Inc. Larry Hood, Chair of Audit Committee Former Audit Partner, KPMG Jane Craighead, Chair of Human Resources Development and Compensation Committee Senior Vice President, Scotiabank Mickey MacDonald President, Micco Companies Brendan Paddick Chief Executive Officer, Columbus Capital Corporation Stan Spavold, Chair of Finance Committee President, CFFI Ventures Inc. Jim Dickson, Chair of Corporate Governance Committee Former Counsel, Stewart McKelvey Vicki McKibbon President of Transportation, Armour Transportation Systems, Inc Karl Smith Former Chief Financial Officer and Executive Vice President, Fortis Inc. EXECUTIVES Ian Smith Chief Executive Officer Teresa Fortney Vice-President, Finance and Chief Financial Officer Christine Penney Vice-President, Sustainability & Public Affairs Dieter Gautschi Vice-President, Global Human Resources Roy Cunningham Vice-President, Chief Operating Officer, Macduff Tony Jabbour Vice-President, Fleet Operations Darren Bowen Vice President, Global Supply Chain INVESTOR RELATIONS Investor relations (902) 443-0550 Investorinquiries@clearwater.ca AUDITORS KPMG LLP Halifax, Nova Scotia SHARES LISTED Toronto Stock Exchange SHARE Symbol: CLR TRANSFER AGENT Computershare Investor Services Inc. 103 | P a g e Clearwater Seafoods Incorporated 757 Bedford Highway, Bedford, Nova Scotia, Canada, B4A 3Z7 Tel. (902) 443-0550 Fax. (902) 443-7797 www.clearwater.ca 

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