ARROWHEAD WATER PRODUCTS LTD.

Transcription

1 ARROWHEAD WATER PRODUCTS LTD. Management s Discussion and Analysis For the first quarter ended December 31, Form F1

2 ARROWHEAD WATER PRODUCTS LTD. MANAGEMENT S DISCUSSION and ANALYSIS ( MD&A ) Form F1 FOR THE FIRST QUARTER ENDED DECEMBER 31, February 23, Overview This Management s Discussion and Analysis ("MD&A") of financial condition and results of operations of Arrowhead Water Products Ltd. ("Arrowhead" or the "Company") was prepared by management and approved by the Board of Directors of the Company. This MD&A is primarily a discussion of the operational and financial performance of the Company for the three months ended December 31, and should be read in conjunction with the Audited Consolidated Financial Statements and accompanying notes of the Company for the year ended September 30,. The reader should be aware that historical results are not necessarily indicative of future performance. Additional information with respect to Arrowhead can be found on SEDAR at This MD&A incorporates information up to and including February 23, The reporting and measurement currency is the Canadian dollar. 2. Advisory Regarding Forward-Looking Statements and Information Certain statements included or incorporated by reference in the MD&A constitute forward-looking statements or forward-looking information under applicable securities legislation. Forward-looking statements are based on the estimates and opinions of Arrowhead's management at the time the statements were made. The reader is cautioned that assumptions used in the preparation of such information may prove to be incorrect. The use of any of the words "anticipate", "continue", "estimate", "expect", "may", "will", "project", "plan", "should", "believe" and similar expressions are intended to identify forward-looking statements and forward-looking information including, but not limited to, statements as to: future capital expenditures, including the amount and nature thereof; business strategy and; expansion and growth of the Company's business and operations. These statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking statements or information. The Company believes that the expectations reflected in those forward-looking statements and forward-looking information are reasonable but no assurance can be given that these expectations, or the assumptions underlying these expectations, will prove to be correct and such forward-looking statements and forward-looking information included in this MD&A should not be unduly relied upon. Such forward-looking statements and forward-looking information speak only as of the date of this MD&A and the Company does not undertake any obligation to publicly update or revise forward-looking statements or forward-looking information, except as required by applicable laws. Any forward-looking statements or forward-looking information previously made may be inaccurate now. All subsequent forward-looking statements and forward-looking information, whether written or oral, attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements. 3. Overall Performance The Company continues to increase sales in its new innovative environmentally friendly 15 litre PET large format water channel. The Company packages spring, drinking and pure distilled water in the new 15 litre bottle which is produced at its Edmonton plant. The Company s key market is to focus on grocery chains and big box stores located in Western Canada. Currently, the Company is operating one Siapi blow molding machine in its Edmonton facility and the Company plans to move its second Siapi machine into a new high growth market in Western Canada. The retailers in Western Canada are moving more and more into large format single use 15 litre PET bottles which are one way and 100% Bisphenol A free (BPA). The food service market is another growing channel for these new innovative single use PET bottles which are 100% recyclable. Consumers may return the empty bottles to any bottle depot in Alberta. Another key selling feature is the bottle deposit is only $0.25 instead of the $10.00 deposit that is found on the older 5 gallon (18.9 litre) polycarbonate bottles which are slowly being phased out by retailers. The new PET bottles are fully compatible with any water cooler on the market today and can be found at most major retailers in Alberta.* 1

3 During the period, 15-litre pet sales surpassed the 18.9-litre (5 gallon) sales by a 72/28 margin as compared to the first quarter of 37/63 in favor of the 18.9-litre. The Company will continue to sell its 18.9-litre bottles, however, as the sales of the new 15-litre PET bottle continue to gain momentum this will decrease the sales of the 18.9-litre bottles in the future. Revenues in 15-litre increased by approximately 75% year over year.* Two (2) major retailers based in Western Canada have been very pleased with the 15-litre product line and are committed to providing their customers with the product and have recently expressed interest in expanding the 15-litre product line into their retail stores in British Columbia. Activity in the water business is subject to a range of external factors that are difficult to actively manage, including industry commodity pricing, cost of fuel, operating costs and labour. The Company has been active in looking for ways to lower production costs. Due to the increase in demand for the 15-litre PET bottle, the Company has been working with various vendors to ship directly via distribution centres across Western Canada, in order to minimize the rising costs of delivering directly to stores. Over the last two (2) quarters of, the Company was faced with rising costs associated with material and logistics costs that affected both retail channels (15-litre and 18.9-litre) mainly increasing costs for its spring water and transportation costs. These costs along with the costs associated from customers changing over to the 15- litre, together with a decline in revenue and an increase in preforms saw margins declining to 24.7% margin as compared with a 31.2% from a year ago. As a result of these increasing costs, management plans to negotiate further rounds of price increases with its customers in order to improve margins.* Results and highlights from operations in the first quarter ended December 31, when compared to the first quarter in were: Sales from the 15-litre channel increased by 75% from $467,540 to $817,631. Total revenues decreased by 9% from $1,253,226 to $1,141,403. Gross profit decreased by 28% from $390,702 to $282,304. Cost of goods sold decreased from $862,524 to $859,098 Total general and administrative expenses decreased by 2% or $10,014. The Company incurred an operating loss of $316,159 as compared to a loss of $161, Corporate Developments Arrowhead is a publicly traded company, listed on the TSX Venture Exchange ( TSXV ). Arrowhead is Canada s largest Canadian-owned, publicly traded water company engaged in the production, sales and distribution of large format (15-litre and 18.9-litre) bottles of drinking water in Western Canada. Arrowhead distributes reverse osmosis, distilled and natural spring water to the Western Canadian retail grocery market. Consumers choose bottled water as an alternative to municipal or local water supplies. On October 1,, after the Company received approval from its shareholders and the TSXV, the Company consolidated (the Consolidation ) its Class A Common Shares on a one for five (1:5) basis (this was a condition of allowing the Company in fiscal to price the Private Placement and Rights Offering at $0.025 per Unit). As a result of the Consolidation, the Company's issued and outstanding Class A Common Shares decreased from 72,461,146 Class A Common Shares (pre-consolidation) to 14,492,229 Class A Common Shares (postconsolidation). The post-consolidation Class A Common Shares commenced trading on the TSXV under the new trading symbol "AWA" on October 1,. Further details with respect to the Consolidation are disclosed in the Company's Management Information Circular dated July 29,, which has been electronically filed with regulators and available for viewing through the Internet on the Canadian System for Electronic Document Analysis and Retrieval (SEDAR) at 2

4 As a result of the Consolidation, the Company's issued and outstanding Warrants decreased from an aggregate of 44,508,616 (pre-consolidation) with an average exercise price of $0.03 to an aggregate of 8,901,723 (postconsolidation) with an average exercise price of $0.15. With the Consolidation, the Company s stock options decreased from 2,650,000 (pre-consolidation) with an exercise price of $0.10 per share to 530,000 (post-consolidation) with an exercise price of $0.50 per share. On October 22,, the Company's Board of Directors approved the granting of 975,000 stock options to the officers, directors, employees and consultants of the Company, subject to regulatory and TSXV approval. The options were issued with an exercise price of $0.10 per share and have a five year term with standard vesting provisions. Arrowhead has experienced tremendous growth in consumer demand with the advancement of its 15-litre oneway Green 15-litre bottle. The Company experienced a 75% increase in revenues from the 15-litre channel for the period when compared to. Management believes consumer demand for an alternative Eco-friendly large format water bottle will continue as consumers seek a more environmentally friendly product (BPA free), minimal bottle deposit (previously $10 now $0.25) and a new environmentally friendly PET bottle which requires 40% less plastic versus the 18.9-litre bottle. These bottles are 100% recyclable and can be returned to over 240 bottle depots for recycling in Alberta. Over the last year, the Company was investigating the possibility of expanding into the British Columbia marketplace and is currently reviewing options for this expansion.* The Company has been in the process of converting a number of its major retail accounts from the traditional 18.9-litre (5 gallon) bottles to the Company's new 15-litre bottle, which are lighter, crushable, Bysphenol-A ( BPA ) free and one way blue box disposable. In order to expand its 15-litre business, the Company is operating a new SIAPI blow molding machine to make the 15-litre bottles at its Edmonton plant and plans to locate its second SIAPI machine in British Columbia. This conversion reduced the Company s cash flow by approximately $157,855 in bottle deposit liability in the first quarter of 2011 compared with a reduction of only $3,713 during the same period a year ago. In the last three (3) years of operation, the Company has reduced its bottle deposit liability for 18.9-litre bottles from approximately $3,000,000 to just under $739,000 at the end of the current period.* During the period, Arrowhead installed a new In-line filler and capper with a conveyor system for its 15-litre line production. The addition of this equipment upgrade will greatly improve the Company's efficiencies in the plant and allow the Company the ability to increase its overall output of the 15-litre water products. 5. Selected Financial Information Audited December 31, September 30, Assets Current assets 1,539,558 1,855,236 Long term assets 1,741,164 1,822,595 3,280,723 3,677,831 Liabilities & Equity Current liabilities 1,117,582 1,076,896 Long term liabilities 694, ,148 Equity 1,468,282 1,705,787 3,280,723 3,677,831 3

5 Revenues (in Canadian $) Q Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 15L Revenue 817, , , , , , , , , L Revenue 321, , , , , , , , ,202 Q Q4 Q3 Continuing Operations Revenue $1,141,403 $1,272,263 $1,294,673 $1,260,405 $1,253,226 $1,300,328 $1,295,961 $1,232,658 Gain/(loss) before other items (316,159) (24,182) (106,173) (95,409) (161,465) (57,542) (190,573) (260,945) Basic loss per share (0.02) (0.00) (0.00) (0.00) (0.01) (0.00) (0.01) (0.01) Net income gain/(loss) (312,833) (29,960) (106,173) (103,306) (162,316) (57,977) (213,198) (261,807) Basic per share (0.02) (0.00) (0.00) (0.00) (0.01) (0.00) (0.01) (0.01) Discontinued Operations Revenue Income (loss) before other items Basic loss per share Net income (loss) (98,485) - Basic per share (0.00) (0.00) - Basic number of shares outstanding 14,492,229 72,461,146 72,461,146 66,832,530 30,832,530 30,832,530 30,832,530 30,832,530 Q2 Q1 Q4 Q3 Q2 Notes: Please refer to Note 3/4 of the Audited Consolidated Financial Statements for the year ended September 30, / for disclosure of discontinued operations. On October 1,, after the Company received approval from its shareholders and the TSXV, the Company consolidated its Class A Common Shares on a one for five (1:5) basis. As a result of the Consolidation, the Company's issued and outstanding Class A Common Shares decreased from 72,461,146 Class A Common Shares (pre-consolidation) to 14,492,229 Class A Common Shares (post-consolidation). 4

6 3 months ended December 31 (in Canadian $) Revenue Retail $ 1,138,810 $ 1,250,821 Other 2,593 2,405 Total Revenue 1,141,403 1,253,226 Cost of sales 859, ,524 Gross margin 282, ,702 General and administrative 397, ,056 EBITDA (114,738) (16,354) Amortization 119, ,107 Stock-based compensation 75,328 5,687 Interest 6,732 12,317 Loss from operations (316,159) (161,466) Gain (loss) on sale of assets 3,326 (851) Loss and comprehensive loss for the period (312,834) (162,317) Deficit, beginning of period (4,074,906) (3,673,150) Deficit, end of period $ (4,387,740) $ (3,835,467) Loss per share, basic and diluted (0.02) (0.01) 6. Revenues The Company s revenues from continuing operations are derived from two main sources: Retail water sales from 15-litre and 18.9-litre channels, which includes recycling and environmental levies; and Other revenues including water related sales, sale of customer accounts and interest income. Overall retail sales for the quarter decreased by $112,011 or 9% when compared to the same quarter last year. Management believes that this is a result of a number of different factors including: As a result of customer changeovers from the 18.9-litre bottle to the 15-litre pet bottle, the Company has experience a short term reduction of 10-12% in sales volumes which ultimately affects overall revenues. In fiscal, the Company conducted a test program for the 15-litre pet bottle in 10 stores with a major retailer who elected to continue with an 18.9-litre bottle program pursuant to a national contract. Due to external factors that are difficult to manage, including commodity pricing by competitors, the Company has been unable to substantially increase its prices.* As a result of these decreased revenues and increasing costs, management plans to negotiate further rounds of price increases with its customers in order to improve margins.* During the first quarter the 15-litre channel contributed approximately $817,631 in revenues versus $467,540 for the same period a year ago, an increase of 75%. 5

7 Arrowhead has experienced tremendous growth in consumer demand with the advancement of its 15-litre oneway Green bottle. Management believes consumer demand for an alternative Eco-friendly large format water bottle will continue as consumers seek a more environmentally friendly product (BPA free), minimal bottle deposit (previously $10 now $0.25) and a new environmentally friendly PET bottle which requires 40% less plastic compared to the 18.9-litre bottle.* Because of this, stores that once carried the 18.9-litre channel will continue to convert to the 15-litre channel. Sales of the 18.9-litre channel decreased over the period by 59% or $462,102 when compared to the same period last year. At December 31, and, upon reconciling its float of 18.9-litre bottles, the Company concluded that there were no amounts representing forfeited deposits and therefore none were recorded as revenue.* 7. Cost of Sales and Gross Margins Continuing Operations Q Q4 Q3 Revenue $1,141,403 $1,272,263 $1,294,673 $1,260,405 $1,253,226 $1,300,328 $1,295,961 $1,232,658 COGS 859, , , , , , , ,815 Gross Margin 282, , , , , , , ,843 Gross Margin % 24.7% 31.3% 32.2% 36.4% 31.2% 39.1% 36.8% 34.7% Q2 Q1 Q4 Q3 Q2 Cost of goods sold during the first quarter remained relatively the same (decreased by $3,425) when compared with the first quarter of. Over the last two (2) quarters of, the Company was faced with rising costs associated with material and logistics costs that affected both retail channels (15-litre and 18.9-litre) mainly increasing costs for its spring water and transportation. These costs along with the costs associated with customers changing over to the 15-litre bottle during the first quarter of 2011, together with a decline in revenue and an increase in preforms resulted in margins declining to 24.7% as compared with a 31.2% from the same period a year ago. As a result of the declining margins, gross profit decrease 28% or about $108,398 from the same quarter last year. Arrowhead disclosed in its year end MD&A: As Arrowhead continues to convert its customers from the 18.9-litre to the more Eco-friendly 15-litre channel, this will put a negative strain on the Company s overall margins. There are currently greater costs associated with the material, production and the logistics of delivering this product to the retailers at current volumes. The Company anticipates that margins will increase as volumes increase.* As a result of these increasing costs, management plans to negotiate further rounds of price increases with its customers in order to improve margins.* The Company further recorded $3,816 in costs for disposals of its 18.9-litre bottle over the period compared to $13,365 for, a reduction of 71% or $9,549. The Company records these disposals on a monthly basis and as more and more cutomers convert to the 15-litre one-way Green bottle, management believes that these costs will continue to reduce on a per bottle basis.* Activity in the water business is subject to a range of external factors that are difficult to actively manage, including industry commodity pricing, cost of fuel, operating costs and labour. Management plans to mitigate these risks while remaining responsive to changes in industry dynamics. Management will endeavor to continue to look at finding ways to decrease the Company's materials, logistics and production costs and increase revenues while expanding to new markets in Western Canada.* 6

8 During fiscal, the Company switched its main preform supplier to a local vendor from a former USA vendor, which significantly reduced the cost and the foreign exchange risk. However, the Company continues to source certain materials, parts and services from USA vendors. Foreign exchange risk arises due to fluctuations in foreign currency rates, which could affect the Company s financial results.* 8. General and Administrative (G&A) Expenses During the first quarter, total G&A expenses decreased by 3% or $10,267 compared to the same period in. Although the Company experienced savings in most categories, the Company did however experience higher than normal increases in professional fees. Year over year saw this increase by $51,424 or 297% when compared to the same period last year. When comparing the first quarter of 2011 to, increases can be summed up by: $27,689 in Legal fees $15,000 in Consulting $4,000 in filing year end fees $4,200 in TSXV fees for stock options Management is of the opinion that any risk of accounting loss is significantly reduced due to the financial strength of the Company s major customers. Given that the Company had only one (1) independent distributor go into the receivership in fiscal, the Company believes that a 3% allowance on the total accounts receivable is adequate at this time. At September 30,, the Company reduced its allowance for doubtful accounts to 3% or $13,930 of gross accounts receivable compared with $91,141 as at September 30,. As at December 31,, the Company maintained its 3% allowance or $12,874 of gross accounts receivable compared with $96,836 at December 31,.* The Company had major savings (see table below) in almost every category in the first quarter when compared to the same period last year. Exceptions were Rent 3% due to extending the lease on the Calgary facility for one (1) year; Computer support/maintenance 8%; Telephone 10%; and Professional fees as noted above. Sales and Marketing decreased by 71% or by $38,358 due to a special advertising promotion with one of the Company s major customers that ended during the Calendar year of. GENERAL AND ADMINISTRATIVE EXPENSES 3 months ended December 31 (in Canadian $) Rent $ 115,018 $ 111,353 Salaries 102, ,931 Professional fees 68,715 17,291 Utilities 39,315 38,261 Travel and entertainment 16,373 17,337 Sales and marketing 15,615 53,973 Insurance, license, and business 10,040 11,021 Computer support and maintenance 6,557 6,088 Telephone 6,034 5,511 Service fees and interest 5,457 8,143 Office 4,865 5,356 Taxes and licenses 3,641 4,660 Memberships dues & subscriptions 2,076 2,278 Miscellaneous Gain/loss on foreign exchange Bad Debt Expense -94 6,251 $ 397,042 $ 407,056 7

9 9. Change in Accounting Estimate As of October 1, 2008, the Company reassessed the period over which future economic benefits would be generated by water bottles classified as property and equipment. The estimation of the useful life of water bottles has been modified from 10 years to 5 years. This change in accounting estimate increased, for the year ended September 30,, the amortization of property and equipment and increased the net loss and decreased property and equipment, as at September 30,, by $46, The change in accounting estimate has been applied prospectively from October 1, Amortization For the first quarter, the amortization of tangible and finite-life intangible assets represented normal expense consistent with the Company s amortization policy. The amortization expense for the first quarter was $119,361 as compared to $127,107 during same period last year. 11. Operating Loss For the first quarter of 2011, the Company had an operating loss for continuing operations of $316,159 compared to a loss of $161,466 for the same period in. The loss for the current quarter primarily resulted in increase in stock base compensation, increase in cost of goods sold, and a decrease in revenues. 12. Stock-based Compensation The Company recognizes compensation expense when stock options are granted under the fair value method. The fair value of stock options is determined using the Black-Scholes option-pricing model. This expense is a non-cash expense, the cumulative effect of which is reflected in contributed surplus on the Balance Sheet. The Company has a stock option plan (the Plan ) available to officers, directors, employees and consultants with grants under the Plan approved from time to time by the Board. Under the Plan, the exercise price of each option equals the market price of the Company s stock at the time of issuance. The Plan provides for vesting at the discretion of the Board and expiration of the options to be five years from the date of grant. Each option can be exercised for one Class A Common Share of the Company. With the consolidation of the Company s shares, the Company s stock options decreased from 2,650,000 (preconsolidation) with an exercise price of $0.10 per share to 530,000 (post-consolidation) with an exercise price of $0.50 per share. Due to the increase in the option price, the Company advised that on October 22,, the Company's Board of Directors approved the granting of 975,000 stock options to officers, directors, employees and consultants of the Company, subject to regulatory and TSXV approval. The options were issued with an exercise price of $0.10 per share and have a five year term. The fair value of the 975,000 options granted was $97,371. Stock based compensation expense recognized during the period was $75,328 ( - $5,687). At the end of the first quarter of 2011, the Company had outstanding options of 1,505,000 ( 3,000,000). For further details on the stock based compensation calculations, refer to note 3(e) of the Unaudited Financial Statements dated December 31, and refer to note 11(f) of the Annual Audited Consolidated Financial Statements dated September 30,. 13. Income Taxes For the period ended December 31,, the Company has not recorded any future income tax expense or recovery. As a result of the losses reported in prior periods, there is no allocation for future income tax expense. 14. Net Profit (Loss) After Taxes For the first quarter of 2011, the net loss for continuing operations was $312,834 compared to a loss of $162,317 for the same period in. 8

10 15. Working Capital For the period ended December 31,, the Company's working capital ratio decreased from 1.72 to 1 (as at September 30, ) to 1:38 to 1, as at December 31,. With the availability of cash and cash equivalents of approximately $739,822, and an operating credit line of up to $750,000, the Company has sufficient working capital to meet its fiscal goals for 2011.* 16. Financial Instruments Canadian generally accepted accounting principles require that the Company disclose information about the fair value of its financial assets and liabilities. Fair value estimates are made at the balance sheet date, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties in significant matters of judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates. Financial instruments of the Company consist of cash, accounts receivable, ban indebtedness, accounts payable, and accrued liabilities and long-term debt. Unaudited Audited December 31, September 30, Carrying Fair Carrying Fair Value Value Value Value Held-for-trading Cash $ 949,770 $ 949,770 $ 1,250,153 $ 1,250,153 Loans and receivable Accounts receivable 442, , , ,928 Liabilities Bank indebtedness 209, ,949 80,662 80,662 Accounts payable and accrued liabilities 467, , , ,797 Long-term debt 225, , , ,505 The Company classifies fair value measurements recognized in the balance sheet using a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: Level 1: Quoted prices (unadjusted) are available in active markets for identical assets or liabilities; Level 2: Inputs other than quoted prices in active markets that are observable for the asset or liability, either directly or indirectly; and Level 3: Unobservable inputs in which there is little or no market data, which require the Company to develop its own assumptions. Fair value measurements are classified in the fair value hierarchy based on the lowest level input that is significant to that fair value measurement. This assessment requires judgment, considering factors specific to an asset or a liability and may affect placement within the fair value hierarchy. Cash is measured using level 1 inputs. 9

11 17. Liquidity and Capital Resources The Company has demonstrated its ability to raise additional capital through debt and equity financings when needed. During the first quarter, the Company made payments of $57,712 compared with last year same period payments of $112,790 to reduce long-term debt obligations. As at December 31,, the Company had cash and cash equivalents (net of bank indebtedness) of $739,822 compared to $1,169,491 at September 30,. Management believes that the existing cash and projected cash flow are sufficient to meet all of its current and contractual obligations for fiscal 2011.* Historically, the Company has generated positive cash flow from the 18.9-litre bottle deposit charge of $10.00 per bottle; however, with the increase in the rate of conversion to the 15-litre bottle from the 18.9-litre bottle, this cash flow has been reduced. The Company repaid bottle deposits during the first quarter and has decreased the long term refundable deposit by $157,855 in the first quarter compared to a decrease of the liability by $3,713 during the same period last year. Over fiscal, the Company repaid and decreased this liability by $361,385 whereas the liability was increased by $96,103 in. This decreasing trend will continue into 2011 as customers continue to convert to the 15-litre bottle from the 18.9-litre bottle.* (in Canadian $) Contractual Obligations Total Fiscal 2011 Fiscal Years and Over Long-term debt $ 429, , ,505 - Capital Leases 24,207 24, Operating Leases/Commitments 191,096 52,288 99,918 38,890 Building Leases 753, , ,346 - Total Contractual Obligations $ 1,398, , ,769 38, Capital Spending During the quarter, the Company purchased $58,329 in capital assets as compared to $8,470 from the same period a year ago. During the period, the Company installed a new In-line filler and capper with a conveyor system for its 15-litre line production in its Edmonton plant. The addition of this equipment upgrade will greatly improve the Company's efficiencies in the plant and allow the Company the ability to increase its overall output of the 15-litre water products. Also, the Company during the current period purchased four (4) new hydraulic jacks for logistics. In the first quarter of, the Company purchased a vehicle van pursuant to a lease back arrangement and the vehicle was sold within a month. With retailers changing over to the 15-litre channel, the Company has a sufficient float of 18.9-litre bottles to maintain its 18.9-litre customer base. The Company does not plan to purchase additional 18.9-litre bottles and will continue to sell bottles to other water companies as its stock of 18.9-litre bottles increases.* 10

12 Capital spending is summarized as follows: 3 months ended December 31, (in Canadian $) Manufacturing equipment $ (58,329) $ - Vehicles - (8470) (58,329) (8,470) 19. Goodwill Disposals 3,816 13,365 Proceeds from the sale of property, plant and equipment 19,908 7,619 $ (34,604) $ 12,514 Goodwill represents the excess of the purchase price over the market price of acquired businesses. Effective October 1, 2007, the Company adopted the new accounting standard whereby goodwill is no longer amortized but is subject to an annual review for impairment. Upon the sale of the HOD, goodwill was eliminated. For disclosure, please refer to Note 3 of the Audited Consolidated Financial Statements for the year ended September 30,. 20. Off Balance-Sheet Arrangements The Company has no off balance-sheet arrangements. 21. Transactions with Related Parties During the quarter, the Company contracted certain legal services with Carscallen Leitch LLP. A director of the Company is Counsel with Carscallen Leitch LLP. These transactions are in the normal course of operations and have been valued in these financial statements at the exchange amount, which is the amount of consideration established and agreed to by the related party. Expenses incurred during the three months ended December 31, were $27,689, ( - nil). 22. Outstanding Share Data On October 1,, after the Company received approval from its shareholders and the TSXV, the Company consolidated (the Consolidation ) its Class A Common Shares on a one for five (1:5) basis (this was a condition of allowing the Company to price the Private Placement and Rights Offering at $0.025 per Unit). As a result of the Consolidation, the Company's issued and outstanding Class A Common Shares decreased from 72,461,146 Class A Common Shares (pre-consolidation) to 14,492,229 Class A Common Shares (post-consolidation). The post-consolidation Class A Common Shares commenced trading on the TSXV under the new trading symbol "AWA" on October 1,. Further details with respect to the Consolidation are disclosed in the Company's Management Information Circular dated July 29,, which has been electronically filed with regulators and available for viewing through the Internet on the Canadian System for Electronic Document Analysis and Retrieval (SEDAR) at At September 30,, (pre-consolidation), the Company had 72,461,146 Class A Common Shares ( - 30,832,530); 2,650,000 stock options ( 3,000,000) and 44,508,616 warrants ( - nil) to acquire Class A Common Shares, issued and outstanding. At December 31, and following the Consolidation, the Company has 14,492,229 Class A Common Shares; 1,505,000 stock options (975,000 granted October 22, ) and 8,901,723 warrants to acquire Class A Common Shares, issued and outstanding. For further details of outstanding share data refer to note 3 of the Unaudited Financial Statements dated December 31, and refer to note 11 of the Annual Audited Consolidated Financial Statements dated September 30,. 11

13 23. Changes in Accounting Policies Effective October 1, 2006, the Company adopted Canadian Institute of Chartered Accountants ("CICA") Handbook Section 1530, Comprehensive Income, CICA Handbook Section 3855, Financial Instruments - Recognition and Measurement, CICA Handbook Section 3861, Financial Instruments - Presentation and Disclosure and CICA Handbook Section 3865, Hedges. These new Handbook Sections provide comprehensive requirements for the recognition and measurement of financial instruments, as well as standards on when and how hedge accounting may be applied. Handbook Section 1530 also introduces a new component of equity referred to as comprehensive income. Section 1530 establishes standards for reporting and presenting comprehensive income. Comprehensive income, composed of net income and other comprehensive income, is defined as the change in shareholders' equity from transactions and other events from non-owner sources. Cumulative changes in other comprehensive income (loss) are included in accumulated other comprehensive income (AGCI) which is presented as a new category in shareholders' equity. For the Company, net earnings is equal to comprehensive income. Accordingly, no amounts are required to be recognized as a separate component of shareholders' equity. Under Sections 3855 and 3861, financial assets and liabilities, including derivative instruments, are initially recognized and subsequently measured based on their classification as held-for-trading, available for sale, heldto-maturity, loans and receivables, or other financial liabilities. On adoption, the Company classified cash and bank indebtedness as held-for-trading measured at fair value and accounts receivable are classified as loans and receivables measured at amortized cost. Amortized cost is the amount at which the financial asset is measured at initial recognition less principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount, and less any reduction for impairment or uncollectability. Gains and losses arising from changes in fair value are recognized in net income upon derecognition or impairment. Accounts payable and accrued liabilities and long-term debt are classified as other financial liabilities and are measured at amortized cost. These classifications did not result in any changes in the recognition or measurement of related amounts and no adjustments were required to amounts previously recognized. The Emerging Issues Committee of CICA issued Abstract No. 166, Accounting Policy Choice for Transaction Costs (EIC-166). This EIC addresses the accounting policy choice of expensing or adding transaction costs related to the acquisition of financial assets and financial liabilities that are classified as other than held-fortrading. Specifically, it requires that the same accounting policy choice be applied to all similar financial instruments classified as other than held-for-trading, but permits a different policy choice for financial instruments that are not similar. The Company has adopted EIC-166 effective September 30, 2007 which requires retroactive application to all transaction costs accounted for in accordance with CICA Handbook Section 3855, Financial Instruments Recognition and Measurement. The Company has evaluated the impact of EIC-166 and determined that no adjustments are currently required. In accordance with the provisions of these new standards, no adjustments are required to the Company s consolidated financial statements as of December 31,. 24. International Financial Reporting Standards ( IFRS ) IFRS will be required to be applied by public entities effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, The transition from current Canadian GAAP to IFRS is a significant undertaking that may affect the Company s reported financial position and results of operations. The Company has not developed an IFRS changeover plan, which will include project structure and governance, training, analysis of key GAAP differences, assessing impact data systems, internal controls over financial reporting and business activities. The Company plans to schedule and develop a plan for IFRS in the second and third quarters of

14 25. Recent Accounting Pronouncements In January 2006, the CICA Accounting Standards Board ( ACSB ) adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, the ACSB confirmed in February, 2008 that International Financial Reporting Standards ( IFRS ) will replace Canadian GAAP in 2011 for profit oriented Canadian publicly accountable enterprises. The Company will be required to report its results in accordance with IFRS as at January 1, The Company has had preliminary discussions with its advisor and will be commencing a detailed analysis and plan for IFRS implementation during its second fiscal 2011 quarter. In January,, the CICA issued Section 1582 (Business Combinations), which replaced former guidance on business combinations (Section 1581). This standard establishes principles and requirements of the acquisition method for business combinations and related disclosures. In addition, in January, the CICA issued Section 1601 (Consolidated Financial Statements), and Section 1602 (Non-Controlling Interests). CICA 1601 establishes standards for the preparation of consolidated financial statements. Section 1602 provides guidance for the treatment of non-controlling interests subsequent to a business combination. These new standards are effective for the Company s annual reporting period on October 1, The Company is currently assessing the impact and does not anticipate adoption of this section will have a material impact on its consolidated financial statements. 26. Disclosure Controls and Procedures The Company has established disclosure controls and procedures for the timely and accurate preparation of financial and other reports. The Chief Executive Officer and the Chief Financial Officer, after evaluating the effectiveness of the disclosure controls and procedures (as defined in applicable Canadian securities laws) of the Company as of December 31,, have concluded that the Company's disclosure controls and procedures are effective to ensure that all information required to be disclosed by the Company in reports that it files or furnishes under applicable Canadian securities laws is (i) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Canadian securities regulatory authorities and (ii) accumulated and communicated to the Company's management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosure. It should be noted that while the Company's Chief Executive Officer and Chief Financial Officer believe that the disclosure controls and procedures will provide a reasonable level of assurance that they are effective, they do not expect that the disclosure controls and procedures will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute assurance that the objectives of the control system are met.* 27. Risk Management Business Risks: Activity in the water business is subject to a range of external factors that are difficult to actively manage, including commodity pricing, cost of fuel, operating and labour costs and redemption of bottle deposits. The Company plans to mitigate these risks by creating a strong balance sheet and remaining responsive to changes in industry dynamics. The Company has a comprehensive insurance policy to help safeguard its assets, operations and employees. This is reviewed annually and revised as changes in circumstances warrant. Credit Risks: The Company currently transacts primarily with retail customers and is exposed to the associated credit risk. Management continually assesses the creditworthiness of these customers and monitors all outstanding balances. Management views the credit risk of its accounts receivables as normal for its industry. Financing Risks: The ability of the Company to complete its budgeted capital program and meet its payment obligations as they become due will continue to be dependent on the Company's ability to secure sufficient funds through additional debt and equity financings and to generate positive cash flow from operations. Competitive Conditions: The operating climate within Western Canada is very competitive, resulting in fluctuations of price and demand for products. The Company attempts to mitigate these risks by creating a good working relationship with its customers and focusing on long-term arrangements with retail customers. Currency Risk: The Company is exposed to foreign exchange risk as it continues to source certain materials, parts and services from United States vendors. The Company also receives machine parts and support for its major computer program from the United States. Foreign exchange risk arises due to fluctuations in foreign currency rates, which could affect the Company s financial results. 13

15 Current Market Conditions: General adverse economic conditions globally, including the possibility of a recession in Canada and a worldwide economic slowdown, recent disruptions to the credit and financial markets in Canada and worldwide and local economic turmoil may adversely affect the value of the Company's business and value of its securities and assets. 28. Changes in Internal Control Over Financial Reporting The Chief Executive Officer and Chief Financial Officer of the Company are responsible for designing internal controls over financial reporting or causing them to be designed under their supervision in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. The design of the internal control over financial reporting was assessed as of December 31,, and during this process, management did not identify any further material weaknesses in internal controls over financial reporting which it had not disclosed already. 29. Management s Responsibility for the Company s Financial Statements The management of Arrowhead is responsible for the integrity of the accompanying financial statements, which have been prepared by management in accordance with GAAP for financial statements in Canada. The preparation of the financial statements necessarily involves the use of estimates and careful judgment, particularly in those circumstances where transactions affecting a current period are dependent upon further events. All financial information presented in this MD&A is consistent with the financial statements. To discharge its responsibilities for financial reporting and safeguarding of assets, management believes that it has established appropriate systems of internal accounting control that provide reasonable assurance that the financial records are reliable and form a proper basis for the timely and accurate preparation of financial statements. Consistent with the concept of reasonable assurance, the Company recognizes that the relative cost of maintaining these controls should not exceed their expected benefits. The Board of Directors discharges its responsibilities with respect to the financial statements primarily through the activities of its Audit Committee, which is comprised of all directors who are not employees of the Company. The Audit Committee has met with management to review the Company's reported financial performance and to discuss audit, internal control, accounting policy and financial reporting matters. The financial statements were reviewed by the Audit Committee and approved by the Board of Directors. 30. Outlook The Company continues to position itself to increase its sales and revenues with its major retail customers in the Western Canadian market. The Company also plans to continue the growth of the new 15-litre channel with its retailers. As production and sales continue to increase in the 15-litre channel, so too will the Company s overall revenues. The new 15-litre bottles are currently being produced from the Company s plant in Edmonton and are a lighter, crushable and blue box disposable PET bottle, which are BPA free. The single use bottle is 100% recyclable and compatible with any water cooler on the market. The bottle has a $0.25 refundable deposit and may be returned in Alberta or British Columbia at any bottle depot for a refund. As a result of the introduction of the new 15-litre channel and the purchase of a second SIAPI Blow Molding machine, the Company will continue to expand its business at retail locations and in the food service channel in Western Canada, primarily in Alberta, with expansion opportunities in the British Columbia market place.* 31. Additional Information All relevant information relating to the Company is filed electronically on the System for Electronic Document Analysis and Retrieval at 14