Swiss Water Decaffeinated Coffee
Annual Report 2018

Plain-text annual report

SWP Q4 cover_Layout 1 19-03-18 8:04 AM Page 1 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) 2018 ANNUAL REPORT SWP Q4 cover_Layout 1 19-03-14 8:24 AM Page 2 Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 1 MANAGEMENT DISCUSSION AND ANALYSIS This Management’s Discussion & Analysis (“MD&A”) of Swiss Water Decaffeinated Coffee Inc. (“Swiss Water” or the “Company”), dated as of March 12, 2019, provides a review of the financial results for the three and year ended December 31, 2018 relative to the comparable periods of 2017. The three-month period represents the fourth quarter (“Q4”) of our 2018 fiscal year. This MD&A should be read in conjunction with Swiss Water’s audited consolidated financial statements for the year ended December 31, 2018, and in conjunction with the Annual Information Form which are available at www.sedar.com. All financial information is presented in Canadian dollars, unless otherwise specified. FORWARD-LOOKING STATEMENTS This MD&A contains forward-looking statements, including statements regarding the future success of our business and market opportunities. Forward-looking statements typically contain words such as “believes”, “expects”, “anticipates”, “continue”, “could”, “indicates”, “plans”, “will”, “intends”, “may”, “projects”, “schedule”, “would” or similar expressions suggesting future outcomes or events, although not all forward- looking statements contain these identifying words. Examples of such statements include, but are not limited to, statements concerning: (i) expectations regarding Swiss Water’s future success in various geographic markets; (ii) future financial results, including anticipated future sales and processing volumes; (iii) future dividends; (iv) the expected actions of the third parties described herein; (v) factors affecting the coffee market including supplies and commodity pricing; (vi) the expected cost to complete the production facility and production line currently under construction; and (vii) the business and financial outlook of Swiss Water. In addition, this MD&A contains financial outlook information that is intended to provide general guidance for readers based on our current estimates, but which is based on numerous assumptions and may prove to be incorrect. Therefore, such financial outlook information should not be relied upon by readers. These statements are neither promises nor guarantees but involve known and unknown risks and uncertainties that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed in or implied by these statements. These risks include, but are not limited to, risks related to processing volumes and sales growth, operating results, supply of coffee, supply of utilities, general industry conditions, commodity price risks, technology, competition, foreign exchange rates, construction timing, costs and financing of capital projects, general economic conditions and those factors described herein under the heading ‘Risks & Uncertainties’. The forward-looking statements contained herein are also based on assumptions that we believe are current and reasonable, including but not limited to, assumptions regarding: (i) trends in certain market segments and the economic climate generally; (ii) the financial strength of our customers; (iii) the value of the Canadian dollar versus the US dollar; (iv) the expected financial and operating performance of Swiss Water going forward; (v) the availability and expected terms and conditions of debt facilities; and (vi) the expected level of dividends payable to shareholders. We cannot assure readers that actual results will be consistent with the statements contained in this MD&A. The forward-looking statements and financial outlook information contained herein are made as of the date of this MD&A and are expressly qualified in their entirety by this cautionary statement. Except to the extent required by applicable securities law, Swiss Water undertakes no obligation to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those described herein. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 2 EXECUTIVE SUMMARY For the three months and year ended December 31, 2018, Swiss Water recorded higher processing volumes and revenues than during the same periods last year. We continued to gain market share against our competitors, increased our existing production capacities, and improved our operational efficiencies while remaining focused on producing high-quality premium decaffeinated coffee. To drive future growth, our plans include expanding our presence in Europe and increasing awareness of the Swiss Water brand by targeting specific customer groups in North America. A summary of our financial results is in the table below: In $000s except per share amounts (unaudited) Sales Gross Profit Operating income Net income EBITDA1 Net income - basic2 Net income - diluted2 3 months ended December 31, 2018 22,979 3,686 1,618 919 2,050 0.10 0.03 $ $ $ 3 months ended December 31, 2017 20,662 $ $ 3,178 958 (380) 1,334 (0.04) $ (0.04) $ $ $ Year ended December 31, 2018 89,939 14,921 5,631 4,531 7,745 0.50 0.35 $ $ $ Year ended December 31, 2017 83,755 12,590 4,812 4,160 6,923 0.46 0.42 1 EBITDA is defined in the ‘Non-IFRS Measures’ section of this MD&A and is a “Non-GAAP Financial Measure” as defined by CSA Staff Notice 52-306. 2 Per-share calculations are based on the weighted average number of shares outstanding during the periods. Operational highlights  Our total volumes shipped in the fourth quarter and for the year grew by 8% and 11% respectively compared to the same periods in 2017. Since the beginning of this year, we have continued to gain new business and win more business with existing customers. In 2018 our global reach extended to 56 different countries, and we exported volume to customers on every continent.  Shipments to roasters grew by 11% in the fourth quarter and for the year over 2017 levels. Shipments to importers remained flat in Q4 and increased by 11% for the year-to-date, compared to the same periods last year. The growth in roaster volumes reflects gains in market share, due in part to a reduction in global decaffeination capacity due to plant shutdowns by competitors in 2017 and in the summer of 2018.  Volumes shipped to our specialty accounts grew by 2% in the fourth quarter and by 11% in the year, compared to the same periods in 2017.  Shipments to our commercial accounts increased by 12% and 11% in the fourth quarter and for the year respectively when compared to the same periods last year.  As expected, our largest geographical market by volume in this year was the United States, followed by Canada, and other international markets. By dollar value, 51% of our sales were to customers located in the United States, 36% were to Canada, and the remaining 13% were to other countries. As we continue to expand our business in Europe, we anticipate revenues from our international markets will increase in both dollar and percentage terms. Financial highlights  Quarterly revenue increased by 11% over Q4 2017 to $23.0 million and revenue for the year improved by 7% to $89.9 million. The increases were due to growth in our processing volumes, partially offset by a lower coffee futures price (“NY’C’”) and fluctuations in the US dollar (“US$”) exchange rate. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 3  Gross profit for Q4 2018 was $3.7 million, or a margin of 16%. This represents a $0.4 million increase over Q4 2017, and a 1% increase in margin. Year-to-date gross profit improved to $14.9 million (or a margin of 17%), compared to $12.6 million (or a margin of 15%) during the same period last year. The improvement in our results is due to management’s efforts in continuing to increase processing volumes and ongoing efforts to control Swiss Water’s operating costs. These initiatives have helped offset the margin compression we recorded during the first half of this year. We continue to pursue margin maintenance and improvements initiatives, following a recent period of inflationary pressure on our cost base. We also continue to seek ways to reduce our variable and fixed costs, without sacrificing the quality of our product.  Operating expenses decreased by 7% to $2.1 million in the fourth quarter, and increased by 19% to $9.3 million for the year-to-date, compared to the same periods last year. In both periods, there were increases due to higher staffing and staff-related expenses, in addition to investment in advertising and consumer initiatives; however, in Q4 2018, the increase was offset by income tax credit for research and development. During 2018 we enhanced our sales and marketing capabilities ahead of the new production capacity we have coming online in 2019.  Operating income increased by $0.7 million, or 69%, to $1.6 million in the fourth quarter and by $0.8 million, or 17%, to $5.6 million for 2018.  Fourth quarter net income increased to $0.9 million, compared to a loss of $0.4 million in Q4 2017. The increase in net income is a result of increased gross profit, in addition to lower non-operating expenses related to the revaluation of an embedded derivative and risk management activities, partially offset by higher income tax expenses. Net income for the year-to-date was $4.5 million, compared to $4.2 million in the same period of 2017. The increase in net income is a result of improved gross profit of $2.3 million offset by increased operating expenses of $1.5 million, a loss on foreign exchange of $0.3 million and an increase in income tax expense of $0.1 million  EBITDA for Q4 was $2.0 million, up by $0.7 million, or 53%, over the same period last year. EBITDA for the year increased, from $6.9 million in 2017 to $7.7 million, or 12% in 2018. The increase is related to improved processing volumes, in addition to significant efforts across the company to enhance cost recovery. We will continue to invest in our production infrastructure and human resources to prepare for the significant growth we anticipate. AMALGAMATION On September 28, 2018, Swiss Water amalgamated and concurrently changed its corporate name from Ten Peaks Coffee Company Inc. to Swiss Water Decaffeinated Coffee Inc. The name change was undertaken in order to better leverage the considerable brand equity in the “Swiss Water” name, as well as the related trademarks and intellectual property of the Swiss Water® Process. Additionally, the new company’s simplified structure will allow for shareholders and potential investors to more readily associate the investment opportunity with our proprietary Swiss Water® Process, while modestly decreasing our future compliance costs. OUTLOOK Looking ahead, we expect to record a strong year-over-year increase in our annual volumes in 2019. During 2018, we saw growth in volumes shipped to roasters, importers, specialty and commercial accounts. This reflects the fact that we have won business with new roasters and increased business with existing customers who have grown their distribution, locations or expanded their product offerings. Some of our new business is from roasters who previously obtained their decaffeinated coffees from a decommissioned CO2 plant in Europe, while other account wins are related to the recent closure of a CO2 plant in Houston, Texas. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 4 We believe these plant closures have tightened the chemical free decaffeination coffee market and that the resulting drop in available decaffeination services will allow us to more rapidly utilize the additional production capacity we have coming online in 2019. Furthermore, in 2018 we have seen an acceleration of customers converting from chemical decaffeination to our chemical free process. Recognition of the Swiss Water brand continues to develop within our expanding portfolio of customers, and coffee consumers. We now export to 56 countries globally. We expect increased marketing and sales investments in 2019 to drive further gains in recognition and conversion going forward. Construction of our new Swiss Water® Process decaffeination facility, which is located in Delta, British Columbia, Canada, is progressing well. Initially, this facility will house one new production line, although the site is large enough to accommodate further expansion as momentum behind chemical free decaffeination accelerates. The new production line is expected to be commissioned in the fourth quarter of 2019. In anticipation of more immediate growth in demand, we completed an efficiency enhancement project in Q2 2018 to increase capacity at our current facility. These changes, together with the capacity that was added at the same facility in Q1 2016, are expected to be sufficient to meet anticipated growth in demand for our premium Swiss Water® Process coffees until the new production line is operational. Overall, we continue to gain market share, particularly in the premium decaffeination market. As a part of our ongoing evaluation of the Company’s cost structure and with the goal of increasing overall margins, we are reviewing cost recovery opportunities for both Swiss Water and its subsidiary, Seaforth Supply Chain Solutions Inc. (“Seaforth”). While Seaforth’s operating costs rose substantially in the first half of 2018, there has been an improvement in operating costs in the subsequent two quarters. The market for decaffeinated coffee continues to be strong. On a year-over-year basis, the growth rate of the decaffeinated coffee market has increased and continues to outpace growth in the US coffee market as a whole. We believe this is due, in part, to the premiumization of the coffee market, as well as growing awareness and consumption of premium decaffeinated coffee. Over the past 5 years the largest consumers of decaffeinated coffee are 18 to 24 year olds 1 . This demographic want to drink great-tasting coffee throughout the day without worrying about the potential side effects of excess caffeine. Younger consumers are more conscious of, and concerned about, artificial ingredients and chemicals in the production of their food and beverages. As a result, we have seen increased demand for our chemical free and sustainable Swiss Water® Process coffees, as more food companies now employ our branded coffees to help them respond to this growing consumer demand. Demand for organic coffee continues to grow and is the most broadly purchased certification: 39% of consumers say they are much more likely to buy coffee that is Certified Organic coffee, and 49% of consumers say they’re more likely to buy coffee if it is grown in an environmentally sustainable way. 1 Various media sources2 have recently underscored the health and environmental hazards associated with methylene chloride (the primary chemical used by our competitors to decaffeinate coffee). Additionally, multiple major retailers in the U.S. are banning paint strippers that contain methylene chloride. We believe 1 National Coffee Association 2018 Coffee Drinking Trends 2 New York Times has published (https://www.nytimes.com/2017/10/21/us/epa-toxic-chemicals.html) and podcasted https://www.nytimes.com/podcasts/the-daily?_r=0 a piece on EPA regulations, as the EPA is highlighting methylene chloride as a key chemical that isn’t, but should be, regulated, because it’s a hazard to people’s health. In 2018, New Scientist published a report (https://www.newscientist.com/article/2138753-ozone-layer-recovery-will-be-delayed-by-chemical-leaks/) about how methylene chloride is slowing the regeneration of the ozone layer. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 5 this rise in consumer awareness is helping to drive demand for our 100% chemical free coffees, and we will continue to proactively employ positive messaging to accentuate the benefits of our amazing coffees without caffeine. Over the near future, our primary focus will be to position Swiss Water to maintain our current growth momentum and enhance our operating margins. In January 2019, we completed the company registration for our European subsidiary. We believe that opening a European sales office will give us a solid footprint to better serve customers in the largest decaffeinated coffee market in the world. In addition, we are expanding our ability to target specific customer groups in the United States. Developing our European and US sales teams has and will continue to increase our expenses somewhat, but we expect these initiatives to generate increased sales orders in the longer term to drive major account wins. As converting large customers to Swiss Water® Process coffees typically takes several quarters, we believe strengthening our sales capability now is a critical part of our preparation to ramp up orders and win new business as we add significant capacity with our new facility in 2019. BUSINESS OVERVIEW Swiss Water is a premium green coffee decaffeinator located in Burnaby, BC. Swiss Water employs the proprietary Swiss Water® Process to decaffeinate green coffee without the use of chemicals, leveraging science-based systems and controls to produce coffee that is 99.9% caffeine free. It is certified organic by the Organic Crop Improvement Association and is the world’s only consumer-branded decaffeination process. Decaffeinating premium green coffee without the use of chemicals is our primary business. Seaforth provides a complete range of green coffee logistics services including devanning coffee received from origin; inspecting, weighing and sampling coffees; and storing, handling and preparing green coffee for outbound shipments. Seaforth provides all of Swiss Water’s local green coffee handling and storage services. In addition, Seaforth handles and stores coffees for several other coffee importers and brokers, and is the main green coffee handling and storage company in Metro Vancouver. Seaforth is organically certified by Ecocert Canada. Swiss Water’s shares trade on the Toronto Stock Exchange under the symbol ‘SWP’, formerly TPK. As at the date of this report 9,061,210 shares were issued and outstanding. Swiss Water’s Business We carry an inventory of premium-grade Arabica coffees that we purchase from the specialty green coffee trade, decaffeinate and then sell to our customers (our “regular” or “non-toll” business). Revenue from our regular business includes both processing revenue and green coffee cost recovery revenue. We also decaffeinate coffee owned by our customers for a processing fee under toll arrangements (our “toll” business). The value of the coffee processed under toll arrangements does not form part of our inventory, our revenue or our cost of sales. Revenue from toll arrangements consists entirely of processing revenue. Our cost of sales is comprised primarily of the cost of green coffee purchased for our regular business, plant labour and other processing costs directly associated with our production facility. This incorporates an allocation of fixed overhead costs, which includes depreciation of our production equipment and amortization of our proprietary process technology. For our regular business, we work with coffee importers to source premium-grade green coffees from coffee-producing countries located in Central and South America, Africa and Asia. The purchase price is based on the NY’C’ coffee futures price on the Intercontinental Exchange, plus a quality differential. The NY‘C’ component typically makes up more than 80% of the total cost of green coffee, Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 6 while the quality differential typically accounts for less than 20%. Both the NY‘C’ price and the quality differential fluctuate in response to fundamental commodity factors that affect supply and demand. KEY PERFORMANCE DRIVERS The following key performance drivers are critical to the successful implementation of our strategy and ability to improve profitability and cash from operations: External Factors  Coffee Futures Prices – We buy and sell coffees based on the NY’C’ plus the quality differentials for specified coffees, both of which rise and fall in response to changes in supply and demand. We manage our exposure to changes in the NY’C’ futures price on the value of our inventories through a commodity hedging program (discussed under ‘Hedge Accounting’ below), but cannot hedge our exposure to changes in quality differentials. In addition to the price risks associated with holding coffee inventories, our revenue and cost of sales are affected by changes in the underlying commodity price. Commodity price increases (decreases) raise (lower) the green coffee cost recovery revenue generated through our non-toll business, as well as the costs of green coffee sold to customers to generate sales. Changes in the NY’C’ also affect our statement of financial position, and the amount of working capital we use in our business. When coffee prices rise (fall), our inventory values gradually increase (decrease) as we replace coffee at higher prices. Our accounts receivable and our accounts payable also rise and fall with the NY’C’. Finally, there is no open market to hedge the quality differential component of our green coffee cost. We sell coffee at replacement quality differentials, and as such, in a period of falling (rising) differentials we will generate differential cost recovery losses (gains), as green coffee revenues will be less than (exceed) green coffee costs. The chart below shows the movement in the NY’C’ for the last eight quarters: NY'C' Close (U$/lb) IntercontinentalExchange December 31, 2016 to December 31, 2018 $1.70 $1.60 $1.50 $1.40 $1.30 $1.20 $1.10 $1.00 $0.90 6 1 - c e D - 1 3 7 1 - n a J - 1 3 7 1 - b e F - 8 2 7 1 - r a M - 1 3 7 1 - r p A - 0 3 7 1 - y a M - 1 3 7 1 - n u J - 0 3 7 1 - l u J - 1 3 7 1 - g u A - 1 3 7 1 - p e S - 0 3 7 1 - t c O - 1 3 7 1 - v o N - 0 3 7 1 - c e D - 1 3 8 1 - n a J - 1 3 8 1 - b e F - 8 2 8 1 - r a M - 1 3 8 1 - r p A - 0 3 8 1 - y a M - 1 3 8 1 - n u J - 0 3 8 1 - l u J - 1 3 8 1 - g u A - 1 3 8 1 - p e S - 0 3 8 1 - t c O - 1 3 8 1 - v o N - 0 3 8 1 - c e D - 1 3 Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 7 In Q4 2018, the NY’C’ averaged US$1.09/lb compared to an average of US$1.25/lb in Q4 2017. For 2018, the NY’C averaged US$1.12/lb, compared to US$1.33/lb for 2017. The rise and fall of the NY’C’ affects our volume of shipments, our revenues and our cost of sales. In an upward trending market, our customers tend to consume their inventories rather than build them. When the NY’C’ declines over a sustained period (as it has for the past 12 months), our customers tend to add to their inventories.  US$/C$ Exchange Rates – As noted above, the majority of our revenues are generated in US dollars, while a significant portion of our costs are paid in Canadian dollars. We therefore have exposure to changes in the US$/C$ exchange rates. This is managed, in part, through derivative financial instruments. All other factors being equal, our profitability and cash from operations will be higher when the US dollar appreciates relative to Canadian dollar. A long-term depreciation of the Canadian dollar will improve our long-term profitability and cash generation. The chart below illustrates the US dollar (“US$”) to Canadian dollar (“C$”) exchange rates for the last eight quarters: US Dollars to Canadian Dollars Bank of Canada Noon Rates December 31, 2016 to December 31, 2018 $1.40 $1.35 $1.30 $1.25 $1.20 6 1 - c e D - 1 3 7 1 - n a J - 1 3 7 1 - b e F - 8 2 7 1 - r a M - 1 3 7 1 - r p A - 0 3 7 1 - y a M - 1 3 7 1 - n u J - 0 3 7 1 - l u J - 1 3 7 1 - g u A - 1 3 7 1 - p e S - 0 3 7 1 - t c O - 1 3 7 1 - v o N - 0 3 7 1 - c e D - 1 3 8 1 - n a J - 1 3 8 1 - b e F - 8 2 8 1 - r a M - 1 3 8 1 - r p A - 0 3 8 1 - y a M - 1 3 8 1 - n u J - 0 3 8 1 - l u J - 1 3 8 1 - g u A - 1 3 8 1 - p e S - 0 3 8 1 - t c O - 1 3 8 1 - v o N - 0 3 8 1 - c e D - 1 3 In Q4 2018, the US$ averaged C$1.32, an increase of 3.9% over the same period in 2017. During the year, the US$ averaged C$1.2956, a decrease of 0.2% over the same period last year. During 2017, the US$ ranged between C$1.21 and C$1.37. In 2018, it ranged between C$1.23 and C$1.36. When the US$ depreciates (appreciates), it decreases (increases) our gross profit on green coffee revenues. Internal Factors  Sustainability and Environmental Responsibility – The Swiss Water® Process is a 100% chemical free Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 8 decaffeination process that enables us to consistently deliver high-quality coffee. Our approach to sustainability is to continually improve and innovate this process to be more efficient by actively managing resource usage in a safe and environmentally responsible manner. In addition to carefully managing our operations, we take steps to ensure sustainable coffee supply by purchasing sustainably certified coffees and organic coffees. We promote social sustainability by participating in programs within the coffee industry that advance the health of women and their families living in coffee-growing communities (Grounds for Health) and that foster research-based approaches to advancing coffee cultivation (World Coffee Research).  Processing Volumes – Our decaffeination facility generates a certain level of fixed operating costs that are incurred regardless of the volume of coffee processed. Accordingly, our profitability and cash from operations will increase as processing volumes increase. Processing volume is a key performance indicator (“KPI”) that we monitor continuously.  Process Consistency – We manage our operations in order to reduce variability in production and drive continuous improvement. Production consistency results in improved product quality. We have developed a number of KPIs designed to monitor process consistency, and have set targets for continuous process improvement.  Product Quality – Quality control is a key part of our operations. We operate under the Food Safety Systems Certification (FSSC) 22000, which manages our food safety, as well as HACCP (Hazard Analysis Critical Control Points) and quality assurance programs. All green coffees delivered to our processing facility are weighed and inspected and are subject to rigorous internal quality-control evaluations. Each lot of green coffee processed is monitored throughout the decaffeination process, and a certificate of analysis is prepared for each lot. A sample from each production lot is also roasted, brewed and cupped to ensure quality. In addition, our focus on reducing the size of production lots and increasing inventory turnover results in fresher coffee being provided to our customers. Production batch size and inventory turns are two other KPIs that we monitor regularly.  Order Fulfillment – Our integrated supply chain management strategy includes maintaining inventories of finished goods at various coffee warehouses throughout North America, and of raw goods for improved inventory replenishment times. Our order fulfillment rates are monitored regularly. An improved order fulfillment rate has contributed to our volume growth and improved customer service levels.  Employee Safety – We are focused on operating our business in a safe manner, and reducing the likelihood that employees will be injured at work. We track employee safety metrics by department, and our safety committee proactively seeks ways to reduce the risks inherent in our operating environment. While we cannot completely eliminate workplace incidents or accidents, we have significantly reduced the number of safety-related incidents over the past few years. We are proud of the fact that SWDCC has not had a lost-time incident in more than four years. We believe that ensuring employee safety leads to improved employee retention and morale, increased efficiency and lower operating costs. CAPACITY TO DELIVER RESULTS The following resources allow us to deliver on our business strategy:  Proprietary Chemical Free Production Lines – We have two decaffeination production lines. This enables us to align our production capacity with changes in demand throughout the year. We operate Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 9 one line when demand is lower, and both lines when demand is higher, giving us better control over our variable costs. As discussed above, we completed an efficiency enhancement project in Q2 2018 to increase capacity at our current operating facility and in 2016, we expanded the capacity of one of our production lines, which enables us to meet near-term growth in demand for our products. Construction of the new facility in Delta is expected to be complete by the fourth quarter of 2019 which will enable us to meet our long term growth ambition.  Consumer Branding as the Premium, 100% Chemical Free Method of Decaffeinating Green Coffee – We have been successful in establishing our brand as a leading chemical free processor of green decaffeinated coffee. Consumers and participants in the coffee trade are increasingly aware of the value of the chemical free Swiss Water® Process due to its quality and taste. We believe that there is significant potential to continue to broaden consumer awareness of the benefits of the Swiss Water® Process.  Established Customer Base - The Swiss Water® Process has an established customer base across North America and in many international markets. Our customers include some of North America’s largest roasters, roaster-retailers and leading coffee brands.  Broad Distribution Channels - Green coffee decaffeinated using the Swiss Water® Process is sold through the coffee market’s key distribution channels: roaster retailers, commercial roasters and coffee importers. This diversity ensures that we access all key segments of the specialty coffee trade and consumer coffee markets.  Working Capital and Expansion Capital –In 2015, 2016 and 2018, we raised equity and debt which is being used to fund the construction of our third production line (to be housed in the new production facility noted above). In 2019, we will continue to revisit our budgets and financing strategy to ensure that we have sufficient funds to execute on our business strategy. We expect to utilize internally generated and external funds to finance the capital costs associated with the new production facility and future growth.  Management Expertise – Swiss Water is highly regarded in the coffee industry for our senior management team’s substantial experience, our close attention to consumer trends in the specialty coffee market, and our in-depth knowledge of green and roasted coffee. In particular, our intense focus on premium product quality and commitment to science-driven insight is well recognized. To maximize these strengths, we have invested significant resources in enhancing our team’s industry- related skills and talents over the past few years. Going forward, we intend to leverage our exceptional experience with, and knowledge of, the specialty coffee industry to continue to build our business. OPERATING RESULTS Revenue We categorize our customers by the nature of their business: either coffee importers or roasters. Coffee importers act like grocery stores to roasters, sourcing and importing green coffee from various origins and carrying a selection of different origins and quality levels for roasters to choose from. Importers buy from us in order to resell our coffees to roasters when and where they need it. Roasters are in the business of roasting and packaging coffee for sale to consumers in their own coffee shops, or for home or office use. Roasters either buy directly from us, or they buy from an importer. Roasters generally carry lower inventories, as they tend to take delivery of green coffee shortly before roasting it. As such, shipments to roasters are more stable from period to period than those to importers. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 10 We also monitor and report our revenue in three categories. “Process revenue” represents the amount we charge our customers for decaffeinating green coffee, and it generally increases as our processing volumes increase. “Green coffee cost recovery revenue”, or “green revenue”, is the amount we charge our customers for the green coffee we purchase for decaffeination. “Distribution revenue” consists of shipping, handling and warehousing charges billed to our customers. It typically rises with our processing volumes and with the growth of Seaforth’s business. Our revenue by category for the indicated periods was: (In $000s) (unaudited) Process revenue Green revenue Distribution revenue 3 months ended December 31 2017 5,652 $ 2018 5,974 $ $ 15,406 1,599 13,800 1,210 Year ended December 31 2017 21,781 57,177 4,797 2018 23,894 $ 60,197 5,848 $ 22,979 $ 20,662 $ 89,939 $ 83,755 For the quarter ended December 31, 2018 sales totaled $23.0 million, an increase $2.3 million, or 11%, compared to the same quarter in 2017. The increases in our fourth quarter sales by category reflect an increase in our processing volumes:  Process revenue increased by $0.3 million, or 6%  Green revenue increased by $1.6 million, or 12%  Distribution revenue rose by $0.4 million, or 32% Sales for 2018 totaled $89.9 million, an increase of $6.2 million, or 7%, over the same period last year. The increases in our annual sales by category reflect an increase in our processing volumes:  Process revenue increased by $2.1 million, or 10%  Green revenue increased by $3.0 million, or 5%  Distribution revenue rose by $1.1 million, or 22% Cost of Sales Cost of sales includes the cost of green coffee purchased for our regular business, the plant labour and other processing costs directly associated with our production facility, customer-specific hedges and commodity hedges. Cost of sales incorporates an allocation of fixed overhead costs, which includes depreciation of our production equipment and amortization of our proprietary process technology. In addition, cost of sales includes the costs of operating Seaforth’s warehouses. Our fourth quarter cost of sales increased by $1.8 million, or 10%, to $19.3 million this year, compared to the same period in 2017. For 2018, our cost of sales was $75.0 million, up by $3.9 million, or 5%, over the same period last year. The increase for the year-to-date is consistent with our increased business activities during the periods. While higher freight charges and variable production costs associated with the significant growth in our volumes accounted for some of the increase, green coffee costs, which is a significant portion of our cost of sales, also increased. In the fourth quarter of 2018, we also absorbed higher gas cost as there was a pipeline explosion in October 2018 in Northern British Columbia which significantly reduced the supply of gas. Our average gas cost per month was approximately three times higher in the fourth quarter versus the first nine months of 2018. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 11 Swings in the US$/C$ exchange rate can create negative margins on green coffee revenue between the time we bring green coffee into inventory and the time it is sold. Gross Profit Gross profit increased by 16% to $3.7 million for the fourth quarter of this year, as higher revenues more than offset the increases in our cost of sales. Gross profit for 2018 increased by 19% to $14.9 million, compared to the same period last year. The improvements are largely related to efforts by management to proactively review Swiss Water’s cost structure and improve Swiss Water’s margin by leveraging enhanced cost recovery, without sacrificing the quality of our coffee. Administration Expenses Administration includes general management, inbound and outbound logistics, finance and accounting, quality control and assurance, engineering, research and development, and other administrative or support functions. Administration expenses include compensation expenses, travel and other personnel-related expenses for administrative staff, directors’ fees, investor relations expenses, professional fees, depreciation of office-related equipment, and amortization of the brand asset. Administration expenses for Q4 2018 totaled $0.9 million. This was a decrease of $0.6 million, or 39%, compared to the same period last year. Approximately $0.4 million of the decrease related to an income tax credit from the Canada Revenue Agency for conducting research and development. Administration expenses for 2018 increased by 6% to $5.4 million. The increase largely reflects costs incurred to support strategic growth initiatives for 2018, including staffing and employee-related expenses and recruitment expenses to establish and expand our teams in Europe and the United States to support our growth momentum. Sales and Marketing Expenses Sales and marketing expenses include compensation and other personnel-related expenses for sales and marketing staff, consumer and trade advertising and promotion costs, as well as related travel expenses. We differentiate ourselves from other decaffeinators by investing in research regarding the behavior of decaffeinated coffee consumers. This research enables us to create effective consumer advertising and promotion, and is the cornerstone of our focused marketing strategy and activities, and of the consultative services it provides to our customers. We also aim to grow brand awareness with both the coffee trade and consumers. We employ a range of marketing activity to achieve this, including digital and print advertising, social media communications and trade show exhibiting and sponsorship at key industry events. Sales and marketing expenses were up by $0.4 million, or 55%, to $1.1 million in Q4 2018 and by $1.2 million, or 47%, to $3.8 million during the year. The increases are due to our expansion into Europe and United States, and higher investment in brand awareness activities, in support of our strategic growth initiatives. Occupancy Expenses Occupancy expenses include the cost of renting offices for sales, marketing and administrative use. Occupancy costs for the fourth quarter and 2018 were largely unchanged from the prior year. Finance Expenses and Income Finance income reflects the charges we bill to customers for financing coffee inventories and interest earned on cash balances and short-term investments. Finance expenses include interest costs on bank debt, other borrowings and the interest expense on the convertible debenture and construction loan. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 12 Net finance expenses were $0.2 million and $0.9 million for the three months and year ended December 31, 2018, respectively, compared to net finance expense of $0.2 million and $0.8 million in the same periods last year. Interest on the convertible debenture is expensed at an effective interest rate of 12.15% (a rate determined by management in accordance with IFRS), while the contractual interest paid on this loan is at a rate of 6.85%. Due to this difference, the amortization of the bond discount changes over time, which resulted in a slightly higher interest expense in Q4 2018 compared to the same period a year ago. Gains and Losses on Risk Management Activities Under hedge accounting, gains or losses on designated hedges are included in either revenue or cost of sales, held on the balance sheet or included in other comprehensive income for future transactions (see ‘Hedge Accounting’, below). Thus, ‘Gain on risk management activities’ includes only those gains and losses on derivative financial instruments or portions of such instruments that are not designated as hedging instruments. For the three months ended December 31, 2018, we recorded a loss of $0.6 million, compared to a gain of $0.4 million for the same period in 2017. A slight loss of $0.01 million was reported for the year, compared to a gain of $1.2 million in 2017. Fair Value Adjustment on Embedded Option Swiss Water entered into a convertible debenture in October 2016. Under IFRS, this instrument is deemed to contain an embedded option which must be revalued at each balance sheet date. The fair value of the derivative liability was determined using the Black-Scholes Option Pricing Model. The variables and assumptions used in computing the fair value are based on management’s best estimate at each balance sheet date. The revaluation on this embedded option resulted in a gain of $0.8 million in the fourth quarter of 2018 and a gain of $1.8 million for the year-to-date, compared to a loss of $0.3 million and a gain of $0.6 million, respectively, in the same periods of last year. Gains and Losses on Foreign Exchange We realize gains and losses on transactions denominated in foreign currencies when they occur, and on assets and liabilities denominated in foreign currencies when they are translated into Canadian dollars as at the financial statement date. For the three months ended December 31, 2018, we recorded no effective net foreign exchange gain or loss, compared to a loss of $0.8 million for the same period in 2017. A loss of $0.3 million was reported for 2018, compared to no effective net foreign exchange gain or loss in 2017. Income Before Taxes and Net Income In the fourth quarter of 2018, we recorded income before taxes of $1.6 million, compared to $0.1 million in the same period last year. Current and deferred income taxes reduced our net income by $0.7 million for the quarter, compared to $0.5 million in Q4 2017. Deferred income taxes arise mainly from temporary differences between the depreciation and amortization expenses deducted for accounting purposes, and the capital cost allowances deducted for tax purposes, as well as changes in corporate income tax rates as adjusted for substantively enacted higher future tax rates. The latter are offset by the tax benefit of loss carry forwards recognized. Overall, we recorded net income of $0.9 million for the fourth quarter, compared to a loss of $0.4 million for the same period last year. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 13 For the year-to-date, we recorded pre-tax income of $6.2 million, up from $5.8 million in 2017. This was reduced by income tax expenses of $1.7 million, compared to income taxes of $1.6 million in the same period last year. Overall, we recorded annual net income of $4.5 million, compared to $4.2 million a year ago. Basic and Diluted Earnings per Share Basic earnings per share is calculated by dividing net income by the basic weighted average number of shares outstanding during the period. Similarly, diluted earnings per share is calculated by dividing net income adjusted for the effects of all dilutive potential common shares, by the diluted weighted average number of shares outstanding. For the purposes of the calculation, under IFRS we are required to assume that the maximum number of shares issuable under the convertible debenture will be issued, even though the debenture contains a net share settlement provision (which, if exercised, would result in far fewer shares being issued). In the fourth quarters and years of 2018 and 2017, the potential common shares issuable under the Restricted Share Unit (“RSU”) Plan are anti-dilutive, and as such they are excluded from the calculation of diluted earnings per share in the quarter. The calculations of basic and diluted earnings per share for the current and prior periods are shown in the following table: (In $000s except for per share amounts) (unaudited) 3 months ended December 31 2017 2018 Year ended December 31 2017 2018 Basic EPS Net income attributable to shareholders Weighted average number of shares Basic EPS Diluted EPS Net income attributable to shareholders Interest on convertible debenture Loss (gain) on fair value adjustment of embedded option Net income after effect of diluted securities Weighted average number of shares – basic Effect of diluted securities: convertible debenture Weighted average number of shares - diluted Diluted EPS Other Comprehensive Income $ $ $ $ 919 9,061,210 0.10 919 272 (813) 378 9,061,210 1,818,182 10,879,392 0.03 $ $ $ $ (380) 9,038,862 (0.04) (380) - - (380) 9,038,862 - 9,038,862 (0.04) $ $ $ $ 4,531 $ 9,058,149 0.50 $ 4,160 9,038,862 0.46 4,531 1,063 (1,799) 3,795 $ 9,058,149 1,818,182 10,876,331 0.35 $ 4,160 1,035 (604) 4,591 9,038,862 1,818,182 10,857,044 0.42 Gains or losses on our designated revenue hedges that will mature in future periods are recorded in other comprehensive income, net of income tax expense. Other comprehensive loss, net of tax, for the fourth quarter of 2018 was $2.6 million, compared to $0.3 million in the same period last year. Other comprehensive loss, net of tax, for the year-to-date was a loss of $4.0 million, compared to income of $1.1 million in the same period of 2017. The increase and decreases are related to the fluctuations in the value of the Canadian dollar versus the US dollar. NON-IFRS MEASURES EBITDA EBITDA is often used by publicly traded companies as a measure of cash from operations, as it excludes financing costs, taxation and non-cash items. The reporting of EBITDA is intended to assist readers in the Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 14 performance of their own financial analysis. However, since this measure does not have a standardized meaning prescribed by IFRS, it is unlikely to be comparable to similar measures presented by other entities. We define EBITDA as net income before interest, depreciation, amortization, impairments, share-based compensation, gains/losses on foreign exchange, gains/losses on disposal of capital equipment, fair value adjustments on embedded options, and provision for income taxes. Our definition of EBITDA also excludes unrealized gains and losses on the undesignated portion of foreign exchange forward contracts. The reconciliation of net income to EBITDA is as follows: (In $000s) (unaudited) 3 months ended December 31 2017 2018 Income for the period Income taxes Income before tax Finance income Finance expenses Depreciation & amortization Unrealized loss (gain) on foreign exchange forward contracts Fair value (gain) loss on embedded option (Gain) loss of foreign exchange Share-based compensation EBITDA $ $ $ 919 718 1,637 (143) 373 426 626 (813) (38) (18) 2,050 $ $ $ (380) 454 74 (174) 368 583 (679) 305 751 106 1,334 $ $ $ Year ended December 31 2018 4,531 $ 1,689 6,220 $ (530) 1,457 1,689 188 (1,799) 278 242 7,745 $ 2017 4,160 1,606 5,766 (580) 1,414 2,172 (1,462) (604) 6 211 6,923 In order to help readers better understand our financial results, the following table shows the reconciliation of operating income to EBITDA: (In $000s) (unaudited) Operating income for the period Add back: Depreciation & amortization Share-based compensation (Gain) loss on risk management activities Deduct: Unrealized loss (gain) on foreign exchange forward contracts EBITDA 3 months ended December 31 2017 2018 Year ended December 31 2017 2018 $ 1,618 $ 958 $ 5,631 $ 4,812 426 (18) (602) 583 106 366 1,689 242 (5) 2,172 211 1,190 626 2,050 $ (679) 1,334 $ 188 7,745 $ (1,462) 6,923 $ EBITDA for the three months ended December 31, 2018 was $2.0 million, up by 53% compared to Q4 2017. For the year, EBITDA increased by 12% to $7.7 million, compared to the same period in 2017. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 15 SELECTED ANNUAL INFORMATION (In $000s except per share amounts) (unaudited) Balance Sheet Total assets Total long-term liabilities Income Statement Sales EBITDA(1) Net income Dividends paid Per share, basic(2) EBITDA(1) Net income Dividends paid Per share, diluted(2) EBITDA(1) Net income December 31, 2018 December 31, 2017 December 31, 2016 86,881 27,284 89,939 7,745 4,531 2,262 0.85 0.50 0.25 0.71 0.35 72,848 19,497 83,755 6,923 4,160 2,260 0.77 0.46 0.25 0.64 0.42 67,899 17,733 81,927 5,772 4,149 2,256 0.64 0.46 0.25 0.63 0.46 (1) EBITDA is defined in the section ‘Non-IFRS Financial Measures’ along with details of its calculation. (2) Per-share calculations are based on the weighted average number of shares outstanding during the period. Our total assets and our total liabilities have increased in each of the last two years following an equity offering in 2015 and a convertible debenture offering in 2016. Proceeds from the equity offering in 2015 were used to increase the capacity of one production line in 2016, resulting in an increase in fixed assets, and repayment of short-term debt. Proceeds from the debt and equity offerings are also being used to construct a new production line, which will be housed in a new production facility that is currently under construction (see ‘Outlook’ section, above). QUARTERLY INFORMATION / SEASONALITY The following table summarizes results for each of the eight most recently completed fiscal quarters. For comparative purposes, we have also provided the averages for the previous 8-quarter period: In $000s except for per share amounts (unaudited) Sales Gross Profit Operating income EBITDA1 Net income (loss) Per Share2 8 Quarter Average Q4 2018 Q3 2018 Q2 2018 Q1 2018 Q4 2017 Q3 2017 Q2 2017 Q1 2017 21,712 22,979 23,087 22,658 21,215 20,662 21,955 21,915 19,223 3,439 1,305 1,833 1,086 3,686 1,618 2,050 919 4,439 1,927 2,717 1,828 0.20 0.18 3,952 1,528 1,868 1,294 0.14 0.10 2,842 555 1,106 489 3,178 958 1,334 (380) 0.05 0.03 (0.04) (0.04) 3,014 1,117 1,678 1,385 0.15 0.15 3,364 1,470 2,235 1,720 0.19 0.17 3,035 1,267 1,677 1,435 0.16 0.08 Net income (loss) - basic Net income (loss) - diluted 0.12 0.09 0.10 0.03 1 EBITDA is defined in the section on ‘Non-IFRS Financial Measures’ along with details of its calculation. 2 Per-share calculations are based on the weighted average number of shares outstanding during the period. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 16 LIQUIDITY AND CAPITAL RESOURCES Operating activities For the three months and year ended December 31, 2018, we generated $2.5 million and $5.7 million, respectively, in net cash from operating activities, compared to using $1.3 million and generating $1.7 million in the same periods last year. Inventory Our inventory decreased in value by 6% and decreased in volume by 5% between December 31, 2017 and December 31, 2018. The decreases reflect a lower NY’C in the current year, as well as a decrease in volume in both finished goods and raw materials inventory. Under hedge accounting, gains/losses on derivative instruments for coffee to be sold in future periods are recorded in inventory. The hedge accounting component of inventory as at December 31, 2018 was a loss of $0.6 million, compared to a minor gain 2017. Accounts Receivable Our accounts receivable increased by $2.2 million, or 18%, between December 31, 2017 and December 31, 2018, compared to an increase of $0.4 million, or 4%, between December 31, 2016 and December 31, 2017. Investing Activities Cash outflows in investing activities for Q4 2018 were $10.7 million, compared to cash inflows of $8.8 million in Q4 2017. Cash outflows in investing activities for 2018 were $14.2 million, compared to cash outflows of $2.5 million in the same period last year. In Q4 and 2018, our cash outflows for capital expenditures were $10.7 million and $21.3 million, which related to our plant expansion in Delta, British Columbia. This compares to cash outflows for capital expenditures of $3.0 million in Q4 2017 and $8.1 million during 2017, which also related to our expansion plans. In Q3 2017, $11.1 million was placed into short-term investments but no similar investments occurred in the same period of 2018. Financing Activities During the year ended December 31, 2018, we paid $2.3 million in dividends to shareholders. This is unchanged from the same period in 2017. In Q4 2018, the Company received proceeds for a term loan of $9.4 million from the Business Development Bank of Canada (“BDC”). Credit Facilities and Liquidity Our current credit facilities include a $14.5 million revolving operating line of credit and a $1.5 million revolving swing line, each of which bears an interest rate of prime plus 0.75%. Any US$-denominated debt under the revolving operating line of credit or swing line can be financed using LIBOR loans at the LIBOR rate plus 2.35% per annum. In addition, we have a US$8.0 million foreign exchange and commodity futures contract facility. This allows us to enter into spot, forward and other foreign exchange rate transactions with our bank with a maximum term of 60 months. Our credit facilities are collateralized by a general security agreement and first security over present and after- acquired personal property and second security over existing and new machinery and equipment and a floating hypothecation agreement over cash balances. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 17 We have certain bank covenants which relate to the maintenance of specified financial ratios and we were in compliance with all covenants as at December 31, 2018. BDC Loan In Q4 2018, the Company completed a transaction with the Business Development Bank of Canada (“BDC”) for a term loan facility (“Term Loan”) of up to $20.0 million. The purpose of the Term Loan is to assist in the financing of new equipment for the facility being built in Delta, British Columbia. The Term Loan bears interest at 4.95% per annum over twelve years with principal repayment commencing on September 1, 2020. The Term Loan matures on August 1, 2032. Interest only will be paid on the outstanding balance on a monthly basis prior to September 1, 2020. The Term loan is secured by a general security agreement and a first security interest on all existing equipment and machinery plus new equipment and machinery financed with the Term Loan. Seaforth has provided a guarantee for the Term Loan. As of December 31, 2018, the loan amount outstanding was $9.4 million with interest accrued of $0.02 million. The interest has been capitalized during the construction phase. Contractual Obligations The following table sets forth our contractual obligations and commitments as at December 31, 2018: (In $000s) (unaudited) Long-term debt(1) Operating leases(2) Purchase obligations(3) Total $ 24,400 8,451 119 $ Less than 1 year - 2,702 $ 119 2-3 years 1,044 3,176 - $ 32,970 Total contractual obligations $ 1 Long-term debt represents the principal amounts of the convertible debenture and construction loan. 2 Minimum obligations for our operating leases. 3 Represents outstanding coffee and natural gas purchase commitments. 2,821 4,220 $ $ $ 4-5 years 1,567 2,573 $ Over 5 years 21,789 - - - 4,140 $ 21,789 Swiss Water leases a facility which houses its decaffeination plant and offices. The current lease term expires in 2023. Seaforth leases warehouses in two locations for its primary operations. These leases expire in June 2019 and November 2019. Swiss Water Decaffeinated Coffee Company USA, Inc. holds a lease for its Seattle, Washington, USA sales office, which expires on March 2020. In 2016, Swiss Water signed a lease agreement for a build-to-suit production facility. The lease has an initial term of five years and can be renewed at Swiss Water’s option in five-year increments up to a total of 30 years. The lease commenced in July 2018. Under the lease, Swiss Water has multiple options to buy-out the lease starting at the end of the second five-year term. The buy-out value will be equal to the fair market value of the property as determined by an appraisal process, subject to specified maximum and minimum values. The lease also includes a construction management agreement for the construction of a highly specialized building to house the production plant. The landlord agreed to finance a portion of the building, with loan payments commencing on the earlier of substantial completion of construction and January 1, 2019. During 2017, the Company accrued $0.8 million for the construction loan. As of December 31, 2018, the Company repaid the construction loan and interest of $6.1 million and $0.1 million respectively. The interest was capitalized as it is in the construction phase. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 18 As at December 31, 2018, our estimated costs to complete the production line and facility located in Delta, BC are $23.9 million. This amount includes costs for the production line, the construction of the specialized portion of the facility which will house the production equipment, leasehold improvements, and ancillary costs necessary to bring the production line into productive use. This is expected to be funded through cash on hand, working capital or other debt facilities, a construction loan, and cash from operations. OFF-BALANCE SHEET ARRANGEMENTS Swiss Water has no off-balance sheet arrangements. RELATED PARTY TRANSACTIONS We provide toll decaffeination services and/or sell finished goods to, and purchase raw material inventory from, a company that is related to one of Swiss Water’s Directors, Roland Veit. The following table summarizes related party sales and purchases during the periods: (In $000s) (unaudited) Income for the period Purchases of raw materials Year ended December 31 2018 2017 $ $ 393 $ 5,957 $ 303 6,934 All transactions were in the normal course of operations and were measured at the fair value of the consideration received or receivable, which was established and agreed to by the related parties. As at December 31, 2018, our accounts receivable balance with this company was $0.01 million (December 31, 2017: $0.02 million) while our accounts payable balance with this company was $0.3 (December 31, 2017: $nil). On March 16, 2017, a subsidiary of Swiss Water and a member of Key Management (the borrower) entered into a promissory note in the amount of US$0.1 million. For as long as the borrower remains an employee, the obligation to repay the principal is forgiven against current and future awards under the RSU Plan, by forfeiture of awards. The loan is interest-free other than in the event of default, in which case the promissory note shall bear simple interest at a rate of 10% per annum. RISKS AND UNCERTAINTIES Swiss Water’s ability to pay dividends is dependent upon the earnings and cash flow generated from the Company’s operations, as well as our current and planned future investments in capital equipment. Cash from operations may fluctuate with the performance of the business, which can be susceptible to a number of risks. These risks may include, but are not limited to, foreign exchange fluctuations, labour relations, coffee prices (notwithstanding hedging programs, as exact hedging correlation is not attainable), the availability of coffee, competition from existing chemical and other natural or chemical free coffee decaffeinators, competition from new entrants with alternate processing methods or agricultural technologies, environmental and regulatory risks, terms of credit agreements, commodity futures losses, ability to maintain organic certification, adequacy of insurance, risks related to information technology, dependence on key personnel, product liability, uncollectable debts, and general economic downturns. The future effect of these risks and uncertainties cannot be quantified or predicted. In addition, Swiss Water leases the building that houses two decaffeination lines. The option to renew this lease for an additional five-year term has been exercised, with the new lease term expiring in 2023. The lease also provides for an additional five-year renewal term (to 2028), subject to the express approval of the landlord. Any plans to relocate the production equipment would result in significant capital expenditures and the payment of the asset retirement obligation (currently recorded as a long-term liability on our financial statements). Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 19 ENVIRONMENTAL RISKS The Canadian Securities Administrators (“CSA”) identifies five categories of risks: litigation, physical, regulatory, reputational and business model, for which issuers are asked to identify material risks and if they are reasonably likely to affect financial statements in the future. Environmental matters relate to a broad range of issues, including those related to air, water, waste and land. As a small company with limited human and financial resources, we focus on only those risks that we believe could have a materially adverse impact on our operations and/or financial results within our planning horizon, rather than seeking to identify all possible future risks. Risk assessment involves judgment, uncertainty and estimates, which can provide only reasonable, rather than absolute, assurance that all the applicable risks and their expected impacts on Ten Peaks are considered. The most pervasive environmental risks that we face relate to the fact that we buy, sell and store an agricultural commodity. The supply of green coffee can be impacted by numerous environmental conditions such as frosts, drought, plant disease and insect damage, which can impact the quality and size of the coffee crop. In addition, certain environmental conditions, such as excessive rains, can hamper crop harvesting. A shortage of coffee can impact our processing volumes and revenues. We seek to mitigate the risks of coffee shortages by maintaining an extensive list of coffee suppliers; by dealing with importers who themselves have multiple suppliers rather than contracting directly with farmers or coffee co-operative organizations; by maintaining up to three months of coffee inventories at any time; by developing and modifying coffee blends that take into consideration coffee availability and cost from various coffee origins; and, by entering into purchase contracts with suppliers for future delivery of coffee (rather than relying on ‘spot’ deliveries). In addition, the coffee commodity price is closely tied to available supplies of coffee globally. We mitigate the commodity price risk through our commodity price risk management policy. Our leased facilities are located in the Metro Vancouver area of British Columbia. Vancouver is considered to be at high risk of a major earthquake. Any significant earthquake in the vicinity could have a material impact on our operations for a period of time, depending on the extent of the damage to the facilities, our equipment, and the transportation infrastructure in the region. In short, a major earthquake could have a material adverse impact on our revenues. We carry property and business interruption insurance, including earthquake coverage, which would help offset the cash flow impact of such an event. In addition, we keep some finished goods inventory in third-party coffee warehouses in other regions, and we would be able to sell these finished goods even if our production and distribution of coffee were temporarily interrupted by an earthquake. Nevertheless, the financial and operational impact of a major earthquake cannot be reasonably predicted. We are subject to a number of environmental laws and regulations related to our facilities in British Columbia, which mandate, among other things, the maintenance of air and water quality. We routinely monitor our compliance with these standards. Based on our compliance record and our maintenance programs, as well as currently enacted laws and regulations, we do not believe that these regulatory risks are material. We expect to incur increased costs for energy and water consumption over time. If we cannot pass on such increased costs to our customers, our profitability may be adversely impacted. We believe that all known environmental obligations and provisions have been appropriately reflected in our financial statements. We have not identified any material litigation, reputational, or business model risks related to environmental matters. Nevertheless, we may be subject to potential unknown or unforeseeable environmental impacts arising from, or related to, our business. Costs associated with such issues could be material. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 20 We believe that the trend toward increased environmental awareness creates an opportunity for us to grow our business, as consumers and coffee industry participants place greater emphasis on reducing their impact on the environment. As one of the few chemical free decaffeinators in the world, we believe that an increased focus on environmental matters will allow us to win more business away from decaffeinators that use chemicals such as methylene chloride to decaffeinate coffee. CRITICAL ACCOUNTING JUDGMENTS AND ESTIMATES Measurement Uncertainty The preparation of financial statements in accordance with IFRS requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingencies at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used when accounting for asset retirement obligations, share-based compensation and convertible debt with embedded derivatives and income taxes. Actual results may be different from these estimates. An accounting estimate is deemed critical only if it requires us to make assumptions about matters that are highly uncertain at the time the accounting estimate is made, and different estimates that we could have used in the current period would have a material impact on our financial condition or results of operations. Asset Retirement Obligation The undiscounted future value of the asset retirement obligation (“ARO”) in respect of our leased decaffeination facility is estimated at $0.9 million. This estimate assumes that we relocate from the current location upon expiry of the third lease renewal term in 2023. Further, the estimate reflects the expected costs of vacating the leased facility in 2023, having regard for the contract language in the lease, the expected useful lives of our plant and equipment, and the expected costs that would be paid to a third party to remove equipment. Convertible Debenture with Embedded Derivatives On October 11, 2016, the Company issued an unsecured subordinated convertible debenture for gross proceeds of $15,000,000. The convertible debenture bears interest at a rate of 6.85% per annum to be paid quarterly in arrears and is due on October 11, 2023. The convertible debenture is convertible into common shares of the Company at a conversion price of $8.25 per common share. Under the terms of the agreement, Swiss Water has the option to pay interest-in-kind for the first two years. If elected, this option will increase the principal sum by the interest owing. This option was not elected. The convertible debenture also includes a Net Share Settlement feature that allows Swiss Water, upon conversion, to elect to pay cash equal to the face value of the convertible debenture and to issue common shares equal to the excess value of the underlying equity above the face value of the convertible debenture. If the Net Share Settlement option is elected, it will result in fewer common shares being issued. In 2016, the Company paid financing costs of $0.5 million in respect of issuing the convertible debenture. Under IFRS, we are required to estimate the interest rate on a similar instrument of comparable credit status and providing for substantially the same cash flows, on the same terms, but without the equity conversion option, in order to estimate the fair value of the liability portion of the convertible debenture upon initial recognition. We have estimated the effective interest rate to be 12.15%, such that the fair value of the liability component of the convertible debenture was initially measured at $11.2 million. During 2018, the company estimated and recorded $1.5 million in interest expense (2017: $1.4 million) and paid $1.0 million (2017: $1.0 million). Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 21 We are also required to estimate the fair value of the embedded derivative liability related to the convertible debenture at initial recognition, and at the end of each reporting period. We use the residual value method to allocate the fair value of the convertible debenture between the liability component and the derivative liability. Under this method, the value of the derivative liability was determined to be $3.3 million at inception. The fair value of the derivative liability was determined using the Black-Scholes Option Pricing Model. The variables and assumptions used in computing the fair value are based on management’s best estimate. The value varies with different variables of certain subjective assumptions. Inputs into the Black-Scholes Option Pricing Model to determine the fair value of the conversion option: Share price Exercise price Option life Volatility Risk-free interest rate Dividend yield Income Taxes December 31, 2018 December 31, 2017 $ 4.97 $ 8.25 4.78 years 37% 1.88% 5.03% $ 6.70 $ 8.25 5.79 years 40% 1.90% 3.73% We compute income taxes using the liability method, under which deferred income taxes are provided for the temporary differences between the financial reporting bases and the tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using the enacted and substantively enacted income tax rates that are expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets also reflect estimates of the recoverability of non-capital loss carry forwards. We have recognized the benefit of loss carry forwards to the extent that it is probable that taxable income will be available in the future against which our non-capital loss carry forwards can be utilized. As at December 31, 2018, Swiss Water and its subsidiaries had combined non-capital tax loss carry forwards totaling $0.6 million, which can be used to reduce income taxes payable in future years. The financial reporting bases of our assets reflect the useful lives of depreciable assets, as well as the carrying amounts of assets with indefinite useful lives. Accordingly, management estimates that impact the carrying amounts of depreciable and non-depreciable assets also have an impact on deferred income tax assets and liabilities. Leases The preparation of consolidated financial statements requires that the Company’s management make assumptions and estimates on the classification of operating and finance leases. When assessing the classification of a lease agreement, certain estimates and assumptions need to be made and applied, which include, but are not limited to, the determination of the expected lease term and minimum lease payments, the assessment of the likelihood of exercising options, and estimation of the fair value of the lease property at lease inception. CHANGES IN ACCOUNTING STANDARDS The following standards became effective for annual periods beginning on or after January 1, 2018, with earlier application permitted. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 22  IFRS 15: Revenue from Contracts with Customers: replaces IAS 11, IAS 18, IFRIC 13, IFRIC 15, IFRIC 18 and SIC-31. IFRS 15 establishes principles to address the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The core principle of IFRS 15 is that revenue related to the transfer of promised goods or services should be recognized when the control of the goods or services passes to customers. Swiss Water has evaluated the impact of applying IFRS 15, analyzing its decaffeination services, decaffeinated coffee sales and distribution agreements. We concluded there is no material change in the timing of revenue recognized under the new standard as the point of transfer of risk and reward for goods and services and transfer of control occurs at the same time. Accordingly, we applied IFRS 15 retrospectively with no impact of transitioning to IFRS 15 on retained earnings as at January 1, 2018. In addition, IFRS 15 requires entities to apportion revenue earned from contracts to distinct performance obligations on a relative standalone selling price basis. The impact of this change on the amount of revenue recognized in a year is insignificant. IFRS 15 contains additional presentation and disclosure requirements which are more detailed than the current standards. It is effective for annual periods beginning on or after January 1, 2018. We have adopted these amended standards and interpretations, and we assessed that there was no material impact on our consolidated financial statements. Additional disclosures have been included in Swiss Water’s condensed consolidated interim financial statements for the period ended December 31, 2018. A number of new standards are effective for annual periods beginning on or after January 1, 2019. The Company has not yet adopted any of these new and amended standards or interpretations. Of those standards that are not yet effective, IFRS 16 Leases is expected to have a material impact on the Company’s financial statements in the period of initial application. IFRS 16: Leases: The Company is required to adopt IFRS 16 from January 1, 2019. The Company has assessed the estimated impact that the initial application of IFRS 16 will have on its consolidated financial statements as described below. The actual impacts of adopting the standard on January 1, 2019 may change because the Company has not finalized the testing and assessment of controls over its system, and because the new accounting policy is subject to change until the Company presents its first financial statements that include the date of initial application. IFRS 16 introduces a single, on-balance sheet accounting model for lessees that is similar to the current finance lease accounting, with limited exceptions for short-term leases or leases of low value assets. Lessees recognizes a right-of-use asset representing its rights to use the underlying asset and a lease liability representing its obligation to make lease payments. The Company expects to recognize new right-of-use assets of approximately $19.0 million and lease liabilities of approximately $19.0 million for its operating leases of office and warehouse facilities. The Company intends to provide additional disclosure for these leases as required under IFRS 16. The nature of expenses related to those leases will now change because the Company will recognize a depreciation charge for right‑of‑use assets and interest expense on lease liabilities. Previously, the Company recognized operating lease expense on a straight‑line basis over the term of the lease. In addition, the Company will include the payments due under the lease in its lease liability. A lessee can choose to apply IFRS 16 using either a full retrospective or a modified retrospective approach. The Company plans to apply IFRS 16 as at January 1, 2019 and intends to apply the simplified transition approach and will not restate comparative amounts for the year prior to first adoption. Right-of-use assets for property leases will be measured on transition as if the new rules Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 23 had always been applied. All other right-of-use assets will be measured at the amount of the lease liability on adoption (adjusted for any prepaid or accrued lease expenses). IFRS 16 replaces existing leases guidance, including IAS 17, Leases, IFRIC 4: Determining whether an Arrangement contains a Lease, SIC-15: Operating Leases – Incentives and SIC-27: Evaluating the Substance of Transactions Involving the Legal Form of a Lease. The following amended standards and interpretations are not expected to have a significant impact on the Company’s consolidated financial statements: Annual Improvements to IFRS Standards 2015–2017 Cycle: IFRS 3 Business Combinations; IFRS 9: Financial Instruments: prepayment features with negative compensation; IFRS 11: Joint arrangement; IAS 12: Income taxes: amendments related to recognition of current and deferred tax related to dividends; IAS 19: Employee Benefits: amendments to plan amendment, curtailment or settlement; IAS 23: Borrowing costs: amendments related to recognition of borrowing costs eligible for capitalization; IFRIC 23: Uncertainty over Income Tax Treatments: clarifies the application of recognition and measurement required per IAS 12: Income taxes, where there is uncertainty over income taxes; IFRS 10: Consolidated Financial Statements and IAS 28: Investments in Associates and Joint Ventures. HEDGE ACCOUNTING We adopted the hedge accounting provisions of IFRS 9 on January 1, 2016 in order to reduce volatility in our financial results, by better matching our accounting practices to our hedging practices. We did not change our risk management strategies with the adoption of hedge accounting. The economic impact of our hedges is unchanged from before January 1, 2016, even though the accounting for these derivative instruments has changed. We enter into three types of hedges: 1) Commodity price risk hedges on our coffee purchase commitments and inventory (“commodity hedges”); 2) Currency risk hedges on future US$ process revenues (“revenue hedges”); and 3) Customer-specific currency risk hedges on US$ purchases of green coffee (“customer-specific hedges”). Each type of hedge is discussed below. Commodity Hedges When we enter into a purchase commitment to buy green coffee, the contract specifies that the purchase price will be based, in part, on the future (to-be-determined) coffee futures price, or NY’C’. We agree on or ‘fix’ the NY’C’ price with the vendor on or before receiving the coffee into inventory. When we bear the economic risk of a change in the commodity price, we offset this risk by selling short a futures contract on the Intercontinental Exchange. When we later sell such coffee at a fixed price to a customer, we cover our short by going long on a futures contract on the Intercontinental Exchange. At each period-end, commodity hedges are re-measured to their fair value. Under hedge accounting, gains /losses for hedged coffee purchase commitments and inventory are recorded in the statement of financial position until such coffee is sold, at which time the gains/losses on our commodity hedges are recognized in cost of sales. In this way, gains/losses on our commodity hedges are matched to our sales in the period. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 24 Revenue Hedges We enter into forward contracts to sell US$ at future dates to hedge the foreign exchange cash flow variability of expected US$ processing fee revenue up to 60 months in advance. The hedged process revenue includes both process revenue from tolling arrangements (processing of customer-owned coffee) as well as the US$ processing fee layer of inventory sales agreements. This enables us to more reliably predict how much Canadian currency we will receive for our collected US$ process revenue. Cash flows in the immediate 12- month period are hedged at a higher percentage of expected future revenues than those farther out, reflecting greater uncertainty in the 13-to 60-month period. At each period end, revenue hedges are re-measured to their fair value. Under hedge accounting, unrealized gains/losses for open revenue hedges are recorded in other comprehensive income. When a revenue hedge matures, the realized gain/loss on that contract is reclassed from accumulated other comprehensive income to process revenue. Customer-Specific Hedges We enter into forward contracts to buy US$ for green coffee inventory which, once decaffeinated, will be sold at a fixed C$ price pursuant to a customer-specific contract. To mitigate the exposure to changing margin on these transactions arising from fluctuations in the US$/C$ exchange rate, we enter into US$ forward purchase contracts which economically lock in the US$/C$ exchange rate, and effectively locks in the C$ cost of inventory to be sold at the fixed C$ amount. The adoption of hedge accounting allows for better matching of US$ purchases with the associated gains/losses on the forward contracts used to economically hedge these items. At each period-end, customer- specific hedges are re-measured to their fair value. Under hedge accounting, the gains/losses on these hedges are deferred on the statement of financial position until the inventory is sold, at which time the gains/losses are recorded in cost of sales on the income statement. FINANCIAL INSTRUMENTS We use financial instruments to mitigate economic risks associated with our business. The three types of hedges we enter into, and the hedging instruments used, are discussed in more detail under ‘Hedge Accounting’ above. We classify our financial assets and financial liabilities in the following measurement categories (i) those to be measured subsequently at fair value (either through other comprehensive income or through profit or loss); and (ii) those to be measured at amortized cost. We have implemented the following classifications for financial instruments other than derivatives:  Cash and cash equivalents and short-term investments are classified as assets at fair value and any period change in fair value is recorded through interest income in the consolidated statement of income, as applicable.  Accounts receivable and other receivables are classified as assets at amortized cost using the effective interest rate method. Interest income is recorded in the consolidated statement of income, as applicable.  Accounts payable, credit facilities, the debt portion of the convertible debenture and other liabilities are classified as other financial liabilities and are measured at amortized cost using the effective interest rate method. Interest expense is recorded in the consolidated statement of income, as applicable. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 25 Commodity Price Risk Commodity price risk is the risk that the fair value of inventory or future cash flows will fluctuate as a result of changes in commodity prices. Swiss Water utilizes futures contracts to manage our commodity price exposure and also buys and sells futures contracts for coffee on the Intercontinental Exchange in order to offset our inventory position and fix the input cost of green coffee. As at December 31, 2018, we had futures contracts to buy 4.5 million lbs of green coffee with a notional value of US$4.7 million, and contracts to sell 4.7 million lbs of green coffee with a notional value of US$4.7 million. The furthest contract matures in in December 2019 (December 31, 2017: buy 2.2 million lbs of green coffee with a notional value of US$2.7 million, and contracts to sell 4.5 million lbs of green coffee with a notional value of US$5.5 million). Foreign Currency Risk We realize a significant portion of our sales in US dollars, and purchase green coffee in US$ which is, in some cases, sold to customers in C$ dollars. We enter into forward exchange contracts to manage our exposure to currency rate fluctuations and to minimize the effect of exchange rate fluctuations on business decisions. These contracts relate to our future net cash flows in US$ from sales. In addition, we enter into forward contracts to purchase US$ for coffee that we resell in C$ dollars. At December 31, 2018, we had forward currency contracts to buy US$6.6 million and sell US$65.0 million (2017: buy US$7.2 million and sell US$46.2 million) from January 2019 through to April 2023 at various Canadian exchange rates ranging from $1.2147 to $1.3820. INTERNAL CONTROLS OVER FINANCIAL REPORTING & DISCLOSURE CONTROLS AND PROCEDURES The Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) of Swiss Water are responsible for establishing and maintaining adequate internal control over financial reporting (“ICFR”) to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. Under the supervision and with the participation of management, we conducted an evaluation of the design and effectiveness of our ICFR as of December 31, 2018, based on the updated framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO 2013”). Based on this assessment, the CEO and CFO concluded that, as of December 31, 2018, Swiss Water’s ICFR was effective. The CEO and CFO are also responsible for establishing and maintaining adequate disclosure controls and procedures. Disclosure controls and procedures are controls and other procedures designed to provide reasonable assurance that information required to be disclosed in documents filed or submitted under securities legislation is recorded, processed, summarized and reported within the time periods specified in securities legislation and includes controls and procedures designed to ensure that information required to be disclosed in documents filed or submitted under securities legislation is accumulated and communicated to Swiss Water’s management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. The CEO and CFO evaluated or caused to be evaluated under supervision, the effectiveness of our disclosure controls and procedures and based on this evaluation, the CEO and CFO concluded that, as of December 31, 2018, Swiss Water’s disclosure controls and procedures were effective. There were no changes in our ICFR that occurred during the period beginning on January 1, 2018 and ended on December 31, 2018 that have materially affected, or are reasonably likely to materially affect, Swiss Water’s ICFR. Swiss Water Decaffeinated Coffee Inc. (formerly Ten Peaks Coffee Company Inc.) 26 SUBSEQUENT EVENTS On January 15, 2019, the Company paid an eligible dividend in the amount of $0.6 million ($0.0625 per share) to shareholders of record on December 31, 2018. On January 22, 2019, the Company incorporated a subsidiary in France, Swiss Water Decaffeinated Coffee Europe SARL. In February 2019, the Company granted 98,000 RSUs pursuant to the Restricted Share Unit Plan. On March 11, 2019, the Company declared an eligible dividend of $0.0625 per share, to be paid on April 15, 2019 to shareholders of record on March 29, 2019. Subsequent to year end, Seaforth entered into an agreement to lease a warehouse facility in British Columbia. The term of the lease is eight years and three months starting April 1, 2019. Minimum payments over the term of the lease with renewal options are $9.7 million. SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) CONSOLIDATED FINANCIAL STATEMENTS For the Year Ended December 31, 2018 SWP Q4 cover_Layout 1 19-03-14 8:24 AM Page 2 Independent auditor’s report To the Shareholders of Swiss Water Decaffeinated Coffee Inc. Our opinion In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of Swiss Water Decaffeinated Coffee Inc. and its subsidiaries (together, the Company) as at December 31, 2018 and 2017, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards (IFRS). What we have audited The Company's consolidated financial statements comprise:       the consolidated statements of financial position as at December 31, 2018 and 2017; the consolidated statements of income for the years then ended; the consolidated statements of comprehensive income for the years then ended; the consolidated statements of changes in equity for the years then ended; the consolidated statements of cash flows for the years then ended; and the notes to the consolidated financial statements, which include a summary of significant accounting policies. 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 Auditor’s responsibilities for the audit of the consolidated financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Independence We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada. We have fulfilled our other ethical responsibilities in accordance with these requirements. PricewaterhouseCoopers LLP PricewaterhouseCoopers, 250 Howe Street, Suite 1400, Vancouver, British Columbia, Canada V6C 3S7 T: +1 604 806 7000, F: +1 604 806 7806 “PwC” refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership. Other information Management is responsible for the other information. The other information comprises the Management's Discussion and Analysis. Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the consolidated 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 consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. Responsibilities of management and those charged with governance for the consolidated financial statements Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRS, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. In preparing the consolidated 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. Those charged with governance are responsible for overseeing the Company’s financial reporting process. Auditor’s responsibilities for the audit of the consolidated financial statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s 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 these consolidated 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 consolidated 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 auditor’s report to the related disclosures in the consolidated 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 auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern. Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation. Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Company to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. We 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. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. The engagement partner on the audit resulting in this independent auditor’s report is Robert Coard. (Signed) “PricewaterhouseCoopers LLP” Chartered Professional Accountants Vancouver, British Columbia March 12, 2019 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) – The accompanying notes form an integral part of these consolidated financial statements. – Page 5 Consolidated Statements of Financial Position as at(Tabular amounts are in thousands of Canadian dollars)December 31, 2018December 31, 2017AssetsNoteCurrent assetsCash and cash equivalents25$8,336 $9,486 Accounts receivable614,313 12,127 Inventories713,851 14,671 Short-term investments8- 7,067 Prepaid expenses and other receivables1,272 1,031 Derivative assets and hedged firm commitments9, 261,497 1,244 Total current assets39,269 45,626 Non-current assetsReceivables 6235 230 Plant and equipment1046,035 23,341 Intangible assets111,167 1,427 Deferred tax assets12175 1,484 Derivative assets 9, 26- 740 Total non-current assets47,612 27,222 Total assets$86,881 $72,848 Liabilities and shareholders' equityCurrent liabilitiesAccounts payable$6,558 $2,639 Accrued liabilities3,397 1,844 Income tax payable12783 105 Other liabilities14473 591 Dividend payable19, 28566 565 Derivative liabilities and hedged firm commitments9, 262,064 229 Total current liabilities13,841 5,973 Non-current liabilitiesOther liabilities 14105 45 Construction loan159,400 844 Convertible debenture1612,082 11,658 Asset retirement obligation17802 802 Deferred tax liabilities121,243 3,426 Derivative liabilities 9, 16, 263,652 2,722 Total non-current liabilities27,284 19,497 Total liabilities41,125 25,470 Shareholders' equityShare capital18$43,591 $43,496 Retained earnings4,523 2,257 Accumulated other comprehensive income(2,512) 1,485 Share-based compensation reserve154 140 Total equity45,756 47,378 Total liabilities and shareholders' equity$86,881 $72,848 Commitments (Note 27)Subsequent events (Note 28)Approved on behalf of the Board(signed) "David Rowntree", Director (signed) "Frank Dennis", Director SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) – The accompanying notes form an integral part of these consolidated financial statements. – Page 6 Consolidated Statements of Income for the Years Ended(Tabular amounts are in thousands of Canadian dollars, except for per share amounts)NoteDecember 31, 2018December 31, 2017Revenue20$89,939 $83,755 Cost of sales(75,018) (71,165) Gross profit14,921 12,590 Operating expensesAdministration expenses(5,371) (5,077) Sales and marketing expenses(3,790) (2,586) Occupancy expenses(129) (115) Total operating expenses(9,290) (7,778) Operating income5,631 4,812 Non-operating or other(Loss) gain on risk management activities(5) 1,190 Fair value gain on embedded option161,799 604 Finance income530 580 Finance expense(1,457) (1,414) Loss on foreign exchange(278) (6) Total non-operating or other589 954 Income before tax6,220 5,766 Income tax expense12(1,689) (1,606) Net income$4,531 $4,160 Basic earnings per share23$0.50 $0.46 Diluted earnings per share23$0.35 $0.42 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) – The accompanying notes form an integral part of these consolidated financial statements. – Page 7 Consolidated Statements of Comprehensive Income and Consolidated Statements of Changes in Equity(Tabular amounts are in thousands of Canadian dollars)Consolidated Statements of Comprehensive IncomeFor the Years EndedNet income$4,531 $4,160 Other comprehensive income, net of taxItems that may be subsequently reclassified to income:Unrealized (loss) gainDerivatives designated as cash flow hedges - currency risk hedges on US$ future revenue(4,675) 2,333 Items reclassified to income:Realized gainsDerivatives designated as cash flow hedges - currency risk hedges on US$ future revenue, recognized in revenue(790) (931) Other comprehensive (loss) income related to hedging activities(5,465) 1,402 Tax recovery (expense) on other comprehensive income relating to hedging activities1,460 (384) Cumulative translation adjustment8 48 Other comprehensive (loss) income, net of tax(3,997) 1,066 Net income and other comprehensive income$534 $5,226 Consolidated Statements of Changes in EquityShare capitalShare-basedAccumulated other compensationcomprehensive Note SharesAmountreserveincomeBalance at December 31, 20169,038,862 $43,496 $63 $419 $357 $44,335 Share-based compensation- - 77 - - 77 Dividends 19- - - - (2,260) (2,260) Net income and other comprehensive income- - - 1,066 4,160 5,226 Balance at December 31, 20179,038,862 $43,496 $140 $1,485 $2,257 $47,378 Balance at December 31, 20179,038,862 43,496 140 1,485 2,257 47,378 Shares issued for restricted share units22,348 95 (95) - - - Share-based compensation- - 109 - - 109 Dividends 19- - - - (2,265) (2,265) Net income and other comprehensive (loss)- - - (3,997) 4,531 534 Balance at December 31, 20189,061,210 $43,591 $154 $(2,512) $4,523 $45,756 Total equity Retained earnings December 31, 2017December 31, 2018 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) – The accompanying notes form an integral part of these consolidated financial statements. – Page 8 Consolidated Statements of Cash Flows(in thousands of Canadian dollars)(Tabular amounts are in thousands of Canadian dollars)For the Years EndedNoteOperating activitiesNet income$4,531 $4,160 Items not affecting cash:Depreciation and amortization1,689 2,172 Share-based compensation expense242 211 Unrealized loss (gain) on risk management activities188 (1,463) Unrealized gain on fair value adjustment ofembedded option(1,799) (604) Payment of restricted share units settled in cash(199) (60) Finance income(530) (580) Finance expense1,457 1,414 Income taxes expense1,689 1,606 Other29 - 7,297 6,856 Change in non-cash working capital relating to operating activities25(723) (3,661) Net cash generated from operations6,574 3,195 Interest received610 500 Interest paid(1,033) (1,033) Income taxes paid(477) (915) Net cash generated from operating activities5,674 1,747 Investing activitiesProceeds from short-term investments7,067 5,633 Additions to plant and equipment(21,029) (8,131) Net cash used in investing activities(13,962) (2,498) Financing activitiesDividends paid(2,262) (2,260) Proceeds from construction loan9,400 - Net cash generated from (used in) financing activities7,138 (2,260) Decrease in cash and cash equivalents(1,150) (3,011) Cash and cash equivalents, beginning of the year9,486 12,497 Cash and cash equivalents, end of the year$8,336 $9,486 December 31, 2018December 31, 2017 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 1. NATURE OF BUSINESS Swiss Water Decaffeinated Coffee Inc., (“Swiss Water” or the “Company”), formerly Ten Peaks Coffee Company Inc., is an entity incorporated under the Canada Business Corporations Act (“CBCA”). The common shares of the Company are listed on the Toronto Stock Exchange under the symbol ‘SWP’, formerly ‘TPK’. The Company’s head office is located at 3131 Lake City Way, Burnaby, British Columbia, V5A 3A3, Canada. On September 28, 2018, Ten Peaks Coffee Company Inc. amalgamated with its 100% owned subsidiary Swiss Water Decaffeinated Coffee Company Inc. As a result of the amalgamation Ten Peaks Coffee Company Inc. remained as the successor entity and concurrently the Company changed its name to Swiss Water Decaffeinated Coffee Inc. Swiss Water is primarily involved in the decaffeination of green coffee without the use of chemicals by employing the proprietary SWISS WATER® Process. The Company leverages science-based systems and quality controls to produce coffee that is 99.9% caffeine free. Swiss Water owns all of the interests of Seaforth Supply Chain Solutions Inc. (“Seaforth”), which is incorporated under CBCA and operates in Burnaby, British Columbia, Canada; and Swiss Water Decaffeinated Coffee USA, Inc. (“SWUS”), an entity registered in Washington State, USA. Seaforth provides a complete range of green coffee handling and storage services, while SWUS acts as a marketing and sales company and it does not have significant assets. 2. BASIS OF PREPARATION These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board. IFRS comprises IFRSs, International Accounting Standards (“IAS”), and interpretations issued by the IFRS Interpretations Committee (“IFRIC”) and the former Standing Interpretations Committee (“SIC”). These consolidated financial statements for the year ended December 31, 2018 were approved for issuance by the Company’s Directors on March 11, 2019. There were no significant non-adjusting events that occurred between the reporting date and the date of authorization except as disclosed in Note 28. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting policies used in the preparation of these consolidated financial statements are as follows: 3.1 Basis of measurement The consolidated financial statements have been prepared on the historical cost basis, except for certain financial instruments that are measured at fair values at the end of each reporting period. Historical cost is based on the fair value of the consideration given in exchange for assets. 3.2 Currency of presentation These consolidated financial statements are presented in Canadian dollars. Except for per share amounts, all amounts are expressed in thousands of Canadian dollars, unless otherwise stated. References to US$ are to United States dollars. 3.3 Basis of consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. Subsidiaries are all entities over which the Company has the power to Page 9 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) control the financial and operating policies generally accompanying a shareholding of more than half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Company controls another entity. All intercompany transactions, balances, income and expenses are eliminated on consolidation. 3.4 New and amended standards adopted by the Company The following amendments to accounting standards became effective for annual periods beginning on or after January 1, 2018. The adoption of these revised standards by the Company did not have a material impact on its consolidated financial statements.  Annual Improvements to IFRSs 2012-2016 Cycle.      IFRS 2: Share based payment: contains amendments to classification and measurement of share-based payment transactions. IFRS 9 Financial Instruments: The Company has early adopted IFRS 9 as of January 1, 2016. IFRS 15: Revenue from Contracts with Customers: The Company has evaluated the impact of applying IFRS 15 by analyzing revenue recognition from the following revenue streams: decaffeinated coffee sales, decaffeination services, and distribution. The Company concluded that there is no material change in the timing of revenue recognized under the new standard as the point of transfer of risk and reward for goods and services and transfer of control occurs at the same time. Accordingly, the Company has applied IFRS 15 retrospectively with no impact of transitioning to IFRS 15 on retained earnings as at January 1, 2018. Also, the Company has included additional disclosure as required by IFRS 15. IFRIC 22: Foreign Currency Transactions and Advance Consideration. IAS 40: Investment Property: contains amendments to transfers of investment property. 3.5 Changes in accounting standards not yet effective A number of new standards are effective for annual periods beginning on or after January 1, 2019. The Company has not yet adopted any of these new and amended standards or interpretations. Of those standards that are not yet effective, IFRS 16 Leases is expected to have a material impact on the Company’s financial statements in the period of initial application.  IFRS 16: Leases: The Company is required to adopt IFRS 16 from January 1, 2019. The Company has assessed the estimated impact that initial application of IFRS 16 will have on its consolidated financial statements as described below. The actual impacts of adopting the standard on January 1, 2019 may change because the Company has not finalized the testing and assessment of controls over its system, and because the new accounting policy is subject to change until the Company presents its first financial statements that include the date of initial application. IFRS 16 introduces a single, on-balance sheet accounting model for lessees that is similar to the current finance lease accounting, with limited exceptions for short-term leases or leases of low value assets. Lessees recognizes a right-of-use asset representing its rights to use the underlying asset and a lease liability representing its obligation to make lease payments. The Company expects to recognize approximately $19.0 million in new right-of use assets, and approximately $19.0 million in lease liabilities for its operating leases of office and warehouse facilities. The Company intends to provide additional disclosure for these leases as required under IFRS 16. The nature of expenses related to those leases will now change because the Page 10 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Company will recognize a depreciation charge for right‑of‑use assets and interest expense on lease liabilities. Prior to the adoption IFRS 16, the Company recognized operating lease expense on a straight‑line basis over the term of the lease. In addition, on the statement of cash flows, the Company will include repayments of the principal portion of the lease liabilities under financing activities whereas before the implementation of IFRS 16 they were included in cash flows from operations. A lessee can choose to apply IFRS 16 using either a full retrospective or a modified retrospective approach. The Company plans to apply IFRS 16 as at January 1, 2019 and intends to apply the simplified transition approach and will not restate comparative amounts for the year prior to first adoption. Right-of-use assets for property leases will be measured on transition as if the new rules had always been applied. All other right-of-use assets will be measured at the amount of the lease liability on adoption (adjusted for any prepaid or accrued lease expenses). IFRS 16 replaces existing leases guidance, including IAS 17, Leases, IFRIC 4: Determining whether an Arrangement contains a Lease, SIC-15: Operating Leases – Incentives and SIC-27: Evaluating the Substance of Transactions Involving the Legal Form of a Lease. The following amended standards and interpretations are not expected to have a significant impact on the Company’s consolidated financial statements:  Annual Improvements to IFRS Standards 2015–2017 Cycle: IFRS 3 Business Combinations; IFRS 9: Financial Instruments: prepayment features with negative compensation; IFRS 11: Joint arrangement; IAS 12: Income taxes: amendments related to recognition of current and deferred tax related to dividends; IAS 19: Employee Benefits: amendments to plan amendment, curtailment or settlement; IAS 23: Borrowing costs: amendments related to recognition of borrowing costs eligible for capitalization; IFRIC 23: Uncertainty over Income Tax Treatments: clarifies the application of recognition and measurement required per IAS 12: Income taxes, where there is uncertainty over income taxes; IFRS 10: Consolidated Financial Statements and IAS 28: Investments in Associates and joint Ventures. 3.6 Segment reporting Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision makers. A business segment is a group of assets and operations engaged in providing products or services that are subject to risks and returns that are different from those of other business segments. A geographical segment reflects the provision of products or services within a particular economic environment that is subject to risks and returns that are different from those of other economic environments. The Company’s sales are primarily generated in a single business segment of decaffeination of green coffee beans. As such, management reports operating activities for geographical information only. 3.7 Foreign currency translation Functional and presentation currency Items included in the consolidated financial statements of each of the Company’s subsidiaries are measured using the currency of the primary economic environment in which each entity operates (“the functional currency”). The functional and presentation currency of Swiss Water is the Canadian dollar. Functional currency of the US subsidiary is the United States dollar. Page 11 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Foreign currency transactions Foreign currency transactions and balances are translated as follows: (i) monetary assets and liabilities denominated in foreign currencies are translated to Canadian dollars at the exchange rate prevailing at the reporting date; (ii) non-monetary items which are measured using historical cost in a foreign currency are translated using the exchange rate at the date of the transaction; (iii) non- monetary items that are measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was determined; and (iv) foreign currency transactions are translated into functional currency of the entity at the exchange rates prevailing at the date of the transaction. Foreign exchange gains and losses are recognized in net income and presented in the Consolidated Statement of Income in accordance with the nature of the transactions to which the foreign currency gains and losses relate, in the period in which they occur. Foreign operations Foreign operations are translated from their functional currencies into Canadian dollars on consolidation as follows: (i) assets and liabilities for each statement of financial position presented are translated at the closing rate at the date of the statement of financial position; (ii) income and expenses for each statement of loss are translated at a quarterly average exchange rate (unless this rate is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); (iii) share capital for each statement of financial position presented are translated at historical rate; and (iv) all resulting exchange differences are recognized in other comprehensive income as cumulative translation adjustments. Exchange differences that arise relating to long-term intercompany balances that form part of the net investment in a foreign operation are also recognized in this separate component of equity through other comprehensive income. 3.8 Cash and cash equivalents Cash and cash equivalents includes cash on hand, other short-term, highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value, and bank overdrafts. Bank overdrafts are shown within borrowings in current liabilities in the balance sheet. 3.9 Inventories Raw materials are stated at the lower of cost, determined on a specific identification basis, and net realizable value, being the estimated selling price of finished goods less the estimated cost of completion of the finished goods. Finished goods are stated at the lower of cost and net realizable value. Cost of finished goods includes all expenses directly attributable to the manufacturing process like direct labour and direct materials, as well as suitable portions of related fixed and variable production overheads, based on normal operating capacity. Costs of ordinarily interchangeable items are assigned on a first-in-first- out basis. Net realizable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses. 3.10 Plant and equipment The Company leases facilities which house its production facility, offices and warehouse facilities. Plant and equipment is carried at acquisition cost or manufacturing cost less depreciation and impairment losses. Historical cost includes expenditures that are directly attributable to the Page 12 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) acquisition of the items. Cost may also include transfers from equity of any gains or losses on qualifying cash flow hedges of foreign currency purchases of property, plant and equipment. Subsequent costs are recognized in the asset’s carrying amount or recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Company and the cost of the item can be measured reliably. All other repairs and maintenance expenditures are recognized in the statement of income during the financial period in which they are incurred. Borrowing costs directly attributed to the construction of any qualifying asset are capitalized during the period of time that is required to complete and prepare the asset for its intended use. Major renovations are depreciated over the remaining useful life of the related asset or to the date of the next major renovation, whichever is sooner. The costs related to the plant and equipment in the course of construction are classified as construction-in-progress. Such items are transferred to the appropriate category of plant and equipment when it is completed and ready for intended use. Depreciation of these assets commences when the asset is available for use. Depreciation is recognized on a straight-line basis to allocate the cost or valuation of each asset to its residual value over its estimated useful life commencing when the asset is ready for its intended use. The estimated useful lives of plant and equipment are as follows: Leasehold improvements Production machinery Assets under financial lease Warehouse and office equipment Computer hardware and software Furniture and fixtures to expiry of the lease renewal option or lease term to expiry of the lease renewal option or lease term to expiry of the lease renewal option or lease term 10 years 5 years 5 years During the year ended December 31, 2018, the Company reviewed the useful lives of its production lines which includes several production machines that had different remaining useful lives. Management determined that the useful lives of certain production machines were longer than originally estimated, and as a result extended the estimated useful lives of these production machines by up to 18 years. At the time of change in the estimate, these assets had a net book value of approximately $6.0 million. The financial impact of the change in estimate was a reduction in depreciation expense of $0.7 million for the year ended December 31, 2018. The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each reporting date. An asset’s carrying amount is written down immediately to its recoverable amount if the asset’s carrying amount is greater than its estimated recoverable amount. Gains and losses on disposals are determined by comparing proceeds with carrying amount. These are included in profit or loss. 3.11 Intangible assets Proprietary process technology (“PPT”) PPT represents intangible assets of Swiss Water with a finite life and is carried at cost less accumulated amortization. Amortization is recognized on a straight-line basis to allocate the cost of PPT to its residual value over its estimated useful life of 14 years. Page 13 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Brand Swiss Water’s brand has a finite useful life and is carried at cost less accumulated amortization. Amortization is recognized on a straight-line basis over its estimated useful life of 14 years. 3.12 Impairment of assets Plant and equipment and intangible assets with finite lives and that are subject to depreciation or amortization are tested for impairment indicators at the end of each reporting period. If any such indicator exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss. An impairment loss is recognized for the amount by which the carrying amount of an asset or cash generating unit (“CGU”) exceeds its recoverable amount. The Company has determined that it has only one CGU and that all assets relate to that CGU. To determine the recoverable amount, management estimates either the fair value less costs to sell, or the value-in-use based on the present value of expected future cash flows from the CGU. In estimating the value-in-use, management must determine the appropriate discount rate in order to calculate the present value of those cash flows, as well as make certain assumptions about future profits which relate to future events and circumstances. Discount factors are determined individually for each asset or CGU and reflect their respective risk profiles as assessed by management. There were no indicators of impairment during the year. 3.13 Financial instruments The Company has early adopted IFRS 9 as issued in July 2014 with a date of initial application of January 1, 2016. IFRS 9 introduces new requirements for the classification and measurement of financial assets. IFRS 9 requires all recognized financial assets to be measured at amortized cost or fair value in subsequent accounting periods following initial recognition. IFRS 9 also amends the requirements around hedge accounting, and introduces a single, forward-looking expected credit loss impairment model. All financial assets, other than accounts receivable, are included in the measurement category of fair value through profit and loss. There was no change to the measurement category for financial liabilities at amortized cost. Classification From January 1, 2016, the Company classifies its financial assets and financial liabilities in the following measurement categories i) those to be measured subsequently at fair value (either through other comprehensive income or through profit or loss) and ii) those to be measured at amortized cost. The classification of financial assets depends on the business model for managing the financial assets and the contractual terms of the cash flows. Financial liabilities are classified as those to be measured at amortized cost unless they are designated as those to be measured subsequently at fair value through profit or loss (“FVPL”) (irrevocable election at the time of recognition). For assets and liabilities measured at fair value, gains and losses are either recorded in profit or loss or other comprehensive income. The Company reclassifies financial assets when and only when its business model for managing those assets changes. Financial liabilities are not reclassified. Page 14 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) The Company has implemented the following classifications for financial instruments, other than derivatives: a) Cash and cash equivalents and short-term investments are classified as assets at fair value and any period change in fair value is recorded through interest income in the consolidated statement of income, as applicable. b) Accounts receivable and other receivables are recognized initially at fair value and subsequently are classified as assets at amortized cost using the effective interest rate method, less loss allowance. Interest income is recorded in the consolidated statement of income, as applicable. c) Accounts payable, credit facilities, the debt portion of the convertible debenture, the construction loan and other liabilities are classified as other financial liabilities and are measured at amortized cost using the effective interest rate method. Interest expense is recorded in the consolidated statement of income, as applicable. With the adoption of hedge accounting, “gains/losses on risk management activities” reflects the change in fair value of undesignated revenue hedges and gains or losses on designated hedging instruments that are not otherwise recorded in the income statement with the hedged item (revenue or cost of sales). Also, with the adoption of hedge accounting, “fair value gains/losses on embedded option” are gains or losses on embedded derivative in the convertible debenture debt instrument. The full fair value of a hedging derivative is classified as a non-current asset or liability when the remaining maturity of the hedged item is more than 12 months and it is classified as a current asset or liability when the remaining maturity of the hedged item is less than 12 months. Recognition and de-recognition Financial assets and financial liabilities, including derivatives, are recognized on the consolidated statement of financial position when the Company becomes a party to the financial instrument or derivative contract. Financial assets are derecognized when the rights to receive cash flows from the financial assets have expired or have been transferred and the Company has transferred substantially all the risks and rewards of ownership. Measurement At initial recognition, the Company measures a financial asset at its fair value, plus, in the case of a financial asset or liability not at FVPL, transaction costs that are directly attributable to the acquisition or issue of the financial asset or liability. Transaction costs of financial assets and financial liabilities carried at FVPL are expensed in profit and loss. Financial assets and financial liabilities with embedded derivatives are considered in their entirety when determining whether their cash flows are solely payment of principal and interest. Debt instruments Subsequent measurement of debt instruments depends on the Company’s business model for managing the asset and the cash flow characteristics of the asset. There are three measurement categories into which the Company classifies its debt instruments: a) Amortized cost: Assets that are held for collection of contractual cash flows where those cash flows represent solely payments of principal and interest are measured at amortized cost. Interest income from these financial assets is included in finance income using the effective Page 15 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) interest rate method. Any gain or loss arising on derecognition is recognized directly in profit or loss and presented in other gains/(losses) together with foreign exchange gains and losses. Impairment losses are presented as separate line item in the statement of profit or loss. b) FVOCI: Assets that are held for collection of contractual cash flows and for selling the financial assets, where the assets’ cash flows represent solely payments of principal and interest, are measured at fair value through other comprehensive income (FVOCI). Movements in the carrying amount are taken through other comprehensive income (“OCI”), except for the recognition of impairment gains or losses, interest income and foreign exchange gains and losses which are recognized in profit or loss. When the financial asset is derecognized, the cumulative gain or loss previously recognized in OCI is reclassified from equity to profit or loss and recognized in other gains/(losses). Interest income from these financial assets is included in finance income using the effective interest rate method. Foreign exchange gains and losses are presented in other gains/(losses) and impairment expenses are presented as separate line item in the statement of profit or loss. c) FVPL: Assets that do not meet the criteria for amortized cost or FVOCI are measured at FVPL. A gain or loss on a debt investment that is subsequently measured at FVPL is recognized in profit or loss and presented net within other gains/(losses) in the period in which it arises. Impairment The Company assesses all information available, including on a forward-looking basis, the expected credit losses associated with its assets carried at amortized cost and FVOCI. The impairment methodology applied depends on whether there has been a significant increase in credit risk. The Company’s only financial asset at amortized cost are accounts receivable and other receivables, for these the Company applies the simplified approach as permitted by IFRS 9 which requires expected lifetime credit losses to be recognized from initial recognition of the receivables. Derivatives and Hedging Activities Derivatives are initially recognized at fair value on the date a derivative contract is entered into and are subsequently re-measured to their fair value at the end of each reporting period. The accounting for subsequent changes in fair value depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged, and the type of hedge relationship designated. The Company designates certain derivatives as either: a) hedges of the fair value of recognized assets or liabilities or a firm commitment (fair value hedges) b) hedges of a particular risk associated with the cash flows of recognized assets and liabilities and highly probable forecast transactions (cash flow hedges), or c) hedges of a net investment in a foreign operation (net investment hedges). The Company documents at the inception of the hedging transaction the economic relationship between hedging instruments and hedged items including whether the hedging instrument is expected to offset changes in cash flows of hedged items. The Company documents its risk management objective and strategy for undertaking various hedge transactions at the inception of each hedging relationship. Page 16 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Cash flow hedges that qualify for hedge accounting The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognized in the cash flow hedge reserve within equity. The gain or loss relating to the ineffective portion is recognized immediately in profit or loss. When option contracts are used to hedge forecast transactions, the group designates only the intrinsic value of the options as the hedging instrument. Gains or losses relating to the effective portion of the change in intrinsic value of the options are recognised in the cash flow hedge reserve within equity. The changes in the time value of the options that relate to the hedged item (‘aligned time value’) are recognised within OCI in the costs of hedging reserve within equity. Commodity and Currency risk hedges The Company applied hedge accounting to economic hedges entered into in accordance with its Foreign Exchange Risk Management Policy (FX Policy) and the Commodity Price Risk Management Policy (Commodity Policy). Economically, the specific hedging activities carried out under these policies by the Company are as follows. The Company designates derivatives as hedges for the risk of changes in fair value of the purchase commitment due to changes in benchmark coffee commodity prices and foreign exchange as fair value hedges, as described under Commodity Price Risk Hedges. The Company also designates derivatives as hedges of foreign exchange risk associated with the cash flows of highly probable forecast transactions as cash flow hedges, as described under Currency Risk Hedges. Commodity price risk hedges on purchase commitments and inventory ("commodity hedges"): When the Company enters into a purchase commitment to purchase green coffee and fixes the New York ‘C’ (“NY’C”) price component (which it will later sell at a to-be-determined price based on the NY’C’), the Company enters into an offsetting short position on the IntercontinentalExchange. The Company monitors, on a macro basis, the amount of purchase commitments and amount of inventory on hand for which the ultimate sale price is variable and has not yet been fixed based on the NY’C’ and compares this to the amount of coffee covered by future net short positions to determine whether the net short position requires adjustment. At each period end, commodity price risk hedges are re-measured to their fair value. Under hedge accounting, the effective portion of the gains (losses) for price fixed hedged coffee contracts and coffee inventory will be held on the consolidated statement of financial position until inventory for such contracts is received and subsequently sold, at which time the gains (losses) will flow to cost of sales on the consolidated statement of income. Currency risk hedges on US$ purchases ("customer-specific hedges"): The Company enters into forward contracts to buy US dollars (US$) for significant purchase commitments, such as green coffee inventory which, once decaffeinated, is sold at a fixed Canadian dollar (C$) price. To mitigate the exposure to changing margin on these transactions arising from fluctuations in the US$/C$ exchange rate, the Company enters into US$ forward purchase contracts which economically lock in the US$/C$ exchange rate, and effectively locks in the C$ cost of inventory to be sold at the fixed C$ amount. Page 17 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) At each period end, currency risk hedges on US$ purchases are re-measured to their fair value. Under hedge accounting, the effective portion of the gains (losses) will be held on the consolidated statement of financial position until the inventory is received and subsequently sold, at which time the gains (losses) will flow to cost of sales on the consolidated statement of income. Currency risk hedges on US$ future revenue ("revenue hedges"): The Company enters into forward contracts to sell US$ at future dates to hedge the foreign exchange cash flow variability of expected US$ processing fee revenue. The hedged processing revenue includes both processing fee revenue from tolling arrangements (processing of customer owned coffee) as well as the US$ processing fee layer of inventory sales agreements. At each period end, currency risk hedges on US$ future revenues are re-measured to their fair value. Under hedge accounting, unrealized gains (losses) for US$ forward contracts are reclassified so that the impact on the consolidated statement of income is deferred through other comprehensive income, until the hedge instrument matures, at which time the realized gain (loss) is reflected in revenue on the consolidated statement of income. On all hedges entered into, if the hedge ratio for risk management purposes is no longer optimal but the risk management objective remains unchanged and the hedge continues to qualify for hedge accounting, the hedge relationship will be rebalanced by adjusting either the volume of the hedged instrument or the volume of the hedged item so that the hedge ratio aligns with the ratio used for risk management purposes. Any hedge ineffectiveness is calculated and accounted for in profit or loss at the time of the hedge relationship rebalancing. Fair Value Hierarchy The Company classifies and discloses the fair value measurements of its financial instruments using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. The fair value hierarchy has the following levels: a) Level 1 – valuation based on quoted prices (unadjusted) in active markets for identical assets or liabilities; b) Level 2 – valuation techniques based on inputs other than quoted prices that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and c) Level 3 – valuation techniques using inputs for the asset or liability that are not based on observable market data (unobservable inputs). The fair value hierarchy requires the use of observable market inputs whenever such inputs exist. The Company classifies a financial instrument to the lowest level of the hierarchy for which a significant input has been considered in measuring fair value. 3.14 Current and deferred income taxes Income tax expense or credit comprises current and deferred tax. Income tax expense is recognized in the statement of income and comprehensive income except to the extent that it relates to items recognized either in other comprehensive income or directly in equity. The income tax expense or credit for the period is the tax payable on the current period’s taxable income based on the applicable income tax rate for each jurisdiction adjusted by changes in deferred tax assets and liabilities attributable to temporary differences and to unused tax losses. Page 18 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) The current income tax charge is calculated on the basis of the tax laws enacted or substantively enacted at the reporting date, and any adjustments to taxes payable in respect of previous years. The Company periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation. It establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities. Deferred income tax is recognized, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, if the deferred income tax arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable income or loss, it is not accounted for. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the reporting date and are expected to apply when the related asset is realized, or the liability is settled. Deferred income tax assets are recognized only to the extent that it is probable that future taxable income will be available against which temporary differences and non-capital loss carry forwards can be utilized. Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets and liabilities and when the deferred tax balances relate to the same taxation authority. Current tax assets and tax liabilities are offset where the entity has a legally enforceable right to offset and intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously. Current and deferred tax is recognized in profit or loss, except to the extent that it relates to items recognized in other comprehensive income or directly in equity. In this case, the tax is also recognized in other comprehensive income or directly in equity, respectively. 3.15 Provisions Provisions are recognized when the Company has a present legal or constructive obligation as a result of a past event, it is probable that it will lead to an outflow of economic resources from the Company and amounts can be estimated reliably, although timing or amount of the outflow may still be uncertain. Provisions are measured at the present value of management’s best estimate of the expenditure required to settle the present obligation at the reporting date, including the risks and uncertainties associated with the present obligation. The discount rate used to determine the present value reflects current market assessments of the time value of money and the increases specific to the liability. Any reimbursement that the Company can be virtually certain to collect from a third party with respect to the obligation is recognized as a separate asset. However, this asset may not exceed the amount of the related provision. All provisions are reviewed at the end of each reporting period and adjusted or reversed to reflect management’s current best estimate of the expenditure required to settle the present obligation at the end of the reporting period. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision is reversed. Provisions are reduced by actual expenditures for which the provision was originally recognized. Page 19 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Where discounting has been used, the carrying amount of a provision is accreted during the period to reflect the passage of time. 3.16 Leases as the lessee Leases where the lessor retains a significant portion of the risks and rewards of ownership are classified as operating leases. Payments on operating lease agreements are recognized as an expense on a straight-line basis over the lease term. 3.17 Revenue recognition Effective January 1, 2018, Swiss Water adopted IFRS 15 retrospectively. There was no impact on retained earnings as of January 1, 2018. The new standard is based on the principle that revenue is recognized when control of a good or service transfers to a customer – so the notion of control replaced the former notion of risks and rewards. The standard requires revenue recognition to follow a five-step model of identifying contracts, separating performance obligations, determining and allocating the transaction price, and recognizing the revenue as each performance obligation is satisfied. The Company’s primary sources of revenue are proceeds from sale of Swiss Water’s decaffeinated coffee and from services provided to decaffeinate customer’s owned coffee. Swiss Water’s revenue is measured based on consideration agreed on in contracts with customers and is recognized when the Company transfers control over products and services to the customer either at a point in time or over time. For all revenue contracts, no significant judgements are made with respect to evaluating the timing of satisfaction of performance obligations, transaction prices, and amounts allocated to performance obligations. Consideration amounts are not variable. Payment terms are typically between 30 and 60 days, apart from select customers where payment terms are extended. For contracts with extended payment terms, the Company charges customers an insignificant financing component. Warranty, returns or refunds do not apply to the Company. Revenue is disaggregated based on customer’s geographic region as described in segmented reporting accounting policy. Also, revenue from contracts with customers is disaggregated by major products and services: decaffeinated coffee sales, decaffeination services, and distribution. Decaffeinated coffee sales Decaffeinated coffee sales are the amounts that are charged to customers for the sale of decaffeinated coffee. The performance obligation is satisfied at a point in time when a customer obtains control of the product, which is when decaffeinated coffee is picked-up by or delivered to the customer. Decaffeination services Decaffeination services represent the amount charged to customers for the service to decaffeinate customer-owned coffee. The performance obligation is to provide the service, which is satisfied over time. Page 20 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Distribution Distribution revenue consists of shipping, handling and warehousing charges billed to customers. The performance obligation is satisfied over time as services are provided, which is at the same time as these services are consumed. Former revenue recognition standard Under former standard, IAS 18, applicable before January 1, 2018, revenue was measured at the fair value of the consideration received or receivable. Revenue was reduced for estimated customer returns, rebates and other similar allowances. Revenue was recognized when all the following conditions were satisfied: (i) persuasive evidence of an arrangement exists; (ii) the goods are shipped; (iii) title has passed to the customer; (iv) the price has been substantively determined; and (v) collection is reasonably assured. 3.18 Employee benefits Liabilities for wages and salaries, including non-monetary benefits, annual leave and accumulating sick leave that are expected to be settled wholly within 12 months after the end of the period in which the employees render the related service are recognized in respect of employees’ services up to the end of the reporting period and are measured at the amounts expected to be paid when the liabilities are settled. The liabilities are presented as current employee benefit obligations in the balance sheet. The Company provides benefits to employees through a registered retirement savings plan (“RRSP”). The Company contributes a percentage of earnings into an RRSP administered by an independent entity. Ultimately, each employee manages his or her own RRSP within the scope of the plan provided by the third-party administrator. The RRSP has no assurance of defined benefits to employees, and as such the Company has no legal or constructive obligations to make further contributions. The Company also pays contributions to government pension insurance plans. The contributions are recognized as employee benefit expenses when they are due. 3.19 Share-based compensation The Company has a restricted share unit (“RSU”) plan for certain officers and employees and a deferred share unit (“DSU”) plan for non-employee directors (collectively, “participants”). The RSUs granted are compound financial instruments as they are expected to be settled using a combination of cash and equity. The equity-settled share-based compensation is measured at the fair value of the Company’s common shares as at the grant date using a volume weighted average share price in accordance with the terms of the RSU plan. The fair value determined at the grant date is charged to income on a straight-line basis over the vesting period, based on the estimate of the number of RSUs that will eventually vest and be converted to common shares, with a corresponding increase in equity (share-based compensation reserve). As necessary, the Company revises its estimate if subsequent information indicates that the number of RSUs expected to vest differs from previous estimates. On the vesting date, the Company revises the estimate to equal the number of equity instruments that ultimately vested. The impact of the revision of estimates, if any, is recognized in income or Page 21 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) expense such that the cumulative expense reflects the revised estimate, with a corresponding adjustment to the share-based compensation reserve. For cash-settled share-based compensation, a long-term liability is recognized, measured initially at the fair value of the long-term liability using a volume weighted average share price. The amount of the liability is charged to income on a straight-line basis over the vesting period, based on the estimate of the number of RSUs that will eventually vest and be settled in cash. As necessary, the Company revises its estimate if subsequent information indicates that the number of RSUs expected to vest differs from previous estimates. On the vesting date, the Company revises the estimate to equal to the number of RSUs that ultimately vested and are settled in cash. The impact of the revision of estimates, if any, is recognized in income or expenses such that the cumulative expense reflects the revised estimate, with a corresponding adjustment to the long-term liability or current liability depends on the timing when the liability become due. At the end of each reporting period until the liability is settled, and at the date of settlement, the fair value of the liability is remeasured using a volume weighted average share price, with any change in fair value recognized in income or expense for the year. DSUs are issued to participants who elect to defer a portion of their current compensation in exchange for DSUs. DSUs are classified as cash-settled share-based payment transactions as participants receive cash following a redemption. The DSUs do not contain any vesting conditions or forfeiture provisions, as they are issued in exchange for deferred compensation. The Company recognizes the expense and the liability to pay for the eventual redemption when the DSUs are issued. Thereafter, the Company re-measures the liability at the end of each reporting date and the date of settlement, with the difference recognized in income or expense for the period. The fair value of DSUs is determined in accordance with the DSU Plan, which uses the average closing price for Swiss Water shares for the five trading days immediately preceding the relevant date. 3.20 Earning per share (“EPS”) The Company presents basic and diluted EPS for its common shares. Basic EPS is calculated by dividing income or loss attributable to shareholders of the Company by the weighted average number of common shares outstanding during the year. Diluted EPS is calculated by dividing income or loss attributable to shareholders of the Company by the weighted average number of common shares outstanding, adjusted for the effects of all dilutive potential common shares. 4. MANAGEMENT JUDGMENTS AND ESTIMATION UNCERTAINTY Judgment is used by management in selecting accounting policies, the determination of functional currency, the identification of cash generating units (“CGUs”), and the identification of revenue streams. In addition, judgment is often required in applying accounting policies, and in respect of items where the choice of a specific policy, accounting estimate or assumption to be followed could materially affect the reported results or net asset position of the Company should it later be determined that a different choice would be more appropriate. Management considers the accounting estimates and assumptions discussed below to be its critical accounting estimates and accordingly, provides an explanation of each below. Actual results could differ from those estimates and assumptions. Page 22 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 4.1 Useful lives of depreciable assets Management reviews the useful lives of depreciable assets at each reporting date. At December 31, 2018 management determined that the useful lives represent the expected utility of the assets to the Company. 4.2 Provision for asset retirement obligations Analysis and estimates are performed by the Company in order to determine the amount of restoration costs to be recognized as a provision in the Company’s consolidated financial statements. The estimates consider the contract language in the lease, the expected useful lives of the Company’s equipment, and the expected costs that would be paid to a third party to remove equipment. The amount recognized as a provision is the best estimate of the consideration required to settle the present obligation at the end of the reporting period, taking into account the risks and uncertainties surrounding the obligation. When the final determination of such obligation amounts differs from the recognized provisions, the Company’s financial statements will be impacted. 4.3 Income taxes The Company computes income taxes using the liability method, under which deferred income taxes are provided for the temporary differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities. Deferred tax assets and liabilities are measured using the enacted and substantively enacted income tax rates that are expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets also reflect estimates of the recoverability of non-capital loss carry forwards. The Company has recognized the benefit of loss carry forwards to the extent that it is probable that taxable income will be available in the future against which the non-capital loss carry forwards can be utilized. The financial reporting bases of the Company’s assets reflect the useful lives of depreciable assets, as well as the carrying amounts of assets with indefinite useful lives. Accordingly, management estimates that impact the carrying amounts of depreciable and non-depreciable assets also have an impact on deferred income tax assets and liabilities. 4.4 Convertible Debenture Management estimates the interest rate on a similar instrument of comparable credit status and providing for substantially the same cash flows, on the same terms, but without the equity conversion option in the calculation of the fair value of the liability portion of the convertible debenture upon initial recognition. Management also estimates the fair values of the derivative liability related to the convertible debenture at initial recognition and at the end of each reporting period using the Black-Scholes option pricing model which requires management estimates. Details of these can be found in Note 16. 4.5 Leases The preparation of consolidated financial statements requires that the Company’s management makes assumptions and estimates on the classification of operating and finance leases. When assessing the classification of a lease agreement, certain estimates and assumptions need to be made and applied, which include, but are not limited to, the determination of the expected lease Page 23 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) term and minimum lease payments, the assessment of the likelihood of exercising options, and estimation of the fair value of the lease property at lease inception. 5. CAPITAL MANAGEMENT The Company’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain the future development of the business. The Company manages its capital structure and makes adjustments to it in light of changes in economic conditions and the risk characteristics of the underlying assets. The Company considers its capital structure to include shareholders’ equity and indebtedness. In order to maintain or adjust the capital structure, the Company may from time to time issue common shares, issue additional debt, adjust its capital spending, modify its dividend policy, and/or dispose of certain assets to manage current and projected debt levels. The Company manages its capital in order to meet its growth objectives while continuing to pay quarterly dividends to its shareholders. The dividend policy of Swiss Water is subject to the discretion of the Board of Directors, which reviews the level of dividends periodically on the basis of a number of factors including Swiss Water’s financial performance, future prospects, and the capital requirements of the business. Quarterly dividends are paid on a level basis in order to smooth out normal seasonal fluctuations that occur over the course of a year. 6. ACCOUNTS RECEIVABLE Accounts receivables are amounts due from customers for goods sold or services performed in the ordinary course of business. Due to the short-term nature of current accounts receivable, their carrying amount is considered the same as their fair value. Information about the Company’s exposure to foreign currency risk, interest rate risk and credit risk can be found in Note 26. The Company's accounts receivable has been reviewed for indicators of impairment. No accounts were found to be impaired and therefore no allowance for credit losses was provided as at December 31, 2018 and December 31, 2017. Non-current receivables includes a $0.1 million balance due from a related party, refer to Note 22. 7. INVENTORIES During the year ended December 31, 2018, the cost of inventories recognized in cost of sales was $68.0 million (2017: $68.0 million). The inventory provision was $0.03 million during the year (2017: $0.08 million). Page 24 Accounts receivable$14,313 $12,127 Non-current receivables $235 $230 December 31, 2018December 31, 2017Raw materials$6,718 $8,147 Finished goods7,252 6,072 Carbon360 397 Packaging109 32 Hedge accounting component(588) 23 $13,851 $14,671 December 31, 2018December 31, 2017 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 8. SHORT-TERM INVESTMENTS Short-term investment, which consisted of a guaranteed investment certificate, matured and was reclassified to cash and cash equivalents. 9. DERIVATIVE FINANCIAL INSTRUMENTS – asset (liability) The Company’s derivative financial instruments were carried at fair value through profit or loss as follows: The Company’s derivative financial instruments were carried at fair value through other comprehensive income as follows: 10. PLANT AND EQUIPMENT Page 25 Coffee futures contracts, net$495 $247 US Dollar forward contracts, current(193) (3) US Dollar forward contracts, long term(300) (13) Derivative financial liability, convertible debenture(910) (2,709) $(908) $(2,478) December 31, 2018December 31, 2017US Dollar forward contracts, current$(876) $1,292 US Dollar forward contracts, long term(2,442) (13) $(3,318) $1,279 December 31, 2017December 31, 2018CostBalance at January 1, 2018$33,744 $5,113 $1,204 $189 $10,660 $50,910 Additions108 22 38 7 23,948 24,123 Disposals(61) (8) (2) - - (71) Transfers234 - 45 - (279) - Balance at December 31, 2018$34,025 $5,127 $1,285 $196 $34,329 $74,962 Accumulated depreciationBalance at January 1, 2018$(23,061) $(3,501) $(862) $(145) $- $(27,569) Depreciation(981) (298) (139) (11) - (1,429) Disposals61 8 2 - - 71 Balance at December 31, 2018$(23,981) (3,791) (999) (156) - (28,927) Balance at December 31, 2018$10,044 1,336 286 40 34,329 46,035 CostBalance at January 1, 2017$33,557 $5,052 $1,062 $181 $2,083 $41,935 Additions187 61 142 8 8,577 8,975 Balance at December 31, 2017$33,744 $5,113 $1,204 $189 $10,660 $50,910 Accumulated depreciationBalance at January 1, 2017$(21,546) $(3,227) $(750) $(134) $- $(25,657) Depreciation(1,515) (274) (112) (11) - (1,912) Balance at December 31, 2017$(23,061) $(3,501) $(862) $(145) $- $(27,569) Balance at December 31, 2017$10,683 $1,612 $342 $44 $10,660 $23,341 Machinery andLeaseholdComputerFurniture andequipmentimprovementequipmentfixturesin progressTotalConstruction SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) For the year ended December 31, 2018, depreciation expense of $1.3 million (2017: $1.8 million) has been charged to cost of sales and $0.1 million (2017: $0.1 million) was included in administrative expenses. There was no impairment loss recognized for the years ended December 31, 2018 and 2017. 11. INTANGIBLE ASSETS For the year ended December 31, 2018, amortization expense of $0.2 million (2017: $0.2 million) relating to proprietary process technology (“PPT”) has been charged to cost of sales and $0.02 million (2017: $0.02 million) relating to Brand was included in administrative expenses. There was no impairment loss recognized for the years ended December 31, 2018 and 2017. 12. INCOME TAXES Income tax expense For the year ended December 31, 2018, tax recovery on other comprehensive income related to hedging activities was $1.5 million (2017: $0.4 million expense). Reconciliation Income tax expense for the year can be reconciled to the accounting profit as follows: Page 26 CostBalance at January 1, 2018$3,246 $1,000 $4,246 Balance at December 31, 2018$3,246 $1,000 $4,246 AmortizationBalance at January 1, 2018$(1,920) $(899) $(2,819) Amortization(241) (19) (260) Balance at December 31, 2018$(2,161) $(918) $(3,079) Balance at December 31, 2018$1,085 $82 $1,167 CostBalance at January 1, 2017$3,246 $1,000 $4,246 Balance at December 31, 20173,246 1,000 4,246 AmortizationBalance at January 1, 2017$(1,680) $(879) $(2,559) Amortization(240) (20) (260) Balance at December 31, 2017$(1,920) $(899) $(2,819) Balance at December 31, 2017$1,326 $101 $1,427 PPTBrandTotalCurrent income tax expense$1,103 $890 Deferred tax expense586 716 Total income tax expense$1,689 $1,606 December 31, 2018December 31, 2017 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Current income tax payable As at December 31, 2018 income tax payable was $0.8 million (2017: $0.1 million). Deferred income tax assets (liabilities) Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets and liabilities and when the deferred tax balances relate to the same taxation authority. The movement in deferred income tax assets and liabilities during the year was as follows: During the year ended December 31, 2018, the Company collected $0.4 million related to Canadian Scientific Research and Experimental Development, a Canadian Government tax incentive program and it is included in the Administrative expenses. Swiss Water has no non-capital tax losses carry forwards as the end of December 31, 2018, while Seaforth has non-capital tax loss carry forwards of $0.6 million that begin to expire in 2033. 13. CREDIT FACILITIES The Company had no outstanding credit facility debt as at December 31, 2018 or December 31, 2017. As at December 31, 2018, the company had the following credit facilities: a) b) a $14.5 million revolving operating line of credit which bears interest at the bank’s prime lending rate plus 0.75% per annum; and a $1.5 million swing operating line of credit which bears interest at the bank’s prime lending rate plus 0.75% per annum. Any US$ denominated debt under the revolving operating line of credit or swing line can be financed using LIBOR loans at the LIBOR rate plus 2.35% per annum. Page 27 Statutory rate27%26%Income before tax$6,220 $5,766 Income tax calculated at applicable tax rates$1,679 $1,503 Non-deductible expenses18 109 Foreign tax rate differential(8) (6) Income tax expense$1,689 $1,606 December 31, 2018December 31, 2017 Goodwill and intangibles Share and debt issue costs and other Property plant and equipment ARO Share based compensation Derivative liability and convertible debenture Other comprehensive income Tax Losses Total Balance at January 1, 2017679$ 433$ (2,626)$ 207$ 376$ (123)$ (147)$ 362$ (839)$ To income tax expense13 (208) (97) 10 (204) (48) (385) (184) (1,103) Balance at December 31, 2017692$ 225$ (2,723)$ 217$ 172$ (171)$ (532)$ 178$ (1,942)$ Balance at January 1, 2018692$ 225$ (2,723)$ 217$ 172$ (171)$ (532)$ 178$ (1,942)$ To income tax expense(9) (88) (54) - (16) (408) 1,461 (12) 874$ Balance at December 31, 2018683$ 137$ (2,777)$ 217$ 156$ (579)$ 929$ 166$ (1,068)$ SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) In addition, the Company has a US$8.0 million foreign exchange and commodity futures contract facility, which allows the Company to enter into spot, forward and other foreign exchange rate transactions and commodity futures transactions with the bank with a maximum term of up to 60 months. These facilities are collateralized by a general security agreement over all of the assets of the Company and a floating hypothecation agreement over cash balances. As at December 31, 2018, the Company was in compliance with its debt covenants and had not made use of any of its credit facilities. 14. OTHER LIABILITIES The balance represents the fair value of the deferred share units (“DSUs”) and of the cash-settled portion of the restricted share units (“RSUs”) outstanding as follows: 15. CONSTRUCTION LOAN Landlord Construction Loan On August 26, 2016, Swiss Water signed a lease agreement, which includes a construction management agreement to build a highly specialized building to house a production plant. The landlord agreed to finance a portion of the construction costs, by means of a construction loan with repayments commencing on the earlier of substantial completion of construction and January 1, 2019. As at December 31, 2017 the Company accrued $0.8 million for the construction loan. During the year ended December 31, 2018 the Company accrued additional construction costs and then repaid the construction loan and interest in the amount of $6.1 million and $0.1 million respectively. The interest was capitalized as it is in the construction phase. Business Development Bank (BDC) Loan During the year ended December 31, 2018, the Company entered into a term loan facility with the Business Development Bank of Canada (“Term Loan”) of up to $20.0 million. The purpose of the Term Loan is to assist in the financing of new equipment for the facility being built in Delta, British Columbia. The Term Loan bears interest at 4.95% per annum over twelve years with monthly principal repayment commencing on September 1, 2020. The Term Loan matures on August 1, 2032. Interest only will be paid on the outstanding balance on a monthly basis prior to September 1, 2020. The Term loan is secured by a general security agreement and a first security interest on all existing equipment and machinery plus new equipment and machinery financed with the Term Loan. Seaforth has provided a guarantee for the Term Loan. As of December 31, 2018, the loan amount outstanding was $9.4 million with interest accrued of $0.02 million. The interest has been capitalized during the construction phase. 16. CONVERTIBLE DEBENTURE On October 11, 2016, the Company issued an unsecured subordinated convertible debenture for gross proceeds of $15.0 million. The convertible debenture bears interest at a rate of 6.85% per annum to be paid quarterly in arrears and is due on October 11, 2023. Page 28 Other liabilities, current$473 $591 Other liabilities, non-current105 45 $ 578$ 636December 31, 2018December 31, 2017 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) The Convertible Debenture is convertible into Common Shares of the Company at a conversion price of $8.25 per Common Share. Under the terms of the agreement, Swiss Water had the option to pay interest- in-kind for the first two years. If elected, this option would have increased the principal sum by the interest owing. The Company chose not to elect to pay interest-in-kind. The convertible debenture also includes a net share settlement feature that allows Swiss Water, upon conversion, to elect to pay cash equal to the face value of the convertible debenture and to issue common shares equal to the excess value of the underlying equity above the face value of the convertible debenture. If the net share settlement option is elected, it will result in fewer common shares being issued. In 2016, the Company paid financing costs of $0.5 million in respect of issuing the convertible debenture. The liability component was initially measured at a fair value of $11.2 million, which represents the present value of the contractually determined stream of cash flows discounted at the prevailing market interest rate at that time applicable to instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but without derivative components, of 12.15% per annum. The Company uses the residual value method to allocate the fair value of the convertible debentures between the liability component and the derivative liability. Under this method, as at December 31, 2018, the derivative liabilities include the fair value of the derivative liability related to a convertible debenture in the amount of $0.9 million (2017: $2.7 million). During the year ended December 31, 2018, this revaluation resulted in a gain being recorded in the statement of income in the amount $1.8 million (2017: gain of $0.6 million). The fair value of the derivative liability was determined using the Black-Scholes Option Pricing Model. The variables and assumptions used in computing the fair value are based on management’s best estimate. The value varies with different variables of certain subjective assumptions. Inputs into the Black-Scholes Option Pricing Model to determine the fair value of the conversion option were as follows: Page 29 Balance, open$11,658 $11,283 Interest charged1,452 1,403 Interest paid(1,028) (1,028) Balance, end$12,082 $11,658 December 31, 2018December 31, 2017Balance, open$2,709 $3,313 Change in fair valuation of derivative embedded option (1,799) (604) Balance, end$910 $2,709 December 31, 2018December 31, 2017Share price $ 4.97 $ 6.70 Exercise price $ 8.25 $ 8.25 Option life4.78 years5.79 yearsVolatility37%40%Risk-free interest rate1.88%1.90%Dividend yield5.03%3.73%December 31, 2018December 31, 2017 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 17. ASSET RETIREMENT OBLIGATION (“ARO”) The Company estimates the total undiscounted amount of any cash flows required to settle its ARO is approximately $0.9 million, which will be incurred on or about the expiry of the third lease renewal term in 2023. As at December 31, 2018, the Company has a long-term liability ARO of $0.8 million (2017: $0.8 million), reflecting the present value of the ARO using a credit adjusted risk free rate of 1.90%. 18. SHARE CAPITAL Swiss Water is authorized to issue an unlimited number of common shares. Each share is equally eligible to receive dividends when declared and represents one vote at meetings of shareholders. As of December 31, 2018, there were 9,061,210 (2017: 9,038,862), common shares issued and outstanding. Restricted share units The Company has a restricted share unit plan (“RSU Plan”) which allows it to grant RSUs to officers, employees and consultants of Swiss Water or its subsidiaries. The RSU Plan is administered by the Board of Directors, which sets the terms of incentive awards under the RSU Plan. The maximum number of common shares available for issue under the RSU Plan is 333,760, being 5% of the issued and outstanding common shares of the Company when it was approved by shareholders in the year 2011. These grants vest on the third anniversary of issuance (with certain exceptions) provided the grant recipient is still employed by Swiss Water or one of its subsidiaries as at the date of vesting. Grants are forfeited (with certain exceptions) if a recipient is no longer employed by Swiss Water or one of its subsidiaries. Upon vesting, each RSU converts to one common share. These grants allow participants to receive up to 50% of the market value of the award in cash (instead of shares) upon vesting, in order to facilitate payment of taxes owing on the awards. Any RSUs paid in cash are returned to the pool and may be re-issued, subject to the maximum number of common shares available under RSU. Periodically, the Company grants RSU awards. Each award is increased by the value of dividends paid to shareholders during the vesting period, using a formula which uses the higher of the then-current share price or $3.20. The movement in RSUs for the years ended December 31, 2018 and December 31, 2017 is as follows: Page 30 Number of RSUsAverage remaining vesting period (years)Performance basedBalance at January 1, 201748,285 7.86$ 1.14RSUs granted52,480 6.15$ 2.15NoRSUs issued for dividends3,522 6.30$ 1.06 NoRSUs forfeited(3,504) 6.26$ - NoBalance at December 31, 2017100,783 6.58$ 1.15 Balance at January 1, 2018100,783 6.58$ 1.15 RSUs granted91,000 6.35$ 2.15 NoRSUs issued for dividends4,891 6.08$ 1.75 NoRSUs cash-settled(28,304) 7.04$ - RSUs exercised(22,348) 7.04$ - RSUs forfeited(23,288) 6.25$ - NoBalance at December 31, 2018122,734 5.01$ 1.83 Volume based weighted average share price SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Deferred share units The Company has a deferred share unit plan (the “DSU Plan”) in order to issue deferred share units (“DSUs”) to non-employee directors (collectively, “participants”) of Swiss Water. The DSU Plan was adopted to allow participants the opportunity to defer compensation and encourage a sense of ownership in Swiss Water. Under the DSU Plan, participants may elect to defer compensation and receive DSUs equal to the value of the deferred compensation. The first DSUs were issued in April 2012. The number of DSUs was determined by dividing the amount of deferred compensation by the Fair Market Value (“FMV”). The FMV of DSUs is defined in the DSU Plan as the weighted average closing price of Swiss Water shares for the five business days immediately preceding the relevant date. Upon the occurrence of a redemption event, the affected participant will be entitled to receive a lump sum cash payment, net of applicable withholding taxes, equal to the product of number of DSUs held by that participant and the FMV on the date of the redemption event. The DSUs do not contain any vesting conditions or forfeiture provisions, as they are issued in exchange for deferred compensation. Under the DSU Plan, outstanding DSUs as at the record date are increased by the dividend rate whenever dividends are paid to shareholders. The movement in DSUs for the years ended December 31, 2018 and December 31, 2017 is as follows: 19. DIVIDENDS For the year ended December 31, 2018, the Company declared quarterly eligible dividends to shareholders totaling $2.3 million or $0.25 per share (2017: $2.3 million or $0.25 per share) of which, $0.6 million was payable at December 31, 2018 (2017: $0.6 million). 20. REVENUE Disaggregation of revenue Revenue disaggregated by geographical markets is disclosed in Note 24. The Company also disaggregates revenue by major products and services: decaffeinated coffee sales, decaffeination services, and distribution with the following results for the year ended December 31, 2018: Page 31 Number of DSUsPerformance basedBalance at January 1, 201768,879 7.08$ DSUs issued11,276 6.63$ NoDSUs exercised(9,581) 6.24$ NoBalance at December 31, 201770,574 6.60$ Balance at January 1, 201870,574 6.60$ DSUs issued 24,665 6.23$ NoBalance at December 31, 201895,239 4.97$ Weighted average share price SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Contract balances As at December 31, 2018 accounts receivable balance of $14.3 million (2017: $12.1 million) consists of amounts due from customer contracts and reflects the Company’s right to a consideration that is unconditional. The Company did not have other contract assets or liabilities from contracts with customers. 21. EMPLOYEE BENEFITS EXPENSES Expenses recognized for employee benefits are detailed below: Short-term benefits are comprised of salaries, accrued bonuses, benefits and director fees. Long-term benefits comprise share-based compensation under the RSU Plan and the DSU Plan. Post-employment benefits are contributions to employee retirement accounts, as well as statutory remittances related to post-employment benefits. These are recognized as an expense when employees have rendered service entitling them to the contributions. 22. RELATED PARTY TRANSACTIONS The Company’s related parties include its subsidiaries, key management personnel and a company related to a director. Details of transactions between the Company and related parties (other than its subsidiaries identified in the Nature of Business note) are discussed below. All intercompany transactions, balances, income and expenses are eliminated on consolidation. Compensation of Key Management Personnel The remuneration of directors and key management personnel during the year was as follows: Page 32 Decaffeinated coffee sales$78,974$73,962Decaffeination services5,1174,995Distribution5,8484,798$89,939$83,755December 31, 2018December 31, 2017December 31, 2018December 31, 2017Short-term benefits8,528$ 6,965$ Long-term benefits254 220 Post-employment benefits701 680 9,483$ 7,865$ December 31, 2018December 31, 2017Short-term benefits1,725$ 1,395$ Long-term benefits207 173 Post-employment benefits71 58 2,003$ 1,626$ SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Promissory note On March 16, 2017, a subsidiary of the Company and a member of key management (the “borrower”) entered into a promissory note in the amount of US$0.1 million. For as long as the borrower remains an employee, the obligation to repay the principal is forgiven against current and future awards under the RSU Plan, by forfeiture of awards. The loan is interest free other than in the event of default, in which case the promissory note shall bear simple interest at a rate of 10% per annum. Trading transactions During the year, the Company entered into the following transactions with a company that is related to a director: As at the balance sheet date, the Company had the following balances receivable from and payable to a company that is related to director: These transactions were in the normal course of operations and were measured at the fair value of the consideration received or receivable, which was established and agreed to by both parties. 23. BASIC AND DILUTED EARNINGS PER SHARE (“EPS”) Page 33 Sales$393 $303 Purchases of raw materials$5,957 $6,934 December 31, 2018December 31, 2017Accounts receivable$5 $15 Accounts payable$310 $- December 31, 2018December 31, 2017Basic EPSNet income attributable to shareholders$4,531 $4,160 Weighted average number of shares9,058,149 9,038,862 Basic EPS$0.50 $0.46 December 31, 2018December 31, 2017Diluted EPSNet income attributable to shareholders$4,531 $4,160 Interest on convertible debenture1,063 1,035 Gain on fair value adjustment of embedded option(1,799) (604) Net income after effect of diluted securities$3,795 $4,591 Weighted average number of shares - basic9,058,149 9,038,862 Effect of diluted securities: convertible debenture1,818,182 1,818,182 Weighted average number of shares - diluted10,876,331 10,857,044 Diluted EPS$0.35 $0.42 December 31, 2018December 31, 2017 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) The following potential common shares are anti-dilutive and are therefore excluded from the weighted average number of common shares outstanding for the purposes of calculating the diluted earnings per share: 24. SEGMENT REPORTING The Company’s sales are primarily generated by the decaffeination of green coffee segment and in three geographic areas: Canada, United States and other international markets. The Company’s revenue from external customers and its non-current assets (not including deferred tax assets), by location, are detailed below. Revenues Non-Current Assets 25. SUPPLEMENTAL CASH FLOW INFORMATION Cash and cash equivalents comprise cash on hand together with short-term investments. These investments consist of highly rated and liquid money market instruments with original maturities of three months or less. Page 34 Weighted average number of RSUs granted95,437 46,556 December 31, 2018December 31, 2017Canada$32,217 $35,103 United States45,558 38,808 International and other12,164 9,844 $89,939 $83,755 December 31, 2017December 31, 2018Canada$47,334 $25,663 United States103 75 $47,437 $25,738 December 31, 2018December 31, 2017Cash$8,336 $1,801 Cash equivalents- 7,685 $8,336 $9,486 December 31, 2017December 31, 2018 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Changes in non-cash working capital. During the year ended December 31, 2017, the Company funded $0.8 million in construction costs with a construction loan which did not require the use of the Company’s cash or cash equivalents. During the year ended December 31, 2018, the Company incurred additional such construction costs and repaid the loan in full in the amount of $6.1 million. As at December 31, 2018, $3.7 million addition to construction in progress was accrued in accounts payable and accrued liabilities. These are operating and investing transactions which did not require the use of the Company’s cash or cash equivalents. 26. FINANCIAL RISK MANAGEMENT The Company’s risk management program focuses on the unpredictability of commodity prices and foreign exchange rates and seeks to minimize potential adverse effects on the Company’s financial performance and cash flows. The Company uses derivative financial instruments to hedge these risk exposures. In addition, the Company monitors other financial risks on a regular basis. Risk management is carried out under policies approved by the Board of Directors. The Company’s exposure to and management of financial risks is discussed in more detail below. 26.1 Commodity price risk Commodity price risk is the risk that the fair value of inventory will fluctuate as a result of changes in commodity prices. The Company utilizes futures contracts to manage its commodity price exposure. The Company buys and sells futures contracts for coffee on the IntercontinentalExchange in order to offset its inventory position and fix the input cost of green coffee. As at December 31, 2018, the Company had futures contracts to buy 4.5 million lbs of green coffee with a notional value of US$4.7 million, and contracts to sell 4.7 million lbs of green coffee with a notional value of US$4.7 million. The furthest contract matures in in December 2019 (December 31, 2017: buy 2.2 million lbs of green coffee with a notional value of US$2.7 million, and contracts to sell 4.5 million lbs of green coffee with a notional value of US$5.5 million). The following tables provide a summary of commodity hedges designated as hedging instruments: Page 35 Accounts receivable$(2,160) $(420) Inventories1,433 (3,097) Other assets and liabilities6 (238) Prepaid expenses and other receivables(322) (653) Accounts payable and accrued liabilities1,535 927 Derivative assets and liabilities at fair value through profit or loss(1,215) (180) $(723) $(3,661) December 31, 2017December 31, 2018 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 26.2 Foreign currency risk The Company realizes a significant portion of its sales in US$, and purchases green coffee in US$ which is, in some cases, sold to customers in Canadian dollars. The Company enters into forward foreign currency contracts to manage its exposure to currency rate fluctuations and to minimize the effect of exchange rate fluctuations on business decisions. These contracts relate to the Company’s future net cash flows in US$ from sales. In addition, the Company enters into forward contracts to buy US$ for coffee that it resells in Canadian dollars. At December 31, 2018, the Company had forward currency contracts to buy US$6.6 million and sell US$65.0 million (2017: buy US$7.2 million and sell US$46.2 million) from January 2019 through to April 2023 at various Canadian exchange rates ranging from $1.2147 to $1.3820. The following tables provide a summary of amounts related to foreign currency forward contracts designated as hedging instruments. Not included in tables below are fair value changes for swap contracts, as these are not designated hedge instruments. Currency risk hedges on US$ purchases As at December 31, 2018, the Company designated as hedging instruments US$6.6 million in forward contracts to buy US dollars, which relate to coffee purchases (2017: US$7.0 million). Page 36 Carrying amount of hedging instrumentsFair value hedgeNominal amount of hedging instruments (in US$'000)$10 $2,804 hedging instrument is located Assets$495 $247 Liabilities- - Changes in fair value used for calculating hedge ineffectiveness- - December 31, 2018December 31, 2017Commodity price risk Coffee futuresCommodity price risk Coffee futuresLine item in the statement of financial position where Derivative Assets Derivative Assets Fair value hedgeand coffee inventoryand coffee inventoryNominal amount of hedged item (in '000 lbs)245 2,285 Inventories & hedgedInventories & hedgedhedged item is located firm commitmentsfirm commitmentsAssets $ 614 $ 28 Liabilities 791 128 Changes in fair value used for calculating hedge ineffectiveness - - Line items in the statement of financial position where Accumulated amount of fair value hedge adjustment on hedged item included in the carrying amount of the hedged items December 31, 2018December 31, 2017Purchase commitments Purchase commitments SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) Currency risk on hedge on US$ future revenue As at December 31, 2018, the Company designated as hedging instruments US$47.1 million in forward contracts to sell US dollars, which relate to highly probable forecasted sales revenue, (2017: US$34.0 million). Page 37 Carrying amount of hedging instrumentsFair value hedgeForeign currencyForeign currency purchase forwards purchase forwardsNominal amount of hedging instruments (in US$'000)$6,593 $6,962 Line item in the statement of financial position where hedging instrument is located Assets$385 $- Liabilities- 229 Changes in fair value used for calculating hedge ineffectiveness- - December 31, 2018December 31, 2017 Derivative liabilities Derivative Assets Fair value hedgeFirm purchase commitmentsFirm purchase commitments& inventories& inventoriesNominal amount of hedged item (in US$'000)$6,593 $6,962 Line item in the statement of financial position where (cid:10)Inventories & hedgedInventories & hedgedhedged item is located firm commitmentsfirm commitmentsAssets - 380 Liabilities 404 - Changes in fair value used for calculating hedge ineffectiveness - - Accumulated amount of fair value hedge adjustment on hedged item included in the carrying amount of the hedged items December 31, 2018December 31, 2017Carrying amount of hedging instrumentsCashflow hedgeNominal amount of hedging instruments (in US$'000)$47,111 $34,015 hedging instrument is located Assets4 1,292 Liabilities3,322 13 - - December 31, 2018December 31, 2017Currency riskForeign currency forwardsCurrency riskForeign currency forwardsLine items in the statement of financial position where Derivative assets and Derivative liabilitiesDerivative assets and Derivative liabilitiesChanges in fair value used for calculating hedge ineffectivenessCashflow hedgeNominal amount of hedged item (in US$'000) 47,111 34,015 Accumulated other Accumulated other hedged item is located comprehensive incomecomprehensive incomeAssets n/a n/a Liabilities n/a n/a Changes in fair value used for calculating hedge ineffectiveness - - Cashflow hedge reserve (3,496) 1,969 Line items in the statement of financial position where Accumulated amount of fair value hedge adjustment on hedged item included in the carrying amount of the hedged items December 31, 2018December 31, 2017Currency riskForeign currency forwardsCurrency riskForeign currency forwards SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 26.3 Interest rate risk Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in market interest rates. The Company believes that interest rate risk is low as all cash equivalents and short-term investments are made in fixed rate instruments. The Company does have some interest rate risk related to its credit facilities; however, the obligations are small enough that any exposure is not material at this time. There is no interest rate risk on the convertible debenture and construction loan as the interest rates are fixed. 26.4 Credit risk The Company is exposed to credit risk with respect to its cash and cash equivalents, short-term investments, accounts receivable and derivative financial instruments. The Company does not have significant credit risk related to cash and cash equivalents and short- term investments as amounts are held with major financial institutions. The Company follows a program of credit evaluations of customers and limits the amount of credit extended when deemed necessary. For the year ended December 31, 2018, revenues from three major customers of $32.0 million (2017: $29.0 million) represented 36% (2017: 35%) of total revenues for the year. These same three customers represented 43% of total accounts receivable as at December 31, 2018 (2017: 47%). The Company had 19% of its accounts receivable past due but not impaired as at December 31, 2018 (December 31, 2017: 16%). Of the past due accounts receivable, 91% are 1-30 days past due (December 31, 2017: 83%), while 9% are 31-60 days past due (December 31, 2017: 17%). The Company manages the credit risk related to its derivative financial instruments by entering into such contracts only with high credit quality institutions. 26.5 Liquidity risk The Company has in place a planning and budgeting process to assist in determining the funds required to support the Company’s normal operating requirements on an ongoing basis and its future plans. The Company ensures that there are sufficient committed financing facilities to meet its short-term business requirements, taking into account its anticipated cash flows from operations, its existing bank indebtedness and additional borrowing capacity. The Company has maintained compliance with its banking covenants and remains able to satisfy its liabilities as they become due. Non-derivative financial liabilities are as follows: 26.6 Fair value of financial instruments Financial instruments that are measured at fair value are categorized as follows. During the year, there were no transfers between level 1 and 2 instruments. Page 38 2020 to 2021Accounts payable$6,558 $6,558 $- $- $- Other liabilities578 473 105 - - Construction loan 9,400 - 1,044 1,567 6,789 Convertible debenture12,082 - - - 15,000 Total $28,618 $7,031 $1,149 $1,567 $21,789 Thereafter2022 to 20232019December 31, 2018Carrying AmountContractual Cash Flows SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 27. COMMITMENTS 27.1 Operating lease commitments Swiss Water leases a facility which houses its decaffeination plant and offices. The lease expires in May 2023. Beyond 2023, the landlord has to approve any subsequent renewal of the lease. Seaforth leases warehouses in two locations for its primary operations. These leases expire in June 2019 and November 2019. Swiss Water Decaffeinated Coffee Company USA, Inc. holds a lease for its Seattle, Washington, sales office, which expires in March 2020. A summary of future minimum payments under these operating leases as at December 31, 2018 is as follows: 27.2 Other operating lease commitment On August 26, 2016, Swiss Water signed a lease agreement for a build-to-suit production facility. The lease has an initial term of five years and can be renewed at the Company’s option in five-year increments up to a total of 30 years. The lease commenced in July 2018. Under the lease, the Company has multiple options to buy-out the lease starting at the end of the second five-year term. The buy-out value will be equal to the fair market value of the property as determined by an appraisal process, subject to specified maximum and minimum values. A summary of future minimum payments under this lease as at December 31, 2018 is as follows: Page 39 Financial assetsCash, cash equivalents and short-term investments$8,336 $8,336 $- $- Derivative assets883 495 388 - $9,219 $8,831 $388 $- Financial liabilitiesDerivative liabilities$5,109 $- $5,109 $- Other liabilities578 - 578 - $5,687 $- $5,687 $- Financial assetsCash, cash equivalents and short-term investments$16,553 $16,553 $- $- Derivative assets1,984 275 1,709 - $18,537 $16,828 $1,709 $- Financial liabilitiesDerivative liabilities$2,951 $- $2,951 $- Other liabilities636 - 636 - $3,587 $- $3,587 $- Level 3Level 2December 31, 2017Level 1Level 2Level 3December 31, 2018Level 1Minimum lease payments due:No later than 1 year$1,524 Later than 1 year and no later than 5 years1,429 $2,953 SWISS WATER DECAFFEINATED COFFEE INC. (formerly TEN PEAKS COFFEE COMPANY INC.) Notes to the Consolidated Financial Statements For the years ended December 31, 2018 and 2017 (Tabular amounts are in thousands of Canadian dollars) 27.3 Other commitments The Company has provided a standby letter of credit in the amount of $0.3 million as security to the landlord. The Company has, in the normal course of business, entered into various contracts. As at December 31, 2018, these contracts related to the purchase of green coffee in the amount of $37.6 million (2017: $33.0 million), and natural gas purchase commitments in the amount of $0.1 million (2017: $0.2 million). $37.7 million (2017: $32.9 million) of these contracts will become payable within twelve months from December 31, 2018. Also, as at December 31, 2018 the Company's capital commitments for the new facility's plant and equipment were $2.4 million (2017: $16.0 million). 28. SUBSEQUENT EVENTS On January 15, 2019, the Company paid an eligible dividend in the amount of $0.6 million ($0.0625 per share) to shareholders of record on December 31, 2018. On January 22, 2019, the Company incorporated a subsidiary in France, Swiss Water Decaffeinated Coffee Europe SARL. On February 21, 2019, the Company granted 98,000 RSUs pursuant to the Restricted Share Unit Plan. On March 11, 2019, the Company declared an eligible dividend of $0.0625 per share, to be paid on April 15, 2019 to shareholders of record on March 29, 2019. Subsequent to year end, Seaforth entered into an agreement to lease a warehouse facility in British Columbia. The term of the lease is eight years and three months starting April 1, 2019. Minimum payments over the term of the lease with renewal options are $9.7 million. Page 40 Minimum lease payments due:No later than 1 year$1,178 Later than 1 year and no later than 5 years4,320 $5,498 SWP Q4 cover_Layout 1 19-03-14 8:24 AM Page 2 SWP Q4 cover_Layout 1 19-03-13 4:00 PM Page 4 www.investor.swisswater.com TSX: SWP 

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