HIGH LINER FOODS INCORPORATED annual report brand organization innovation

Transcription

1 HIGH LINER FOODS INCORPORATED annual report 2006 brand organization innovation

2 High Liner Foods is one of North America s largest processors and marketers of prepared frozen seafood and our High Liner brand is one of Canada s favourite food brands. Our branded products are sold in most grocery and club stores throughout the United States, Canada and Mexico under the High Liner and Fisher Boy brands. High Liner is also a leading supplier of private label products to North American food retailers and a food service supplier to restaurants and institutions. Sales ($ in thousands) 261,725 Product sales volumes (in metric tonnes) 44,833 High Liner historic stock performance 8.75 (TSX) * Procured externally Produced in High Liner facilities High Low Close * Close at December 29, 2006

3 At-a-glance Letter to shareholders Our strategy Strengthen our brands High Liner has been a respected name in seafood for more than eighty years. Products marketed under the High Liner brand represent 70 percent of our sales. Strengthen our organization We are seafood experts with a complex procurement and distribution network, product development capabilities and customer relationships that stretch across the continent. Grow through innovation Trust in High Liner earned since the brand s inception in 1926 has allowed us to introduce unique and interesting choices to increasingly knowledgeable consumers. Corporate governance Management s discussion and analysis Financial statements & notes High Liner Foods annual report

4 at-a-glance profile key performance indicators canada Mario Marino Vice President and Chief Operating Officer Canadian Operation Retail frozen seafood is a $587 million market in Canada, growing by 4% in High Liner products are sold to every major Canadian grocery retailer enjoying virtually 100% distribution. Retail sales grew 5.1% in % of Canadian sales are of High Liner brand products. Our Food Service business delivers seafood and menu expertise to restaurants and Canada s leading food service distributors. Food Service sales grew 10% in 2006, two times our benchmark. Sales Sales EBITDA Sales vs. EBITDA (in $000s) We continue to enjoy strong sales growth in Canada driven by our leading brand, new products and customer relationships. EBITDA usa Mark Lamothe President and Chief Operating Officer US Operation Frozen seafood is a $1.8 billion market in the United States, excluding sales made by club stores and mass merchandisers. Fisher Boy is the #4 national brand with 25% distribution, and a stronger presence in its core markets. The brand accounts for 8% of consolidated sales. Building on our established club store business, we launched High Liner in traditional grocery stores in late 2005, achieving 20% distribution by the end of High Liner is the leading producer of private label processed seafood in the U.S. Sales Sales EBITDA Sales vs. EBITDA (in $000s) High Liner will grow its U.S. business by investing in the High Liner brand. EBITDA 2 High Liner Foods annual report 2006

5 market environment strategy High Liner in North America The High Liner brand and our product innovation expertise drive business with Canada s national food distributors and five major retailers who rely on us to grow the seafood category. The High Liner brand includes more than 300 individual products. We introduced 18 new products in New products represented $16 million in sales in the last two years. Our Canadian business is growing due to our focus on: Introducing new species and new products to both the retail and food service channels. Responding to consumer demand for quality, nutrition, taste and convenience. Leading in the premium segment with our Signature products. Growth drivers: The factors driving growth in Canada, the U.S. and Mexico include: Growing demand for seafood with expanding consumer awareness of the health benefits of seafood. Consumer demand for convenience and quality drives growth in raw fillets and premium sauced products. Increased global supply of seafood due to increased aquaculture and stabilization of wild caught species in most areas of the world. Unlike Canada, the U.S. market is highly regionalized. We are building our business in the U.S. by: Expanding distribution region by region. Strengthening our relationships with existing national customers. The premium value-added seafood segment in the U.S. is growing rapidly and represents a significant opportunity for High Liner. Our proven expertise in this segment should allow us to capture a larger share of shopping baskets in the U.S. Our U.S. growth will be driven by investing in our brands and launching new products: Grow the High Liner brand through new premium products for the club store, traditional retail and natural foods channels. Adopt Fisher Boy as a High Liner product line. Grow Fisher Boy by launching new products outside the breaded and battered sticks and portions category. Corporate-wide strategies: We are focused exclusively on creating and marketing top quality frozen seafood. In 2007 we will: Optimize our supply chain. Optimize inventory without compromising quality of service. Enhance our profitability by leveraging market trends. Focus product development on consumer trends. Invest in strategic marketing and capital assets with demonstrated return on investment. Take advantage of consolidation opportunities as they arise. High Liner Foods annual report

6 letter to shareholders High Liner delivered solid performance in The demand for seafood has never been stronger and our business in Canada enjoyed another year of exceptional growth in both retail and food service. In the United States, we refocused our business on our core competency marketing prepared seafood to build the High Liner brand, particularly in the club and natural food stores, and to stabilize the Fisher Boy brand. During 2006 our sales increased by 4.6% to $262 million and our net income from continuing operations rose by 33% to $5.1 million. We achieved this growth despite continuing increases in raw material and packaging costs, driven by escalating fuel prices and worldwide demand for seafood. While the growing popularity of seafood establishes a strong foundation for continued growth in High Liner s sales volume, demand in developing, as well as developed, countries is causing raw seafood prices to soar. We ve absorbed average seafood cost increases of more than $6.0 million in each of the past three years. In the retail industry the ability to increase prices to protect margins depends on a brand s pricing power. In Canada, where High Liner products are found in almost all grocery stores, we successfully implemented two price increases in As expected, sales volumes declined in the short term, but most products had recovered by the end of the year. In the U.S. where we do not have a leading brand, it has been more difficult to defend our margins. This squeeze has, in turn, reduced our ability to promote our products. However, our U.S. strategy is longer-term and we have launched initiatives that should restore profitability. Continued strength in Canada Several factors drive our solid performance in Canada: we launched 18 successful new products, we increased our retail market share with vigorous support from one of our largest national retailers, sales volumes in the food service channel also increased substantially, driven by new products and renewed support from leading national distributors. 4 High Liner Foods annual report 2006

7 High Liner is uniquely positioned to provide seafood to consumers in North America at a time when demand for seafood is strong and growing. Henry Demone President & Chief Executive Officer Financial highlights (All amounts in thousands except per share amounts) 2006 (1) 2005 (1)(3) % Change Sales $ 261,725 $ 250, Operating EBITDA (2) 13,568 10, Net income from continuing operations 5,123 3, Basic earnings per common share Diluted earnings per common share Net income for the period 4,330 (40,469) N/A Basic earnings per common share 0.30 (3.93) N/A Diluted earnings per common share 0.30 (3.93) N/A Total assets 113, ,253 (11.1) Book value per common share Shareholders equity $ 71,236 $ 68, Operating highlights Product sales volumes (in metric tonnes (4) ) Produced in High Liner facilities 32,572 35,399 (8.0) Procured 12,261 10, ,833 45,738 (2.0) Number of employees (9.0) Gross capital expenditures from continuing operations ($000) 3,614 4,149 (12.8) (1) Fiscal 2006 year-end is 52 weeks ended December 30, 2006 and fiscal 2005 year-end is 52 weeks ended December 31, (2) Earnings before interest, taxes, depreciation and amortization, other income and non-operating transactions as disclosed on the consolidated statements of income. (3) Restated see Note 3 to the financial statements. (4) One metric tonne = 2,204.6 lbs. Building strength in the United States In the United States, we continued to build on our successful programs in club stores with new products, all distributed and marketed under the High Liner brand. Club stores demand constant innovation to differentiate their shopping experience from traditional retail stores. This makes it a natural and profitable channel for High Liner. We can use our considerable product innovation capabilities to advantage in this channel while reaping the benefits of lower marketing costs. In addition to the products introduced in club stores in 2006, we also developed two new product lines for the natural food retail channel, a small but growing market in North America. These products were also distributed under the High Liner brand, further reinforcing our presence in that market. High Liner Foods annual report

8 letter to shareholders (cont d) To strengthen Fisher Boy, we developed a kid-tested kidpreferred formulation launched in the critical Lent season. We also increased market support and sales focus for the brand. The market for breaded seafoods is not growing, but it remains the largest, most profitable seafood category in the United States. By the end of the year, we had halted the decline in sales and established a stronger foundation for future growth. To move the brand beyond fish sticks and portions, we also introduced new Fisher Boy products. Our strengthened sales and marketing team and focus on building brand awareness caused U.S. sales of High Liner products to increase almost 24% in U.S. dollars in Meeting tough benchmarks High Liner is uniquely positioned to provide seafood to consumers in North America at a time when demand for seafood is strong and growing. Our strengths allowed us to achieve a significant increase in net income in 2006, but I am still not satisfied with our results. We must work harder to meet the challenge of increases in raw material costs that we expect to continue for the foreseeable future. And we must continue to build our market position in the United States. I have established two benchmarks for success in our 2007 business plan: 15% return on assets managed (12% in 2006) and 10% return on equity. In 2006, our ROA was 12% and ROE was 8.3%. We met our 12% ROA benchmark in 2006 by increasing income and decreasing assets (primarily inventory). We have identified several priorities aimed at increasing ROE to our new benchmark. First, we must reduce the impact of higher raw material costs. This can be done most efficiently by increasing the selling prices of our products. We have done this successfully in Canada but it s a challenge in the U.S. Second, we must make sure that every new product complies with our rigorous development standards to ensure it will meet our return expectations. Third, we must reduce operating costs. During 2006 we identified opportunities to enhance our productivity, logistics, distribution network and inventory management. We will be steadfastly focused on implementing these initiatives to reduce costs and improve efficiency in High Liner Foods annual report 2006

9 Our strengthened sales and marketing team and focus on building brand awareness caused U.S. sales of High Liner products to increase almost 24% in Looking ahead The challenges and opportunities in our industry have created industry-wide pressure to consolidate. We have seen several major mergers and acquisitions in the food business over the past few years as it becomes essential to leverage sales organizations, logistics networks and plant utilization to deliver adequate returns to shareholders. Competition for assets in the seafood industry has become intense. High Liner has the financial capacity to be a consolidator, and we are evaluating opportunities to grow our procurement, processing, marketing and distribution capabilities, but not at any price. In appreciation Our management team and employees are prepared for both the opportunities and challenges of It was a pleasure to welcome Mark Lamothe as president and chief operating officer in our U.S. operations in early Early in 2007 we also welcomed Scott Brown, an experienced chef, as director of product development and Joanne Brown as director of human resources. These new leaders join our experienced senior team, which I am confident has the commitment and vision to achieve profitable growth year over year. All of our employees are working to deliver industry-leading value to our customers, shareholders and partners. Finally, I would like to acknowledge the tremendous contribution made to High Liner by Donald Sobey during the years he served on our board. His insight and diligence were invaluable. I would also like to welcome Derek Buntain to the board of directors. Derek joined the board in August His wealth of experience as a remarkably successful leader in financial services has already been of value to the board, and his re-election is confidently recommended to shareholders at the upcoming annual general meeting. (Signed:) Henry Demone President & Chief Executive Officer High Liner Foods annual report

10 our strategy: strengthen our brands 8 High Liner Foods annual report 2006

11 High Liner has recognized, trusted brands that deliver on consumer expectations. Our branded products are sold in most grocery and club stores throughout Canada, the United States and Mexico. Captain High Liner knows seafood High Liner has been a respected name in seafood for more than eighty years. Today the High Liner brand is the strongest seafood brand in Canada, recognized by almost every Canadian from coast to coast, capturing a 42.9% market share of frozen seafood sold in retail stores in this country. In the U.S., national High Liner brand awareness has shown steady growth since we introduced the brand to club stores in Unlike Canada, the U.S. market is highly regionalized, and our strategy is focused on increasing distribution one region, one customer at a time. Capturing a larger share of the U.S. shopping cart We also believe that our efforts to capture a larger share of the U.S. shopping cart will be more effective if we focus on one brand with the greatest long term potential. We believe that brand is High Liner. In 2007, High Liner will adopt Fisher Boy as a product line. Although Fisher Boy has some national brand awareness in the United States, the perception that it is a value brand in the breaded and battered category will be better exploited as a value line within the High Liner family. Moving Fisher Boy s brand awareness to High Liner will also allow us to more effectively promote the variety and quality of our full range of products and leverage the Canadian brand strength. In Canada, consumer loyalty gives a brand owner like High Liner compelling power within the market place to influence buying decisions and protect margins. The core of our Canadian strategy is our High Liner brand, an enviable platform for new products and species that can expand our volume of business with existing customers. In the U.S., our focus is on vigorously entrenching our legacy brand. Seafood is smart food Our efforts to build awareness are already bearing results. Products sold under the High Liner brand now represent 70 percent of our North American sales as our reputation for delivering excellent quality, good taste and convenience grows. At the same time, sales of seafood including High Liner products are increasing as science is successfully convincing consumers that eating seafood is important to good nutrition. The world is realizing that seafood is smart food and we are convincing consumers that nobody is smarter or knows seafood better than Captain High Liner. High Liner Foods annual report

12 our strategy:t 10 High Li r F d annual report 2006

13 High Liner has expertise in worldwide procurement, sophisticated profi ciency in frozen food logistics and strong relationships with major supermarket chains and club stores throughout North America. Decades of experience creates advantages We are seafood experts who search the world to identify the best suppliers. We have the global logistical skills to move that supply into our plants and distribution networks. Our product development capabilities allow us to create and market products for increasingly savvy consumers who demand premium healthy foods and convenience. Finally, we have a breadth and strength of relationships upon which we can build to extend our reach to every potential customer in North America. However, the intense competition in the marketplace makes it essential that we constantly strengthen our organization to compete more effectively, improve our margins and continue to grow net income. Our focus has been on reducing costs at our plants in Canada and the United States, rationalizing our supply chain and expanding our capabilities. We ve centralized product development for Canada and the United States in Lunenburg, establishing a seasoned team of development talent in one location. This team will continue to develop and launch successful products for Canada while working closely with our U.S. marketing experts to develop products for the U.S. market. We ve also expanded our procurement network to source 30 species of seafood from 30 suppliers in 13 countries. We have established relationships with suppliers who can provide High Liner with labour intensive products at reduced costs. In 2005, we established an office in Qingdao, China and employ procurement and quality control experts to oversee our procurement activities in Asia. We ve also implemented sophisticated technology and worked with regulators to improve inspection protocols. Our supply chain is a complex network In fact, our supply chain is a complex network of suppliers, distributors, storage facilities, co-packers and various modes of transportation that move our product from the sea to our customer. During 2006, we worked with a supply chain expert to identify opportunities to improve productivity and optimize our distribution network. We ve also identified opportunities to improve the distribution of imported finished goods to western Canada and the United States. In 2007 we will focus on implementing many of the initiatives identified. During 2006, we reduced inventories by 22% from $52.7 million at the end of 2005 to $41.3 million at the end of We ve implemented processes that will sustain optimum inventory management in These processes will reduce costs and ensure our products remain of consistently high quality. Finally, we ve expanded our distribution system to include the natural foods channel, a niche channel that is significant for its confirmation of the quality and wholesomeness of High Liner s products. In 2006, the world s largest retailer of natural and organic foods selected our products for distribution. These improvements to our organization will improve the quality of service we offer to our distributors and the products that we deliver to our final consumer. High Liner Foods annual report

14 our strategy: th e grow through 12 High Liner Foods annual report 2006

15 Our interactive procurement web portal enables communications across the supply chain and around the world, engaging suppliers, quality inspectors, distribution centres and our procurement teams in a collaborative process. If it s made by the Captain, It s Always a Wise Catch! Trust in High Liner earned since the brand s inception in 1926 has allowed us to introduce unique and interesting choices to increasingly knowledgeable consumers if it s made by the Captain, It s Always A Wise Catch! In fact, our ability to develop and successfully introduce new products to our markets is at the heart of our ability to grow revenue and earnings. Over the past three years we have successfully launched 100 new products that represented more than 20% of our sales in This includes 40 new products launched in In Canada our new products included vacuum packed frozen fish fillets and kabobs, QuickSteam TM seasoned rubbed fillets and multigrain fillets featuring increasingly popular new species. In the United States, our new products included Multigrain Tilapia, and Seafood Risotto. We even created new products Seafood Selects TM and Solo Selects TM for the niche natural foods market and two new Fisher Boy product lines: Daily Catch TM and Southern Style TM. Our ability to innovate successfully is based on two enviable core strengths: trust and expertise. During 107 years in the seafood business, we have consistently used our knowledge and experience to respond to if not anticipate the constantly evolving tastes and expectations of consumers. We ve pioneered the import of aquaculture species, developing products using farmed tilapia, salmon, shrimp and basa. We ve launched more than 15 tilapia products alone growing our sales volume from 56,000 pounds in 2004 to 4.5 million pounds in 2006 in four markets Canadian retail, Canadian food service, U.S. club stores and U.S. retail. Tilapia is now one of the most popular seafood choices in the U.S. and is growing in popularity in Canada. Our expertise is firmly imbedded in a disciplined process for developing and testing our products. Every product must pass through four stages of evaluation and testing before it will be stocked on the shelf of any store or served to any consumer. As a result, we have a high success rate for new product launches. Determined to be an industry leader We ve also developed new approaches to processing and packaging our products, aimed at enhancing food quality and safety. Our new QuickSteam TM tilapia and basa fillets are only one example. Fillets are rubbed with very light seasoning and packaged in a vacuum-sealed microwaveable tray. The packaging of the rubbed fillets is designed to expand when heated. It forms a tent in which the fillet steams delicately in its own seasoning. It s a new technology, a new species, and a delicious meal. Our determination to be an industry leader led High Liner to be one of the first companies to remove trans fats from the products we offer our customers. Seafood is a healthy, low fat source of protein, but we believe our brand demands more. We constantly strive to provide consumers with products that support their growing interest in health, as well as great taste. High Liner Foods annual report

16 corporate governance Claire Milton General Counsel & Secretary Greg LeBlanc, C.A. Corporate Controller We are proud of our corporate services team. We have a dedicated group of professionals who understand the relationship between good corporate governance and value. Governance at High Liner begins with our Code of Conduct. The Code includes policies to ensure responsible disclosure practices, and the highest standards of business integrity and ethics. The Code is built on High Liner s core values: quality, integrity, innovation and involvement. The Code of Conduct and all of our governance documents are published at Commitment We know that our commitment to corporate governance is enhancing our ability to execute our long-term strategy. Good governance provides the discipline and focus necessary for the Board of Directors to fulfill its role as steward of High Liner s future. The Board of Directors reviews High Liner s governance structure and practices every year to maintain pace with changing legal requirements and to support value creation for all High Liner stakeholders employees, customers and investors. Achievements The Board operates under a written charter describing its key responsibilities. The Committees of the Board each have a written charter, and fulfill their responsibilities using detailed annual work plans. The Board has adopted position descriptions for directors, for the Chairman and Committee Chairs. The Board has a large majority of independent Board members. All Audit and Human Resources and Corporate Governance committee members are non-management and independent. All meetings of the Board include a session without management present. All Board members are required to own common shares of High Liner. The Share Option Plan is approved by shareholders. Executive compensation is based on a pay-for-performance philosophy. The Code of Conduct includes a Compliance Reporting Line, allowing for anonymous submission of complaints to an external complaint management service. The Board conducts regular effectiveness surveys and director self-assessments. 14 High Liner Foods annual report 2006

17 I believe that High Liner s commitment to corporate governance has lead to improved organizational effectiveness and enhanced the connectivity of our Board to the strategic plan, the identifi cation of risk, and communications with stakeholders. David J. Hennigar, Chairman High Liner s directors are experienced, proven leaders representing a diverse group of professions and industries. They are the stewards of our business, and bring creativity, vision, sound judgment, integrity, and independence of thought to the Board table. They are High Liner shareholders, and are committed to achieving long-term sustainable returns to all shareholders. Our Management Information Circular provides full information on the annual compensation paid to directors, and executives, including salary, bonus, equity compensation and shareholdings. Our directors and executives are required to be shareholders of High Liner to ensure that their interests are aligned with investors in good times and bad. At present, all of our external directors (who each have been on the board for more than one year) own equity worth at least three times their annual retainer. Some directors far exceed this requirement. The Chief Executive Officer exceeds his share ownership requirement by more than two times, and his common shares were valued at the end of 2006 at more than $1.6 million. strong governance, strong performance 2005 CICA Corporate Reporting Award, Small Cap Category; 8.3% Return on Equity in Board of directors (from left to right) David J. Hennigar Executive Committee (Chairman) Bedford, NS Chairman of the Board J. Thomas MacQuarrie, Q.C. Human Resources & Corporate Governance Committee Halifax, NS Fred J. Dickson, Q.C. Executive Committee Audit Committee Truro, NS C. Randolph Bell Audit Committee St. John s, NL Robert E. Shea Audit Committee Boston, MA Frederick B. Ladly Human Resources & Corporate Governance Committee Fallbrook, ON Henry E. Demone Executive Committee Lunenburg, NS J. Robert Winters, Q.C. Audit Committee Truro, NS Robert P. Dexter, Q.C. Audit Committee (Chairman) Halifax, NS D. H. L. Buntain Human Resources & Corporate Governance Committee George Town, Grand Cayman, Cayman Islands, BWI George E. Bishop, F.C.A., DCL (Acadia) Human Resources & Corporate Governance Committee Hantsport, NS Robert L. Pace Audit Committee Halifax, NS David E. Read Human Resources & Corporate Governance Committee (Chairman) Executive Committee Halifax, NS Full biographies of the thirteen members of the Board, and detailed information about how the board carries out its duties are included in the 2006 Management Information Circular, available at High Liner Foods annual report

18 management s discussion & analysis Introduction Management s discussion and analysis (MD&A) provides management s perspective on High Liner, our performance, and our strategy for the future. Important notes We, us, our, Company, High Liner. In this MD&A, these terms all refer to High Liner Foods Incorporated, and its businesses and subsidiaries. Review and approval by the Board of Directors. The Board of Directors, on recommendation of the Audit Committee, approved the content of this MD&A on February 21, This MD&A includes High Liner s operating and fi nancial results for 2006 and 2005, and should be read with our Consolidated Financial Statements, which start on page 37. Other important documents. High Liner also publishes documents that include additional information of interest to investors: Annual Information Form Management Information Circular Quarterly reports These documents are available on SEDAR s website at and in the Investor Information section of High Liner s website at 16 High Liner Foods annual report 2006

19 We are committed to continuous improvement at High Liner through strategies that build upon our traditional strengths and sound fi nancial management. Kelly Nelson, FCA Vice President, Corporate Services & Chief Financial Officer Quarterly and annual comparisons in this MD&A. Unless otherwise indicated, all comparisons to the fourth quarter of 2006 are against the fourth quarter of 2005, and all comparisons to the full year of 2006 are against the full year of Accounting estimates and assumptions. The preparation of consolidated fi nancial statements in conformity with Canadian generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting period. We use accounting estimates to determine an allowance for doubtful accounts receivable, estimate amounts owing to customers for various sales and marketing costs, and other costs to be invoiced to us after period end but relating to the accounting period in question. We base our estimates on historical experience, current trends and various other assumptions that are believed to be reasonable under the circumstances. If fi nal amounts differ from estimates, it is expected to have little or no impact on our fi nancial condition. In our judgment, none of the estimates discussed in Note 1 of the Consolidated Financial Statements for the period ended December 30, 2006 require High Liner to make assumptions about matters that are highly uncertain. None of the estimates is considered a critical accounting estimate. Forward-looking statements. This MD&A includes statements that are forward looking. Our actual results may be substantially different because of the risks and uncertainties associated with our business and the general economic environment. We discuss the principal risks of our business in Section 7 of this MD&A. We cannot provide any assurance that forecasted fi nancial or operational performance in the MD&A will actually be achieved. If it is achieved, we cannot provide assurance that it will result in an increase in our share price. Table of contents 1. Vision, core businesses, and strategy 18 A description of our vision and core businesses with an explanation of our strategy. 2. Key performance drivers 21 A discussion of the key performance drivers behind High Liner s ability to build shareholder value. 3. Capability: resources and core competencies 22 Liquidity and capital resources 22 Operational resources 24 Core competencies Other items important to understanding our results 26 Accounting standards 26 Transactions with related parties 26 Interest 26 Other expense 26 Non-operating transactions 26 Income taxes 27 Discontinued operations 27 Contingencies Performance 28 Overview 28 Consolidated results 29 Performance by business Summary of results for the fourth quarter ended December 30, Risk management 34 Board accountability 34 Procurement 34 Customer risk 35 Foreign currency 35 Other commodities 36 Food safety 36 Technology 36 High Liner Foods annual report

20 Management s Discussion and Analysis (cont d) 1. Vision, core businesses, and strategy High Liner has been in business since We own the well-known Canadian seafood brand, High Liner. We also do business in the United States and Mexico, and we are building the High Liner brand in those countries. We procure all our seafood raw material and some finished goods from around the world. Our headquarters are in Lunenburg, Nova Scotia. We deliver on the expectations of the modern consumer by selling food products that respond to their demands for convenient, tasty, nutritious food. Vision At High Liner, our vision sets our overall direction: We will be the leader in value-added frozen seafood in North America. We focus on frozen seafood, because we are experts in this category. However, we would enter other food categories if we believe it would strengthen our seafood business. Core businesses High Liner operates in the North American packaged foods industry. We process and market frozen seafood and other food products, and distribute them to retail and food service customers. We sell our own brands, including High Liner and Fisher Boy and we manufacture private labels. We own and operate food-processing plants in Lunenburg, Nova Scotia and Portsmouth, New Hampshire. High Liner consists of four main businesses: Canadian operations Retail From our sales and marketing headquarters in Toronto, Ontario, the High Liner brand is sold to every major Canadian grocery retailer. It is Canada s leading retail seafood name. The brand includes more than 100 individual products, from our traditional battered and breaded fish portions to innovative, premium products of a variety of seafood species that respond to modern tastes. Retail also sells private label brands to customers. United States operations U.S. retail brands From Portsmouth, New Hampshire, our U.S. subsidiary produces seafood under the Fisher Boy and High Liner brands. Products are distributed throughout the United States and in Mexico. The club store channel is important to our growth strategy for the U.S. Retail business, and we sell to all major U.S. club store chains. We have built our business in this channel by introducing innovative premium products under the High Liner brand. U.S. retail private label Our U.S. subsidiary is the largest supplier of retail private label processed seafood in the United States. We produce over 50 different labels for U.S. grocery retailers, primarily breaded and battered fish sticks and portions. Strategy Overview Our overall business is a simple one: we satisfy the seafood preferences of North American consumers. We realized a few years ago that we did not have to be a vertically integrated seafood harvester to achieve this goal. We needed to be, and already were, seafood experts. We sold our capital-intensive fishing and primary processing assets in 2003 and 2004 and our pasta operations in We now focus exclusively on creating and marketing top quality frozen seafood. Food service Our food service business, also headquartered in Toronto, is growing, due to our increasing ability through worldwide procurement to provide food service customers with new products from new species. Food Service specializes in delivering seafood and menu expertise to restaurant chains and Canada s leading food service distributors. Most food service products are sold under the High Liner brand, but private labels are also produced for some of our larger customers. 18 High Liner Foods annual report 2006

21 Our mission statement describes our business: Our team brings value to our retail, club store, and food service customers through our commitment to the development and delivery of high-quality and innovative value-added seafood, and by providing them with a superior service level. We increase earnings, and thus shareholder value by: Partnering with our customers and suppliers Developing our brands Achieving operational excellence Providing leadership, development opportunities, and a safe and pleasant working environment to our employees. Seafood is a growing category in the food industry. The global supply of seafood is expanding, and consumer demand is increasing due to the recognized health benefits and taste of seafood. Our organic growth will be based on these trends. Growth in the global supply of seafood is due to increased aquaculture production and the stabilization of wild caught species in most areas of the world. However in recent years, demand has increased faster than supply, resulting in significant increases in raw material costs. This increased demand comes about as a result of increasing interest from North American consumers as seafood is considered to be a healthy food choice. In addition, increasing disposable incomes in countries like Russia and China have increased global demand. As a consumer-driven sales and marketing company, we focus on matching supply to demand. Procuring seafood on global markets allows us to provide products based on consumer preferences. The eating preferences of North Americans are changing. Value and quality have always been in demand, but now people want healthier, more convenient foods. They also want a variety of premium, restaurant quality food at home. Consumers increasingly choose seafood as it matches these criteria. These trends will allow us to grow sales without burdensome capital investments. Our plants have the production capacity to significantly increase volumes. In addition to organic growth, our current financial position allows us to consider growth by acquisition. Our acquisition criteria are strict, however. The target business must be complementary to frozen seafood, and would leverage our existing leading brands, strong customer relationships, marketing and logistics expertise, and product development expertise. Strategic goals for 2007 We will achieve organic growth by ensuring our key performance drivers (see section 2) fuel long-term strategic objectives. To grow and prosper to become the value-added seafood category expert in North America, we have established three strategic goals for 2007: 1. Optimize our supply chain: We are comprehensively reviewing our supply chain, with expert assistance, and will successfully implement priority recommendations. We will also focus on working capital, especially inventory, to maintain it at an optimum level without sacrificing customer service. 2. Enhance our profitability by leveraging market trends: We will focus product development on consumer trends. We will invest wisely in strategic marketing and capital with demonstrated return on investment. We will also take advantage of consolidation opportunities as they arise. 3. Build the High Liner brand in the U.S. market: We will continue to grow the High Liner brand in the U.S. by expanding distribution and launching new products in both the club channel and in traditional grocery stores. As already announced, we will convert Fisher Boy to a product line under the High Liner brand and stabilize volume with renewed marketing. High Liner Foods annual report

22 Management s Discussion and Analysis (cont d) Our strategy will result in growth in shareholder value. To measure our performance, we have chosen four key financial measures. We have set these measures based on the performance achieved by comparable food companies in our peer group in North America Benchmark 2006 Actual Returns On assets managed 12.0% 12.0% On equity 10.0% 8.3% Profitability Trailing 12-month EBIT as a percentage of net sales 8.0% 4.0% Financial strength Interest bearing debt to trailing 12-month EBITDA (not to exceed) 3.0x 0.8x Each of these is discussed below. ROAM is calculated as follows: Operating EBITDA (as defined on page 30) less depreciation and amortization, DIVIDED BY average assets managed. Assets managed include all assets, less future income taxes and accounts payable. We average the closing assets managed of 2005 and 2006 to determine our average assets. In 2006 our return on assets managed (ROAM) was 12.0%, equal to our benchmark. We were successful in 2006 in increasing income and decreasing assets (primarily inventory), which increased ROAM. We believe we are managing our assets well and plan to continue to do so to increase ROAM in the future. We have increased the benchmark to 15%, which is the third quartile performance of selected publicly traded protein manufacturing businesses in North America. ROE is calculated as follows: Net income from continuing operations, excluding after-tax non-operating transactions (as described in note 10 to the financial statements), less dividends on preference shares DIVIDED BY average common equity. Average equity is calculated as total shareholders equity less preference shares. We average the common equity at the end of 2005 and 2006 to determine our average common equity. Our return on equity (ROE) in 2006 was 8.3%, which is lower than our target. In order to improve ROE, we need to increase income and leverage. This will be achieved by focusing on the objectives listed above. Our trailing 12-month earnings before interest and taxes (EBIT) as a percentage of net sales is 4.0%. This needs to improve and is lower than in past years due to the sale of our high margin scallop business in 2003, increased input costs, decrease in high margin Fisher Boy business and growth in lower margin business. Interest bearing debt to trailing 12-month EBITDA is calculated as follows: Interest bearing debt, being bank loans, plus current and long term portions of capital lease obligations DIVIDED BY operating EBITDA, which is defined on page 30. Interest bearing debt to trailing 12-month EBITDA is 0.8 times, which is substantially lower than the benchmark. This tells us that we could have more interest bearing debt on our balance sheet and still be within industry norms. Financing new growth with higher financial leverage will improve our return on equity. * In 2004 and prior years, goodwill has been excluded from assets managed. ** Includes the operations of the Nova Scotia-based fishing assets sold in May Trailing 12-month earnings before interest and taxes as a percentage of net sales is calculated as follows: All earnings before interest and taxes, excluding nonoperating items DIVIDED BY sales, as disclosed on the consolidated statement of income. * In 2004 and prior years, the book value of goodwill has been deducted from equity. ** Includes the operations of the Nova Scotia-based fishing assets sold in May High Liner Foods annual report 2006

23 2. Key performance drivers Measurement against our key performance drivers will tell us whether we are achieving our Strategic Goals. In last year s MD&A we included our key drivers, which are listed below. We have made considerable progress by focusing on these drivers. Strengthen our brands Market share The market shares of our brands speak volumes. We purchase market share information collected through third party in-store data collection technologies. We measure share on a rolling four-week, twelve or thirteen-week, and fifty-two week basis, and can tell quickly whether consumers are responding to our new product ideas. Our market share in Canada is strong, where we are the leader in retail and a very strong competitor in food service. In the United States, our Fisher Boy brand has a strong presence in certain regions. Market share for our retail brands is discussed in detail on page 31 and 32 of this MD&A. Distribution We measure distribution or all commodity volume (ACV). This is a measure of the volume of the traditional grocery stores as a percentage of total stores in a market (Canada or the United States) in which our products are found. An increase in ACV means that our products are in more stores and therefore available to more consumers in more markets. In Canada, our ACV approaches 100% as High Liner products can be found in virtually all grocery stores. In the U.S. grocery channel our Fisher Boy ACV is approximately 25% and our High Liner ACV is 20%. In recent years, our Fisher Boy distribution has declined. In 2006, ACV for Fisher Boy stabilized. We are pleased with distribution achieved thus far for our High Liner products, launched late in In Mexico, although we do not track ACV, we are a leading seafood supplier. While we use ACNielsen to track our market share and ACV of our retail brands in traditional grocery stores, this data excludes club stores and mass merchandisers. Our ACV is therefore actually higher than disclosed by ACNielsen. Percentage of overall sales from our brands Most of our sales are of our branded products. We measure the percentage of our sales from our brands on a rolling 52 weeks basis and strive to keep it at 80%. In 2006, our brand sales were 80% of our total sales. We anticipate this percentage to be similar in Strengthen our organization Productivity We have two manufacturing plants each with capacity for growth. We measure throughput, pounds produced per working hour, and pounds of production on a rolling 12 months basis, to ensure optimum productivity and plant utilization. We have undertaken a thorough analysis of all of our operations with the goal of identifying opportunities for improvement in productivity and efficiency. Our investment in the analysis will contribute to annual cost savings and improvements in our long-term profitability. Customer service Our strong customer relationships are a competitive strength. To preserve them, we must consistently strive to exceed customer expectations. To that end, we measure case fill rates, our ability to achieve at least 98.5% purchase order fulfillment, to ensure that our customers continue to rely on High Liner. For 2006, our purchase order fulfillment, measured on cases of products shipped compared to what was ordered, was 97.6%. People We are building a high-performance organization by investing in our people. We intend to develop our future leaders from within, and therefore we are focused on increasing individual capacity for leadership. Grow through innovation Overall sales increases Global procurement means that we are no longer limited in our product ideas. We can access any species that meets consumer tastes, and therefore we are focused on product development. Overall sales increases will tell us whether our ideas are successful. We aim to achieve at least a 5% increase in sales year over year. In 2006, our sales increased 4.6%, despite a stronger Canadian dollar, which reduces sales. When adjusted for the stronger Canadian dollar, sales for fiscal 2006 increased 7.5%, with the higher Canadian dollar reducing the value of reported U.S. sales by approximately $7.2 million. High Liner Foods annual report

24 Management s Discussion and Analysis (cont d) Sales from new products Maintaining our benchmark sales from new products tells us that we are renewing our product line in a sustainable way. We measure annual sales and profits from new products to show us that we are reaching consumers with new and consistently reliable food choices. In 2006, sales from new products launched in the year exceeded $10.0 million. Sales of new products launched in the past two years were more than $35.0 million. New products in the U.S. We have three important initiatives to improve results in our U.S. business. Our High Liner products offer more selection and variety than our traditional U.S. products. In 2005 we brought the premium quality of our High Liner brand to the retail channel in the U.S. In 2006 we increased High Liner brand sales by launching new products in traditional retail and club channels, and to the developing natural foods channel. We will continue to increase High Liner sales in the U.S. by introducing new products, and will measure sales dollar growth against our targets. As announced earlier in 2006, we will convert the Fisher Boy brand to a product line of the High Liner brand. 3. Capability: resources and core competencies High Liner has both the financial and operational resources to achieve our objectives. Liquidity and capital resources We ended 2006 in a strong financial position: $10.1 million in short term debt $1.0 million in long-term debt (capital lease obligations) Total interest bearing debt is 14% of total capitalization $40.0 million in committed lines of credit With a strong balance sheet, we are well positioned to execute our strategy. Debt We have no long-term debt other than a few capitalized equipment and vehicle leases. Note 7 to the financial statements includes a table showing the required principal repayments of capital lease obligations for 2007 and later years. Other than capital leases, we do not have any significant purchase obligations. With respect to other longterm obligations, we have obligations to employees under pension plans and other similar retirement benefits. These are disclosed in note 14 to the financial statements. Excluding a significant event, such as an acquisition, no new long-term debt will be required in We do plan to enter into further capital leases of approximately $0.2 million in 2007 principally for fleet vehicles. Our working capital debt bears interest at floating rates. In 2006 we negotiated a new $40.0 million credit facility with the Royal Bank of Canada, as agent, for operating purposes of the Company. This replaced the expired US$7.0 million facility of our U.S. subsidiary and the Canadian company s $35.0 million operating line. This new facility provides for the following: Canadian dollar Prime Rate loans and U.S. Base Rate loans in U.S. dollars at Prime or Base Rate plus 0.00% to 0.25% Bankers Acceptances (BA) loans at BA rates plus 1.00% to 1.50%; and LIBOR advances at LIBOR plus 0.75% to 1.50% The rates change depending on the Company s EBITDA to interest bearing debt. We currently borrow at the low end of these interest rate ranges as our interest bearing debt to EBITDA is below 3.0 times. Average short-term borrowings in 2006 were approximately $21.1 million, compared to $14.4 million in We had higher than expected inventory levels in the first and second quarters of The Company has instituted several new inventory management measures, which have reduced inventory and are expected to result in lower working capital loans in Debt is seasonably higher in the first quarter due to building inventory levels in anticipation of Lenten sales and to cover sales in North America during the Chinese New Year when Asian plants are shut down for several weeks. 22 High Liner Foods annual report 2006

25 At December 30, 2006, our bank loan was $10.1 million and our unused available credit on pre-arranged short-term working capital borrowing facilities was $34.5 million, based on margin calculations. This is more than sufficient to cover expected working capital requirements for On December 31, 2005 we had letters of credit outstanding in the amount of US$1.4 million. These were extinguished during the year and new letters of credit were created during the year as required for the procurement of seafood products from overseas. On December 30, 2006 we had new letters of credit outstanding in the amount of US$3.4 million to secure obligations for the purchase of seafood and $0.7 million to certain obligations under the Company s supplemental executive retirement plan. Working capital Net debt to capitalization (000 s) 180, , , , ,000 80,000 60,000 40,000 20,000 0 Net Debt Common Shareholders Equity 02 * 03 * ,000 25,000 20,000 15,000 10,000 5,000 Preference Shareholders Equity EBITDA * Includes the Nova Scotia-based fishing assets sold in May Accounts receivable include $1.0 million and accounts payable include $0.1 million recorded on the sale of fishing assets in May These relate to residual obligations under the sale agreements and related pension and severance costs. This will reduce over time until fully extinguished, likely in In 2006 $1.2 million of liabilities was paid out on a guarantee obligation under those sale agreements. Reducing working capital is a long-term priority. Inventory at year-end has decreased from last year due to introducing a more disciplined inventory management process and systems, including regular management reports to the Audit Committee and increased accountability to ensure inventory levels are optimal. 0 Cash flow Cash flow provided by continuing operations before changes in non-cash working capital items for 2006 increased from the same period last year, the result of higher earnings from operations, due to a number of factors identified under the discussion of earnings on page 30. Net changes in non-cash working capital balances related to operations provided cash in 2006 and used cash in This is a result of changes in inventory levels, for the reasons mentioned above. Free cash flow 1 was $16.9 million for the year ended December 30, 2006, up from a negative $11.3 million for the year ended December 31, Cash flow from operations increased by $4.3 million during the most recent year due to an increase in operating income as explained on page 30. As well, working capital in 2006 decreased $10.7 million, freeing cash, while in 2005 working capital increased by $14.1 million. The majority of the change in working capital in both 2005 and 2006 is from inventory changes. The table below reconciles our free cash flow with measures that are in accordance with generally accepted accounting principles. (000s) Cash flow from operations before changes in non-cash working capital* $ 9,784 $ 6,980 Gross capital expenditures** (3,614) (4,149) Changes in non-cash working capital* 10,719 (14,123) Free cash flow $ 16,889 $ (11,292) * Per Cash Flow Statement. ** Per Note 13 to the Consolidated Financial Statements. Capital expenditures Gross capital expenditures for 2006 were $3.6 million compared to $4.1 million last year. Efforts to improve our existing facilities and equipment continued in 2006 and focused on capital spending which prolonged the useful life of our assets, increased efficiency, reduced costs and promoted safety of operations. We plan to invest approximately $6.0 million in capital assets in Approximately half of our capital expenditures in 2007 are for strategic initiatives and profit improvement projects, both of which will generate savings or cost reductions. Cash generated from operations and short-term borrowings will fund capital additions in Free cash flow is defined as cash from operations, reduced by capital expenditures and adjusting for changes in working capital (excluding changes in cash, marketable securities, and short-term debt). Management believes this is a useful performance measure as it approximates cash available to pay interest, income taxes and dividends. As companies are financed differently, free cash flow is useful in comparing companies. However, free cash flow does not have a standardized meaning prescribed by generally accepted accounting principles and therefore may not be comparable to similar measures presented by others. Free cash flow has been calculated and presented in a manner consistent with prior years. High Liner Foods annual report

26 Management s Discussion and Analysis (cont d) Capital structure Detailed information regarding the designation and number of each class of shares outstanding and of each class of security convertible into shares is disclosed in note 8 to the financial statements. Conversion of inter-company debt to equity During the fourth quarter of 2006 we converted intercompany debt owed by our U.S. subsidiary to the Canadian parent to equity. We concluded that the debt owed would remain as a permanent investment in those operations. Lenders already viewed these amounts as equity in the subsidiary. This conversion simplifies the capital structure of our U.S. subsidiary. As inter-company debt and equity is eliminated on consolidation, there is no change in the consolidated balance sheet or income statement as a result of this conversion. However, the conversion of debt to equity created a capital loss for Canadian income tax purposes, which allowed us to carry the loss to previous periods and offset capital gains previously recorded on the sale of fishing assets in As required by generally accepted accounting principles, the recovery of income taxes of $1.5 million was recorded in the foreign currency translation account on the balance sheet as an offset against the losses from prior years accumulated in this account. Equity The book value of our common shares at the end of 2006 was $4.97 compared to $4.72 at the end of We have implemented normal course issuer bids in each of the last three years (see below) due to our confidence in the underlying value of our business. The 2005 normal course issuer bid permitted the purchase of up to 530,000 of our common shares, representing just fewer than 5% of those outstanding, during the 12-month period ending on May 4, Up to that date we purchased 422,518 common shares at an average price of $9.46 for an aggregate consideration of $4.0 million, of which 5,000 common shares at an average price of $9.31 were purchased in fiscal Normal course issuer bid A normal course issuer bid that commenced on May 12, 2006 permits the purchase of up to 510,000 of our common shares during the 12-month period ending on May 11, To December 30, 2006 we have purchased 3,000 common shares pursuant to this bid at an average price of $8.71. Purchases were not significant in 2006 due to other priorities for cash and due to internal trading black out periods imposed on insiders in accordance with our internal Disclosure Controls. A NORMAL COURSE ISSUER bid is a bid by a listed company to buy back its own shares on a stock exchange, subject to certain rules that protect investors, but without complying with all of the requirements applicable to issuer bids because the bid is made for a number of shares that is below a prescribed threshold. Dividends Current year dividends on the second preference shares in the amount of $1.2 million for 2006 were paid in full in In 2005 we paid dividends of $1.0 million on these shares. Dividends fluctuate in relationship to prime bank rates. In 2005 and 2006 we paid quarterly $0.05 dividends on our common shares. The dividend policy on common shares reflects our confidence in our growth strategy, together with significant improvements on our balance sheet since divesting our fishing assets. On February 21, 2007, the Directors approved a quarterly dividend of $0.05 per share on the Company s common shares payable on March 15, 2007 to holders of record on March 1, Subject to cash flow, it is the Company s intention to declare quarterly dividends on its common shares in Operational resources Our organic growth plans can be achieved without significant operational expansion. Our existing operational resources include: Plant capacity Our Lunenburg and Portsmouth manufacturing facilities have ample production capacity to meet forecasted demands. Each is operating at approximately 70% capacity. Our product development expertise is not limited to our own production. We do purchase significant quantities of raw finished goods, and some of our new value-added premium products are purchased as finished goods. Distribution centres Both our Lunenburg and Portsmouth facilities include large distribution centres. We also have Directors of Logistics in each location to ensure that the warehousing and transportation of our products is handled in cost-effective and customer service oriented methods. As noted in Section 1, our supply chain is under intensive review to achieve optimization, and we will report on the progress of this initiative throughout High Liner Foods annual report 2006

27 Technology Our business is simplified through an enterprise wide business management system, using the latest version of Oracle software. We have also developed a proprietary Internet-enabled procurement system that allows us to manage procurement on-line in real time. Business intelligence software allows us to manage our information on a real time basis to help us make business decisions quickly, manage inventory and provide more informative financial disclosure. We have ensured that we are equipped to respond to customer demands for electronic transmission of business documents, including invoices, purchase orders, and payment confirmations. Core competencies Our core operational competencies are: Brand equity High Liner is the leading Canadian seafood brand, with a 42.9% retail market share on a 52 week basis ending December 23, We are the preferred seafood brand, and the value of our leadership position is not recorded in our financial statements. The strength of our brand reputation can be leveraged into growth with new species, in new channels, and to new customers, particularly in the United States. Procurement expertise We are seafood experts, and therefore we can procure seafood on world markets from a position of strength. Our procurement group s proprietary Internet-based procurement and inventory management system enables the purchase of approximately 30 species of seafood from geographically diverse suppliers. The results are lower raw material costs, better predictability of raw material supply and pricing, high quality, and reduced risk. Our expertise has also allowed us to competitively outsource low value-added, labour intensive products to other processors, freeing capacity in our own plants for more specialized, higher value-added products. Lastly, our procurement knowledge has provided the freedom to develop products based on changing consumer tastes. We can be flexible, and now we more nimbly respond to trends and tastes as they emerge. Customer relationships We have been supplying food products to major grocery retailers for decades. We have developed strong relationships with our customers through excellent customer service and brand recognition. We reach our consumers through these exceptionally strong customer relationships. We sell to all the national retail chains and to the major regional chains in North America. We have ensured that our infrastructure is capable of meeting the exacting demands of these customers, for both excellent products and service delivery. In 2005 and 2006, Associated Food Distributors recognized our food service business with a Distributor Choice Award in the Large Volume Supplier category. Innovative products Innovation is one of our core values. During the year we launched 40 new products. Our premium products have been an excellent example of our innovation in seafood products in the Canadian marketplace. Increasing the depth of our product line by adding new species from aquaculture such as tilapia and basa has allowed us to develop even more innovative products. In addition, our new products, recently launched to the natural food distribution channel in the U.S., are examples of High Liner s leading position in the development of new and innovative products. Governance Our 2006 Annual Report, and our 2006 Management Information Circular includes full details of our governance structures and processes. We maintain a set of disclosure controls and procedures designed to ensure that information required to be disclosed in filings made pursuant to Multilateral Instrument is recorded, processed, summarized and reported within the time periods specified in the Canadian Securities Administrators rules and forms. Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures as of December 30, They have concluded that our current disclosure controls and procedures provide reasonable assurance that (i) information required to be disclosed by the Company in its annual filings or other reports filed or submitted by it under applicable securities legislation is recorded, processed, summarized and reported within the prescribed time periods, and (ii) material information regarding the Company is accumulated and communicated to the Company s management, including its Chief Executive Officer and Chief Financial Officer in a timely manner. In addition, our Chief Executive Officer and Chief Financial Officer have designed or caused to be designed under their supervision, internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes. There have been no material changes to the Company s internal controls during the year. High Liner Foods annual report

28 Management s Discussion and Analysis (cont d) 4. Other items important to understanding our results Accounting standards We did not adopt any new accounting standards in 2005 or In 2006 we recorded an accrual for salaried vacation pay. In prior periods, we had not recorded an accrual for salaried vacation payable to employees, as in the vast majority of cases and due to our internal vacation policies it was taken in time and not paid in cash. However, since accrued vacation pay is a liability, we have now recorded this in the financial statements. In accordance with Section 1506 of the CICA Handbook, this change has been made retroactively by restating the opening balances of assets, liabilities and equity as of the beginning of fiscal As such, the Company has restated comparative financial statements to reflect the change. See note 2 to the financial statements. In 2007 we will adopt the following required new accounting standards. Financial instruments In 2005, the Canadian Institute of Chartered Accountants issued Handbook Sections 1530 Comprehensive Income, 3855 Financial Instruments recognition and measurement, and 3865 Hedges, that establish standards for recording and measuring financial assets, financial liabilities and nonfinancial derivatives and introduce a new statement of Other Comprehensive Income. These Sections state that the most relevant measure for financial instruments and the only relevant measure for derivative financial instruments is fair value. We will adopt these new standards effective for interim and annual financial statements commencing in the first quarter of fiscal Most significantly for High Liner, the new standards will require presentation of a separate statement of comprehensive income. Foreign exchange gains and losses on the translation of the financial statements of selfsustaining subsidiaries, currently recorded in a separate section of shareholders equity, will be presented instead in comprehensive income. In addition, High Liner enters into foreign exchange derivative instruments to hedge future cash flows. We have concluded that these foreign exchange contracts will continue to qualify for hedge accounting under the new standards. Under these new rules the value of these derivative contracts will be marked to market at the end of every quarter, with the change in value being recorded in Other Comprehensive Income. We include details of our hedging relationships as of December 30, 2006 in Note 1 to the Financial Statements and provide additional details on foreign currency on page 35 of this MD&A. Transactions with related parties The Company s business is carried on through the parent company, High Liner Foods Incorporated, and a wholly owned operating subsidiary, High Liner Foods (USA) Incorporated. These two companies purchase and/or sell inventory between them, and do so in the normal course of operations. As well, the parent company provides management and IT services to the subsidiary, and sometimes lends it money. Periodically, capital assets are transferred between companies. On consolidation, revenue, costs, IT services, gains or losses, and all inter-company balances, are eliminated. During the fourth quarter we converted US$28.7 million of inter-company debt to equity. See page 24 for more details. Additional related party transactions, those with third parties, are described in Note 18 of the financial statements. Interest Interest expense in 2006 increased over 2005 as a result of higher average short-term bank loans, due to higher inventories, and an increase in interest rates. We expect our short-term bank loans in 2007 to be lower than those of 2006 due to efforts made in lowering inventory levels. Other expense Other expense represents small losses on the sale of fixed assets, primarily vehicles. Non-operating transactions (see note 10 to the financial statements) Non-operating transactions in 2006 and 2005 result from the adjustment of accrued costs recorded in prior years on the disposal of our fishing assets due to estimates used that differed from the actual costs paid. These were mostly pension and severance accruals. In addition, 2005 non-operating transactions include $0.4 million of pension settlement costs paid in 2005 to former employees. These former employees were terminated in 2003 in connection with the sale of our Nova Scotia-based fishing assets. According to CICA Handbook section 3461, these costs could be expensed only when the final settlement amounts were paid. We do not expect further pension settlement costs. 26 High Liner Foods annual report 2006

29 Income taxes High Liner s effective income tax rate from continuing operations in 2006 is an expense of 45.6%, compared to 44.5% for Our statutory rate for 2006 is approximately 35.8%. Our effective rate is higher than the statutory rate in both 2005 and 2006 for two main reasons: 1) U.S. state taxes paid are not based on income and have the effect of increasing our effective tax rate; and 2) future income taxes were not recorded on the loss resulting in our U.S. subsidiary due to the lack of certainty in utilizing such losses before they expire. The major components of income tax expense and a reconciliation of the Company s effective tax rate are included at note 11 to the financial statements. As the Company has recorded future income tax assets that are available to offset income taxes of future years, we do not expect to pay full Federal income taxes in Canada or the United States in cash until 2008 at the earliest. However, we do expect to pay some cash taxes in 2007 and later years in certain Canadian provinces and U.S. states, as we do not have significant tax losses or deductions to offset these. Discontinued operations On July 27, 2006 we sold our Italian Foods operations for proceeds of $1.7million ($1.1 million cash and $0.6 million note receivable) and the collection of $0.8 million of accounts receivable. Liabilities of $1.2 million relating to this business have been extinguished as well. Since we exited the pasta category, and cash flows from pasta were eliminated from ongoing operations, accounting standards require that we report our pasta business as discontinued operations. We implemented this in our second quarter and restated comparative figures to show our Italian Foods operations as discontinued operations. The sale resulted in no gain or loss, as the assets of the operations were written down to fair market value in As well, in accordance with CICA Section 3062, at the end of 2005 we performed an annual test for impairment of goodwill in our U.S. subsidiary. Book value of goodwill of $41.4 million, prior to write-down, resulted from the Company s 1998 purchase of the assets of Italian Village Ravioli and Pasta Products Inc. and Floresta Pasta Products Inc. Using discounted cash flows over a period of 20 years and certain key assumptions the test determined that goodwill was fully impaired. The carrying value of goodwill was adjusted by this amount. This charge was a non-cash and non-operating item. See note 3 to the financial statements for a full discussion of the events and circumstances that led to the write-down of goodwill. The write-down of goodwill and the costs incurred in moving to a pasta co-packer in 2005 are recorded on the Other loss / Non-operating transactions line under discontinued operations on the income statement in note 3 to the 2006 financial statements. In addition to the above, Discontinued Operations for 2005 and 2006 include the reversal of accruals recorded on the disposal of our Arnold s Cove, Newfoundland operation in 2004, mostly related to pension and severance accruals. Contingencies Arising out of our sale of our fishing assets in 2003, we have sued the purchasers of the shore based assets of Scotia Trawler Equipment Limited to recover $1.0 million of the purchase price withheld pending resolution of land title issues. As far as management is concerned, our obligations under the agreement have been met, and we intend to pursue the claim to a satisfactory end. (See note 19 to the financial statements). Discontinued operations for 2005 include additional pre-tax costs incurred of approximately $1.7 million in connection with the move to a pasta co-packer, and costs incurred as a result of the termination of our contract with that co-packer and the move to other co-packers. These costs include a write-down of an impaired loan of $0.7 million. High Liner Foods annual report

30 Management s Discussion and Analysis (cont d) 5. Performance Overview Sales as reported Sales from Nova Scotia-based fishing assets sold in May 2003 Impact of change in the USD/CAD exchange rate Sales at a constant foreign exchange rate of , excluding sales from Nova Scotia-based fishing assets sold in May 2003 Sales increased in 2006: Strong retail and food services sales in Canada Higher sales of High Liner branded products in the U.S. Decrease from 2002: Stronger Canadian dollar reduces the translated value of U.S. sales Sale of Nova Scotia-based fishing assets in May 2003 Operating EBITDA from continuing operations Operating EBITDA including the operations of the Nova Scotiabased primary fishing assets sold in May 2003 Operating EBITDA excluding the Nova Scotia-based primary fishing assets sold in May 2003 Improvement in 2006 due to: Lower marketing costs in the U.S. and increased profitability from new products in both the U.S. and Canada Reduction from 2002 due to: Higher seafood, distribution costs and other commodity costs increasing faster than price increases Loss of ACV for Fisher Boy brand Net income from continuing operations excluding non-operating items * Includes the operations of the Nova Scotia-based fishing assets sold in May Improvement in 2006 due to: Successful new product launches increased profitability in Canada Earnings improved in the U.S. due to new products and reduced marketing expense Reduction from 2002 due to: Sale of the Nova Scotia-based fishing operations in May 2003 Higher seafood, distribution costs and other commodity costs, increasing faster than price increases, although somewhat offset by stronger Canadian dollar EPS from continuing operations excluding non-operating items * Includes the operations of the Nova Scotia-based fishing assets sold in May High Liner Foods annual report 2006

31 Consolidated results Selected annual information The table below summarizes key financial information for our last three fiscal years. (all amounts in thousand, except per share amounts and exchange rates) Sales Canada $ 156,144 $ 142,214 $ 136,965 United States 105, , ,302 Total 261, , ,267 Net income from continuing operations: Total 5,123 3,854 12,266 Basic earnings per Common Share Diluted earnings per Common Share Net income: Total 4,330 (40,469) 8,162 Basic earnings per Common Share 0.30 (3.93) 0.66 Diluted earnings per Common Share 0.30 (3.93) 0.65 Total assets 113, , ,171 Total long-term financial liabilites Cash dividends per share: Common Shares Second Preference Shares Gross capital expenditures* 3,614 4,149 5,298 Average foreign exchange rate for the year (USD/CAD) $ $ $ * Per Note 13 to the Consolidated financial statements. Seasonality Quarterly operating results fluctuate throughout the year. Summary information for each of the eight most recently completed quarters is presented on page 60 in this Annual Report. Operating results in the first quarter are historically strongest as retailers promote seafood during the Lenten period. The fourth quarter is historically the second strongest quarter as several festive occasions occur during this time that increase demand for our products. The second and third quarters are more challenging. Consumers spend more time outdoors during the warmer months and use ovens less often, decreasing demand for our products. As a retail-oriented business, we spend significant amounts on consumer advertising and new product launches. Although the related activities benefit more than one period, the related costs must be expensed when the initial promotional activity takes place. The accounting periods during which we choose to make these expenditures may change from year to year, and therefore there may be fluctuations in income related to these activities. Due to the strong sales performance in the first quarter, inventory levels are also seasonally high at the end of the year and throughout the first quarter. This coupled with the seasonal closure of plants in Asia during Chinese New Year, results in significantly higher inventories in January, February and March than during the rest of the year. Going forward, we expect seasonality to be similar to past trends. Sales Total sales for 2006 increased compared to last year. Price increases implemented increased sales in dollars by $8.9 million. These price increases have the effect of reducing volumes for a period after they become effective. Pounds sold in 2006 decreased by 2.0% from 2005 due primarily to lower Fisher Boy and private label sales in the United States. The increase in sales dollars results from price increases and strong sales in Canada, both retail and food service, and from the High Liner brand in the United States, primarily from new products launched in 2005 and High Liner Foods annual report

32 Management s Discussion and Analysis (cont d) Foreign exchange The Canadian dollar strengthened in 2006, which was up 6.4% over 2005 (based on the average daily exchange rate of $ in 2006 compared to $ in 2005). Because we report financial results in Canadian dollars, a strengthening Canadian dollar has the effect of reducing the Canadian dollar value of U.S. dollar denominated sales, which comprise approximately 40% of total sales. The stronger Canadian dollar reduced the value of sales in 2006 by approximately $7.2 million. Based on sales in 2007, we estimate a $0.01 change in the U.S./Cdn dollar exchange rate will impact sales by approximately $1.1 million. A strengthening Canadian dollar has a positive impact on earnings. Because the majority of U.S. dollar denominated sales also have U.S. dollar denominated input costs, only the profit on these sales is subject to foreign exchange risk. However, most raw materials for Canadian dollar sales are purchased in U.S. dollars. A strengthening Canadian dollar, therefore, reduces the cost of raw materials for products sold in the Canadian market. During the year, we had hedged the majority of our purchases, which resulted in an average exchange rate of , compared with an actual average floating exchange rate of Based on current operations, we estimate a $0.01 change in the U.S./Cdn dollar exchange rate, before hedging, will impact after-tax income by approximately $700,000. EBITDA Our consolidated Operating EBITDA from continuing operations in 2006 increased from fiscal 2005 due to price increases, which offset the increased seafood raw material and other costs that we experienced in 2005 and 2006 as well as increased volume from new products. The table below reconciles our Operating EBITDA with measures that are in accordance with generally accepted accounting principles. (000s) Gross profit, per financial statements $ 49,311 $ 48,237 Selling, general and administrative expenses, per financial statements (36,170) (38,175) Foreign exchange, per financial statements 427 (27) Operating EBITDA $ 13,568 $ 10,035 OPERATING EBITDA is earnings before interest, taxes, depreciation and amortization, other expense and nonoperating transactions as disclosed on the consolidated statements of income. Management believes that this is a useful performance measure as it approximates cash generated from operations, before capital expenditures and changes in working capital and excludes non-operating items. Operating EBITDA also assists comparison among companies as it eliminates the differences in earnings due to how a company is financed. However, Operating EBITDA does not have a standardized meaning prescribed by generally accepted accounting principles and therefore may not be comparable to similar measures presented by others. We have included foreign exchange in Operating EBITDA beginning in the second quarter of 2006 and prior years have been restated to reflect this change. We discuss Operating EBITDA, sometimes referred to simply as EBITDA, and both terms are used interchangeably in various places in this document. We also refer to Operating EBITDA of our Canadian operations and of our U.S. operations. These are calculated in the same fashion as described above and can be reconciled to our segment disclosure note 13 to the consolidated financial statements. The reason for the increase in Operating EBITDA from 2005 is discussed by business below. Performance by business Canadian operations Operating EBITDA in Canada for the year increased 33.7% compared to last year. Canadian retail increased prices averaging 4% in February and 2% in October. Likewise, Canadian food service increased prices on processed products averaging 4.5% effective March and raw commodity products changing with the market. These price increases offset higher seafood and other costs that we experienced in 2005 and Price increases of $5.3 million and lower trade spending of $0.4 more than offset the higher seafood cost of $3.2 million experienced in 2006, helping offset increases from As well, new products increased the profitability in 2006 by $2.3 million, offset in part by higher fixed marketing and sales costs of $1.1 million primarily slotting and coupon redemption costs, both of which are netted from sales. Extra slotting of $0.7 million was spent in 2006 due to the launch of new products in As well, we spent $0.6 million more on couponing to promote our products to consumers. 30 High Liner Foods annual report 2006

33 Canadian retail Sales volume of our High Liner brand products in Canada increased 5.1% 2 in 2006 compared to last year despite pressure on volumes due to price increases introduced in the year. Our retail business increased as a result of good execution at the store level: retailers worked well with us on promotional activities in the stores. New products also played a key role in the success of this business in Sales volume for our premium Signature line in 2006 was 10.9% 2 higher compared to Sales price increases dampened the growth of this product line in 2006 as it is typical for volumes to decrease following a price increase. However, volumes do recover, as they have done in the later part of 2006 and into Most of the increase in Signature sales in 2006 was due to launching three new products. Sales volume of raw fillets, mostly in seafood departments of grocery stores, increased 27.0% 2 in 2006, due to sales of wild salmon and tilapia products, both of which were introduced in late 2004 as part of our strategy to expand our presence in supermarkets. Seafood departments represent an opportunity for growth within the traditional grocery store channel and we are continuing to develop new products that address the preferences of our customers and consumers. High Liner s Canadian overall seafood market share 3 for the fifty-two week period ended December 23, 2006 was 42.9%, up from 41.7% for the comparable period last year. This is a 12% increase in pounds in 2006, which is 3 percentage points higher than the growth in the category. Increases are due to the success of our new product launches. Note that the 12% increase according to ACNielsen is higher than the 5.1% that we report internally as 1) we report sales when they are sold to customers, while ACNielsen reports sales as they are sold to consumers, 2) we report all High Liner sales in all retail channels, while the ACNielsen includes sales to grocery banners, but excludes club stores and mass merchandisers. Canadian food service Canadian food service sales volume in 2006 increased by 10.8% 2. The business performed well in all respects: sales for most species and to most customers were up from last year. The introduction of new products and new species is driving this growth. Sales for Atlantic scallops were down as certain sizes of scallops were unavailable, and we were challenged to obtain sufficient supply of other sizes at acceptable prices. In 2006 we sold cheese sticks for part of the year to a large national fast food restaurant, which also increased sales. As well, we expanded private label product offerings to two key food service customers. For the second year in a row, our food service business received the Distributor Choice award within the Large Volume Supplier Category from the Associated Food Distributors (AFD). AFD is a national buying group, which represents more than 40 independent food service distribution companies within Canada. U.S. operations United States operations sales in U.S. dollars increased by 4.3% due to the good performance of the High Liner brand. In Canadian dollars, sales decreased 2.2% due to a stronger Canadian dollar. The reduction in sales due to the stronger Canadian dollar was $7.1 million. Overall, operating EBITDA 4 for our United States operations in 2006 was up from last year despite lower sales volume, and increased costs for seafood raw material, and higher freight costs. This increase was due to price increases, additional tilapia volume at club stores and lower marketing costs. Higher seafood cost of $5.5 million and distribution cost of $0.9 million experienced in 2006 were not fully offset by price increases, which amounted to $3.6 million. As well, trade spending increased by $0.2 million in order to promote our products with our customers. On the other hand, new products increased profitability by almost $1.0 million. Fixed marketing costs are $2.2 million lower in 2006 as we did not have any major new product launch in 2006 compared to 2005 when we launched new High Liner products. U.S. retail High Liner Sales for our High Liner brand increased almost 24% in U.S. dollars in In pounds, sales are up only 2.2% from last year due to the implementation of a price increase. Sales in dollars are up due to the price increase and changes to our product mix at club stores to higher value items. The sales increase is also due to a number of factors, including the launch in 2006 of a new line of High Liner family-sized products based on our Canadian Signature products. We began shipping these to our largest customer in the U.S. in April. Sales of these products advanced the brand s presence in traditional grocery stores. In the fourth quarter of 2006, we launched six all-natural, no-additives products under the High Liner brand to a new U.S. customer in the developing natural foods channel. Although sales in 2006 were nominal, this is an important step for us as it is our first entry in the natural/health food segment. 2 As measured in volume (pounds). 3 Market share is estimated by ACNielsen which tracks all Canadian basic grocery banner stores, excluding club stores/warehouses, and is measured in pounds. The category reported here is total frozen fish, which excludes all shellfish and entrees. 4 Operating EBITDA is defined on page 30. High Liner Foods annual report

34 Management s Discussion and Analysis (cont d) Sales volume for our High Liner brand in U.S. club stores decreased 2.4% 5 due to a reduction in cod sales, which declined due to price increases late in the first quarter, partially offset by higher tilapia sales. We implemented price increases in this channel in the first quarter of The price increase in this channel improved profitability, despite reducing sales. In U.S. dollars, our High Liner brand in U.S. club stores increased 19.2% as we changed our product mix at club stores to higher value items and implemented price increases. During the year we were successful in introducing new products in U.S. club stores. Fisher Boy Fisher Boy brand sales, which account for less than 8% of our total company sales, were lower due to continued intense competition in the frozen fish stick category and the general decline in the breaded and battered category. The battered and breaded fish stick and fish portions category decreased by approximately 7.2% 6 for the 52-week period ended December 30, Within this category, the fish stick segment declined 9.2% 7 during the same period. Fisher Boy sales volume was down 8.9% 5 in This is in line with the decline in the fish stick segment, as fish sticks are the majority of the Fisher Boy product line. Reduced trade spending to offset the higher cost of seafood raw material also reduced sales, as the prices to consumers were higher. On a positive note, Fisher Boy s declining distribution seen over the past few years has now leveled off. We were also successful in 2006 in launching new Fisher Boy products. As part of our strategy to improve the competitive position of our Fisher Boy products, we will gradually transition all Fisher Boy products to the High Liner brand. Fisher Boy packaging featuring the High Liner logo alongside the current Fisher Boy logo will be introduced for the Lenten period of 2007 and will be gradually modified to complete the transition to the Company s core brand. This will make our marketing spending more efficient as we focus it on one brand, and displays at retail will be much more visible to consumers as we will display a wider selection of seafood choices all under the one umbrella brand. U.S. private label Our private label business consists of sales of products produced for a variety of retail grocery chains under the customer s logo or label to their specifications, rather than under our own brand. During 2006, our U.S. private label seafood sales volume decreased 13.1% 5. Most of the products we sell to our private label customers are fish sticks and related products. As such, the reduction in sales is due to a general decline in the fish stick category. As well, sales declined from lower sales to our two largest customers due to competitive pressures on their businesses resulting in lower market share for these two customers. Price increases implemented in the first quarter also reduced sales volume. We are a large producer of private label frozen seafood products for U.S. customers. We continue to have strong relationships with our private label customers and we did not lose any customers in 2005 or Unallocated In addition to our Canadian and U.S. operations, we also report in our segment information note to our consolidated financial statements that we have unallocated costs in operating EBITDA. These are corporate costs that we chose not to allocate to our two main operations, and include such items as non-sales and marketing incentives and costs relating to shareholder matters. Unallocated costs are higher in 2006 as incentive payments for 2006 are $0.5 million higher than 2005 due to better operating results. As well, we incurred additional consulting costs of approximately $0.3 million in 2006 in connection with a goodwill impairment test, accounting and tax consultations regarding possible acquisitions and capital restructuring, and due diligence on a potential acquisition. In 2005 we recorded a recovery of pension cost of $0.4 million that was unallocated to our other operating divisions. Outlook For 2007, Canadian retail will focus on growing and supporting recently launched products and continuing to develop and launch new products. Canadian food service will continue to focus on growing national and regional chain business, and expanding product offerings. In the U.S., we will continue to grow the High Liner brand in 2007 by expanding distribution for existing products and by launching new products. We also plan to grow Fisher Boy by launching new products and transitioning the Fisher Boy brand to the High Liner brand. Investment in our brands in the U.S. will mean that results in 2007 are expected to be similar to those of We plan to expand our private label product line and increase profitability. We expect the strong Canadian results experienced in 2006 to continue in However, after a period of a strengthening Canadian dollar, we have seen some weakness in late 2006 and early This likely means that we can no longer count on a strong Canadian dollar to offset increases in the U.S. dollar cost of raw materials, and, if weakening continues, our costs will increase. Commodity pricing on seafood, packaging, product coatings and cooking oils will also put upward pressure on costs. 5 As measured in volume (pounds). 6 Market share is estimated by ACNielsen which tracks all U.S. grocery stores with sales of U.S.$2.0 million or more and is measured in pounds. The category reported here is breaded fish, which includes fish sticks and fillets/portions. 7 The category reported here is fish sticks. 32 High Liner Foods annual report 2006

35 6. Summary of results for the fourth quarter ended December 30, 2006 Revenues during the quarter increased from the same period in fiscal 2005, due to strong sales in both Canada and the U.S. Canadian food service sales volume for the fourth quarter of fiscal 2006 increased 11.4% 8 compared to the corresponding quarter last year. The increase is primarily attributable to strong performance in all respects as sales for most species and to most customers were up from last year. Retail sales volume in Canada for the fourth quarter of fiscal 2006 decreased 1.5% in pounds compared to the corresponding quarter last year, but increased in dollars by almost 6% due to price increases. In the U.S., sales volume for our High Liner brand increased 2.5% 8 as a result of strong sales to club stores. In dollars, sales increased by more than 10% as a result of a change in the product mix particularly in club stores, to higher value items and price increases. Fisher Boy sales for the fourth quarter of fiscal 2006 increased 0.2% 8 compared to the corresponding quarter last year. U.S. private label seafood sales decreased 10.4% 8 in the same period, which is in line with the decrease in the category for the period. In addition volumes with two large customers declined due to a loss of their market share at retail. Operating EBITDA 9 from continuing operations for the fourth quarter increased, the result of several factors. First and most importantly, price increases implemented in 2006 added $1.6 million to EBITDA in the fourth quarter. Seafood costs in the quarter were unchanged from the last quarter of As well, distribution costs were $0.9 million lower than last year, due to lower freight surcharges. Also, we incurred $0.9 million more in marketing costs in the fourth quarter of Of this amount, marketing costs in the U.S. were $1.2 million lower in the quarter primarily due to the launch of High Liner products in the U.S. during the fourth quarter of On the other hand, marketing costs in Canada were higher this year due to the launch of new products late in Our effective tax rate for the fourth quarter of 2006 is 44.8%, which is higher than our statutory rate. This compares to a recovery of 3.4% in the fourth quarter of These variances from the expected rate are due to 1) U.S. state taxes paid that are not based on income, and 2) future income taxes were not recorded on the loss resulting in our U.S. subsidiary due to the lack of certainty in utilizing such losses before they expire. 8 As measured in volume (pounds). 9 Operating EBITDA is defined on page 30. High Liner Foods annual report

36 Management s Discussion and Analysis (cont d) 7. Risk management High Liner has designed an enterprise wide approach to risk management, from the top down, to ensure we can identify, prioritize, and manage risk effectively and consistently across the organization. Board accountability The Board of Directors oversees risk management at High Liner, and has delegated to the Audit Committee the task of providing reasonable assurance that we appropriately identify and manage risks. The Audit Committee reviews at least annually the Company s Business Risk Management Policies, particularly the Price Risk Management Policy, and reviews and approves the disclosure of risk factors in this MD&A and in other public documents issued by High Liner. A price risk report is reviewed at each Audit Committee meeting. The Audit Committee also reviews the Company s insurance program. We have identified 6 principal risks that could have a significant, adverse impact on our performance, reputation or ability to service our customers and have, in the absence of controls, a reasonable probability of occurring. Every principal risk is assigned to at least one member of our senior management team or to a board or management committee who has reporting, oversight and operational accountability for the risk. These risks are regularly reviewed by our senior management team, and by one or more internal committees or Board committees, which have governance and oversight accountability for the risk. This commentary is from a high level perspective on the nature of each risk and describes the main practices in place to manage these risks. A more detailed discussion of these risks is included in our 2006 Annual Information Form, available at or at Procurement We are dependent upon the procurement of frozen raw seafood materials and finished goods on world markets. The Canadian operation buys as much as $100 million and the U.S. operation buys approximately $43 million of this product annually. Prices can fluctuate and there is no formal commercial mechanism for hedging either sales or purchases. Purchases of seafood on global markets are principally in U.S. dollars. We hedge exposures to currency values, and we enter into longer term supply contracts when possible. All hedging activities are carried out in accordance with our formal Price Risk Management Policy, under the oversight of the Audit Committee. Our strategy is to always have at least two suppliers of seafood products when we can, and in some cases we have three or four. Only 26% of our supply is single sourced. After a period of a strengthening Canadian dollar, we have seen some weakness in late 2006 and early This likely means that we can no longer count on a strong Canadian dollar to offset increases in the U.S. dollar cost of raw materials, and if weakening continues, it may increase our costs. After substantial increases in 2005 and 2006, the trend for most seafood prices is more stable, but at a higher level of prices than we have seen in the past few years. This higher cost, spurred by strong demand for seafood and an increase in cost due to high world oil prices, is expected to continue into 2007 and beyond. We estimate an increase in seafood cost in 2007 in U.S. dollars of approximately 9.2%, or US$10.6 million. Price increases implemented in late 2006 will offset these higher costs. The stronger Canadian dollar is expected to reduce the impact of this increase to approximately 8.4%, $11.1 million Canadian, based on our forecasted exchange rate for 2007 of $ Canadian for each US$1.00, compared to our average purchases for 2006 that were at an average exchange rate of ( in Canada and in the U.S.). As we now purchase all seafood that we sell, we have developed close relationships with key suppliers. These suppliers obtain seafood from around the world. We currently purchase significant quantities of frozen raw material and finished goods originating from Russia, Asia, South America, North America and Europe. Our supplier base is diverse to minimize over-reliance on any source. We also maintain strict Supplier Approval and Audit Standards. Through audit procedures, all food suppliers are required to meet our quality control and safety standards, which in many instances are higher than regulatory standards. All raw materials are inspected, to assure consumers that High Liner quality is consistent, regardless of source or origin. 34 High Liner Foods annual report 2006

37 Customer risk We sell the vast majority of our products to large food retailers, Supercenters and club stores in North America and food service distributors in Canada. The food distribution industry is consolidating. Our customers are getting larger, more sophisticated and want to conduct business with sophisticated, reliable suppliers. We are an important supplier to our customers because we can transact business on their terms. We must continue to grow and stay ahead of customer expectations in order to continue to be important to them. We currently have one customer that represents approximately 12% of our sales. We focus on ensuring that our supply chain management and technology infrastructure keeps pace with the service delivery expectations of our customers. Foreign currency Overview High Liner Foods income statement and balance sheet are both affected by foreign currency fluctuations in a number of ways. Generally, a stronger Canadian dollar is beneficial to earnings but can reduce shareholder s equity as discussed below. Conversely, a weakening Canadian dollar increases costs and decreases sales and related profit. Income statement effects of foreign currency The average Canadian dollar in 2006 (at an exchange rate of $ for each U.S. dollar) has strengthened by 6.4% over the average of About half of the Company s sales and expenses are denominated in U.S. dollars. As such, fluctuations in exchange rates impact the translated value of sales, costs and expenses. Secondly, most of the items we sell in Canada have U.S. dollar denominated costs as we procure these on world markets in U.S. dollars. Thirdly, items we produce in Canada and sell in the U.S. are sold in U.S. dollars and are affected by exchange fluctuations. High Liner Foods operates a self-sustaining subsidiary in the U.S.A. Its domestic currency is U.S. dollars. In addition, some sales of the Canadian company are transacted in U.S. dollars. Because we report our financial results in Canadian dollars, a strengthening Canadian dollar has the immediate effect of reducing the Canadian dollar value of U.S. dollar denominated sales, costs and expenses. In 2006, U.S. dollar denominated sales comprised approximately 40% of our total on-going sales. In 2007, our U.S. dollar denominated sales are expected to approximate 45% of our total sales. The majority of sales in U.S. dollars, being those of our U.S. subsidiary, have U.S. dollar denominated input costs, and therefore changes in exchange rate only affect the conversion to Canadian dollars of profit earned by them. For products produced in Lunenburg, destined for the U.S. market, raw material is also purchased in U.S. dollars. However, labour, packaging and overheads for these products are purchased in Canadian dollars and therefore a strengthening Canadian dollar increases these costs in U.S. dollar terms and reduces the related profit. Conversely, a weakening Canadian dollar decreases these costs in U.S. dollar terms and increases the related profit. The raw material for products sold in Canadian dollars for the Canadian market is purchased substantially in U.S. dollars. A strengthening Canadian dollar reduces the cost of these raw materials. We do not benefit from the total change in the Canadian dollar when competitive factors come into play, as they do in our Canadian food service business. Our Canadian food service competitors use the lower Canadian dollar costs of imported products to reduce prices to compete with us, and we must therefore pass on some of the cost reductions to retain market share. After a period of a strengthening Canadian dollar, we have seen some weakness in late 2006 and early This likely means that we can no longer count on a strong Canadian dollar to offset increases in the U.S. dollar cost of raw materials, and if weakening continues, it will increase our costs. For 2007, approximately US$11.0 million of the Canadian operation s sales are expected to be in U.S. dollars. Approximately US$87.0 million of purchases of raw material and finished goods for the Canadian operation will be acquired with U.S. funds. Therefore our exposure on purchases for the Canadian marketplace is expected to exceed our sales of products produced in Canada for the U.S. market by US$76.0 million in This exposure is reduced to a US$73.0 million exposure after taking into account the conversion of U.S. subsidiary income to Canadian dollars and inter-company charges. Based on this, the net effect of a one-cent change in the U.S. dollar exchange rate for the Canadian dollar, prior to hedging activities, is a change in after-tax income of approximately $730,000. Our Treasury Team, with oversight from the Audit Committee, manages foreign exchange risk. The Team meets weekly to assess the Company s current cash and exposure positions. In accordance with the Price Risk Management Policy, we undertake hedging activities using various derivative products. To reduce our exposure to the U.S. dollar, the Policy allows us to hedge forward a maximum of fifteen months; at 80-90% of exposure for the first 3 months, 60-85% for the next 3 months, 30-75% for the next 3, 10-60% for the next three, and 0-60% for the last three. The lower end of these ranges are required to be hedged by the policy with the upper ranges allowed if management feels the situation warrants a higher level of purchases to be hedged. Details on the hedges in place on December 30, 2006 are included in note 1 to the financial statements. High Liner Foods annual report

38 Management s Discussion and Analysis (cont d) Balance sheet effects of foreign currency As we have operations in the United States, and monetary assets and liabilities in Canada that are denominated in U.S. dollars, assets and liabilities of the consolidated company change as exchange rates fluctuate. At December 30, 2006 the Canadian dollar is relatively unchanged from its value at December 31, However, over a longer term, the strengthening Canadian dollar has decreased the carrying value of items such as accounts receivable, inventory, fixed assets, and accounts payable. The net offset of those changes that relate to our self-sustaining U.S. subsidiary flows through the Foreign Currency Translation Account in shareholders equity on the balance sheet. Changes in monetary assets and liabilities in Canada that are denominated in U.S. dollars flow through the income statement. Other commodities Our operating costs are affected by changes in crude oil prices, which particularly influence the costs of our outgoing freight. As a result of higher crude oil prices from 2004 to 2006, freight costs have increased and our freight suppliers add fuel surcharges. To minimize our risk, and in accordance with the Price Risk Management Policy, we have entered into costless collar hedges using heating oil as a proxy for diesel in 2007 to hedge 75% of our diesel exposure. The collar ranges are between US$1.68 per gallon and US$2.03 per gallon. These ranges essentially fix our fuel surcharges between 13% and 27% on 75% of our diesel exposure. Other commodities, whose fluctuating market prices may affect our financial results, are flour, paper products and frying oils. The company s Price Risk Policy dictates that we use fixed pricing with suppliers whenever possible but allows the use of hedging with costless tunnels or swaps if deemed prudent. During 2006 and 2007 we have been able to deal with this risk to managements satisfaction using contracts with our suppliers. Food safety Our brand equity and reputation are inextricably linked to the quality and safety of our food products. We are vigilant in ensuring our products are safe and comply with all applicable laws and regulations. In Canada all seafood-processing plants are required to adopt a QMP (Quality Management Plan) covering the regulatory and safety aspects of food processing. High Liner s QMP has been approved by the Canadian Food Inspection Agency and is in good standing since inception of this requirement. Canada s QMP is an accepted standard under the U.S. HACCP system. Plants outside of North America must also pass HACCP audits to be able to export products to the U.S. All of the Company s non-north American suppliers are HACCP approved plants. The Canadian Food Inspection Agency (CFIA) must inspect food that is procured outside of Canada. The Food and Drug Administration (FDA) inspects food that enters the United States. In addition, all purchases are subject to quality inspection by the Company s own quality inspectors. We have strict specifications for suppliers of both raw material and finished goods to ensure that procured goods are of the same quality as products made in our own plants, contained in our Supplier Standards and Audit Manual. We employ several experts in this area, including food scientists, quality technicians, raw material inspectors, labelling and nutritional consultants. We also have a supplier code of conduct and retain independent auditors to monitor compliance. Technology Our technology infrastructure is critical to the daily requirements of our business and finance operations. The integrity and availability of information stored on that infrastructure must be assured. The inability to process customer payments, manage our supply chain, and operate manufacturing equipment due to loss of technology could shut down operations and impact our ability to deliver products to market. Numerous controls have been implemented to manage technology risk, including a comprehensive technology business recovery plan, and offsite backup technology centres. We also use a minimal number of technology platforms. Our leading edge enterprise-wide computer software systems (principally Oracle and Lotus Notes ), and our investment in Internetenabling connectivity with suppliers and customers, means that we are able to control our business processes. At High Liner, food safety is our top priority. All of our processing plants have the proper State or Provincial and Federal licenses to operate. The United States requires its seafood processing plants to adopt a quality management plan known as HACCP (Hazard Analysis of Critical Control Points). Our plant in Portsmouth, New Hampshire is regularly inspected and meets or exceeds all HACCP requirements. 36 High Liner Foods annual report 2006

39 Auditors report To the Shareholders of High Liner Foods Incorporated We have audited the consolidated balance sheets of High Liner Foods Incorporated as at December 30, 2006 and December 31, 2005 and the consolidated statements of income, retained earnings and cash flows for the periods then ended. These financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 30, 2006 and December 31, 2005 and the results of its operations and its cash flows for the periods then ended in accordance with Canadian generally accepted accounting principles. (Signed:) Ernst & Young LLP Chartered Accountants Halifax, Canada February 2, 2007 High Liner Foods annual report

40 Management s responsibility for financial reporting The Management of High Liner Foods Incorporated includes corporate executives, operating and financial managers and other personnel working full-time on Company business. The statements have been prepared in accordance with generally accepted accounting principles consistently applied, using Management s best estimates and judgments, where appropriate. The financial information elsewhere in this report is consistent with the statements. Management has established a system of internal control that it believes provides a reasonable assurance that, in all material respects, assets are maintained and accounted for in accordance with Management s authorization and transactions are recorded accurately on the Company s books and records. The Company s internal audit program is designed for constant evaluation of the adequacy and effectiveness of the internal controls. Audits measure adherence to established policies and procedures. The Audit Committee of the Board of Directors is composed of five outside directors. The Committee meets periodically with management, the internal auditor and independent chartered accountants to review the work of each and to satisfy itself that the respective parties are properly discharging their responsibilities. The independent chartered accountants and the internal auditor have full and free access to the Audit Committee at any time. In addition, the Audit Committee reports its findings to the Board of Directors which reviews and approves the consolidated financial statements. (Signed:) K. L. Nelson, FCA Vice President Corporate Services and Chief Financial Officer 38 High Liner Foods annual report 2006

41 Consolidated balance sheets Dec. 30, 2006 Dec. 31, 2005 (000s) (Restated Note 2) Assets (note 6) Current: Cash $ 240 $ 580 Accounts receivable (notes 3, 4 and 19) 31,221 28,095 Income tax receivable Inventories (notes 3 and 4) 41,278 52,670 Prepaid expenses (note 16) 3,495 7,246 Future income taxes (note 11) Total current assets 76,690 89,148 Property, plant and equipment (notes 3 and 5) 26,038 26,952 Other: Future income taxes (note 11) 3,005 4,642 Other receivables, deferred charges and sundry investments (note 16) 1,084 1,179 Employee future benefits (note 14) 6,360 5,332 10,449 11,153 $ 113,177 $ 127,253 Liabilities and Shareholders Equity Current: Bank loans (note 6) $ 10,115 $ 24,808 Accounts payable and accrued liabilities (notes 3 and 6) 27,087 29,407 Income taxes payable 159 Current portion of capital lease obligations (note 7) Total current liabilities 37,762 54,900 Long-term capital lease obligations (note 7) Employee future benefits (note 14) 3,702 3,138 Shareholders equity: Preference Shares (note 8) 20,000 20,000 Common Shares (note 8) 28,106 27,963 Contributed surplus Retained earnings 36,204 35,075 Foreign currency translation account (notes 2 and 9) (13,577) (14,950) 71,236 68,582 $ 113,177 $ 127,253 See accompanying notes to the financial statements. On behalf of the Board (Signed:) (Signed:) Henry E. Demone Director David J. Hennigar Director High Liner Foods annual report

42 Consolidated statements of income (loss) For the fifty-two weeks ended December 30, 2006 (with comparative figures for the fifty-two weeks ended December 31, 2005) Dec. 30, 2006 Dec. 31, 2005 (000s) (Restated Note 3) Sales $ 261,725 $ 250,203 Cost of sales 212, ,966 Gross profit 49,311 48,237 Selling, general and administrative expenses (36,170) (38,175) Foreign exchange gain (loss) 427 (27) Depreciation and amortization (3,017) (3,061) Interest expense: Short-term (834) (352) Long-term (73) (67) Other expense (48) (123) Non-operating transactions (note 10) (176) 510 Income before income taxes 9,420 6,942 Income taxes (note 11) Current Future (2,482) (1,042) (1,815) (2,046) Total income taxes (4,297) (3,088) Net income from continuing operations 5,123 3,854 Net loss from discontinued operations; net of income tax (note 3) (793) (44,323) Net income (loss) $ 4,330 $ (40,469) Per Share Earnings Earnings / (loss) per Common Share (note 12) Basic from continuing operations Basic from discontinued operations (0.08) (4.19) Basic 0.30 (3.93) Diluted from continuing operations Diluted from discontinued operations (0.08) (4.19) Diluted 0.30 (3.93) Average Common Shares outstanding (note 12) Basic 10,306,009 10,566,802 Diluted 10,370,974 10,566,802 See accompanying notes to the financial statements. Consolidated statements of retained earnings For the fifty-two weeks ended December 30, 2006 (with comparative figures for the fifty-two weeks ended December 31, 2005) Dec. 30, 2006 Dec. 31, 2005 (000s) (Restated Note 2) Balance, beginning of year as previously reported $ 36,033 $ 79,685 Adjustment relating to salaried vacation pay (note 2) (958) (958) Balance, beginning of year as restated 35,075 78,727 Net income (loss) for the year 4,330 (40,469) Dividends Common Shares (2,027) (2,147) Second Preference Shares (1,174) (1,036) Balance, end of year $ 36,204 $ 35,075 See accompanying notes to the financial statements. 40 High Liner Foods annual report 2006

43 Consolidated statements of cash flows For the fifty-two weeks ended December 30, 2006 (with comparative figures for the fifty-two weeks ended December 31, 2005) Dec. 30, 2006 Dec. 31, 2005 (000s) (Restated Note 3) Cash provided by (used in) operations: Net income from continuing operations for the year $ 5,123 $ 3,854 Charges (credits) to income not involving cash from operations: Depreciation and amortization 3,017 3,061 Stock compensation expense 33 Loss (gain) on asset disposals 259 (315) Payments of employee future benefits in excess of expense (463) (1,666) Future income taxes 1,815 2,046 Cash flow from continuing operations before changes in non-cash working capital 9,784 6,980 Net change in non-cash working capital balances (note 15) 10,719 (14,123) Cash flows from operating activities of discontinued operations (162) (2,175) 20,341 (9,318) Cash provided by (used in) financing activities: Change in current bank loans (14,693) 17,487 Repayments of capital lease obligations (444) (473) Dividends paid Preference (1,174) (1,036) Common (2,027) (2,147) Repurchase of capital stock (note 8) (73) (5,545) Issue of equity shares (note 8) 192 1,025 (18,219) 9,311 Cash provided by (used in) investing activities: Purchase of property, plant and equipment (2,466) (3,423) Net expenditures on disposal of assets (1,073) (517) Decrease in other receivables Investing activities of discontinued operations (note 15) 1,172 2,851 (2,294) (141) Impact of foreign exchange translation on cash (168) 222 Change in cash during the year (340) 74 Cash, beginning of year Cash, end of year $ 240 $ 580 Supplemental cash flow information (note 15) See accompanying notes to the financial statements. High Liner Foods annual report

44 Notes to consolidated financial statements December 30, 2006 Note 1: Significant accounting policies The accompanying consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles. Basis of consolidation The accompanying financial statements consolidate the accounts of the Company and all its subsidiary companies. Fiscal year The Company s fiscal year end is on the Saturday closest to December 31. This results in a 53-week year-end every five to seven years. Both 2006 and 2005 fiscal years are 52 weeks. Inventory valuation Manufactured finished goods inventories are valued at the lower of cost (includes raw materials, direct labour and overhead) and net realizable value, with cost determined principally on a first-in, first-out basis. Procured finished goods inventory and unprocessed raw material inventory is valued at the lower of weighted average cost and replacement cost. Foreign currency Unless otherwise noted, all amounts in these financial statements are in Canadian dollars. The average U.S. to Canadian dollar exchange rate throughout 2006 was (2005; ). The year end exchange rate was (2005; ). Assets and liabilities of the U.S. subsidiary operation, which is financially and operationally independent of the parent, are translated at exchange rates prevailing at the balance sheet date. The revenues and expenses are translated at average exchange rates prevailing during the year. The gains and losses on translation are deferred and included as a separate component of shareholders equity entitled foreign currency translation account until there is a realized reduction in the net investment of the U.S. subsidiary. The Company s net investment in its U.S. subsidiary is not hedged. At December 30, 2006, the Company s net investment in its U.S. subsidiary was US$14.4 million (December 31, 2005; US$16.5 million). Foreign currency denominated assets and liabilities of Canadian operations are translated into Canadian dollars at exchange rates prevailing at the balance sheet date for monetary items and at exchange rates prevailing at the transaction date for non-monetary items as well as revenues and expenses. Gains or losses on translation are included in income. Gains and losses resulting from foreign exchange contracts used to hedge seafood purchases are included in the inventory value of the related products and flow through cost of sales when the products are sold. Property, plant and equipment Property, plant and equipment is carried at cost, net of accumulated depreciation. Depreciation is provided on the straightline basis at the following rates per annum: Buildings Useful life Lunenburg facility Originally constructed in 1963, improvements since then have extended the useful life to 2024 Portsmouth facility Originally constructed in 1967, improvements since then have extended the useful life to 2028 Computer and electronic equipment 25% Machinery and equipment, other 6 2/3% Equipment under capital lease Lease term Long-lived asset impairment Long-term assets of the Company are reviewed when changes in circumstances suggest their carrying value has become impaired. Management considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations (undiscounted and without interest charges). If impairment is deemed to exist, the assets will be written down to fair value, with a charge to income. 42 High Liner Foods annual report 2006

45 Investment tax credits Investment tax credits (ITCs) earned as a result of purchasing capital assets, are recorded as a reduction to property, plant and equipment. ITCs are amortized at the same rates as the related capital assets and the amortization of ITCs is recorded as a reduction of the amortization of the related capital assets. Investment tax credits also arise as a result of the Company incurring eligible research and development expenses and these credits are recorded as a reduction to related expenses. Stock-based compensation The Company has a stock-based compensation plan, which is described in note 8 and recognizes compensation expense for option awards using the fair value method of accounting. In January 2004 the Company amended its stock option plan to add tandem share appreciation rights (SARs) with option grants, which allow the employee to either exercise the stock option for shares, or to exercise the tandem SARs and thereby receive the intrinsic value of the stock option in cash. The Company accrues compensation expense on a graded vesting basis in the amount by which the quoted market value of the common shares exceeds the option price. The counterpart of the expense relating to options anticipated to be exercised in shares is recorded as contributed surplus. The counterpart of the expense relating to options anticipated to be paid out in cash is recorded as a liability. Changes, either increases or decreases, in the quoted market value of the common shares between the date of grant and the reporting period date result in a change in the measure of compensation for the award. When employees exercise their stock options for shares, thereby canceling the tandem SARs, share capital is increased by the sum of the consideration paid by the employee together with the related portion previously added to contributed surplus when compensation costs were charged against income. When employees choose to exercise tandem SARs, the amount of cash paid out reduces the liability that was accrued from the expensing of the options. Employee benefit plans The Company accrues its obligations under employee benefit plans, net of plan assets. The cost of the Company s defined benefit pensions and other retirement benefits earned by employees is actuarially determined using the projected benefit method prorated on service and management s best estimate of expected plan investment performance, salary escalation and retirement ages of employees. For the purpose of calculating the expected return on plan assets, those assets are valued at fair value. Past service costs from plan amendments are amortized on a straight-line basis over the average remaining service period of employees active at the date of amendment. The excess of the net actuarial gain (loss) over 10% of the greater of the benefit obligation and the fair value of plan assets is amortized over the average remaining service period of the active employees. The average remaining service period of the active employees covered by the pension plan is 16.3 years. The average remaining service period of the active employees covered by the other benefits plan is 9 years. The cost of the Company s defined contribution plans is the amount of contributions the Company is required to pay for services rendered by its employees. Financial instruments The Company, in accordance with a written policy to manage its foreign currency, commodity and interest rate exposures, utilizes derivative financial instruments. The policy prohibits, the use of derivative financial instruments for trading or speculative purposes. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are effective in offsetting changes in fair values or cash flows of hedged items. The Company determines effectiveness by comparing its hedging contracts in place for the period to the hedged U.S. dollar finished goods and raw material procured inventory receipts. The Company has a policy of hedging up to 75% of rolling 15 month projected foreign currency cash flows. The Company uses hedge accounting for each type of derivative financial instrument used to manage its foreign exchange risk. Realized and unrealized gains or losses associated with derivative instruments which have been terminated or cease to be effective prior to maturity are recognized in income, in the same period as the corresponding gains/losses, revenues or expenses associated with the hedged items. The Company systematically enters into foreign exchange forward contracts to hedge future cash flows. The contracts are valued at rates prevailing at the balance sheet date. The resulting gains and losses on these contracts are not recognized until the hedged cash flows are realized. High Liner Foods annual report

46 Notes to Consolidated Financial Statements (cont d) Forward contracts At year-end, the Company had the following total foreign exchange forward single rate contracts outstanding, all with maturities of less than one year: Dec. 30, 2006 Dec. 31, 2005 Sell Receive Sell Receive Cdn$ 12,036,644 US$ 10,334,000 Forward range contracts At year-end, the Company had the following foreign exchange average rate range forwards purchase contracts outstanding, all with maturities of less than one year: Dec. 30, 2006 Dec. 31, 2005 Weighted Weighted Weighted Weighted Forward Range Average Average Total Average Average Total Contracts Put Rate Call Rate USD Value Put Rate Call Rate USD Value Average rate range $ 33,100, $ 35,472,500 Average rate range forward purchase contracts Where the average noon-day exchange rate during the contract term falls between the benefit and protection rates, no cash settlements are exchanged between the Company and the intermediary. If the average noon-day exchange rate during the contract term is less than the benefit rate, then on the contract expiry date, the Company would pay the intermediary the difference in the rate times the notional dollar value hedged. If the average noon-day exchange rate during the contract term is greater than the protection rate, then on the contract expiry date, the intermediary would pay the Company the difference in the rate times the notional dollar value hedged. The Company has entered into average rate costless collars where it uses heating oil options to protect the Company from significant fluctuations in the price of fuel. These contracts are estimated to hedge approximately 75% of the Company s freight-out exposure. The Company records the fair value of these options as of the balance sheet date. Estimated fair value of financial instruments The estimated fair value of financial instruments as at December 30, 2006 and December 31, 2005 are based on relevant market prices and information at that time. The fair-value estimate is not necessarily indicative of the amounts that the Company might receive or pay in actual market transactions. The total fair-value of all of the above foreign exchange future contracts as at December 30, 2006 was an asset of $0.7 million (December 31, 2005; liability of $0.4 million). The total fairvalue of the heating oil contracts as at December 30, 2006 was not significant (December 31, 2005; not significant). The Company s remaining financial instruments consist of receivables, current liabilities and capital lease obligations. The difference between the carrying values and the fair market values of the primary financial instruments are not significant given the short-term maturities and, or the credit terms of those instruments. Income taxes The Company follows the liability method of accounting for income taxes, whereby future income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using substantially enacted tax rates and laws that are anticipated when these temporary differences are expected to reverse. The effect of a change in income tax rates on future income tax assets and liabilities is recognized in income in the period that the change occurs. Deferred charges Deferred charges consist of set-up costs relating to the Company s short-term credit facility. These deferred charges are being amortized over 3 years and are stated at cost, net of accumulated amortization. Use of accounting estimates and measurement uncertainty The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Specific areas requiring the use of management estimates include the allowance for doubtful accounts, uncollectible notes and other receivables, depreciation of property, plant and equipment, estimated future tax and marketing accruals. Actual results could differ from those estimates. 44 High Liner Foods annual report 2006

47 Revenue recognition Sales are recognized in income when the related products have been shipped to customers using third party carriers, as this is when an invoice is issued at a fixed or determinable selling price. Based on experience, the Company is reasonably assured that the customer will accept the products. The Company experiences very few product returns and collectibility of its invoices is consistently high. The Company offers various marketing programs to customers and consumers including volume rebates, cooperative advertising and various other trade marketing costs, as well as consumer coupons. Sales are recorded net of these estimated sales and marketing costs, which are recognized as incurred at the time of sale. Certain customers require the payment of one-time listing allowances (slotting fees) in order to obtain space for a new product on its shelves. These fees are recognized as reductions of revenue at the earlier of the date the fees are paid in cash or on which a liability to the customer is created (usually on shipment of the new product). Coupon redemption costs are also recognized when issued as reductions of net sales. Note 2: Restatement In 2006 the Company recorded an accrual for salaried vacation pay. In prior periods, the Company had not recorded an accrual for salaried vacation payable to employees since corporate policies require that vacation be taken in time and not cash. However, since the Company s policy is that salaried employees earn vacation in one year to be taken in the following year, a liability for vacation pay is required and has now been recorded in the financial statements. In accordance with Section 1506 of the CICA Handbook, this change has been made retroactively by restating the opening balances of assets, liabilities and equity as of the beginning of fiscal As the change was immaterial to income in 2005 and 2006, there is no impact on income in both years. The following summarizes the changes made at the beginning of fiscal 2005 to account for this: Changes in consolidated balance sheets (000s) Jan. 2, 2005 Future income taxes (non-current asset) $ 350 Accounts payable and accrued liabilities 1,226 Foreign currency transalation account 82 Retained earnings (958) Note 3: Discontinued operations Information relating to the discontinued operations is summarized as follows: Summary of discontinued operations (000s) Fiscal 2006 Fiscal 2005 Sales $ 4,296 $ 10,230 Loss before the following: (1,052) (1,244) Litigation costs (422) Depreciation (7) (308) Interest revenue short term 16 Write-down of goodwill (41,231) Other income (loss) / non-operating transactions 393 (1,590) Discontinued operations before taxes (666) (44,779) Income tax (expense) / recovery (127) 456 Net loss from discontinued operations $ (793) $ (44,323) High Liner Foods annual report

48 Notes to Consolidated Financial Statements (cont d) On July 27, 2006 the Company sold its Italian Foods operations for proceeds of $1.7 million ($1.1 million cash and $0.6 million note receivable). In addition, the Company collected $0.8 million of trade receivables and paid $1.2 million of accounts payable relating to the Italian Foods operations. Since cash flows from the Italian Foods business have been eliminated from ongoing operations and involvement in the Italian Foods category ceased after the sale, results for discontinued operations have been presented separately and comparative figures have been restated. Prior to being reclassified as discontinued operations, the Italian Foods business operated as part of the Company s USA Operating entity segment. The sale resulted in no gain or loss, as the assets of the operations were written down to fair market value in In accordance with CICA Section 3062, at the end of 2005, the Company performed an annual test for impairment of goodwill. Book value of goodwill of $41.2 million resulted from the Company s 1998 purchase of the assets of Italian Village Ravioli and Pasta Products Inc. and Floresta Pasta Products Inc. Using discounted cash flows over a period of 20 years and certain key assumptions, the test determined that goodwill was fully impaired. As Italian Village was fully integrated into the Company s U.S. seafood division, previous years Step 1 impairment tests were done on the expected future cash flows of the entire U.S. subsidiary. Declining results in the pasta operations and the inability to turn this business around resulted in decreased expected future cash flows, and eventually the sale of this division in At the same time, a reduction in the number of grocery stores carrying the Company s Fisher Boy brand products decreased by approximately 50%, a result of consolidating customers and intense competition. The combination of the poor results from Italian Village and the deterioration in the Company s Fisher Boy brand business resulted in a reduction of expected future cash flows from the U.S. subsidiary and a failure of the Step 1 impairment test in late The Company proceeded to conduct a Step 2 test valuation under generally accepted accounting principles, which showed that several assets, including real estate, trademarks and other intangibles were undervalued on the historical financial statements. This, coupled with the expectation of decreased future cash flows, resulted in the inability to justify maintaining any goodwill on the balance sheet and the Company wrote off the full carrying cost of goodwill in December Also during 2006, the Company reversed a payable relating to the disposal of its Arnold s Cove primary processing plant on October 8, The disposal has been accounted for as discontinued operations and the payable reversal of pre-tax $0.4 million has been included in the non-operating transaction line along with other discontinued operation transactions for the period as noted above. The following assets and liabilities are included on the balance sheet relating to discontinued operations: (000s) Dec. 30, 2006 Dec. 31, 2005 Accounts receivable $ $ 1,047 Inventories 1,143 Property, plant and equipment 630 Accounts payable and accrued liabilities 464 2,725 Note 4: Current assets (a) Accounts receivable (000s) Dec. 30, 2006 Dec. 31, 2005 Canadian dollar trade $ 15,884 $ 13,951 U.S. dollar trade (US$10,112; 2005 US$8,749) 11,783 10,200 Other 3,554 3,944 $ 31,221 $ 28,095 Other receivables include $1.0 million in 2006 and 2005 (note 19) relating to the sale of the Company s Nova Scotia fishing assets in Arising out of this sale, the Company has sued the purchasers of the assets to recover $1.0 million of the purchase price withheld pending resolution of land title issues. As far as the Company s management is concerned, its obligations under the agreement have been met, and the Company intends to pursue the claim to a satisfactory end. 46 High Liner Foods annual report 2006

49 (b) Inventories (000s) Dec. 30, 2006 Dec. 31, 2005 Finished goods $ 26,432 $ 32,673 Raw and semi-finished material 11,029 16,593 Supplies, repair parts and other 3,817 3,404 $ 41,278 $ 52,670 Note 5: Property, plant and equipment (000s) Dec. 30, 2006 Dec. 31, 2005 Land $ 229 $ 229 Buildings 23,923 23,640 Computers and electronic equipment 6,263 6,097 Machinery and equipment, other 41,714 43,346 Equipment under capital lease 2,595 2,923 74,724 76,235 Less accumulated depreciation: Buildings 14,208 13,777 Computer and electronic equipment 4,677 4,831 Machinery and equipment, other 26,772 28,325 Equipment under capital lease 1,127 1,375 46,784 48,308 Fixed assets relating to discontinued operations (note 3) 630 Investment tax credits (1,902) (1,605) $ 26,038 $ 26,952 Note 6: Current liabilities (a) Bank loans (000s) Dec. 30, 2006 Dec. 31, 2005 Bank loans, denominated in Canadian dollars, interest rate currently not exceeding prime (average variable rate for amounts at 2005 year end was 4.53%) $ $ 9,692 Bank loans, denominated in U.S. dollars, interest rate currently not exceeding U.S. base rate (average variable rate for amounts at 2006 year end 6.10%; 6.00% for 2005 year end amounts) 10,115 15,116 $ 10,115 $ 24,808 The Company has pledged as collateral for its bank loan a general security agreement creating a first-ranking charge (subject to permitted encumbrances) over all of the personal property, including all of its intellectual property. The Company has the option of borrowing using bankers acceptances (BAs), LIBOR or prime loans and borrows using the lowest cost instruments, usually LIBOR or BAs. The Company s total pre-arranged short-term working capital borrowing facilities at December 30, 2006 was a $40.0 million operating line (December 31, 2005; $35.0 million and US$7.5 million operating line). These facilities are reviewed annually. High Liner Foods annual report

50 Notes to Consolidated Financial Statements (cont d) The $40.0 million facility provides for the following: Canadian dollar Prime Rate loans and U.S. Base Rate loans in U.S. dollars at Prime or Base Rate plus 0.00% to 0.25%.; Bankers Acceptances (BA) loans at BA rates plus 1.00% to 1.50%; and LIBOR advances at LIBOR plus 0.75% to 1.50%. The rate of interest charged on borrowings depends on a financial ratio. At this time, the Company borrows at the lower of this range as determined by the ratio. (b) Accounts payable and accrued liabilities (000s) Dec. 30, 2006 Dec. 31, 2005 Canadian dollar trade payables $ 13,990 $ 13,413 U.S. dollar trade payables (US$10,822; 2005 US$11,804) 12,611 13,762 Other* 486 2,232 $ 27,087 $ 29,407 * Other payables include $0.1 million (2005; $1.3 million) of amounts relating to the sale of the Company s Nova Scotia fishing assets in Accounts payable bear normal commercial credit terms and are non-interest bearing. Note 7: Capital lease obligations (000s) Dec. 30, 2006 Dec. 31, 2005 Capital leases at 5.56% to 11.66% due 2007 to 2009 $ 1,037 $ 1,159 Less current installments $ 477 $ 633 The principal payments required, in Canadian dollars, on capital leases in each of the next three fiscal periods are as follows: Cdn ($000) Note 8: Share capital The share capital of the Company is as follows: Authorized Dec. 30, 2006 Dec. 31, 2005 Cumulative Redeemable Second Preference Shares of the par value of $100 each 200, ,000 Preference Shares of the par value of $25 each, issuable in series 9,999,944 9,999,944 Subordinated Redeemable Preference Shares of the par value of $1 each, redeemable at par 1,025,542 1,025,542 Common Shares, without par value 200,000, ,000, High Liner Foods annual report 2006

51 Issued Dec. 30, 2006 Dec. 31, 2005 Shares ($000s) Shares ($000s) Preference Second Preference Shares 200,000 20, ,000 20,000 Common Common Shares (i) 10,314,662 28,106 10,283,737 27,963 (i) Common shares issued are shown net of 1,047,118 shares (2005; 1,039,118 shares) in the amount of $11,121,920 (2005; $11,049,246), which are owned by a subsidiary company. Common Share transactions Fiscal 2006 Fiscal 2005 Shares ($000s) Shares ($000s) Balance, beginning of period 10,283,737 27,963 10,710,455 32,424 Shares issued: Stock options exercised 38, ,600 1,025 Shares repurchased (8,000) (73) (580,318) (5,545) Stock options expense reclassed from contributed surplus Balance, end of period 10,314,662 28,106 10,283,737 27,963 In 2006, the Company purchased an aggregate of 8,000 shares at an average cost of $9.08 including commissions. In 2005, the company purchased an aggregate of 580,318 shares at an average cost of $9.56 including commissions. The summary of the share purchases is as follows: Actual Share Actual Share Actual Share Purchases Purchases Purchases Issue Bid Expiration Authorization Total May 2, , , ,800 May 4, ,000 5, , ,518 May 11, ,000 3,000 3,000 8, , ,318 Preference Shares The Second Preference Shares are redeemable by the Company at their par value plus accrued and unpaid dividends. Cumulative dividends are payable quarterly at one-half a chartered bank s prime lending rate plus 3 percent. Share option plan The Company has a common share option plan for designated directors, officers and certain managers of the Company and of subsidiary companies, with total options granted not to exceed 10 percent of the issued Common Shares. Stock-based compensation cost charged against income in 2006 was $33,000 (2005; nil). The offsetting amount is recorded as contributed surplus. Any consideration paid by employees on exercise of stock options is credited to share capital. All stock options exercised during the year that were originally credited to contributed surplus, are reclassified to capital stock. High Liner Foods annual report

52 Notes to Consolidated Financial Statements (cont d) All options outstanding were granted with the exercise price equaling the market price on the grant date. The following options were outstanding at year-end. Remaining Average Exercise Price Contractual Life $ In Years Expiry Dec. 30, 2006 Dec. 31, , ,525 29, ,175 32, ,000 36, ,000 14, ,300 78, ,000 40, ,400 17, , , , , ,000 36, ,500 69, , ,825 Included in the above figures are options of 162,625 at an average exercise price of $8.65 that were not exercisable on December 30, 2006, as they had not vested (December 31, 2005, 106,000 options at an average exercise price of $9.76). All other options outstanding on December 30, 2006 and December 31, 2005 were exercisable. A summary of option activities is as follows: Fiscal 2006 Fiscal 2005 Weighted Weighted Average Average Options Exercise Price Options Exercise Price Beginning of year 485,825 $ ,675 $ 7.52 Granted 171, , Expired/cancelled (3,150) 7.79 (3,300) 8.75 Forfeited (54,350) 9.77 (12,950) 9.51 Exercised (38,925) 4.92 (153,600) 6.67 End of year 561,025 $ ,825 $ 8.19 Under the terms of the plan: (i) The Company s Human Resource and Corporate Governance Committee of the Board designates from time to time eligible participants to whom options will be granted, and the number of shares to be optioned to each; (ii) Eligible participants are persons who are directors, members of management committee and senior managers of the Company and of subsidiary companies; (iii) Shares to be optioned shall not exceed the aggregate number of 738,451; the total number of shares to be optioned to any eligible participant shall not exceed 5% of the issued and outstanding shares of the class as at the date such option is granted. The aggregate annual number of options granted to all Company directors in total cannot exceed 75,000. There is a remaining total of 537,588 common shares reserved for issuance under the plan; (iv) The option price for the shares is determined by the Committee at the time of granting of the option but cannot be less than the fair market value of the shares at the time the option is granted; (v) The term during which any option granted may be exercised is determined by the Committee at the time the option is granted but may not exceed the maximum period permitted from time to time by The Toronto Stock Exchange; (vi) The common share options vest over a one-year period; (vii)the purchase price is payable in full at the time the option is exercised. 50 High Liner Foods annual report 2006

53 Stock options issued in 2004 and subsequent years were awarded as Stock Appreciation Rights ( SARs ) granted in tandem. The SARs have the same vesting, expiry and exercise terms and conditions as the options. The SARs give the option holder the choice to either exercise the option or forfeit the option and receive a cash payment equal to the difference between the market value of the shares on the date of exercise and the exercise price. The Company recognizes compensation expense for those options that have been awarded with SARs in tandem based on the excess of the market value at the balance sheet date over the exercise price. Note 9: Foreign currency translation account (000s) Fiscal 2006 Fiscal 2005 Balance, beginning of the year $ (15,040) $ (12,837) Adjusment relating to salaried vacation pay (note 2) Balance, beginning of the year as restated (14,950) (12,747) Income tax recovery on conversion of the U.S. subsidiary debt to equity 1,492 Translation adjustments related to net assets of self-sustaining foreign operations (119) (2,203) Balance, end of period (13,577) (14,950) Year-end exchange rate (Canadian/U.S.) $ $ In 2006, the Company converted inter-company debt owed by the U.S. subsidiary to the Canadian parent to equity. The conversion was made to simplify the capital structure of the U.S. subsidiary and will remain as a permanent investment in those operations. The conversion created a $1.5 million tax recovery related to a net capital loss for Canadian tax purposes and the recovery was recorded in the foreign currency translation account on the balance sheet as an offset against the losses from prior years that had been accumulated in this account which relates to the U.S. subsidiary. Note 10: Non-operating transactions Non-operating transactions in 2006 and 2005 represent net costs/recoveries related to the disposal of the Company s Nova Scotia groundfish and scallop harvesting business. Note 11: Income taxes Temporary differences and loss carry forwards which give rise to future income tax assets and liabilities are as follows: (000s) Dec. 30, 2006 Dec. 31, 2005 Future income tax assets Property, plant and equipment $ 4,076 $ 5,142 Goodwill 9,347 Tax loss carry forwards 16,462 7,676 Deferred charges and other 1,494 2,404 Scientific research and experimental development ,032 24,696 Future income tax liabilities Property, plant and equipment (1,209) (1,452) Investment tax credits (382) (468) (1,591) (1,920) Net tax assets before valuation allowance 20,441 22,776 Valuation allowance (17,141) (17,588) Net future income tax assets 3,300 5,188 Less: current portion asset Less: long-term portion asset 3,005 4,642 Long-term portion liability $ $ High Liner Foods annual report

54 Notes to Consolidated Financial Statements (cont d) The Company has recorded in its accounts, investment tax credit carry-forwards of approximately $2.4 million (December 31, 2005; $2.6 million) available to reduce Canadian federal income taxes, expiring from 2007 through The Company also has un-recorded provincial investment tax credits carry-forwards of approximately $1.0 million (December 31, 2005; $1.4 million). These are available to reduce provincial income tax, and expire from 2007 to The Company has recorded future tax assets of $3.3 million after a valuation allowance of $17.0 million is taken into consideration. The valuation allowance is primarily for accumulated tax losses and the benefit of the write-down of goodwill in its U.S. subsidiary operation due to the uncertainty of fully utilizing these losses. Tax loss carry-forwards for the U.S. subsidiary expire throughout 2008 to In 2006, the Company recorded $0.5 million in investment tax credits, as a reduction to property, plant and equipment. Also in 2006, the Company recorded $0.2 million as a reduction to expenses for investment tax credits earned on eligible research and development costs. In both 2006 and 2005, the Company s effective tax rate is higher than the statutory rate, primarily as a result of changes in the valuation allowance in each year. The reconciliation of the Company s effective income tax rate is as follows: % Fiscal 2006 Fiscal 2005 Income tax statutory rate Rate differences in foreign subsidiary (0.6) (1.5) Adjustment on filing of tax return 2.1 (3.2) Capital losses 3.0 Non-deductible items Valuation allowance Large corporations tax (1.7) Other 0.2 (0.5) Note 12: Per share earnings The following is the reconciliation of the numerators and the denominators of basic and diluted earnings per share computations. Based on net income Fiscal 2006 Fiscal 2005 Per Share Per Share (000s, except per share amounts) Income Shares Amount Income Shares Amount Net income (loss) $ 4,330 $ (40,469) Preference Share dividends (1,174) (1,036) Basic earnings per share: Income (loss) available to common shareholders 3,156 10,306 $ 0.30 (41,505) 10,567 $ (3.93) Diluted earnings per share: Effect of dilutive securities: Stock options 65 Income (loss) available to common shareholders and assumed conversions $ 3,156 10,371 $ 0.30 $ (41,505) 10,567 $ (3.93) 52 High Liner Foods annual report 2006

55 Options to purchase 205,577 common shares at an average price of $10.40 per share (2005; 221,000 common shares at $10.39 per share) were outstanding at year end but were not included in the compilation of diluted earnings per share because the options exercise price was greater than the average market price of the common shares for the year. Because of the net loss in 2005, the effect of potentially dilutive stock option securities in the amount of 118,968 in 2005 have been excluded from the calculation due to the fact that they are anti-dilutive. Note 13: Segmented information The Company operates in one dominant industry segment, the manufacturing and marketing of prepared and packaged frozen seafood. The Company evaluates performance of the reportable segments on a geographical basis using income before taxes from continuing operations. Operations and identifiable assets by reporting segment are as follows: Sales to geographic segments: Fiscal 2006 Fiscal 2005 (Restated - Note 3) Operating Entities Operating Entities Canada USA Total Canada USA Total Canada $ 154,421 $ 1,801 $ 156,222 $ 139,607 $ 699 $ 140,306 Inter-segment (i) (1,801) (1,801) (699) (699) 154, , , ,607 United States 16, , ,308 20, , ,583 Inter-segment (i) (14,382) (14,382) (18,422) (18,422) 1, , ,926 2, , ,161 Other 85 3,293 3, ,388 2,435 Net sales to external customers $ 156,144 $ 105,581 $ 261,725 $ 142,214 $ 107,989 $ 250,203 (i) Inter-segment sales are at market. Segment contribution to income before taxes from continuing operations: Fiscal 2006 Fiscal 2005 (Restated - Note 3) Canada USA Unallocated Total Canada USA Unallocated Total Income before the following: $ 15,438 $ 702 $ (2,572) $ 13,568 $ 11,547 $ (512) $ (1,000) $ 10,035 Depreciation and amortization (1,698) (959) (360) (3,017) (1,660) (1,033) (368) (3,061) Interest expense (907) (907) (419) (419) Other (loss) income / nonoperating transactions (224) (224) Income from continuing operations before income tax 13,740 (257) (4,063) 9,420 9,887 (1,545) (1,400) 6,942 Capital expenditures (ii) Gross capital expenditures 2, ,614 2,957 1,192 4,149 Investment tax credits (520) (520) (319) (319) Net capital expenditures $ 2,177 $ 917 $ $ 3,094 $ 2,638 $ 1,192 $ $ 3,830 (ii) Capital expenditures include additions financed through capital leases of $0.6 million in 2006 ($0.4 million in 2005). High Liner Foods annual report

56 Notes to Consolidated Financial Statements (cont d) Segmented Assets (000s) Dec. 30, 2006 Dec. 31, 2005 Canada $ 73,003 $ 77,065 USA 36,634 44, , ,485 Unallocated 3,540 5,768 $ 113,177 $ 127,253 Note 14: Employee future benefits Description of pension and non-pension benefit plans In Canada, the Company maintains a number of defined contribution plans and defined benefit pension plans covering all Canadian employees. With respect to United States employees, the Company s subsidiary maintains a defined contribution plan (401k) that covers all U.S. employees. The Company sponsors three funded and one non-funded defined benefit pension plans. The funded defined pension benefit plan for the Nova Scotia union employees is a flat-dollar plan with negotiated increases. The funded defined benefit plan for Canadian salaried employees is based on average career earnings. The non-funded supplemental executive retirement plan (SERP) and the funded defined benefit plan for management employees are both based on the employee s final average earnings. No Company pension plans provide indexation in retirement. The Company sponsors a non-pension benefit plan for employees hired before May 19, This benefit is a paid-up life insurance policy or a lump sum payment based on the employee s final earnings. Total cash payments for pension plans The total cash payments for all defined benefit pension plans during 2006 by the Company was $1.3 million (2005; $2.6 million) which consisted of contributions required to fund the defined benefit pension plans. The total cost for the Company s defined contribution pension plans was $0.6 million (2005; $0.6 million). Measurement dates The Company measures the fair value of assets and the accrued benefit obligations as at December 30. The most recent accounting extrapolation on all pension and non-pension plans was completed as of December 30, The most recent funding valuations for the Company s defined benefit plans were completed as at May 31, 2006 for management and salaried employees, and December 31, 2004 for Nova Scotia union employees. Reconciliation of the accrued benefit obligations and fair value of plan assets is below, segmented by plans with surplus and those with deficit: Pension Benefit Other Pension Benefit Other Plans with Plans with Benefit Plans with Plans with Benefit Surplus Deficits Plan (ii) Surplus Deficits Plan (ii) Accrued benefit obligation Balance at the beginning of the year $ 22,761 $ 5,385 $ 510 $ 22,649 $ 4,333 $ 524 Current service cost (employer) Interest cost 1, , Exchange (13) Employee contributions Benefits paid (1,936) (252) (46) (2,098) (213) (68) Plan amendments Reductions from settlement (2,514) Actuarial (gain) loss (1,290) (193) 2, Balance of end of year $ 21,756 $ 5,393 $ 516 $ 22,761 $ 5,385 $ High Liner Foods annual report 2006

57 Pension Benefit Other Pension Benefit Other Plans with Plans with Benefit Plans with Plans with Benefit Surplus Deficits Plan (ii) Surplus Deficits Plan (ii) Plan assets Fair value at the beginning of the year, estimated $ 24,307 $ 1,444 $ $ 23,810 $ 1,365 $ Adjustment to actual assets at beginning of year (136) (8) Actual return on plan assets 1, , Employer contributions 1, , Employees contributions Benefits paid (1,936) (211) (2,098) (169) Reductions from settlement (2,514) Fees and expenses (141) 3 (152) (24) Fair value at end of year 25,514 1,440 24,307 1,444 Funded status plans (i) 3,758 (3,953) (516) 1,546 (3,941) (510) Unamortized net actuarial loss 2, ,259 1,291 Unamortized past service costs Accrued benefit asset/ (liability) 6,360 (3,186) (516) 5,332 (2,628) (510) Total accrued benefit assets $ 6,360 $ 5,332 Total accrued benefit liability (i) $ (3,702) $ (3,138) (i) (ii) The non-funded pension plan is the supplemental executive retirement plan (SERP), which accounts for $3.3 million (2005; $3.2 million) of the non-funded amount, and the Salaried Plan that accounts for the remainder. The Company has a letter of credit outstanding as at December 30, 2006 relating to the securitization of the Company s SERP benefit plan in the amount of $0.7 million. The other benefit plan is non-funded. Plan assets consist of: Percentage of Plan Assets Breakdown of Plan Assets Dec. 30, 2006 Dec. 31, 2005 Equity securities including income trusts (iii) 91% 86% Debt securities 9% 14% Total 100% 100% (iii) The plan assets include common shares in the Company at market value of $0.9 million (2005; $0.9 million). High Liner Foods annual report

58 Notes to Consolidated Financial Statements (cont d) Summary of the weighted average significant actuarial assumptions used in measuring the Company s accrued benefit obligations: Pension Benefit Other Benefit Pension Benefit Other Benefit Plans 2006 Plans 2006 Plans 2005 Plans 2005 Benefit cost for the year ended: Discount rate 4.97% 6.00% 5.77% 6.00% Expected long-term rate on plan assets 7.37% n/a 7.36% n/a Rate of compensation increase 4.00% 3.00% 5.00% 3.00% Accrued benefit obligation as of year end: Discount rate 5.19% 6.00% 4.98% 6.00% Rate of compensation increase 4.00% 3.00% 4.00% 3.00% Components of defined costs recognized during the year: Pension Benefit Other Benefit Pension Benefit Other Benefit (000s) Plans 2006 Plans 2006 Plans 2005 Plans 2005 Current service cost $ 735 $ 20 $ 580 $ 20 Interest cost 1, , Actual return on plan assets (2,006) (2,717) Settlement loss 361 Plan amendments Amortization of net actuarial (gain) loss (2,316) 3,439 Costs arising in this period (1,777) 52 3, Differences between costs arising in the period and costs recognized in the period in respect of: Return on plan assets Actuarial gain 2,733 (3,228) 1 Plan amendments (308) (238) Defined benefit cost recognized $ 789 $ 52 $ 886 $ 54 Note 15: Supplemental cash flow information Cash interest and cash taxes paid in 2006 and 2005 are as follows: (000s) Fiscal 2006 Fiscal 2005 Interest $ 994 $ 336 Income and capital taxes Change in Non-Cash Working Capital Balances: (000s) Fiscal 2006 Fiscal 2005 Receivables $ (3,906) $ (5,933) Inventory 13,611 (7,972) Prepaid expenses (149) 124 Payables and accruals (329) (342) 9,227 (14,123) Income tax recovery on the conversion of the U.S. subsidiary intercompany loans from debt to equity (note 9) 1,492 $ 10,719 $ (14,123) 56 High Liner Foods annual report 2006

59 Investing activities relating to discontinued operations in 2006 represent the cash proceeds on the sale of the Company s Italian Foods operations (note 3). Amounts in 2005 relate to the settlement of a legal action that arose on the purchase of the Italian Foods operation in Note 16: Non-monetary transactions The Company has entered into non-monetary transactions with a media company whereby the Company receives advertising services from the media company in exchange for barter credits that it earned in previous years on the sale of inventory. The Company records such transactions at the fair value of the advertising credits received in prepaid expenses and other receivables. The fair value of the exchange is $0.2 million (2005; $0.3 million). Note 17: Commitments Operating lease commitments are less than $0.5 million for each of the next five years. They result principally from leases for office equipment, premises and production equipment. The Company has letters of credit outstanding as at December 30, 2006, relating to the procurement of inventories of $4.0 million (2005; $1.6 million) that are denominated in U.S. dollars (translated at the balance sheet date rate (note 9)). The Company also had a letter of credit outstanding as at December 30, 2006 relating to the securitization of the Company s SERP benefit plan (note 14) in the amount of $0.7 million (2005; nil). Note 18: Related party transactions The Company has entered into certain transactions and agreements in the normal course of business with certain of its related parties. These transactions are measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. During the year, the Company purchased $3.6 million (2005; $3.8 million) of corrugated packaging from a related company at negotiated market prices. The Company uses corrugated packaging to ship its products to its customers. This related party is controlled by a company that owns a significant, non-controlling amount of High Liner common stock. As part of the Company s share repurchase plan, the Company paid immaterial commissions in both 2006 and 2005 to a company in which a director of High Liner has an ownership interest. At December 30, 2006, there were no material payables owed to related parties. Note 19: Contingencies The Company may, from time to time, be involved in legal proceedings, claims and litigations that arise in the ordinary course of business which the Company believes would not reasonably be expected to have a material adverse effect on the financial statements of the company. Note 20: Comparative figures Certain comparative financial information has been reclassified to conform to the presentation adopted in 2006 relating to discontinued operations, the restatement describe in note 3, and other balance sheet and cash flow reclassifications. High Liner Foods annual report

60 Five year financial data (000s, except per share amounts) (1) 2004 (1) 2003 (1) 2002 (1) Sales $ 261,725 $ 250,203 $ 259,267 $ 280,639 $ 282,364 Gross profit 49,311 48,237 55,817 63,685 64,608 Other selling, general and administrative expenses (36,170) (38,175) (36,721) (41,578) (38,773) Foreign exchange gain (loss) 427 (27) (22) Operating EBITDA (2) 13,568 10,035 19,074 22,165 25,867 Depreciation and amortization (3,017) (3,061) (3,108) (3,372) (4,782) Interest expense (907) (419) (352) (1,658) (4,459) Other expense (48) (123) Income before the following: 9,596 6,432 15,620 17,257 16,825 Non-operating items / gain (loss) on asset disposals (176) , Income before income taxes 9,420 6,942 16,515 55,823 16,982 Income tax expense Current (2,482) (1,042) (723) (599) (1,404) Future (1,815) (2,046) (3,526) (2,914) (3,385) Total income taxes (4,297) (3,088) (4,249) (3,513) (4,789) Net income from continuing operations for the period 5,123 3,854 12,266 52,310 12,193 Net loss from discontinued operations, net of income taxes (793) (44,323) (4,104) (6,506) (2,204) Net income (loss) for the period $ 4,330 $ (40,469) $ 8,162 $ 45,804 $ 9,989 Book value per Common Share at year end Basic info per Common Share Based on net income 0.30 (3.93) Based on income from continuing operations Based on after-tax operating income from continuing operations (3) Diluted earnings per Common Share based on net income 0.30 (3.93) Common Shares Outstanding at year end 10,315 10,284 10,710 10,794 9,836 Average for year 10,306 10,567 10,863 9,945 9,822 Second Preference Shares Dividends declared and paid Current 1,174 1, ,078 1,017 Arrears 6,260 1,362 Dividends paid per share Common Shares Dividends declared and paid 2,027 2,147 2, Dividend per share C&D Preference Shares Dividends declared and paid N/A N/A N/A Dividend per share N/A N/A N/A Gross capital expenditures from continuing operations 3,614 4,149 5,298 6,698 4,126 (1) 2002 to 2005 are restated to reclassify discontinued operations to a separate income statement line. Included in 2002 and 2003 are results relating to the Nova Scotia fishing assets that were sold in May, (2) Earnings before interest, taxes, depreciation and amortization, other income and non-operating transactions. See definition on page 30. (3) After-tax operating income is net income from continuing operations adding back non-operating and unusual transactions. 58 High Liner Foods annual report 2006

61 (000s) (1) 2004 (1) 2003 (1) 2002 (1) Cash $ 240 $ 580 $ 506 $ 926 $ 1,088 Accounts receivable 31,221 28,095 28,167 31,840 35,001 Income tax receivable Inventories 41,278 52,670 44,901 49,870 50,053 Prepaid expenses 3,495 7,246 1,062 1,502 1,600 Future income taxes ,383 7,525 6,991 Total current assets 76,690 89,148 82,019 91,663 94,733 Property, plant & equipment 26,038 26,952 27,176 27,492 44,303 Deferred charges _ Goodwill 42,714 45,781 55,661 Future income taxes 3,005 4,642 6,654 7,632 5,387 Other assets 1,084 1,179 7,952 5,513 6,702 Employee future benefits 6,360 5,332 3,342 1,701 2,188 Total assets $ 113,177 $ 127,253 $ 170,171 $ 179,790 $ 209,905 Bank loans 10,115 24,808 7,321 10,252 5,960 Accounts payable and accrued liabilities 27,087 29,407 32,583 38,668 43,792 Income taxes payable 159 Current portion of long-term liabilities ,919 Total current liabilities 37,762 54,900 40,348 49,248 65,671 Long-term liabilities ,395 Employee future benefits 3,702 3,138 2,826 2,844 2,759 Future income taxes 7,267 6,351 4,004 Shareholders equity: Preference shareholders 20,000 20,000 20,000 20,000 21,246 Common shareholders 51,236 48,582 98, ,502 66,830 Total liabilities and shareholders equity $ 113,177 $ 127,253 $ 170,171 $ 179,790 $ 209,905 (1) Restated see Note 2 and Note 20 to the financial statements. High Liner Foods annual report

62 Quarterly financial data Fiscal 2006 First Second Third Fourth Full (000s, except per share amounts) Quarter Quarter Quarter Quarter Year Sales $ 77,692 $ 57,633 $ 60,743 $ 65,657 $ 261,725 Operating EBITDA (i) 5,600 2,025 2,454 3,489 13,568 Net income from continuing operations 3, ,241 5,123 Net income (loss) from discontinued operations (504) (581) (793) Net income (loss) 2,578 (405) 848 1,309 4,330 After tax operating income from continuing operations (iii) 3, ,526 5,295 Earnings per Common Share from continuing operations Basic earnings per Common Share (ii) 0.27 (0.01) Diluted earnings per Common Share (ii) 0.27 (0.01) Earnings per Common Share based on net income Basic earnings per Common Share (ii) 0.22 (0.07) Diluted earnings per Common Share (ii) 0.22 (0.07) Earnings per Common Share, after-tax operating income from continuing operations (iii) Basic earnings per Common Share (ii) 0.27 (0.02) Diluted earnings per Common Share (ii) 0.27 (0.02) Fiscal 2005 First Second Third Fourth Full (000s, except per share amounts) Quarter Quarter Quarter Quarter Year Sales $ 71,310 $ 55,943 $ 59,944 $ 63,006 $ 250,203 Operating EBITDA (i) 6,185 2,063 2,193 (407) 10,035 Net income from continuing operations 3,606 1, (1,480) 3,854 Net income (loss) from discontinued operations (515) (370) (374) (43,064) (44,323) Net income (loss) 3, (44,544) (40,469) After tax operating income (loss) from continuing operations (iii) 3, (511) 4,438 Earnings per Common Share from continuing operations Basic earnings per Common Share (ii) (0.16) 0.26 Diluted earnings per Common Share (ii) (0.16) 0.26 Earnings per Common Share based on net income Basic earnings per Common Share (ii) (4.28) (3.93) Diluted earnings per Common Share (ii) (4.28) (3.93) Earnings per common share, after-tax operating income from continuing operations (iii) Basic earnings per Common Share (ii) (0.07) 0.32 Diluted earnings per Common Share (ii) (0.07) 0.32 (i) Earnings before interest, taxes, depreciation and amortization, other income and non-operating transactions. See definition on page 30. (ii) Total for the year does not add to the sum of the quarters due to the nature of the calculations and rounding. (iii) After-tax operating income is net income from continuing operations adding back non-operating and unusual transactions. 60 High Liner Foods annual report 2006

63 Shareholder information Design: Craib Design & Communications Honourary Directors J.B. Estey J.B. Morrow M.J. Regan D.R. Sobey Officers and Canadian Management D.J. Hennigar Chairman of the Board H.E. Demone 1 President and Chief Executive Officer M.P. Marino 1 Vice President and Chief Operating Officer, Canadian Operations K.L. Nelson, FCA 1 Vice President, Corporate Services and Chief Financial Officer P.W. Snow 1 Vice President, Procurement J. Brown 1 Director, Human Resources C.E. Milton, LL.B. General Counsel and Secretary G.W. LeBlanc, CA Corporate Controller High Liner Foods (USA) Incorporated M. Lamothe 1 President and Chief Operating Officer A. Christianson Vice President, Operations D. Devine Vice President, Marketing Plants Nova Scotia: Lunenburg New Hampshire: Portsmouth Subsidiary Companies High Liner Foods (USA) Incorporated Auditors Ernst & Young, LLP Chartered Accountants Transfer Agent For help with: changes of address transfer of shares loss of share certificates consolidation of multiple mailings to one shareholder estate settlements Contact: CIBC Mellon Trust Company of Canada AnswerLine TM : (toll free in North America) or Mailing Address: P.O. Box 7010 Adelaide Street Postal Station Toronto, Ontario M5C 2W9 inquiries: inquiries@cibcmellon.com Fax: Banks The Royal Bank of Canada HSBC Investor Relations For: additional financial information industry and Company developments additional copies of this report Contact: C.E. Milton, LL.B. General Counsel and Secretary Facsimile: investor@highlinerfoods.com Investor Relations website: Mailing Address: 100 Battery Point P.O. Box 910 Lunenburg, NS B0J 2C0 Common Shares listed on The Toronto Stock Exchange Trading Symbol: HLF Annual General Meeting of Shareholders Friday, May 11, :30 am World Trade and Convention Centre Halifax, Nova Scotia Consumer website: 1 Management Committee

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