FPI Limited announces 2006 Annual Financial Results: Focus on product line profitability, corporate cost controls and operational efficiencies eliminates losses and generates net income of $1.9 million



    ST. JOHN'S, NL, March 9 /CNW/ - FPI Limited,("FPI" or "the Company") an
industry leader in seafood harvesting, processing, global sourcing and
marketing, today released its financial results for the year ended December
31, 2006. Consolidated reporting included the results of the Marketing and
Manufacturing Group and the Primary Group, including The Seafood Company based
in the United Kingdom.

    
    Highlights for 2006:

    - The Company experienced an improvement of more than $12.4 in
      consolidated net results, from a net loss of approximately
      $10.5 million in 2005 to net income of approximately $1.9 million in
      2006.

    - The Marketing and Manufacturing Group reviewed customer portfolios and
      product offerings with an increased focus on profitability. The U.S.
      business was streamlined to eliminate non-core product categories which
      were not generating appropriate returns. This business strategy
      achieved the anticipated effect in revenues and gross profit.
      Consolidated revenues were lower ($752.9 million in 2006 versus
      $833.7 million in 2005) while gross profit increased to $83.6 million
      in 2006 from $70.7 million in 2005.

    - Gross profit as a percentage of sales increased in both the Marketing
      and Manufacturing Group and the Primary Group. On a consolidated basis,
      the corporation achieved 11.1 per cent gross profit as a percentage of
      sales, an increase of 2.6 per cent over 2005.

    - Despite external pressures on certain elements of the Primary Group's
      business, including currency exchange rates, energy costs and foreign
      competition, the Primary Group continued to build on its strengths,
      implement cost controls and maximize operational efficiencies. The
      Primary Group contributed $40.0 million to consolidated gross profit in
      2006, an increase of $16.0 million over the previous year.

    - The Seafood Company has positioned FPI well in growing its value added,
      fresh, chilled and ready-to-eat seafood sectors in the U.K.
      Additionally, the acquisition helped secure market access for the
      Primary Group's shrimp production in Newfoundland and Labrador.

    "The focus on profitability in our U.S. products and programs was a key
element of our business strategy in 2006," said Beverley Evans, Chief
Financial Officer of FPI Limited. "The mature relationships we have built in
the North American marketplace allow us to offer superior service to our
customers with streamlined offerings. The Pan-Sear Selects(TM) line of
seasoned fillets is an excellent example. We have moved to match our
customers' demands for premium quality, innovative and versatile seafood
options with our determination to focus on product lines that generate healthy
returns."
    "The Primary Group - continues to make the structural and operational
adjustments required in a business environment characterized by unfavourable
exchange rates, high energy costs and tough competition from Asia," said
Graham Roome, Executive Vice President of FPI Limited and Chief Operating
Officer of the Primary Group. "Although these challenges were significant
again in 2006, we remain determined to manage the operations with a view to
enhancing economic viability."
    "Overall, after a consolidated net loss in 2005, we have made important
progress in achieving a swing of $12.4 million and returning the Company's
bottom line to net income of approximately $1.9 million for 2006," said Ms. 
Evans.

    About FPI: FPI Limited is a Newfoundland and Labrador-based seafood
company engaged in harvesting, processing, global sourcing, and marketing a
wide selection of high quality seafood products.

    FPI Limited trades on the Toronto Stock Exchange under the symbol FPL.

    MANAGEMENT'S DISCUSSION AND ANALYSIS

    March 9, 2007

    This Management's Discussion and Analysis ("MD&A") contains statements and
other forward-looking information about potential future circumstances,
results, and developments related to the Company and its business and
operations. Such statements and information are qualified in their entirety by
the inherent risks and uncertainties surrounding future expectations generally
and may differ materially from the Company's actual future results or events.
There are a number of factors that could cause results or events to differ
from current expectations, including, among other things, uncertainties
regarding the continued availability of seafood products, the significant
level of government regulation of the seafood industry, the inherent
limitations on the Company's ability to restructure and grow its business
operations arising from the limitations of the FPI Act, foreign exchange risk
associated with the international nature of the Company's operations, the
reliance of the Company on certain contractual arrangements and the ability of
the Company to renew or renegotiate such contracts on favourable terms,
increasing competition in the industry, and general industry and economic
conditions. The foregoing list of factors is not intended to be exhaustive of
all possible factors. For additional information with respect to certain of
these risks or factors, reference should be made to the Company's Annual
Information Form ("AIF") and other continuous disclosure materials filed from
time to time by the Company with Canadian securities regulatory authorities.
The Company's AIF is available on the Company's website at www.fpil.com or
through the SEDAR website of the Canadian Securities regulators at
www.sedar.com.
    The Company disclaims any intention or obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. This MD&A should be read in conjunction with the
Company's audited comparative consolidated financial statements as at and for
the year ended December 31, 2006, and the related notes thereto.
    All information reflected herein is expressed in Canadian dollars ("CAD")
and is determined on the basis of Canadian generally accepted accounting
principles ("GAAP"). Tabular amounts are expressed in thousands of dollars
except where otherwise noted.

    OVERVIEW

    Through its subsidiary, Fishery Products International Limited, FPI
Limited ("FPI" or the "Company") operates a seafood business engaged in
harvesting, processing, global sourcing, and marketing a wide selection of
quality seafood products. Headquartered in St. John's, Newfoundland and
Labrador, Canada, the Company enjoys broad market reach in many food business
sectors. FPI operates through two separate and distinct business segments: the
Marketing and Manufacturing Group (formerly "Ocean Cuisine International") and
the Primary Group, each working to maximize value and brand equity at every
stage of the product process - from ocean to table. With extensive knowledge
and a keen vision of the seafood business, FPI is a leading supplier to its
markets.
    FPI's common shares are traded on the Toronto Stock Exchange under the
trading symbol "FPL". FPI is subject to the Fishery Products International
Limited Act: An Act Respecting the Return of the Business of Fishery Products
International to the Private Sector, as amended (the "FPI Act"), a statute of
the Province of Newfoundland and Labrador.

    MARKETING AND MANUFACTURING GROUP. The Marketing and Manufacturing Group
manages the Company's value added processing operations, global seafood
sourcing, and culinary research and development. This business unit is also
the Company's North American sales and marketing arm, engaged in marketing
primary, value added, and globally sourced seafood products to customers
throughout Canada and the United States ("U.S.").
    The Marketing and Manufacturing Group is headquartered in Danvers,
Massachusetts, and employs approximately 640 people. It operates two value
added processing facilities in North America: one in Burin, Newfoundland and
Labrador, and one in Danvers, Massachusetts. Value added processing means
adding ingredients such as breading, batter, glazes, sauces, and vegetables to
seafood, thereby enhancing value through presentation and taste. In 2006, the
Marketing and Manufacturing Group sourced less than one tenth (2005;
approximately one tenth) of its seafood raw material for value added
processing from the Primary Group. The business units transfer these products
based on fair market pricing and the best use of seafood raw material.
    The Marketing and Manufacturing Group's North American operations are
organized along two key market sectors - Away from Home and At Home - and
markets value added, primary, and globally sourced seafood through a direct
sales force (major offices in Danvers, Toronto, and Montreal; regional offices
throughout North America) and an extensive broker network in the U.S. FPI's
Away from Home customer channels include foodservice operators in multiple
restaurant segments, broadline foodservice distributors, and specialty seafood
distributors. The Company's At Home customer channels include supermarkets,
specialty retailers, and club stores.

    THE PRIMARY GROUP. The Primary Group manages the Company's harvesting,
primary processing, and international sales and marketing. This Group operates
along five key product categories: groundfish, snow crab, sea scallops, cooked
and peeled coldwater shrimp (ice shrimp), and shell-on coldwater shrimp
produced on offshore freezer vessels. Included in the Primary Group's results
are the results of The Seafood Company Limited ("The Seafood Company"), a
company based in the United Kingdom ("U.K.") that was acquired in the third
quarter of 2005.
    Headquartered in St. John's, Newfoundland and Labrador, the Primary Group
employs approximately 2,010 people in Atlantic Canada. The Primary Group has
five processing plants in Newfoundland and Labrador as well as a fleet of
groundfish, coldwater shrimp, and scallop vessels, and vessel service centres
in Newfoundland and Labrador and Nova Scotia. This Group markets seafood to
customers internationally through its own sales efforts in Canada, the U.K.,
Germany, and Asia and utilizes the services of the Marketing and Manufacturing
Group to distribute its products throughout North America. The Primary Group's
operations encompass the harvesting, sourcing, processing, and marketing of
groundfish (such as flounder, sole, cod, turbot, and redfish) and shellfish
(such as coldwater shrimp, snow crab, and sea scallops) as well as pelagic
products (such as mackerel, capelin, and lumpfish). The Group's operations
include the processing of fish and shellfish into premium-quality,
market-ready products and seafood raw material for value added processing.
    In addition to its harvesting operations, the Primary Group purchases
groundfish and shellfish raw material from hundreds of independent harvesters
throughout Newfoundland and Labrador and also sources groundfish raw material
through the Marketing and Manufacturing Group's global sourcing operations.
    The Primary Group is also involved in the global sourcing of finished
products, largely the purchase and resale of a wide variety of market-ready
seafood, including a significant volume of snow crab. Other globally sourced
products include coldwater shrimp, lobster, turbot, warmwater shrimp,
scallops, and crayfish.

    The Seafood Company Limited. The Seafood Company is an importer, processor
and distributor of premium chilled, frozen and value added shellfish products
in the United Kingdom marketplace. The Seafood Company employs approximately
260 staff operating from its sites in West Sussex and Norfolk, U.K. Its
facilities include a modern factory, coldstore, and office facilities at its
Cromer site in Norfolk, and coldstore, packing facilities, commercial and
administrative offices at its Anchor site in West Sussex.
    The Seafood Company's operations include the sourcing, processing and
marketing of a wide range of premium shellfish including coldwater shrimp,
warmwater shrimp, lobster, crab, scallops and mussels along with a wide range
of value added seafood products.

    BUSINESS STRATEGY

    The Board and Management believe that FPI has the people, the assets, and
the shared vision to be among the most valuable and innovative seafood
companies in the world. This vision includes enhancing shareholder value,
providing customers with high quality products, creating a work environment
that respects and rewards contribution by employees at all levels of the
Company, protecting the ocean environment through sustainable harvesting
practices, and being ethical and responsible to all the Company's
stakeholders. Motivated by these objectives, the Company has continued to make
considerable marketing and operational investments within its two business
units. While each business unit has distinct activities, strengths, challenges
and mandates, they both share the underlying goal of creating value for the
Company's entire customer base through the delivery of quality products and a
focus on customer service.
    The Primary Group operates FPI's core fishing business. Its goal is to
produce competitive, high quality seafood by using advanced technology and
superior processes. Capital expenditures made in recent years have improved
operational efficiencies significantly. The Company's investments have built
facilities, equipment and vessels that are among the most modern in the world.
    External pressures on certain elements of the Primary Group's business
continued in 2006. The high value of the Canadian dollar relative to other
currencies, especially the U.S. dollar, continues to present a significant
challenge. The negative impact of this factor is only partially offset by the
Company's active currency management program. High-energy costs, driven by the
escalation in the world price of oil, have further eroded the productivity
gains realized through the major capital investments in the Primary Group's
operations. Added to these challenges is competition from high volume, low
cost producing countries and the persistent difficulty of inadequate raw
material supply. Together, these external factors underscore the importance of
continuing to build on our strengths, cut costs and maximize operational
efficiencies in 2007 and beyond. The Company is focused on these objectives.
    The Seafood Company has positioned FPI well in growing its value added,
fresh, chilled and ready-to-eat seafood sectors in the U.K. Additionally, the
acquisition helped secure market access for the Primary Group's Newfoundland
and Labrador shrimp production.
    FPI continues to make strategic re-alignments in the Marketing and
Manufacturing Group. The objective is to establish this business unit as the
Canadian and U.S. market leader in the seafood sector by delivering
innovative, customer-focused products and programs in the respective markets
in a disciplined fashion. The U.S business has been streamlined in the current
year to eliminate non-core product categories which were not generating
appropriate returns. While there are some pressures in the business,
particularly in the U.S. club store market, customer responses to new product
offerings have been positive.

    FINANCIAL RESULTS

    The following is a summary of FPI's consolidated financial performance
    for the year ended December 31, 2006, compared with 2005.

    Financial Performance Highlights

    -------------------------------------------------------------------------
    dollars in thousands, except per share amounts          2006        2005
    -------------------------------------------------------------------------
    Sales                                                752,850     833,661
    Gross profit                                          83,551      70,703
    Net income (loss)                                      1,915     (10,478)
    Net income (loss) per common share
      Basic                                                 0.13       (0.70)
      Diluted                                               0.13       (0.70)
    -------------------------------------------------------------------------

    CONSOLIDATED SALES AND GROSS PROFIT

    Consolidated sales and gross profit reflect the combined results of the
Company's two business units: the Primary Group and the Manufacturing and
Marketing Group.
    Sales for the year ended December 31, 2006, are $752.9 million, a decrease
of $80.8 million over the previous year's revenue of $833.7 million. A
reduction in revenue was experienced across both the globally sourced and
value added product lines in the Marketing and Manufacturing Group, as a
result of lower sales volumes, foreign exchange and overall focus on improving
gross profit. In addition, the Primary Group experienced significant decreases
in primary processed product lines offset by an increase in value added and
globally sourced product sales as compared to 2005. The Seafood Company,
acquired by FPI on September 2, 2005, which was previously managed by the
Marketing and Manufacturing Group division subsequent to the acquisition, and
is currently managed by the Primary Group, is the significant contributor to
the increase in value added and globally sourced sales and gross profit for
the year in the Primary Group.
    The Company's gross profit for the year ended December 31, 2006, is
$83.6 million as compared to $70.7 million in 2005, an increase of
$12.9 million, or 18.2%. An increase in gross profit of $16.0 million in the
Primary Group, offset by a decrease of $3.1 million in the Marketing and
Manufacturing Group, results in a net increase of $12.9 million. Gross profit
as a percentage of sales is 11.1%, 2.6 percentage points higher than the 8.5%
achieved in 2005. Gross profit as a percentage of sales increased in both the
Marketing and Manufacturing Group and the Primary Group. The Marketing and
Manufacturing Group's gross profit of 9.6% is 0.9 percentage points higher
than the prior year and the Primary Group's gross profit of 13.3% is
5.2 percentage points higher than that achieved in 2005.
    Despite the challenges of higher fuel costs, increased competition from
low cost producers as well as the appreciation of the Canadian Dollar against
the Pound Sterling, the Euro and the US Dollar, the Primary Group experienced
an increase in gross profit due to curtailment of groundfish production and an
increase in sales of higher margin value added and globally sourced products.
    The Marketing and Manufacturing Group's gross profit increased as a result
of higher sales prices in certain North American markets, lower sales
allowances and lower spending on distribution expenses. Overall, the reduction
in sales and increase in gross profit is a result of management's strategic
plan to focus on bottom line profitability. In 2006, the Company evaluated its
customer and product portfolios, and concentrated its efforts on maximizing
returns.

    FOREIGN EXCHANGE IMPACT ON SALES

    Foreign exchange continued to adversely impact sales throughout 2006. The
Company's average effective U.S. exchange rate in 2006 was 1.136, an overall
decrease of 700 basis points from its average effective rate of 1.209 in 2005.
As the majority of the Company's sales are denominated in U.S. dollars, this
has resulted in an effective reduction in sales of $25.8 million when
translating U.S. dollar sales to Canadian dollars. Further, the Company's
average effective Euro exchange rate decreased since 2005, resulting in an
effective reduction in sales of $1.7 million when translating Euros to
Canadian dollars.

    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Unaudited                                   2006                    2005
                                       %     Average           %     Average
                                           Effective               Effective
    Currency                       Sales        Rate       Sales        Rate
    -------------------------------------------------------------------------
    U.S. dollar                     53.4       1.136        64.5       1.209
    Euro                             2.8       1.373         2.5       1.485
    Pound Sterling                 19.0       2.110         6.1       2.108
    Canadian dollar and other       24.8                    26.9
    -------------------------------------------------------------------------
                                   100.0%                  100.0%
    -------------------------------------------------------------------------


    BUSINESS SEGMENTS SALES AND GROSS PROFIT

    Effective January 1, 2006, the Company realigned certain of its reportable
segments. As a result, The Seafood Company, previously included in the
Marketing and Manufacturing Group segment, is now reported as part of the
Primary Group segment. The change reflects the ongoing evolution of the
Company's business and does not impact the consolidated results. As a result
of the realignment, comparative results have been reclassified to conform with
the presentation adopted for the current year.

    MARKETING AND MANUFACTURING GROUP. The Marketing and Manufacturing Group
is responsible for sourcing customer requirements for seafood from domestic
and international supply partners, adding value to seafood through further
processing and ensuring FPI seafood is on more plates, in more places, through
more channels.
    During the first half of 2006, the U.S. division of the Marketing and
Manufacturing Group adopted a strategy to eliminate low margin products from
its product portfolio. This was a conscious strategy to focus on the
categories, products and customers that provided acceptable returns to the
Company.
    The Marketing and Manufacturing Group's revenues for the year ended
December 31, 2006 are $452.9 million, a decrease of $83.1 million from the
$536.0 million in 2005. This decrease was mainly driven by a reduction of low
margin globally sourced business in the United States through rationalization
of certain of its product lines, in addition to lower volumes of value added
sales. The weakened U.S. dollar in 2006 also contributed to reduced sales in
the Manufacturing and Marketing Group by approximately $22.0 million. Globally
sourced product revenues were unfavorably impacted by decreased sales of
warmwater shrimp, king crab, sea bass and coldwater lobster. The decline in
value added product sales is primarily attributable to lower volumes of Club
products following aggressive promotions during 2005.

    THE PRIMARY GROUP. The Company's Primary Group, which includes The Seafood
Company, is responsible for harvesting and primary processing in Canada, value
added processing in Europe, and international marketing of seafood products.
The Primary Group's sales consist of shellfish, groundfish, and pelagic
species.
    Sales in the Primary Group for the year ended December 31, 2006 total
$300.0 million, a $2.3 million, or 0.8%, increase from sales of $297.7 million
in 2005. Increased sales of value added and globally sourced product are
offset by a decrease in sales of primary processed product produced in
Newfoundland and Labrador, predominantly within groundfish, a price decrease
on certain shellfish species as a result of market conditions and a negative
foreign currency impact as a result of the strengthened Canadian dollar. The
increase in value added and globally sourced product production is a result of
the acquisition of The Seafood Company.
    The Primary Group contributed $40.0 million toward the Company's total
gross profit for the year, which is $16.0 million higher than the
$24.0 million contributed for the prior year. Gross profit as a percentage of
sales was 13.3%, representing an increase of 5.2 percentage points from the
8.1% gross profit percentage achieved in 2005. Value added and globally
sourced product gross profits have increased in 2006 over prior years
primarily as a result of the acquisition of The Seafood Company. The increase
in gross profit as a result of value added and globally sourced products is
offset by a decrease in gross profit realized on primary processed groundfish
as compared to 2005 due to reduced sales volumes.
    The Primary Group is working on various strategies to control losses
caused by foreign exchange fluctuations, increasing fuel prices, increasing
competition from low cost producers, such as China, and significant overhead
and distribution costs. Although these challenges are significant, FPI
continues to critically review the management of the Primary Group's
operations with the objective of enhancing profitability.

    ADMINISTRATIVE AND MARKETING EXPENSES

    Administrative and marketing expenses are $49.9 million for the year ended
December 31, 2006; a $6.4 million decrease from the $56.3 million incurred in
the year ended 2005. This decrease is primarily due to a decline in
administrative and marketing costs company wide as a result of management's
increased focus on cost control and cost cutting measures. This decrease is
partially offset by the acquisition of The Seafood Company on September 2,
2005. Excluding The Seafood Company, there is $11.1 million reduction for the
year ended December 31, 2006 as compared to the prior year. This decrease
results primarily from the restructuring and reduction of senior staff levels
in an effort to reduce costs, as well as reduced discretionary spending on
selling activities.

    FOREIGN EXCHANGE DERIVATIVE GAINS (LOSSES)

    The Company has foreign exchange derivative contracts that do not qualify
for hedge accounting. These derivatives resulted in losses of $1.7 million for
the year ended December 31, 2006 as compared to $6.9 million in gains for the
year ended December 31, 2005.

    DEPRECIATION AND AMORTIZATION

    Depreciation and amortization for the year ended December 31, 2006 is
$15.3 million, an increase of $0.6 million as compared to $14.7 million
recorded in 2005. This increase is the result of depreciation recognized in
The Seafood Company which was acquired on September 2, 2005 as well
amortization of intangible assets, such as customer relationships and
favourable lease terms, which were acquired as part of The Seafood Company.

    INTEREST EXPENSE

    Interest expense for the year ended December 31, 2006 totals
$15.3 million, a decrease of $0.3 million as compared to $15.6 million for the
same period in 2005. This is predominantly driven by a decrease in interest on
bank indebtedness of $1.1 million from $8.8 million in 2005 to $7.7 million in
the current year. This significant decrease in the Company's bank indebtedness
is due to lower inventory levels and the refinancing of the short-term bridge
loan for The Seafood Company during the second quarter of 2006 as is discussed
further in the Financing Activities section of the report. This decrease is
partially offset by the increase in interest on long-term debt due to
refinancing of the aforementioned credit facilities, in addition to an
increase in lending rates on long-term financing.

    INCOME TAXES

    The Company's consolidated income tax expense increased from a
$2.7 million recovery in 2005 to a $4.0 million expense in 2006. The effective
tax rate for the year ended December 31, 2005 was 20.3%, compared to an
effective rate of 67.4% for the year ended December 31, 2006.
    The Company's effective tax rate is significantly higher than the
statutory rate for the year as a result of future tax rate reductions
announced in the 2006 Federal Budget which significantly decreased the
Company's net future tax position, therefore reducing tax recoveries.
    As at December 31, 2006, the Company has approximately $1.5 million in
non-capital loss carry forwards, which are available to reduce future Canadian
income taxes otherwise payable. The Company has recognized the benefit on
$0.8 million of these non-capital losses as a future income tax asset. As
well, the Company has approximately $7.9 million in capital loss carry
forwards, which are available to reduce future Canadian capital gains. No
benefit for these capital losses has been recognized by the Company.

    OTHER ITEMS

    ARBITRATION SETTLEMENT. In the fourth quarter of 2006, pursuant to a claim
against the shipyard contracted to construct the motor vessel, the
Newfoundland Lynx, the Company received the report of the arbitrator, The
London Court of International Arbitration. The Company's claim included costs
for additional work and warranty associated with the completion of the vessel
and consequential direct and indirect losses. The award, totalling
$3.6 million, specified $1.5 million as relating to the vessel completion
which has been applied to the cost of the vessel, $1.9 million for direct and
indirect losses associated with the 2004 and 2005 fiscal years and interest of
$0.2 million.

    GAIN ON DISPOSAL OF VESSEL. In the fourth quarter of 2006, the Company
disposed of one of its vessels, the Newfoundland Marten. A gain of
$1.0 million was recognized on disposal. This gain, in addition to gains
recognized on other vessel disposals are recorded in gain on disposal of
capital assets.

    IMPAIRMENT OF CAPITAL ASSETS. During the fourth quarter of 2006, the
Company recognized an asset impairment charge of $0.4 million representing a
write-down in the carrying value of a vessel, the Newfoundland Otter, to fair
value. This vessel was sold subsequent to year-end for proceeds equal to its
revised carrying value.
    During the third quarter of 2005, the Company recognized an asset
impairment charge of $2.9 million representing a write-down in the carrying
value of a primary processing facility to fair value, as the future use of
this facility was uncertain. This write-down was net of the estimated
insurance settlement with respect to damage to the facility caused by an
explosion during the third quarter.

    SETTLEMENT OF PLANT CLOSURE OBLIGATIONS. During the fourth quarter of 2005
the Company recognized a charge of $1.8 million for settlement of certain
plant closure obligations.

    LIQUIDITY AND CAPITAL RE

SOURCES OPERATING ACTIVITIES. The Company's cash provided by operating activities of $82.6 million for the year ended December 31, 2006 compares to $1.9 million cash applied for the year ended December 31, 2005. The increase in cash provided by operating activities in the year is primarily a result of various changes in non-cash working capital balances discussed below. As at December 31, 2006, the Company had working capital of $109.5 million and a current ratio of 1.8:1. This compares with working capital of $56.5 million and a current ratio of 1.2:1 as at December 31, 2005. Accounts receivable at December 31, 2006 total $79.6 million, a $28.0 million decrease over the $107.6 million at December 31, 2005. This change is primarily a result of decreased sales for the third and fourth quarters of 2006 as compared to the same periods in 2005. Also contributing to the decrease in accounts receivable is a $3.9 million reduction in receivables related to consignment sales, a $0.6 million decrease in income taxes receivable and a $0.6 million reduction in other receivables, partially offset by the $3.6 million receivable for the Newfoundland Lynx arbitration claim recognized in the fourth quarter of 2006, as previously discussed in the Other Items section of this report. Another primary driver of decreased accounts receivable is the improvement in days sales outstanding of 28.0 days at December 31, 2006 from 32.4 days as at December 31, 2005. The inventory balance at December 31, 2006 was $137.6 million, a decrease of $59.9 million as compared to the balance of $197.5 million as at December 31, 2005. This decrease is primarily due to management's continued focus on reducing the Company's inventory position through reduced procurement, a continuous initiative to maintain lower stock levels, streamlined purchasing efforts, and decreased production in the Primary Group as a result of the ongoing internal review of groundfish operations. Prepaid expenses and other at December 31, 2006 are $4.7 million, a decrease of $4.8 million over the balance of $9.5 million at December 31, 2005. This decrease in prepaid expenses and other is primarily a result of the decrease in the current portion of outstanding non-hedge accounted foreign exchange contracts of $2.8 million as compared to December 31, 2005. In addition, the Company's prepaid expense decreased as a result of a negotiated insurance policy renewal which resulted in an overall reduction in premium rates. Accounts payable and accrued liabilities at December 31, 2006 are $63.5 million, a decrease of $17.0 million from the balance of $80.5 million at December 31, 2005. These decreases result from focused procurement activity during the year, as well as reduced harvesting activity in the third and fourth quarters of 2006. The Company expects that its ability to generate sufficient amounts of cash as needed in the short and long-term, and to maintain financial capacity and flexibility for its operating activities is adequate and there are no trends, demands, commitments, events, or uncertainties that are reasonably likely to impact the position by a material amount. If the Company is not able to adequately finance its working capital requirements, there may be a material adverse effect on the Company's financial condition and results of operations. INVESTING ACTIVITIES. Cash provided by investing activities for the year ended December 31, 2006 is $22.1 million, an increase of $72.3 million as compared to $50.2 million applied to at December 31, 2005. In 2006, the primary sources of cash inflow are $10.6 million related to premiums and funds received on foreign exchange derivative instruments, $16.0 million proceeds on disposal of a vessel, the Newfoundland Marten, offset by the Company's purchase of two new vessels in the year of $5.9 million. The primary cash outflow for 2005 was $40.7 million related to the acquisition of The Seafood Company. FINANCING ACTIVITIES. Cash applied to financing activities of $105.0 million for the year ended December 31, 2006 was $161.7 million higher than the $56.7 million provided in the year ended December 31, 2005. This increase is primarily due to decreased bank indebtedness as a result of management's focus on reducing inventory levels through less procurement and management of safety stock levels. Further, during the second quarter of 2006, the Company refinanced its secured credit facility, which was used to finance the acquisition of The Seafood Company during September 2005. The refinanced secured credit facilities consist of: (i) a three year term loan facility of up to (pnds stlg)11,000,000 (CAD $25,106,400) at an interest rate of LIBOR plus an applicable margin; and (ii) a three year revolving credit facility of (pnds stlg)11,500,000 (CAD $26,247,600) at an interest rate of LIBOR plus an applicable margin. In the fourth quarter of 2006, the Company amended the aforementioned revolving credit facility and was granted a temporary increase in the amount of (pnds stlg)7,500,000 (CAD $17,118,000) to a maximum of (pnds stlg)19,000,000 (CAD $43,365,600) which expires in April 2007. Of the total drawn revolving credit facility of (pnds stlg)14,462,000 (CAD $33,008,069), the amount of (pnds stlg)6,000,000 (CAD $13,694,400) has been excluded from current liabilities because the Company intends that at least that amount would remain outstanding under this agreement for an uninterrupted period extending beyond one year from the consolidated balance sheet date. The remaining balance of (pnds stlg)8,462,000 (CAD $19,313,669) is included in bank indebtedness. The new credit facility is secured by the shares of The Seafood Company. Canadian equivalent balances previously disclosed have been revalued as at the date of this consolidated balance sheet. Transaction costs in the amount of (pnds stlg) 165,150 (CAD $370,100) pertaining to the refinancing have been deferred and are being amortized over the three-year term of the credit facilities. The commercial terms of the credit facilities included a front end fee of 0.25% of the facility amounts for a total fee of (pnds stlg) 56,250 (CAD $128,400). This amount is deferred and amortized over the three year term of the credit facilities. Deferred costs in connection with credit facilities in place prior to June 30, 2006 of (pnds stlg)44,500 (CAD $93,000) were written off in the third quarter of 2006. Bank indebtedness of $61.0 million at December 31, 2006 was $113.6 million lower than the $174.6 million balance at December 31, 2005. This is primarily a result of lower inventory levels as compared to the prior year in addition to the refinancing of the credit facilities discussed above. FPI's overall capital structure is 39.7% funded by long-term debt (excluding current portion) at December 31, 2006, compared with 35.7% as at December 31, 2005. Long-term debt (excluding current portion) at December 31, 2006 totals $110.9 million as compared to $94.0 million at December 31, 2005. This increase in long-term debt results from the aforementioned refinancing of credit facilities related to The Seafood Company acquisition. On December 4, 2006, the Company received approval from the Toronto Stock Exchange for the renewal of its normal course issuer bid, pursuant to which the Company may purchase up to 701,806 of its common shares during the one-year period commencing December 6, 2006. As at December 31, 2006, the Company had repurchased 103,100 shares pursuant to this program of which 41,700 shares remained uncancelled. Those shares that were not cancelled had an aggregate cost of $298,000 of which $139,000 was charged to share capital and $159,000 was charged to contributed surplus. These shares were cancelled subsequent to year-end. As at March 9, 2007 the Company had purchased 70,700 shares pursuant to this bid at an average cost of $7.14 per share. The Company had approximately 13.9 million common shares outstanding as at December 31, 2006 (December 31, 2005; 14.8 million). As at March 9, 2007, common shares outstanding were approximately 13.9 million which includes 159,300 shares repurchased by the Company but not cancelled. The Company has stock-based compensation plans for directors, executives, and certain senior management. The 2000 Performance Stock Option Plan allows the Company to grant options for the purchase of up to 1,395,000 common shares. These options have a maximum term of ten years and vest according to certain pre-defined percentage increases in the market price of the Company's common shares. There were no options granted under this Plan in 2006 (2005; 147,700). Options to purchase common shares granted and outstanding under this Plan as at December 31, 2006 were 808,700 (2005; 1,273,200). At December 31, 2006, the Company has 568,500 common shares that remain available for issuance under this Plan. The Executive Stock Option Plan allows the Company to grant options for the purchase of up to 1,000,000 common shares. There were no options granted under this Plan during 2006 (2005; 12,300). Options to purchase common shares granted and outstanding under this Plan as at December 31, 2006, were 31,300 (2005; 41,300). As at December 31, 2006, the Company has 4,000 shares remaining available for grant under this Stock Option Plan. There were no dividends declared or paid during 2006, as the Company suspended payment of quarterly dividends during the first quarter of 2005. Shareholders' equity totals $168.2 million as at December 31, 2006, compared with $169.1 million at December 31, 2005. CONTRACTUAL OBLIGATIONS. The following table describes the Company's contractual obligations by category and the related payments for each of the next five years and thereafter. Summary of Contractual Obligations ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total Commitments by Period ------------------------------------------------------------------------- unaudited - in thousands Total 2007 2008 2009 2010 2011 There- after ------------------------------------------------------------------------- Long-term debt $ 121,044 10,135 14,114 29,656 13,301 13,705 40,133 Operating leases 17,394 3,614 2,931 2,449 2,153 1,933 4,314 Purchase obligations 65,217 65,217 - - - - - ------------------------------------------------------------------------- Total contractual obligations 203,655 78,966 17,045 32,105 15,454 15,638 44,447 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The Company has long-term debt with contractual maturities as described in note 9 to the consolidated financial statements. The Company also has operating leases and purchase obligations entered into in the normal course of business. Purchase obligations include purchase orders outstanding relating primarily to inventories and capital assets. SUMMARY OF RESULTS FOR THE FOURTH QUARTER ENDED DECEMBER 31, 2006 The Company reported revenue for the fourth quarter of $188.1 million, representing a decrease of $51.1 million over the $239.2 million reported in the fourth quarter of 2005. Gross profit of $23.6 million is 12.5 percent of sales, as compared to 8.3 percent of sales in the fourth quarter of 2005. The Primary Group's sales for the fourth quarter of 2006 total $77.1 million, a $20.3 million or 20.8% decrease over sales of $97.4 million in 2005. This decrease is primarily a result of a significant reduction in sales of primary processed product partially offset by increased sales of value added product. Lower average selling prices due to market conditions combined with the strengthened Canadian dollar, resulted in lower sales revenue across all product lines. Reduced sales volume of primary processed product that occurred during the quarter is primarily attributable to decreases experienced in the groundfish species. Decreases in sales pricing were experienced on certain shellfish species as a result of market conditions that continued through the quarter. The Marketing and Manufacturing Group's revenues for the fourth quarter of 2006 total $111.0 million, a decrease of $30.8 million from revenues of $141.8 million in 2005 including a negative exchange rate impact of $2.3 million. This decrease was predominantly driven by reduced sales of commodity items including coldwater lobster, seabass, king crab and salmon. The Marketing and Manufacturing Group's value added product revenues decreased in both Canada and the United States in the fourth quarter of 2006. The continued impact of new products within the UpperCrust(TM) and Sea Cuisine brands resulted in increased revenues in the U.S. Foodservice, Club, and Grocery channels. Revenues also increased in the U.S. National Accounts channel. However, these gains were more than offset by the declines on value added shrimp products particularly at the Club and National Account channels during the fourth quarter. In Canada, sales decreased 4.6% primarily due to reduced value added sales across all channels. The Company's fourth quarter 2006 gross profit of $23.6 million is $3.6 million, or 18.0%, higher than 2005. Gross profit for the fourth quarter was favourably impacted by performance of the Primary Group through its improved discipline in the product rationalization process leading to lower selling and distribution costs, as well as a change in sales mix to meet customer demands in the Marketing and Manufacturing Group segment. The Primary Group contributed $12.8 million toward the Company's total gross profit for the quarter, which was $2.8 million higher than the $10.0 million contributed for the fourth quarter 2005. Gross profit as a percentage of sales was 16.6% representing a 6.3 percentage point increase from the 10.3% gross profit achieved for the fourth quarter 2005. Value added product and globally sourced product gross profits have increased this quarter over prior years as a result of the acquisition of The Seafood Company. Despite the challenges of rising fuel costs, the strengthened Canadian dollar, and increased competition from low cost producers like China, primary processed products experienced only a slight decrease in gross profit as a percentage of sales due to the curtailment of groundfish production. As a result of changes in the economic environment, wage rates and foreign exchange, these plants have operated at a loss in recent years. The Marketing and Manufacturing Group's gross profit of $10.9 million for the fourth quarter of 2006 increased by $0.8 million over gross profit recorded in the fourth quarter of 2005. This improvement is primarily due to improved margins from the product rationalization process and lower distribution expenses offset by raw material costs for both value added groundfish and shrimp which have increased in comparison to the prior year. The 2006 fourth quarter net loss was $1.7 million ($0.13 per share), as compared to a net loss of $3.0 million ($0.20 per share) for the fourth quarter of 2005. In addition to increased gross profits as previously discussed, the Company's financial results for the fourth quarter of 2006 were favourably impacted by a $1.0 million gain on disposal of a vessel, the Newfoundland Marten, in addition to a $2.1 million arbitration settlement awarded to the Company in 2006 in relation to direct and indirect losses incurred by the Company as a result of the delayed commencement of operations of the Newfoundland Lynx. Also contributing to improved results is a reduction in administrative and marketing expenses of $3.0 million, from $16.2 millionfor the thirteen weeks ended December 31, 2005 to $13.0 million for the same period in 2006. These favourable results were offset by an increase in the foreign exchange derivative loss of $9.8 million. The Company's financial results for the fourth quarter of 2005 were significantly impacted by charges totalling $1.8 million for settlement of obligations for closure of certain plants. QUARTERLY FINANCIAL INFORMATON The following section provides financial data for the eight most recently completed financial quarters of the Company. This financial information is derived from the Company's unaudited interim and audited annual financial statements for each of the quarters then ended. Reference should be made to the Company's quarterly and annual report to shareholders for each such quarter for the complete financial statements and MD&A of such operating results. Summary of Quarterly Data ------------------------------------------------------------------------- unaudited - dollars in thousands, except per Apr. 1, Jul. 1, Sept. 30, Dec. 31, share data 2006 2006 2006 2006 ------------------------------------------------------------------------- Sales 201,780 188,454 174,493 188,123 Net (loss) income (2,676) 2,771 3,568 (1,748) Net (loss) income per common share Basic (0.18) 0.19 0.25 (0.13) Diluted (0.18) 0.19 0.25 (0.13) ------------------------------------------------------------------------- ------------------------------------------------------------------------- unaudited - dollars in thousands, except per Apr. 2, Jul. 2 Oct. 1, Dec. 31, share data 2005 2005 2005 2005 ------------------------------------------------------------------------- Sales 184,649 203,614 206,210 239,188 Net (loss) income (3,400) 1,113 (5,146) (3,045) Net (loss) income per common share Basic (0.22) 0.07 (0.35) (0.20) Diluted (0.22) 0.07 (0.35) (0.20) ------------------------------------------------------------------------- The Company's operations and, therefore, its sales and cash flows, are seasonally affected. Inventory levels normally fluctuate in the following manner: increasing during the late spring/early summer with the seasonal fisheries, particularly those for coldwater shrimp and snow crab; peaking in September/October with the global sourcing of warmwater shrimp for pre holiday sales in the fall; and declining in the late fall/early winter with strong sales and slower global sourcing/harvesting activity. Sales, particularly those of value added products, are strong in the early spring, largely as a result of the Lenten period. Through the late spring and summer months, the sales mix incorporates more primary and globally sourced products, such as snow crab and lobster, as seasonal fisheries are underway. The fall and winter months are also strong periods as a result of increased sales, largely of shellfish, during the holiday season. The Company's operations can also be affected by weather in the winter months when ice and poor weather conditions impact the harvesting of fish. With sales of $184.6 million in the first quarter of 2005, the Company began the year with lower revenues than the first quarter of 2004, largely as a result of decreased sales volumes of globally sourced and value added products and increased sales promotion allowances. Reduced margins in the Primary Group's groundfish operations, lower sales volumes of value added and globally sourced products in the Marketing and Manufacturing Group, and significant sales promotion programs in the Marketing and Manufacturing Group, resulted in lower gross profits than in the prior year. Sales of $203.6 million for the second quarter of 2005 surpassed the first quarter sales of $184.6 million by $19.0 million. Sales of globally sourced products during the second quarter of 2005 were greater than sales of these same products during the first quarter of 2005. Sales promotion allowances continued to reduce margins during the second quarter of 2005, as did the delay in the opening of certain fisheries within the Primary Group and the continuing negative impact of foreign exchange rates. Sales in the third quarter of 2005 included $6.8 million resulting from the operations of The Seafood Company, which had been newly acquired. Excluding the impact of the acquisition, sales decreased by $4.2 million from the second quarter of 2005, which was primarily a result of negative exchange rate impacts. Reduced margins, a capital asset impairment charge of $2.9 million, and a $1.3 million write-off of costs relating to the proposed Marketing and Manufacturing Group income trust transaction contributed to a $5.1 million net loss in the quarter. The Company reported sales of $239.2 million in the fourth quarter of 2005, an increase of $33.0 million over the third quarter of 2005. The Seafood Company accounted for $25.8 million of sales reported in the fourth quarter of 2005. The negative exchange rates continued to impact results into the fourth quarter of 2005. Notwithstanding, the Marketing and Manufacturing Group's North American sales of both value added and globally sourced product increased significantly over the third quarter of 2005 as a result of strong fourth quarter sales that typically result from strong seasonal sales during that time of year. A $1.8 million charge for the settlement of obligations for closed plants significantly contributed to a loss in the quarter, as did continuing reduced margins and the strengthening Canadian dollar. With sales of $201.8 million in the first quarter of 2006, the Company began the year with higher revenues than the first quarter of 2005, largely as a result of increased sales volumes of globally sourced and value added products combined in part with continued growth in globally sourced product as part of the Company's strategy to expand its international and domestic customer base. Reduced margins in the Primary Group's groundfish operations, lower sales volumes of value added and globally sourced products in the Marketing and Manufacturing Group, and significant sales promotion allowances in the Marketing and Manufacturing Group resulted in lower gross profits than in the prior year. Sales of $188.5 million for the second quarter of 2006 were lower than the second quarter sales of $203.6 million of 2005 by $15.1 million. Lower sales of globally sourced and value added products during the second quarter of 2006 in the Marketing and Manufacturing Group and lower sales of primary processed product in Primary Group due to ceased production combined with a weaker U.S. dollar significantly contributed to this decline from the prior year. Sales promotion allowances continued to reduce margins during the second quarter of 2006 as well as higher costs due to storage and distribution expenses, as did the delay in the opening of certain fisheries within the Primary Group and the continuing negative impact of foreign exchange rates. Sales of $174.5 million in the third quarter of 2006 were $31.7 million lower than third quarter sales of $206.2 million in 2005. Lower sales of globally sourced and value added products in the Marketing and Manufacturing Group, lower sales of primary processed product and globally sourced sales in Primary Group combined with negative foreign exchange rate impact are the primary factors contributing to the decrease from the prior year. Further, the reduction in sales and increase in gross profit is aligned with management's strategic plan to focus on profitability. Throughout 2006, the Company has conducted a detailed evaluation of its customers and product portfolios, and concentrated on efforts to maximize returns. For the fourth quarter of 2006, the Company continued to focus on profitability. It reported sales of $188.1 million, a decrease of $51.1 million from the same period in 2005. Also contributing to the reduction of sales was the negative impact of exchange rates and the reduced sales and production of primary processed product which continued to influence the Company's results. FINANCIAL INSTRUMENTS The Company utilizes financial derivatives to manage its foreign currency and interest rate exposures. The purpose of these hedges is to provide an element of stability to cash flow in a volatile environment. 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. The Company has assessed and documented the effectiveness of its hedging relationships in accordance with the requirements of Canadian Institute of Chartered Accountants ("CICA") Accounting Guideline 13, Hedging Relationships ("AcG-13"). The Company has determined that all designated hedging relationships are effective and qualify for hedge accounting treatment. The Company periodically enters into forward foreign exchange contracts and option agreements to buy or sell various foreign currencies in order to manage its exposure to exchange rate fluctuations. The Company also holds contracts that do not qualify for hedge accounting that are marked-to-market each month with the gain and loss recognized in income. The Company periodically enters into interest rate swap agreements to hedge the impact of rate changes on bank indebtedness and long-term debt. The terms of these contracts match the terms associated with the underlying debt instruments. These contracts are used to fix the interest rates on the variable rate debt. Interest paid or received under such swap contracts is recognized over the life of the contracts as an adjustment to interest expense. As these instruments qualify for hedge accounting treatment, any unrealized gains or losses resulting from market movements are not recognized in the financial statements until maturity of the underlying financial instruments. In 2005 and 2006, the Company terminated certain of its forward foreign exchange contracts and option agreements which were designated and accounted for as cash flow hedges. The net cumulative gain of $5.4 million realized on the termination of these instruments is deferred and amortized into income over the same period as the corresponding cash flows of the original contracts. Amortization recognized in income in 2006 is $4.8 million (2005; $0.6 million). All derivative instrument contracts are with banks listed on Schedule I to the Bank Act (Canada). FOREIGN EXCHANGE. The Company prepares consolidated financial statements in CAD. See note 1 to the Company's consolidated financial statements for details. In 2006, approximately 75% of FPI's consolidated sales were based in foreign currencies, with approximately 53% in USD. To a large extent, a natural hedge for movements in the USD against the CAD exists in FPI's cost structure as: (i) international global sourcing of seafood products is primarily conducted in USD; (ii) a portion of the Company's long-term debt and short-term bank loans are denominated in USD; and (iii) the cost base of the Company's value added processing operations is largely in USD. However, there remains a net positive USD cash flow that may impact operating earnings as the CAD/USD exchange rate changes. The Company has developed a risk management program to mitigate potential foreign currency risks. Foreign currency cash flows may be hedged to a maximum of 100%, 24 months into the future. The Company enters into foreign exchange contracts and option agreements to manage its exposure to foreign currency rate fluctuations, primarily from sales in the U.S. dollar, British pounds and the Euro. Such contracts are formally documented and correspond to forecasted cash flows. The derivatives are assessed to ensure they are effective in offsetting changes in the fair market value of the underlying position. Gains or losses on contracts are included in sales revenue in the period in which the underlying position occurs. In addition to the hedging of cash inflows, the Company hedges currency exposure in certain of its global sourcing operations and where there are fixed rate contracts with foreign currency provisions. The objective of these currency hedges is to preserve optimal margins. In 2006, FPI used short-term forward contracts to fix the margin on 2.7% (2005; 6.0%) of its Canadian globally sourced product sales. Certain derivative financial instruments held by the Company as at December 31, 2006 and 2005, do not qualify for hedge accounting. These instruments are accounted for using the mark-to-market method under which contracts are recorded at fair values in the Company's consolidated balance sheet. Changes in the consolidated balance sheet accounts result primarily from changes in the valuation of the portfolio of contracts, new transactions, and the maturity and settlement of certain contracts. The market prices used to value these transactions reflect management's best estimate considering various factors, including closing exchange and over-the-counter quotations, time value, and volatility factors underlying the commitments. Net gains and losses recognized on these derivative financial instruments in a period are separately disclosed in the Company's consolidated statements of operations. Please refer to note 19 of the Company's consolidated financial statements for a list of forward foreign exchange and option contracts outstanding at December 31, 2006. The fair market value of all contracts that qualify for hedge accounting outstanding at December 31, 2006, amount to a $1.3 million unrealized loss (2005; $2.1 million unrealized gain). While this fair market value provides an indication of contract value if settled on December 31, 2006, the Company intends to hold the contracts until maturity. The Company accounts for these contracts as fully effective hedges and no amount is included in the financial statements until the maturity of the hedge instrument. The fair market value of contracts which do not qualify for hedge accounting outstanding as at December 31, 2006, amount to a net liability of $9.6 million (2005; $2.8 million net asset). The net liability is included in the consolidated balance sheet as either prepaid expenses and other, other assets, accounts payable and accrued liabilities or deferred gains and other based on the nature of the contracts and is marked-to-market each period. During 2006, the Company recorded a loss of $1.7 million (2005; $6.9 million gain) related to its non-hedge contracts. INTEREST RATE SWAP AGREEMENTS. The Company is exposed to market risk from changes in interest rates, related primarily to variable interest rates on current bank indebtedness and floating rate term debt. The Company manages its interest rate risk through interest rate swaps. The positions minimize the impact of future changes in interest rates on Canadian dollar and U.S. dollar floating rate debt. The interest rate swaps are based upon notional amounts that correspond generally to the Company's floating rate debt. The Company periodically enters into bond forwards to hedge against interest rate fluctuations during the negotiation of fixed rate term financing. The gain or loss on the bond forward is classified as either a deferred gain or deferred charge, in other assets, on the Company's consolidated balance sheets. The deferred amounts are amortized over the term to which they relate and are recorded in interest expense. Please refer to note 19 of the Company's consolidated financial statements for a list of interest rate sawp agreements outstanding at December 31, 2006. While the Company intends to hold the interest rate swaps until maturity, the mark-to-market amounts of $0.2 million on outstanding contracts represent the amount to be paid by the Company if the transactions are terminated at December 31, 2006. For the year ended December 31, 2006, net interest expense from interest rate swaps is $0.3 million (2005; $1.2 million). CREDIT RISK. In the normal course of business, the Company seeks to minimize credit risk by monitoring the financial condition of its customers and reviewing the credit history of each new trade customer. The Company is also exposed to credit risk in the event of non-performance by counterparties to its derivative financial instruments. Although collateral or other security to support financial instruments subject to credit risk is usually not obtained, customers and counterparties are of high credit quality and their credit standing or that of their guarantor is regularly monitored. As a result, losses due to customer or counterparty non-performance are not anticipated. The Company believes there are no significant concentrations of credit risk. The Company's consolidated sales result from a broad international customer base, in excess of 3,500 accounts. FPI's largest customer represents approximately 11% of total sales. As a result of consolidation of large customers in recent years, the top ten customers now represent approximately 45% of total annual consolidated sales. RELATED PARTY TRANSACTIONS In the normal course of business, the Company transacts with companies which have common directors and a company in which FPI holds an equity investment, as follows: ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Transactions Sales of product $ 457 195 Purchases of product and services 9,164 12,175 Net commissions and royalties 1,300 1,622 Payments of the Company's proportionate share of vessel modifications and related equipment purchases of a jointly controlled asset - 2,551 Other 164 320 ------------------------------------------------------------------------- These transactions are measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. The balances outlined below are non-interest bearing and under normal credit terms, applied with unrelated parties, and arise from the transactions referred to above. These balances are included in accounts receivable and accounts payable on the Company's consolidated balance sheets. ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Balances Receivable from companies with common directors $ 191 - Receivable from a company in which FPI holds an equity investment 3,007 6,896 Payable to companies with common directors 963 2,269 ------------------------------------------------------------------------- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTERNATIONAL OPERATIONS. The Company records transactions and prepares its financial statements in CAD. For the year ended December 31, 2006, the Company maintains operations in the U.S., the U.K., and Germany, with business also conducted in other countries. The Company's businesses in the U.S. and the U.K. are considered financially and operationally self-sustaining, while the business located in Germany is considered an integrated operation. The assets and liabilities of the Company's self-sustaining operations are translated into CAD at the year-end exchange rate. Revenues and expense items are translated into CAD at average exchange rates prevailing throughout the year. The resulting net gains and losses, together with those related to short-term and long-term borrowings denominated in USD and designated as a hedge of the self sustaining subsidiary operations in the U.S., are accumulated in a separate component of shareholders' equity, described in the Company's consolidated balance sheet as foreign currency translation adjustment. The exchange gains and losses arising on the translation of the current monetary items of the Company's integrated operation are included in the determination of net income. Gains and losses on the translation of other foreign currency transactions are also included in the determination of net income. Given much of the Company's total revenues and expenses are transacted in currencies other than CAD, the Company is exposed to exchange rate risks. SALES PRICE VOLATILITY. Historically, certain FPI product lines recorded very significant price volatility, with the most recent examples being warmwater shrimp, Atlantic snow crab, scallops, and lobster. The breadth of FPI's overall product line and the Company's ability to substitute products, if necessary, reduce the margin impact of excessive volatility in individual product categories. GLOBAL SOURCING. In view of the ongoing moratoria or limited reopenings of key Canadian groundfish stocks, global sourcing of groundfish remains a vital component of the Company's operations. For the year ended December 31, 2006, the Company globally sourced 18,800 tonnes (2005; 19,300 tonnes) of groundfish, either as raw material or finished goods. The global sourcing of warmwater shrimp is also an important component of the Company's operations. The Company globally sourced 16,000 tonnes (2005; 19,200 tonnes) of this product during 2006. A detailed discussion on raw material is found in the Company's Annual Information Form ("the AIF") filed with Canadian securities regulatory authorities. This document is available through the Company's website at www.fpil.com or on the SEDAR website at www.sedar.com. OPERATING RISK. In addition to the foregoing risks, the seafood industry is highly competitive in all markets in which the Company operates. With customer business typically conducted without written agreements, the loss of significant customers may have a material adverse effect on the Company's financial condition and operating results. In addition, consolidation among food distributors may bring increased pressure on pricing and trade terms for food processors like FPI. The Company is also subject to potential product liabilities in connection with its food processing operations. The Company maintains insurance in respect of such liabilities in accordance with market practice within the industry. However, there can be no assurance that the Company will be adequately insured with respect to any losses arising from product liability claims. FPI's operations, including the harvesting, processing, and transportation of seafood are subject to stringent statutes, regulations and by-laws and other requirements with respect to workers' health and safety and environmental matters in Canada, the U.S., and elsewhere. FPI's earnings are also directly impacted by changing prices in relation to the purchases of fuel: (i) to operate its fleet; (ii) to operate its plants; and (iii) by its independent truckers. In addition to these direct impacts, changing fuel prices indirectly impact the Company's packaging and fishing gear costs (particularly items such as petroleum-based plastic and nets) as well as costs such as electricity and travel. The Company does not engage in any hedging of its operating costs due to the absence of an organized commodity market for the vast majority of these cost components. OTHER RISKS LABOUR CONTRACTS. The Company currently has four collective agreements with labour unions, representing approximately 2,100 employees. During the year, a new collective agreement was ratified with a bargaining unit pertaining to an agreement that expired on April 30, 2006. The new collective agreement is effective until April 30, 2009. Negotiations are currently ongoing with respect to collective agreements which expired on December 31, 2004, March 31, 2005 and December 31, 2006. LEGAL PROCEEDINGS. In the ordinary course of business, the Company from time to time becomes involved in various claims and legal proceedings. The Company has no reason to believe that the disposition of any such current matters could reasonably be expected to have a material adverse impact on the Company's financial position, results of operations, or the ability to carry on any of its business activities. During 2006, charges were laid against the Company by the Government of Newfoundland and Labrador in relation to its export practices of Yellowtail Flounder. Management is presently not able to assess or predict the scope or outcome of these charges. Accordingly, no provision has been included on these financial statements. REGULATORY ENVIRONMENT. The regulatory environment in the Atlantic Canadian fishing industry is extremely complex. Elements of risk include: changes in quota allocations; potential changes in the enterprise allocation system; new licensing fees to cover governmental administration costs; the granting of additional processing and harvesting licenses, which would dilute the resource base amongst more participants; and the scheduling of various fisheries. The ultimate regulatory regime reflects a complex interplay of scientific and resource management objectives and a wide array of ongoing political and social pressures. A significant reduction in quota or adverse material changes to the Company's allocation percentages might have a detrimental effect on the Company's financial condition and results of operations, although it is not readily quantifiable due to the variability of possible assumptions. Adverse impacts that result from such changes would be sought to be significantly mitigated through increased procurement activities, product additions or withdrawals, or species substitution. The regulations associated with the importation and processing of seafood within Canada and the U.S. are governed by the Canadian Food Inspection Agency and Food and Drug Administration, respectively, who provide guidelines for the safety and protection of consumers in each market. These guidelines govern quality and good manufacturing procedures that are acceptable to the regulatory authorities in each country. Further, the regulations associated with the importation and processing of seafood within the international marketplace are governed by International Food Standards, which ensure consistent food safety and quality internationally. The Company is subject to the provisions of the FPI Act, which restricts the Company's ability to take certain corporate actions. Furthermore, the Government of Newfoundland and Labrador's ability to unilaterally amend the FPI Act, to further restrict the activities carried on by the Company, or to prevent or prohibit any action or proposal contemplated by the Company, could have an adverse effect on the Company's business and could adversely affect FPI's financial condition and results of operations. INFLATION. Although the Company believes that inflation has not had any material effect on current operating results, the Company's business may be affected by inflation in the future. TAXES. The Company is subject to taxation in different jurisdictions throughout the world. The Company's future effective tax rate and tax liability are impacted by a number of factors, such as the amount of taxable income in particular jurisdictions, the tax rates in such jurisdictions, tax treaties between jurisdictions, the extent to which funds are transferred between jurisdictions and income is repatriated, and future changes in law. The tax liability for each legal entity is determined on a non consolidated basis without regard to the taxable losses of non-consolidated affiliate entities. As a result, the Company may pay income taxes in certain jurisdictions, although on an overall basis a net loss for the period may be incurred. For a detailed discussion of other risks that may impact on the Company's business and operations, reference should be made to the Company's AIF filed with Canadian securities regulatory authorities. This document is available through the Company's website at www.fpil.com or on the SEDAR website at www.sedar.com. OFF-BALANCE SHEET ARRANGEMENTS GUARANTEES. For details pertaining to guarantees, refer to note 18 to the Company's consolidated financial statements. DERIVATIVE FINANCIAL INSTRUMENTS. For details pertaining to derivative financial instruments refer to the section entitled "Financial Instruments" in this MD&A. LETTERS OF CREDIT. For details pertaining to letters of credit, refer to note 18 to the Company's consolidated financial statements. CHANGES IN ACCOUNTING POLICIES STOCK-BASED COMPENSATION FOR EMPLOYEES ELIGIBLE TO RETIRE BEFORE THE VESTING DATE. The Company has adopted the recommendations of Emerging Issues Committee Abstract 162, "Stock-based compensation for employees eligible to retire before the vesting date" (EIC 162) for the period ended December 31, 2006. The abstract requires that the compensation cost for a stock option attributable to an employee who is eligible to retire at the grant date be recognized on the grant date if the employee can retire from the entity at any point and the ability to exercise the award does not depend on continued service. It further requires that the compensation cost for a stock option award attributable to an employee who will become eligible to retire during the vesting period be recognized over the period from the grant date to the date the employee becomes eligible to retire. This EIC became effective for the Company on October 1, 2006, and requires retroactive application to all stock-based compensation awards accounted for in accordance with the CICA Handbook Section 3870, Stock-Based Compensation and Other Stock-Based Payments. Previously, stock-based compensation was recognized over the applicable vesting period, without regard to the employee's retirement eligibility. The adoption of EIC 162 does not have a material impact on the Company's financial statements. INVESTMENT IN ATLANTIC QUEEN SEAFOODS. Effective April 6, 2006, the Company's ownership interest in Atlantic Queen Seafoods ("AQS") increased from 25% to 33 1/3% due to the cancellation of shares by another member of the AQS consortium. As a result, effective April 6, 2006, the Company's investment in AQS is accounted for using the Equity Method. Prior to April 6, 2006, this investment was accounted for on a Cost basis. The Company's change in ownership percentage does not impact the Company's operating results for the current or prior years, as the terms of the AQS Shareholders Agreement stipulate that all income be paid out in the normal course of operations. This consistently results in a net income position of $nil for AQS. FUTURE CHANGES IN ACCOUNTING POLICIES The Company is currently evaluating the following proposed guidelines of the CICA: FINANCIAL INSTRUMENTS-RECOGNITION AND MEASUREMENT, HEDGES AND COMPREHENSIVE INCOME. In April 2005, the Canadian Institute of Chartered Accountants released three new accounting standards related to "Financial Instruments - Recognition and Measurement," "Hedges" and "Comprehensive Income." These standards must be implemented no later than fiscal years beginning on or after October 1, 2006. Under the new standards, all financial instruments must be classified as held for trading, held to maturity, available for sale or loans and receivables. This classification determines how the financial instrument is measured and how gains and losses are recognized. The new standards require all derivatives to be recorded on the consolidated balance sheet at fair value. Off-balance sheet treatment is no longer permitted. The method of hedge accounting which was previously unspecified must now be specified. Under the new standards, gains and losses resulting from any ineffectiveness in hedging relationships are required to be identified, measured and recognized in income immediately. As well, other comprehensive income has been introduced where certain gains and losses are temporarily presented outside of income. The Company has considered all financial instruments, potential hedging relationships and the presentation of other comprehensive income and is prepared to adopt the standard on January 1, 2007. INVENTORY. The CICA issued an Exposure Draft of new Section 3031, "Inventories", with a view to replace Section 3031 of the same title. The proposals provide more guidance on the measurement and disclosure requirements for inventories. Specifically, they require inventories to be measured at the lower of cost and net realizable value, and provide guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realizable value. The proposed standards allow reversal of previous write-downs to net realizable value when there is a subsequent increase in the value of inventories. The proposals also provide guidance on the methods used to assign costs to inventories. The final standard is expected to be issued in early 2007 effective for interim and annual financial statements for fiscal years beginning on or after July 1, 2007 with earlier adoption encouraged. This standard may have an impact on the Company's accounting and reporting for inventories, including the determination of cost, the reversal of impairment write-downs and disclosure. The Company is currently evaluating the impact of this revision on its financial reporting. TRANSITION TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS). On January 10, 2006, the Canadian Accounting Standards Board (AcSB) ratified a strategic plan that will significantly impact financial reporting in Canada. The plan entails converging Canadian generally accepted accounting principles (GAAP) with IFRS over a five-year transitional period. The AcSB published an updated detailed implementation plan for achieving convergence in June 2006. This plan states a reporting deadline of the year 2011. At that point, Canadian GAAP will cease to exist as a separate, distinct basis of financial reporting for public companies. The Company will address the impact of the adoption of IFRS as and when the transition requirements become more clearly defined. The adoption of IFRS may have a material impact on the Company's financial statements. DISCLOSURE CONTROLS AND PROCEDURES Under the supervision and participation of Management, including the Chief Financial Officer of the Company, the Executive Vice President and Chief Operating Officer of the Primary Group division and the Executive Vice President Sales and Marketing of the US Marketing and Manufacturing Group division, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Multilateral Instrument 52-109, Certification of Disclosure in Issuers' Annual and Interim Filings ("MI 52-109"), as of December 31, 2006. As the Company did not have an individual designated as Chief Executive Officer of the consolidated Company at such date, the Executive Vice President and Chief Operating Officer of the Primary Group and Executive Vice President Sales and Marketing of the US Marketing and Manufacturing Group have signed and filed the Chief Executive Officer's Form 52-109F1 for the purposes of MI 52-109 as they performed similar functions to a Chief Executive Officer in respect of their operating divisions. Based on that evaluation, such officers concluded that the Company's disclosure controls and procedures are effective in making known to them material information relating to the Company and its consolidated subsidiaries required to be disclosed in the reports filed or submitted under MI 52-109. INTERNAL CONTROLS OVER FINANCIAL REPORTING During fiscal 2006, the Company continued the documentation and assessment of the design of internal controls over financial reporting. Similar to the evaluation of disclosure controls and procedures referred to above, the design of internal controls over financial reporting was evaluated as defined in Multilateral Instrument 52-109. Based on the results of this evaluation, the Chief Financial Officer of the Company, the Executive Vice President and Chief Operating Officer of the Primary Group division and the Executive Vice President Sales and Marketing of the US Marketing and Manufacturing Group division attest that the internal controls over financial reporting are effectively designed to provide reasonable assurance that its financial reporting is reliable and that the Company's consolidated financial statements are prepared in accordance with Canadian GAAP. Management also conclude that during the fiscal year ended December 31, 2006, no changes were made to internal controls over financial reporting that materially affect, or would be reasonably considered to materially affect these controls. CRITICAL ACCOUNTING ESTIMATES The preparation of the Company's consolidated financial statements in accordance with Canadian GAAP requires Management to make estimates and assumptions that affect the reported amounts of revenues and expenses during the period, the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements. On an ongoing basis, Management reviews its estimates. Underlying estimates and assumptions are based on historical experience and other factors believed by Management to be reasonable under the circumstances. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ materially from these estimates. The following accounting policies require Management's significant judgments and estimates regarding matters that are highly uncertain. A change in these estimates may have a significant impact on the Company's consolidated financial statements. As such, these estimates are considered critical. The following assessment of critical accounting estimates is not meant to be exhaustive. These estimates and assumptions are subject to change as new events occur, as more experience is acquired, as additional information is obtained and as the operating environment changes. The Company may realize different results from the application of new accounting standards promulgated, from time to time, by various rule-making bodies. CAPITAL ASSET AMORTIZATION. The Company's capital assets are carried at cost less accumulated amortization. Interest on debt incurred to finance the construction of a capital asset is included in the cost of the asset during the construction period. Amortization of capital assets is provided on a straight-line basis over their estimated useful lives. Management determines the useful life based on prior experience with similar assets. Assessing the reasonableness of the estimated useful lives of capital assets requires judgment and is based on currently available information. Changes in circumstances, such as technological advances, changes to the Company's business strategy or changes in the Company's capital strategy, may result in the actual useful lives differing from the Company's estimates. A change in the remaining useful life of an asset will affect the amortization rate used to amortize the asset and thus affect amortization expense as reported in the Company's results of operations. An increase of one year in the useful life of the Company's capital asset base would impact annual amortization expense by approximately $0.7 million. IMPAIRMENT OF LONG-LIVED ASSETS. In 2004, the Company adopted the recommendations of the CICA with respect to impairment of long-lived assets, which establishes new standards for the recognition, measurement and disclosure of the impairment of long-lived assets. An impairment loss is recognized on a long-lived asset when its carrying value exceeds the total undiscounted cash flows expected from its use and disposition. Before January 1, 2004, the amount of the loss was determined by deducting the asset's net recoverable amount (based on undiscounted cash flows expected from its use and disposition) from its carrying value. After January 1, 2004, the amount of the loss is determined by deducting the asset's fair value (based on discounted cash flows expected from its use and disposition) from its carrying value. The Company believes that accounting estimates related to impairment assessments are critical accounting estimates because: (i) they are subject to significant measurement uncertainty and are susceptible to change as management is required to make forward looking assumptions regarding market demand and pricing, cost of production, transportation costs, taxes and overhead costs, and (ii) any resulting impairment loss could have a material impact on the Company's consolidated income statement and the reported amount in the Company's consolidated balance sheet. If Management's best estimate of key assumptions, including assumptions in relation to labour contract negotiations and government discussions, were to change significantly and the associated estimated future cash flows were to materially decrease, FPI may experience future impairment charges and such charges may be material. For further details pertaining to the Company's impairment assessments during 2005 and 2006, refer to the section entitled "Other items" of this MD&A. GOODWILL IMPAIRMENT ASSESSMENT. Impairment of goodwill is assessed annually and when events or changes in circumstances indicate that goodwill might be impaired. In accordance with the CICA recommendations with regard to Goodwill and Other Intangible Assets, the annual goodwill impairment test involves a two step approach: 1) compare the fair value of a reporting unit with its carrying amount, including goodwill, to identify potential impairment. If the fair value of a reporting unit exceeds its carrying amount, goodwill is not impaired and the second step of the impairment test is unnecessary; and 2) if the carrying amount of a reporting unit exceeds its fair value, the fair value of the reporting unit's goodwill is compared with its carrying amount to measure the impairment loss, if any. The Company's reporting units are the Marketing and Manufacturing Group and the Primary Group. The Company completed its annual impairment test during the third quarter of fiscal 2006 for the goodwill recorded by the Primary Group on the acquisition of The Seafood Company. The first step of the annual goodwill impairment test required the Company to determine and compare the fair value of the reporting unit to its carrying value as of September 1, 2006. The fair value of the reporting unit was determined using the income approach. Under the income approach, the fair value of the reporting unit is calculated based on the present value of estimated future cash flows. The estimated fair value exceeds the carrying value of the reporting unit, resulting in no indication of impairment. Consequently, the second step of the impairment test is not required. Management believes that its estimates of future cash flows and fair values are reasonable. Assumptions used are consistent with internal planning and reflect best estimates based on factors including past operating results, budgets, economic projections, and market trends. These estimates, however, have inherent uncertainties that Management may not control. As a result, amounts reported for these items may be different if varied assumptions are contemplated or if conditions change. The Company continues to evaluate goodwill on an annual basis and whenever events and changes in circumstances may indicate potential impairment. INVENTORY VALUATION. The Company records a provision to reflect Management's best estimate of the net realizable value of inventory as at each consolidated balance sheet date. The Company reviews its inventory value in conjunction with its review of margins, aging of inventory, quality issues and overall inventory levels. The Company assesses the actual profit margins across the various inventory categories as compared to normal profit margins and determines the need for specific allowances. Management reviews the entire provision, to assess whether, based on economic conditions, it is adequate. At December 31, 2006, $2.7 million (2005; $2.0 million) is reserved against inventory. REVENUE RECOGNITION - SALES ALLOWANCES. The Company provides for estimated customer marketing costs including volume rebates, buying group rebates, and various other trade marketing costs. Sales allowances comprise a variety of customer spending/distributor incentives that serve to promote the movement of product through the channels of distribution. The Company utilizes internal software systems to calculate a liability against each sales transaction with a customer based on the programs in effect with the customer/distributor/broker. The volume of activity generates the level of the sales allowance. The utilization of demonstrations and coupons is an integral component of the Company's sales strategy. A pre-approved demonstration schedule is established with an agreed cost per location. Based on this information, an accrual is calculated. This accrual is primarily event related, with the remaining balance based on volume. Conversely, if a coupon is utilized, then an accrual can be established based upon best estimates and existing sales trends. The Company has considerable experience and history that allow a reasonable assessment of such estimates. PENSIONS AND OTHER POST-RETIREMENT BENEFITS. The Company has retirement plans that provide for defined benefits for all non-unionized employees other than certain employee groups in the U.S., Canada and Europe who are members of defined contribution plans. Effective December 31, 2006, the Company amended certain of its Canadian defined benefit pension plans, in particular the Primary Group and Marketing and Manufacturing Group plans, to provide a defined contribution accrual from January 1, 2007 onward for all members of those plans. The members of these plans were also given a one-time option to convert their accrued defined benefits under these plans to an opening balance in the new defined contribution provisions. The defined benefit plans are funded pension plans, and provide pensions based on final average earnings. In addition, the Company sponsors defined benefit life insurance and health care plans for eligible retired employees. Obligations under the employee benefit plans are accrued as the employees render the service necessary to earn the pension and other employee future benefits. The Company performs a valuation of the defined benefit plans at least every three years to determine the actuarial present value of the accrued pension and other retirement benefits. The cost of pensions and other post-retirement benefits earned by employees is actuarially determined using the projected benefit method prorated on services and Management's best estimates of expected plan investment performance, salary escalation, retirement ages of employees, and expected health care costs. While the Company's Management believes that these assumptions are reasonable, differences in actual results or changes in assumptions could materially affect employee benefit obligations and future net benefit plans costs. The two most significant assumptions used to calculate the net employee benefit plan costs are the discount rate used to determine the actuarial obligation of the plan and the expected long-term rate of return on plan assets. Discount Rate. The Company determines the appropriate discount rate at the end of each year. The discount rate was 5.25% at December 31, 2006, as consistent with that at December 31, 2005. This rate is determined based on Corporate AAA/AA long-term bond rates. The table below shows the impact on the net benefit plan expense, for the year ended December 31, 2006, resulting from a 0.25% increase and a 0.25% decrease in the discount rate. Expected Long-Term Rate of Return on Plan Assets. The Company assumes a rate of return on plan assets of 7.5%. Over the long-term, the actual rate of return has, on average, been in excess of this amount. The table below illustrates the impact on the net benefit plan expense for the year ended December 31, 2006, of a 0.25% increase and a 0.25% decrease in the expected long-term rate of return on plan assets. Sensitivity of Assumptions on Net Employee Benefit Plans Cost ------------------------------------------------------------------------- Rate Change Impact on Net Employee Benefit Plans Cost ------------------------------------------------------------------------- unaudited - in thousands 0.25% 0.25% Increase Decrease ------------------------------------------------------------------------- Discount rate $ (105) 272 Expected rate of return on plan assets 62 175 ------------------------------------------------------------------------- FAIR VALUE OF DERIVATIVE FINANCIAL INSTRUMENTS. The Company utilizes financial derivatives to manage its foreign currency and interest rate exposures. For details pertaining to derivative financial instruments refer to the section entitled "Financial Instruments" in this MD&A. The Company discloses the estimated fair value of open hedging contracts as at the end of a reporting period. The Company writes foreign currency options. These securities, which according to GAAP do not act as a fully effective hedge, and which mature over a short period of time, are stated at estimated quoted market prices. The estimate of fair value for interest rate and foreign currency hedges is determined primarily through quotes from financial institutions. SELECTED ANNUAL INFORMATION The following section provides historical financial data for the Company's three most recently completed financial years. This financial data is derived from the Company's audited consolidated financial statements as at and for the years ended December 31. Reference should be made to the audited financial statements, notes thereto and accompanying MD&A of such operating results. Historical Financial Data ------------------------------------------------------------------------- in thousands, except per share amounts 2006 2005 2004 ------------------------------------------------------------------------- Sales $ 752,850 833,661 800,401 Net income (loss) 1,915 (10,478) 4,440 Net income (loss) per common share Basic 0.13 (0.70) 0.29 Diluted 0.13 (0.70) 0.29 Total assets 421,770 538,076 465,459 Total long-term financial liabilities 110,909 93,973 100,061 Dividends declared per share - 0.05 0.20 ------------------------------------------------------------------------- Decreased sales in 2006, are reflective of the Company's continued focus throughout the year on reducing the procurement and sale of lower margin products. With this objective in mind, the Marketing and Manufacturing Group experienced lower sales of both globally sourced and value added products. Also contributing to a reduction in sales revenue is the appreciation of the Canadian dollar. The Primary Group's sales of globally sourced and value added product increased primarily due to the acquisition of The Seafood Company in 2005, and were partially offset by a decrease in sales of primary processed product, mainly in groundfish. The increased sales revenues in 2004 and 2005 reflect a continued trend of increasing revenues in the Marketing and Manufacturing Group, attributable to increased sales volumes in both globally sourced and value added shrimp products. The Primary Group's sales results were negatively impacted by the strengthening Canadian dollar, however, a hedging gain on the U.S. dollar cash inflows somewhat offset the impact on overall sales results. In 2005 the Company also acquired 100% of the outstanding shares of The Seafood Company. This acquisition contributed to the Company's increase in sales during 2005. Although net income increased in 2006, the Company's results continued to be significantly impacted by the appreciation of the Canadian dollar against the Pound Sterling, Euro, and U.S. dollar as it was in 2005. Further impacting net income for 2006 was the $2.1 million arbitration settlement recognized in the fourth quarter in relation to the delayed commencement of operation of the Newfoundland Lynx in 2004 and 2005, as previously discussed. Furthermore, an asset impairment charge of $0.5 million was recognized during the year, mainly representing a write-down in the carrying value of a vessel, the Newfoundland Otter, to fair value. The Company's financial results for 2005 were significantly impacted by charges of $1.8 million for the settlement of certain plant closure obligations. The Company also expensed $1.3 million of costs related to an income trust transaction involving its Marketing and Manufacturing Group segment, which was terminated. An asset impairment charge of $2.9 million was also recognized, which represented a write-down in the carrying value of primary processing facility to fair value. In 2004, the Company recognized an asset impairment charge of $4.8 million for the write-down to fair value of the carrying value of its primary processing facility at Harbour Breton, which was closed during the period. As well, in December 2004, the Company expensed $4.5 million of costs related to the proposed income trust transaction embarked upon during the year involving its Marketing and Manufacturing Group business unit. A pension settlement expense of $0.4 million was also recognized during the year. These significant events reduced earnings before taxes by $9.7 million. The increase in total assets in 2004 reflected continued investment in the Primary Group segment, including a new frozen-at-sea technology trawler delivered in 2004. There were also significant investments made in plant equipment and renovations during these years. The Company's increase in total assets in 2005 was primarily the result of the acquisition of The Seafood Company. The decrease in total assets in 2006 is related to the settlement for the cost overruns and business interruption losses incurred on Newfoundland Lynx in 2004 and 2005. Inventory also decreased due to Management's focus on reducing the Company's inventory position through reduced procurement, streamlined purchasing efforts, and decreased production in the Primary Group as a result of the ongoing internal review of groundfish operations, in addition to the weakening U.S. dollar. The decrease in long-term financial liabilities in 2005 reflects a lower expenditure on capital asset additions in the year. The acquisition of The Seafood Company was financed through short-term bank indebtedness. The Company experienced a significant increase in long-term financial liabilities in 2006 as a result of its refinancing of its short-term credit facility used to finance the acquisition of The Seafood Company, as previously discussed earlier in this report. OUTLOOK FOR 2007 The Company and its business and operations are subject to a number of risks and uncertainties. These risks and uncertainties, in addition to those described below, are described in detail in the Company's AIF filed with the Canadian securities regulatory authorities. The strategy of the Primary Group is to continue to seek to drive operational efficiencies with the view to achieving acceptable returns on the significant capital investments that have been made by the Company during the last number of years. Significant factors with respect to the availability of the natural resource, the stability of the U.S. dollar, Pound Sterling and Euro, the rising cost of fuel and the impact of low cost producers on the world marketplace, on an individual basis and in combination, have negatively impacted the Primary Group's business and will continue to negatively impact this business in 2007. Management continues to move forward aggressively on initiatives to improve productivity and reduce costs in several areas of the Primary Group's business in order to mitigate the impact of foreign currency fluctuations, the global competition and the availability of the natural resource. The business is achieving stronger sales volumes and increasing prices in certain of its shellfish and groundfish species. The Primary Group is committed to reducing harvesting and processing costs as well as administrative and selling costs and is aggressively targeting international market development to expand its customer base. A key factor in achieving acceptable and consistent performance is the stability of the inshore snow crab and coldwater shrimp industries in Newfoundland and Labrador, which require the maintenance of a structure and regulatory framework that is acceptable to all stakeholders. The Marketing and Manufacturing Group will build on the initiatives/disciplines that were undertaken/ adopted during 2006 to provide a more stable earnings performance during 2007. It is anticipated that there will be certain raw material challenges during the year. However, the Marketing and Manufacturing Group is anticipating that the impact of price increases, continued new product rollouts, combined with operational efficiencies should offset the earnings impact of the raw material issues. POTENTIAL SALE OF CERTAIN ASSETS In a series of announcements commencing January 11, 2007, the Company disclosed publicly that preliminary discussions had been held with several interested parties with respect to the potential sale of certain FPI assets. An Independent Committee of the Board of Directors was struck to evaluate these offers. National Bank Financial was engaged to assist and advise in this exercise. In accordance with its mandate, the Independent Committee reviewed the merits of each of these offers and prepared recommendations for the full Board of Directors. The Board subsequently met to consider the recommendations of the Independent Committee, and began a process of related discussions with the Government of Newfoundland and Labrador. Under provincial legislation, any associated transaction would require government approval. INVESTOR INFORMATION Financial and related information about the Company, including annual and quarterly reports, annual information forms, and press releases are available electronically on the Internet through SEDAR at www.sedar.com or on FPI's corporate website at www.fpil.com. CONSOLIDATED FINANCIAL STATEMENTS MANAGEMENT'S RESPONSIBILITIES FOR FINANCIAL REPORTING The accompanying consolidated financial statements were prepared by Management in accordance with Canadian generally accepted accounting principles, consistently applied, and include certain amounts based upon Management's best estimates and judgments. Any financial information contained elsewhere in the Annual Report conforms to the financial statements. Management is responsible for developing and maintaining the necessary systems of internal controls to provide reasonable assurance that transactions are authorized, assets safeguarded, and that the financial records form a reliable base for the preparation of accurate and timely financial information. The Board of Directors has established an Audit Committee, composed of three directors who are not officers or employees of the Company, to ensure that Management fulfills these responsibilities. The Audit Committee periodically meets privately with Management and the Company's external auditors to ensure that their respective responsibilities are properly discharged with respect to financial statement presentation and disclosure and recommendations on internal control. The Company's external auditors, Ernst & Young LLP, have audited the Company's consolidated financial statements in accordance with Canadian generally accepted auditing standards and their report follows. The external auditors have full unrestricted access to the Audit Committee to discuss their audit and their related findings as to the integrity of the financial reporting process. ON BEHALF OF THE COMPANY: (signature) (signature) (signature) Graham M. Roome Beverley A. Evans Keith A. Decker Executive Vice President and Chief Financial Executive Vice President Sales Officer and Marketing, Chief Operating Officer, US Marketing Primary Group and Manufacturing Group March 4, 2007 ERNST & YOUNG AUDITORS' REPORT TO THE SHAREHOLDERS We have audited the consolidated balance sheets of FPI Limited as at December 31, 2006, and 2005, and the consolidated statements of operations, retained earnings and cash flows for the years then ended. These consolidated 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 31, 2006, and 2005, and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. St. John's, Canada (signature) March 4, 2007 Chartered Accountants CONSOLIDATED BALANCE SHEETS As at December 31, ------------------------------------------------------------------------- dollars in thousands 2006 2005 ------------------------------------------------------------------------- Assets Current assets Cash $ 9,103 8,779 Accounts receivable (notes 4, 9 and 20) 79,573 107,615 Inventories (notes 4 and 9) 137,649 197,516 Prepaid expenses and other 4,744 9,509 Future income tax assets (note 14) 3,644 1,126 Capital assets held for resale (note 5) 10,647 - ---------------------- Total current assets 245,360 324,545 Capital assets (notes 5 and 10) 133,285 165,677 Future income tax assets (note 14) 12,837 16,047 Goodwill (notes 3 and 6) 10,447 9,171 Intangible assets (notes 3 and 6) 5,866 6,206 Other assets (note 8) 13,975 16,430 ---------------------- $ 421,770 538,076 ------------------------------------------------------------------------- Liabilities and Shareholders' Equity Current liabilities Bank indebtedness (note 9) $ 61,046 174,649 Accounts payable and accrued liabilities (note 20) 63,456 80,483 Current portion of long-term debt (note 10) 10,135 7,745 Future income tax liabilities (note 14) 1,212 2,355 Current deferred gains - 2,781 ---------------------- Total current liabilities 135,849 268,013 Long-term debt (note 10) 110,909 93,973 Deferred gains and other 1,988 2,143 Future income tax liabilities (note 14) 4,861 4,865 ---------------------- 253,607 368,994 ---------------------- Shareholders' equity Share capital (note 11) 46,564 49,292 Contributed surplus 67,386 69,251 Retained earnings 68,119 66,204 Foreign currency translation adjustment (note 13) (13,906) (15,665) ---------------------- 168,163 169,082 ------------------------------------------------------------------------- $ 421,770 538,076 ------------------------------------------------------------------------- Commitments and contingencies (note 18) See accompanying notes to consolidated financial statements. ON BEHALF OF THE BOARD: Eric F. Barratt Rex C. Anthony Chair, Audit Committee Chair, Board of Directors CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, ------------------------------------------------------------------------- dollars in thousands, except per share amounts 2006 2005 ------------------------------------------------------------------------- Sales $ 752,850 833,661 Cost of goods sold 669,299 762,958 ---------------------- Gross profit 83,551 70,703 Commission income 1,647 1,900 ---------------------- 85,198 72,603 Administrative and marketing expenses 49,878 56,343 Depreciation of capital assets 14,215 14,382 Amortization of intangible assets 1,057 361 Interest on bank indebtedness (note 9) 7,704 8,843 Interest on long-term debt (note 10) 7,554 6,708 Foreign exchange derivative loss (gain) (note 19) 1,726 (6,931) Impairment of capital assets (note 5) 464 2,866 Arbitration settlement (note 5) (2,139) - Gain on disposal of capital assets (note 5) (1,136) 126 Settlement of obligations for closed plants - 1,755 Write-off of income trust transaction costs - 1,300 ---------------------- Income (loss) before taxes 5,875 (13,150) Income tax expense (recovery) (note 14) 3,960 (2,672) ---------------------- Net income (loss) for the year $ 1,915 $ (10,478) ------------------------------------------------------------------------- Earnings (loss) per share (note 17): Basic $ 0.13 (0.70) Diluted $ 0.13 (0.70) ------------------------------------------------------------------------- See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Years ended December 31, ------------------------------------------------------------------------- dollars in thousands ------------------------------------------------------------------------- Retained earnings, beginning of year $ 66,204 77,444 Net income (loss) for the year 1,915 (10,478) ---------------------- 68,119 66,966 Dividends - 762 ---------------------- Retained earnings, end of year $ 68,119 66,204 ------------------------------------------------------------------------- See accompanying notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, ------------------------------------------------------------------------- dollars in thousands 2006 2005 ------------------------------------------------------------------------- Operations Net income (loss) $ 1,915 (10,478) Add (deduct) items not affecting cash Amortization 15,272 14,743 Future income tax (1,187) (2,528) Net (gain) loss on disposal of capital assets (1,136) 126 Foreign exchange derivative loss (gain) 1,726 (6,931) Stock option expense 237 360 Impairment of capital assets 464 2,866 Write-off of income trust transaction costs - 1,300 Changes in non-cash working capital balances related to operations Accounts receivable 29,318 (8,733) Inventories 64,135 (12,055) Prepaid expenses 2,028 1,127 Accounts payable and accrued liabilities (28,533) 6,448 Deferred (loss) gains on terminated forward contracts (2,781) 2,781 Foreign currency translation adjustments 821 8,719 Accrued benefit asset 299 329 ---------------------- Cash provided by (applied to) operating activities 82,578 (1,926) ------------------------------------------------------------------------- Investing Additions to capital assets (6,638) (11,205) Proceeds from disposal of capital assets 16,338 42 (Increase) decrease mortgages receivable (200) 71 Decrease deferred gains (397) (222) Premiums and funds received on foreign exchange derivative instruments 10,645 6,220 Acquisition (note 8) - (40,666) Income trust transaction costs - (1,300) Other investing activities 2,352 (3,096) ---------------------- Cash provided by (applied to) investing activities 22,100 (50,156) ------------------------------------------------------------------------- Financing Issue of long-term debt 34,996 3,641 Repayment of long-term debt (19,310) (9,851) Repayment of working capital credit facility - (124,495) Issue of working capital credit facility - 124,495 Change in bank indebtedness (115,835) 67,407 Dividends paid - (762) Issue of common shares 73 38 Repurchase of common shares (4,903) (3,768) ---------------------- Cash (applied to) provided by financing activities (104,979) 56,705 ------------------------------------------------------------------------- Effect of exchange rate changes on cash 625 (766) ------------------------------------------------------------------------- Change in cash position during the year 324 3,857 Cash position, beginning of year 8,779 4,922 ---------------------- Cash position, end of year $ 9,103 8,779 ------------------------------------------------------------------------- Supplemental cash flow information (note 21) See accompanying notes to consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2006, and 2005 (tabular amounts expressed in thousands of dollars except where otherwise noted) ------------------------------------------------------------------------- BASIS OF PRESENTATION FPI Limited ("FPI" or the "Company") is incorporated under The Corporations Act of the Province of Newfoundland and Labrador. The Company's business is the harvesting and global sourcing of raw material for processing into both primary and value added seafood in its primary and value added processing plants in North America and Europe. The Company also globally sources market-ready primary products for marketing directly to its customers. Sales, marketing, and distribution of products are carried on in Canada, the United States ("U.S."), Europe, Japan, China, and Southeast Asia. These consolidated financial statements include the accounts of the Company and those of its subsidiaries, together with the Company's proportionate share of the assets, liabilities, revenues, and expenses of a jointly controlled entity and a jointly controlled asset. 1. SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies of the Company and its consolidated subsidiary companies are set out below. These policies are in accordance with Canadian generally accepted accounting principles ("GAAP"). USE OF ESTIMATES. The preparation of the consolidated financial statements in accordance with Canadian GAAP requires Management to make estimates and assumptions based on currently available information. Such estimates and assumptions may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as at the reporting date, and the reported amounts of revenue and expenses during the fiscal period. Significant areas requiring the use of Management estimates include capital asset amortization and impairment assessment, goodwill impairment assessment, intangible asset amortization and impairment assessment, inventory valuation, allowance for doubtful accounts, allowance for customer marketing costs, pensions and other post-retirement benefits, and the fair value of derivative financial instruments. Actual results could differ from the estimates and assumptions used. REVENUE RECOGNITION. Sales are recognized in income when the related products have been shipped to customers and collection is reasonably assured. Revenue is recorded net of various customer marketing costs including volume rebates, buying group rebates, and various other trade marketing costs. COMMISSION INCOME. Commission income is recognized on sales arising from consignment arrangements entered into by the Company. INVENTORIES. Inventories of finished goods are valued at the lower of cost and net realizable value. Inventories of raw materials and supplies are valued at the lower of cost and replacement cost. Cost is determined on a weighted average basis. CAPITAL ASSETS. Capital assets are carried at cost. Interest on debt incurred to finance the construction of a capital asset is included in the cost of the asset during the construction period. Amortization of capital assets is provided on a straight-line basis over the following estimated useful lives of the assets: ------------------------------------------------------------------------- Years ------------------------------------------------------------------------- Buildings and wharves 8 - 50 Machinery and equipment 3 - 20 Vessels and vessel equipment 25 - 35 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Leasehold improvements are amortized over the term of the lease. VESSEL DRYDOCK COSTS. Estimated vessel drydock costs are provided for on a straight-line basis over the period to the next scheduled drydock. These provisions are recorded based on Management's best estimate of expected costs. These estimates could therefore vary by a material amount in the near term. Any variance between actual costs and amounts provided is accounted for in the consolidated statement of operations, in the period of the completion of the drydock. GOODWILL AND OTHER INTANGIBLE ASSETS. Goodwill represents the excess of the cost of investments in subsidiaries over the fair value of the net identifiable tangible and intangible assets acquired. Goodwill is not amortized. The Company reviews goodwill on at least an annual basis to ensure its fair value is in excess of its carrying value. Any impairment in the value of goodwill is charged to income in the period such impairment is determined. Other intangible assets are amortized on a straight-line basis over the expected period of benefit. Intangible assets are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. An impairment loss is recognized when estimated undiscounted cash flows expected to result from the use of the asset plus net proceeds expected from the disposition of the asset (if any) are less than the carrying value of the asset. When an impairment loss is recognized, the carrying amount of the asset is reduced to its estimated fair value. DEFERRED FINANCING COSTS. Transaction costs pertaining to the issue of term debt are deferred and amortized over the term of the debt. Amortization of these deferred charges is included in interest expense. FOREIGN CURRENCY TRANSLATION. The majority of the Company's foreign subsidiary operations are classified as self sustaining operations. Assets and liabilities are translated at exchange rates in effect at the balance sheet date. Revenues and expenses are translated at average exchange rates prevailing during the year. The resulting net gains or losses, together with those related to short-term and long-term borrowings in U.S. dollars ("USD") and designated as a hedge of the self-sustaining foreign subsidiary operations, are accumulated in a separate component of shareholders' equity, described in the consolidated balance sheets as foreign currency translation adjustment. These transactions are accounted for as hedges to the extent that they are designated as, and effective as, hedges of the net investment in the self-sustaining operations. The Company's foreign subsidiary sales operation based in Germany is classified as an integrated operation. Exchange gains or losses arising on the translation of the current and long-term monetary items of this operation are included in the determination of net income. Non-monetary assets and liabilities of this integrated operation are translated at historical exchange rates. EMPLOYEE FUTURE BENEFITS. For the year ended December 31, 2006 the Company has retirement plans that provide for defined benefits for all non-unionized employees, other than certain employee groups in the U.S., Canada and Europe who are members of defined contribution plans. Effective December 31, 2006, the Company amended certain of its Canadian defined benefit pension plans, in particular the Primary Group and Marketing and Manufacturing Group plans, to provide a defined contribution accrual from January 1, 2007 onward for all members of those plans. The members of these plans were also given a one-time option to convert their accrued defined benefits under these plans to an opening balance in the new defined contribution provisions. The defined benefit plans are funded pension plans and provide pensions based on final average earnings. In addition, the Company sponsors defined benefit life insurance and health care plans for eligible retired employees. Obligations under the employee benefit plans are accrued as the employees render the service necessary to earn the pension and other employee future benefits. The Company's policies for accounting for future employee benefits are as follows: - The cost of pensions and other retirement benefits earned by employees is actuarially determined using the projected benefit method prorated on services and Management's best estimates of expected plan investment performance, salary escalation, retirement ages of employees, and expected health care costs. - For the purpose of calculating 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 life of employees active at the date of amendment. - The excess of the net actuarial gain (loss) over 10% of the greater of the accrued benefit obligation and the fair value of plan assets is amortized over the average remaining service life of active employees. - When a restructuring of a benefit plan gives rise to both a curtailment and a settlement of obligations, the curtailment is accounted for prior to settlement. INCOME TAXES. The Company follows the liability method of accounting for income taxes. Under this method, future income tax assets and liabilities are determined based on the differences between the financial reporting and tax basis of assets and liabilities and are measured using substantively enacted tax rates and laws that are expected to be in effect in the periods in which the future tax assets or liabilities are expected to be realized or settled. 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. Current income tax expense is recognized for the estimated income taxes payable for the current year. STOCK-BASED COMPENSATION PLANS. The Company has stock-based compensation plans for directors, executives, and certain senior managers, which are described in note 12. The Company records compensation expense upon issuance of stock options to employees calculated using the fair value method. Compensation expense recognition commences when stock options are issued, with full recognition over the estimated vesting period. The expense to be amortized over the vesting period is determined using the Black-Scholes model. As permitted under the CICA accounting standard for Stock-Based Compensation and Other Stock-Based Payments, the Company does not record compensation expense for stock options granted to employees under its own stock option plan prior to January 1, 2003. However, as required by the CICA standard, the Company discloses the pro-forma net income and pro-forma earnings per share using the fair market value method of accounting for stock-based compensation awards for those awards issued during the 12 months ended December 31, 2002. This pro-forma information is presented in note 17. The compensation cost attributable to options and awards granted to employees who are eligible to retire or will become eligible to retire during the vesting period is recognized immediately if the employee is eligible to retire on the grant date or over the period between the grant date to the date the employee becomes eligible to retire. EARNINGS PER SHARE. The Company follows the treasury stock method of calculating diluted earnings per share. Accordingly, diluted earnings per share is computed based on the weighted average number of common shares outstanding and dilutive common share equivalents. ASSET RETIREMENT OBLIGATION. The fair value of legal obligations associated with the retirement of tangible long-lived assets is recognized in the financial statements in the period in which the liability is incurred. Upon initial recognition of a liability for an asset retirement obligation, a corresponding asset retirement cost is added to the carrying amount of the related asset, which is subsequently amortized to income over the remaining useful life of the asset. Following the initial recognition of an asset retirement obligation, the carrying amount of the liability is increased for the passage of time by applying an interest method of allocation to the liability with a corresponding accretion cost reflected in operating expenses. Revisions to either the timing or the amount of the original estimate of undiscounted cash flows are recognized each period as an adjustment to the carrying amount of the asset retirement obligation and the related long-lived asset. IMPAIRMENT OF LONG-LIVED ASSETS. Impairment of long-lived assets is assessed using a two-step approach. Under the first step, the impairment of capital assets and finite-life intangible assets is tested when events or changes in circumstances indicate that the asset's carrying value is not recoverable and may be in excess of its fair value. The carrying amount of a long-lived asset is not recoverable if its carrying value exceeds the sum of the undiscounted cash flows expected to result from its use and eventual disposition. If the asset's carrying amount is in excess of the undiscounted cash flows, step two of the asset impairment test must be performed. Under step two of the test, impairment is measured as the excess of an asset's carrying value over fair value. Fair value is measured using a discounted cash flow approach. FINANCIAL INSTRUMENTS. Hedging Relationships. 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. Changes in the fair value of the derivative must be highly effective in offsetting either changes in the fair value of on-balance sheet items or changes in the amount of future cash flows. Hedge effectiveness is evaluated at the inception of the hedge relationship and on an ongoing basis, both retrospectively and prospectively, using critical terms method and quantitative statistical measures of correlation. If a hedge relationship is found to be no longer effective, the derivative is no longer designated as a hedge. If the designated hedged item matures or is sold, extinguished or terminated, the derivative is reclassified with subsequent changes in fair value being reported in income on a mark-to-market basis. Forward Contracts and Option Agreements. The Company periodically enters into forward foreign exchange contracts and option agreements to buy or sell various foreign currencies in order to limit exposure to exchange rate fluctuations on foreign currency cash inflows and outflows. Foreign currency cash flow may be hedged up to a maximum of 100%, 24 months into the future. Gains or losses on translation of the hedge transactions are recognized in income in the same period as gains and losses on the underlying transactions are recognized. Interest Rate Risk Management. The Company periodically enters into interest rate swap agreements to hedge the impact of rate changes on bank indebtedness and long-term debt. The terms of these contracts generally match the terms associated with the underlying debt instruments. These contracts are used to fix the interest rates on the variable rate debt. Interest to be paid or received under such swap contracts is recognized over the life of the contracts as adjustments to interest expense. The Company enters into bond forward contracts to hedge against interest rate fluctuations during the negotiation of debt financing. Premiums received on bond forwards are classified as deferred gains and other on the consolidated balance sheets. Settlements paid on bond forwards are classified as deferred charges on the consolidated balance sheets. The deferred gains or deferred charges are amortized over the life of the debt to which it relates and is recorded as an adjustment to interest expense. Derivative Financial Instruments Outside Hedging Relationships. Certain derivative financial instruments held by the Company during 2005 and 2006 do not qualify as hedging instruments. These instruments are accounted for using the mark-to-market method. Under the mark-to-market method of accounting, contracts are recorded at fair value in the balance sheet. Changes in the balance sheet accounts result primarily from changes in the valuation of the portfolio of contracts, new transactions, and the maturity and settlement of certain contracts. The market prices used to value these transactions reflect Management's best estimate considering various factors including closing exchange and over-the-counter quotations, time value, and volatility factors underlying the commitments. Net gains and losses recognized in a period are separately disclosed in the statements of operations. GOVERNMENT ASSISTANCE. Government grants received on the acquisition of capital assets are recorded in deferred gains and other and recognized in income on the same basis as the amortization of the capital assets to which they relate. RESEARCH AND PRODUCT DEVELOPMENT EXPENSES. Research costs are charged to expense as incurred. Development costs are charged to expense as incurred unless they meet generally accepted accounting criteria for deferral and amortization. In the opinion of Management, no development costs incurred to date meet all the criteria for deferral and amortization. Therefore, all development costs have been expensed as incurred. 2. CHANGES IN ACCOUNTING POLICY STOCK-BASED COMPENSATION FOR EMPLOYEES ELIGIBLE TO RETIRE BEFORE THE VESTING DATE. The Company has adopted the recommendations of Emerging Issues Committee Abstract 162, "Stock-based compensation for employees eligible to retire before the vesting date" (EIC 162) for the period ended December 31, 2006. The abstract requires that the compensation cost for a stock option attributable to an employee who is eligible to retire at the grant date be recognized on the grant date if the employee can retire from the entity at any point and the ability to exercise the award does not depend on continued service. It further requires that the compensation cost for a stock option award attributable to an employee who will become eligible to retire during the vesting period be recognized over the period from the grant date to the date the employee becomes eligible to retire. This EIC became effective for the Company on October 1, 2006, and requires retroactive application to all stock-based compensation awards accounted for in accordance with the CICA Handbook Section 3870, Stock-Based Compensation and Other Stock-Based Payments. Previously, stock-based compensation was recognized over the applicable vesting period, without regard to when an employee was eligible to retire. The adoption of EIC 162 did not have a material impact on stock-based compensation expense recorded by the Company in current or prior years. INVESTMENT IN ATLANTIC QUEEN SEAFOODS. Effective April 6, 2006, the Company's ownership interest in Atlantic Queen Seafoods ("AQS") increased from 25% to 33 1/3% due to the cancellation of shares by another member of the AQS consortium. As a result, effective April 6, 2006, the Company's investment in AQS is accounted for using the Equity Method. Prior to April 6, 2006, this investment was accounted for on a Cost basis. The Company's change in ownership percentage does not impact the operating results for the current or prior years, as the terms of the AQS Shareholders Agreement stipulate that all income be paid out in the normal course of operation. This consistently results in a net income position of $nil for AQS. 3. BUSINESS ACQUISITION Effective September 2, 2005, the Company acquired 100% of the outstanding shares of The Seafood Company Limited, a privately held, importer, processor and distributor of premium chilled and frozen shellfish products in the United Kingdom retail marketplace for total consideration, including transaction costs, of pnds stlg 18,887,000 (CAD $41,329,000). The acquisition was accounted for using the purchase method and was classified as a self-sustaining foreign operation. The following table summarizes the purchase price allocation which was based on the estimated fair values of assets acquired less liabilities assumed for the acquisition translated at the exchange rate at the date of acquisition. ------------------------------------------------------------------------- ------------------------------------------------------------------------- Purchase Consideration ------------------------------------------------------------------------- Fair value of assets acquired Current assets $ 31,611 Capital assets 11,808 Intangible - customer relationships 6,565 Intangible - favourable lease terms 608 ------------------------------------------------------------------------- 50,592 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Less: liabilities assumed Current liabilities 13,366 Long-term future income tax liabilities 4,435 Other long-term liabilities 1,344 ------------------------------------------------------------------------- 19,145 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Fair value of net assets acquired 31,447 Goodwill 9,882 ------------------------------------------------------------------------- Purchase consideration 41,329 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Consideration Cash 39,196 Notes payable 663 Acquisition costs 1,470 ------------------------------------------------------------------------- $ 41,329 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The guaranteed redeemable notes payable have a maturity date of September 2008 and a LIBOR floating interest rate based on London Interbank Market deposit rate. The noteholders have the right to require the Company to redeem the notes, either in full or in an amount of principal as specified in the relevant Notice of Repayment, at par together with any interest outstanding, on April 30, 2006, or on any interest payment date which falls after April 30, 2006. Such rights shall be exercised by the noteholders giving written notice to the Company at least 30 days prior to April 30, 2006 or to the relevant interest payment date. The Company may, by agreement with the noteholders, purchase any notes in whole or in part at the nominal amount plus accrued and unpaid interest at any time or on such other terms as may be agreed. As at December 31, 2006 the Company's notes payable balance is $89,000 (2005; $606,600) as the maturity of these notes were redeemed during 2006 at the request of certain loan holders as per the aforementioned terms and conditions. 4. CURRENT ASSETS ACCOUNTS RECEIVABLE ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Trade $ 65,595 92,331 Income tax 56 647 Consignment sales (note 20) 3,007 6,896 Mortgages (note 8) 1,607 1,505 Arbitration settlement receivable (note 5) 3,643 - Other 5,665 6,236 --------------------- $ 79,573 107,615 ------------------------------------------------------------------------- ------------------------------------------------------------------------- INVENTORIES ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Finished goods $ 106,763 151,721 Raw materials and supplies 30,886 45,795 ---------------------- $ 137,649 197,516 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 5. CAPITAL ASSETS ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Buildings, wharves and land $ 76,870 73,644 Machinery and equipment 135,559 134,783 Vessels and vessel equipment 49,623 90,819 ---------------------- 262,052 299,246 ------------------------------------------------------------------------- Less accumulated depreciation Buildings and wharves $ 38,254 34,779 Machinery and equipment 89,209 82,674 Vessels and vessel equipment 2,264 17,237 ---------------------- 129,727 134,690 ------------------------------------------------------------------------- Deactivated plants, vessels and vessel equipment 960 1,121 ------------------------------------------------------------------------- Net book value $ 133,285 165,677 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Included in vessels and vessel equipment is an amount of $5,869,000 pertaining to two vessels purchased by the Company in the second half of 2006 and held in escrow as of December 31, 2006. Depreciation charges have not been recognized on these vessels in the year. In December 2006, pursuant to a claim against the shipyard contracted to construct the motor vessel, the Newfoundland Lynx, the Company received the report of the arbitrator, The London Court of International Arbitration. The Company's claim included costs for additional work and warranty associated with the completion of the vessel and consequential direct and indirect losses. The award, totalling $3,643,000, specified $1,504,000 as relating to the vessel completion which has been applied to the cost of the vessel, $1,899,000 for direct and indirect losses associated with the 2004 and 2005 fiscal years and interest of $240,000. In the fourth quarter of 2006, the Company disposed of one of its vessels, the Newfoundland Marten. A gain of $1,044,000 was recognized on disposal. Also included in the gain on disposal of capital assets are gains on the disposition of the Triano and Ruby Elaine. Excluded from the above is a vessel held for resale of $10,647,000 which is recorded in current assets. Subsequent to year-end this vessel was sold for cash. The Company recognized an asset impairment charge in 2006 of $419,000 representing a write-down in the carrying value of this vessel to fair value, as the condition of impairment existed at year-end. This loss, in addition to losses recognized on certain other of the Company's long-lived assets, is recorded in impairment of capital assets. During 2005, the Company recognized an asset impairment charge of $2,866,000 representing a write-down to fair value of the carrying value of a primary processing facility. The fair values of the impaired assets were determined based on expected future discounted cash flows. 6. GOODWILL AND OTHER INTANGIBLE ASSETS GOODWILL Goodwill represents the excess of the cost of investments in subsidiaries over the fair value of the net identifiable tangible and intangible assets acquired. In connection with the annual goodwill impairment evaluation specified by CICA Section 3062, the Company completed its annual impairment test during the third quarter of 2006 for the goodwill that had been recorded by the Company's Primary Group, the operation of which collectively comprise a reporting unit, on the acquisition of The Seafood Company. The first step of the annual goodwill impairment test required the Company to determine and compare the fair value of the reporting unit to its carrying value as of September 1, 2006. The fair value of the reporting unit was determined using the income approach. Under the income approach, the fair value of the reporting unit is calculated based on the present value of estimated future cash flows. The estimated fair value exceeded the carrying value of the reporting unit, resulting in no indication of impairment. Consequently, the second step of the impairment test was not required. The Company will continue to evaluate goodwill on an annual basis and whenever events and changes in circumstances indicate that there may be a potential impairment. The change in goodwill is attributable to translating the Pound Sterling denominated goodwill to the Canadian dollar reporting currency. FINITE-LIFE INTANGIBLES ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Accumulated Amorti- Net book Net book Cost zation value value ------------------------------------------------------------------------- Customer relationships $ 6,847 1,526 5,321 5,672 Favourable lease terms 629 84 545 534 ------------------------------------------------------------------------- $ 7,476 1,610 5,866 6,206 ------------------------------------------------------------------------- Customer relationships and favourable lease terms are intangible assets that have a limited life. The customer relationships intangible asset represents the underlying worth of the Company's customer relationships, the ability of customers to generate revenues beyond an initial sale, and are being amortized on a straight-line basis over the expected period of benefit of six years. The favourable lease terms intangible asset represents lease terms that are more favourable than those currently available in the marketplace, and is being amortized on a straight-line basis over the expected period of benefit of ten years. Aggregate amortization expense related to intangible assets for the year ended December 31, 2006 was $1,057,000 (December 31, 2005; $361,000). Changes in finite-life intangibles balances result from translating the Pound Sterling denominated intangible assets to the Canadian dollar reporting currency as well as amortization. 7. JOINT VENTURES JOINTLY CONTROLLED ENTITY. The Company has a 25% interest in a jointly controlled entity, Katsheshuk Fisheries Limited ("KFL"). The consolidated financial statements include the Company's proportionate share of the assets, liabilities, revenues, and expenses of the entity, the material elements of which are as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Current assets $ 531 341 Capital assets, net book value 3,394 3,540 ---------------------- $ 3,925 3,881 ------------------------------------------------------------------------- Current liabilities $ 1,481 936 Long-term liabilities 2,042 2,207 ---------------------- $ 3,523 3,143 ------------------------------------------------------------------------- Sales $ 2,852 1,488 Expenses 3,188 1,975 ---------------------- Net (loss) $ (336) (487) ------------------------------------------------------------------------- Cash flow generated from (applied to): Operating activities $ 280 19 Investing activities $ (68) (84) Financing activities $ (165) (28) ------------------------------------------------------------------------- The Katsheshuk II, a vessel owned and operated by KFL, was financed through two term loans totalling $13,100,000, shareholder loans totalling $2,000,000, and $612,000 of working capital. During 2005, KFL entered into additional shareholder loans of $1,200,000 to fund vessel refit work. Of the $3,200,000 of total shareholder loans, the Company contributed $800,000, its proportionate amount. The term loans mature in September 2008 and September 2013 and have an effective interest rate of 5.8% (after considering the interest rate swaps that fixed the interest rate) and are secured by a first marine mortgage on the vessel. The term loans are also secured by a guarantee of the joint venturers for $2,000,000. The Company's share of the guarantee is $667,000 (one third of the guaranteed amount). JOINTLY CONTROLLED ASSET. A vessel that was acquired in 2004 and had been undergoing modification and refurbishment, commenced operations in the third quarter of 2005. The vessel is a jointly controlled asset, in which the Company has a 40% ownership interest. The Company records its share of the jointly controlled asset as well as its share of liabilities and expenses pertaining to the ongoing operations and maintenance of the vessel, the material elements of which are as follows: ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Capital assets, net book value $ 4,420 4,587 ------------------------------------------------------------------------- Current liabilities $ 505 1,536 Long-term liabilities 2,283 2,414 ---------------------- $ 2,788 3,950 ------------------------------------------------------------------------- Sales $ - - Expenses 549 243 ---------------------- Net loss $ (549) (243) ------------------------------------------------------------------------- Cash (applied to) generated from: Operating activities $ (1,410) (164) Investing activities $ (3) (2,118) Financing activities $ (131) 2,545 ------------------------------------------------------------------------- 8. OTHER ASSETS ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Accrued benefit asset (note 15) $ 7,639 7,917 Mortgages receivable 1,526 1,429 Deferred financing costs, less accumulated amortization of $2,547,000 (2005; $1,216,000) (note 9 and 10) 3,984 4,747 Deferred bond forward contract costs (note 10) 735 867 Foreign exchange derivative asset (note 19) - 880 Other 91 590 ---------------------- $ 13,975 16,430 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Mortgages receivable represents advances to independent fish harvesters and are secured by vessels. The current portion of mortgages receivable included in accounts receivable amounts to $1,607,000 (2005; $1,505,000). Mortgages receivable bear interest at rates that fluctuate with prime and have repayment terms up to seven years. The carrying amount of the mortgages receivable approximates fair value based on the variable interest rates charged on the mortgages. Repayment terms for mortgages receivable are based on the Company retaining between 5 to 30 percent of the value of the vessel landings. 9. BANK INDEBTEDNESS At December 31, 2006, the Company had $61,046,000 (2005; $174,649,000) outstanding in bankers acceptance and bank operating loans bearing interest at rates ranging from 6.0% to 8.75% (2005; 4.0% to 7.16%), which are classified as bank indebtedness on the balance sheet. The Company's credit facility, a syndicated facility with a group of lenders, is secured primarily by inventory and receivables and has a maximum credit limit of $148,000,000, subject to availability under a defined borrowing base. This credit facility bears interest at variable rates, based on the Canadian prime rate and bankers acceptance rates for Canadian dollar loans, and base rates and LIBOR rates for U.S. dollar loans. The syndicated credit facility includes a capacity for letters of credit, foreign exchange contracts, and interest rate swap contracts. In the second quarter of 2006, the Company refinanced its secured credit facility, which was used to finance the acquisition of The Seafood Company during September 2005. The refinanced secured credit facilities consist of: (i) a three year term loan facility of up to 11,000,000 pnds stlg (CAD $25,106,400) at an interest rate of LIBOR plus an applicable margin; and (ii) a three year revolving credit facility of 11,500,000 pnds stlg (CAD $26,247,600) at an interest rate of LIBOR plus an applicable margin. In the fourth quarter of 2006, the Company amended the aforementioned revolving credit facility and was granted a temporary increase in the amount of 7,500,000 pnds stlg (CAD $17,118,000) to a maximum of 19,000,000 pnds stlg (CAD $43,365,600) which expires in April 2007. Of the total drawn revolving credit facility of 14,462,000 pnds stlg (CAD $33,008,069), the amount of 6,000,000 pnds stlg (CAD $13,694,400) has been excluded from current liabilities because the Company intends that at least that amount would remain outstanding under this agreement for an uninterrupted period extending beyond one year from the balance sheet date. The remaining balance of 8,462,000 pnds stlg (CAD $19,313,669) is included in bank indebtedness. The new credit facility is secured by the shares of The Seafood Company. Balances previously disclosed have been revalued as at the date of this balance sheet. Bank indebtedness denominated in foreign currencies at December 31, 2006 amounted to USD $31,826,000 (2005; USD $81,670,000) and 8,462,000 pnds stlg (2005; pnds stlg 20,696,000). Transaction costs in the amount of 162,150 pnds stlg (CAD $370,100) pertaining to the aforementioned refinancing have been deferred and are being amortized over the three-year term of the credit facilities. The commercial terms of the credit facilities included a front end fee of 0.25% of the facility amounts for a total fee of 56,250 pnds stlg (CAD $128,400). This amount was deferred and is being amortized over the three year term of the credit facilities. Deferred costs in connection with credit facilities in place prior to June 30, 2006 of 44,500 pnds stlg (CAD $93,000) were written off in the third quarter of 2006. In addition, the Company continued to amortize deferred financing costs pertaining to its North American syndicated credit facility in 2006. Interest on bank indebtedness in the consolidated statement of operations includes amortization of deferred financing costs of $1,031,000 for the fifty-two weeks ended December 31, 2006 (2005; $491,000). 10. LONG-TERM DEBT ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- 6.38% marine mortgage maturing in 2024 (2006 - USD $10,523; 2005 - USD $11,133) $ 12,262 12,980 6.23% secured bank term loan maturing in 2013 23,512 24,937 4.85% secured bank term loan maturing in 2013 (2006 - USD $11,765; 2005 - USD $13,575) 13,710 15,827 5.68% - 6.54% secured bank term loan maturing in 2013 21,302 22,499 7.74% marine mortgage maturing in 2012 9,303 10,610 Atlantic Canada Opportunities Agency non-interest bearing unsecured loan, advanced to date 500 388 Secured bank term loan facility maturing in 2009 (2006 - 10,686 pnds stlg; 2005 - nil pnds stlg) 24,390 - Secured revolving credit facility maturing in 2009 (2006 - 6,000 pnds stlg; 2005 - nil pnds stlg) 13,694 - Joint venture debt (proportionate amount) 2,371 2,534 6.36% marine mortgage maturing in 2015 (2006 - USD $ nil; 2005 - USD $10,244) - 11,943 ---------------------- $ 121,044 101,718 Less current portion 10,135 7,745 ---------------------- $ 110,909 93,973 ------------------------------------------------------------------------- The bank term loan is a three-year credit facility secured by the shares of The Seafood Company and bears interest at LIBOR plus an applicable margin. This term loan is repayable in quarterly principal installments of 275,000 pnds stlg (CAD $628,000) until June 2007, 412,500 pnds stlg (CAD $942,000) until June 2008, 687,500 pnds stlg (CAD $1,569,000) until June 2009 with the remaining principal due upon maturity. As previously discussed in Note 9, pnds stlg 6,000,000 (CAD $13,694,400) of the 11,500,000 pnds stlg (CAD $26,247,600) three-year revolving credit facility has been included in long-term debt. This facility is secured by the shares of The Seafood Company and bears interest at LIBOR plus an applicable margin. There are no set terms of principal repayment of this facility over the three years to its maturity. The 6.23% and 4.85% secured bank term loans are ten-year term floating interest rate credit facilities entered into through a refinancing arrangement in 2003 and are secured by certain capital assets of the Company. The floating interest rates before the effect of interest rate swaps on these facilities as at December 31, 2006 were 5.57% and 6.58%, respectively. The Company entered into interest rate swaps to fix the interest rates for the first five years of these two facilities, resulting in effective interest rates of 6.23% and 4.85%, respectively. The 6.23% term loan is repayable in quarterly principal installments of $356,000 until the third quarter of 2008 when the quarterly payment increases to $1,069,000. The 4.85% term loan is repayable in quarterly principal installments of $528,000 (USD $453,000). The 5.68% - 6.54% secured bank term loan is a ten-year term floating interest rate credit facility for plant revitalization, which is secured by certain capital assets of the Company. The floating interest rate on this facility as at December 31, 2006, was 5.67%. An interest rate swap held on all draws, with the exception of one, on this facility results in an effective interest rate of 6.33%. This facility was fully drawn in 2006. This term loan is repayable in quarterly principal installments of $313,000 until 2008. The quarterly payment increases to a maximum of $1,070,000 in 2011. The 6.38% (after considering the impact of a bond forward hedging contract) marine mortgage has a ten-year term with an amortization period of 20 years, and is secured by a first marine mortgage on the vessel that has a carrying value of $18,962,000 (2005; $21,285,000). Proceeds from this term financing were used to finance the construction of the Newfoundland Lynx, which commenced operations in the fourth quarter of 2004. The 6.38% marine mortgage is repayable in quarterly principal installments of CAD $178,000 (USD $153,000). In the fourth quarter of 2006, the Company extinguished the 6.36% marine mortgage, which had been used to finance the Newfoundland Marten. A fee of $260,000 was incurred by the Company in relation to the early extinguishment of this mortgage, which was due to mature in 2015. The 7.74% marine mortgage is secured by a vessel that has a carrying value of $14,055,000 (2005; $14,666,000). The 7.74% marine mortgage is repayable in blended monthly payments of principal and interest in the amount of $174,000. The Atlantic Canada Opportunities Agency ("ACOA") debt facility of $500,000 is repayable in sixty equal monthly payments commencing April 1, 2007. The funding was used to upgrade the secondary processing facility in Burin. Annual principal repayments of long-term debt are as follows: ------------------------------------------------------------------------- 2007 $ 10,135 2008 14,114 2009 29,656 2010 13,301 2011 13,705 Thereafter 40,133 ------------------------------------------------------------------------- $ 121,044 ------------------------------------------------------------------------- The estimated fair value of the Company's long-term debt, including the current portion, at December 31, 2006, and 2005, was $119,993,000 and $99,845,000, respectively. Fair value has been estimated based on discounting expected future cash flows at the discount rates that represent borrowing rates presently available to the Company for loans with similar terms and maturities. Included in interest on long-term debt is the amortization of deferred gains pertaining to a bond forward in the amount of $64,000 (2005; $74,000), the amortization of deferred costs pertaining to a hedge on a long-term debt in the amount of $132,000 (2005; $139,000), and the amortization of deferred financing costs of $300,000 (2005; $254,000) pertaining to the credit facilities. 11. SHARE CAPITAL AUTHORIZED. Unlimited number of voting common shares without par value. Unlimited number of non-voting preference shares without par value, issuable in series. ISSUED. ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Number of Number of Common Stated Common Stated Shares Capital Shares Capital ------------------------------------------------------------------------- Balance, beginning of year 14,759,730 $ 49,292 15,248,879 $ 50,901 Issued under employee and executive share purchase plans for cash 15,085 73 5,451 38 Repurchased by the Company (841,062) (2,801) (494,600) (1,647) ------------------------------------------------------------------------- Balance, end of year 13,933,753 $ 46,564 14,759,730 $ 49,292 ------------------------------------------------------------------------- ------------------------------------------------------------------------- SHARE REPURCHASE. The Company acquired 841,062 (2005; 494,600) common shares pursuant to a normal course issuer bid in 2006. These shares were purchased for cancellation at an aggregate cost of $4,903,000 (2005; $3,768,000), of which $2,801,000 (2005; $1,647,000) was charged to share capital, based on the average per share amount in the share capital account at the date of purchase, and the balance of $2,102,000 (2005; $2,121,000) was charged to contributed surplus. Included in the 841,062 shares repurchased by the Company are 41,700 shares which had not been cancelled at December 31, 2006. These shares had an aggregate cost of $298,000 of which $139,000 was charged to share capital and $159,000 was charged to contributed surplus. These shares were cancelled subsequent to year-end. In December 2006, the Company announced a renewal of the normal course issuer bid pursuant to which the Company could purchase up to 701,806 of its common shares. Included in the 841,062 shares repurchased in 2006 are 103,100 shares that the Company acquired as at December 31, 2006 pursuant to the share repurchase program that commenced in December 2006. 12. STOCK-BASED COMPENSATION PLANS 2000 PERFORMANCE STOCK OPTION PLAN. Under the 2000 Performance Stock Option Plan, the Company may grant options to directors, executives and certain senior managers for up to 1,395,000 common shares. The Company has 568,500 shares remaining to be granted under this stock option plan. The exercise price of each option will be the closing market price of the common shares on the trading day immediately preceding the date of grant. These options have a maximum term of ten years and vest as to 20% when the market price has increased 12% over the exercise price, and exceeds that level for 20 consecutive trading days, and an additional 20% of options for each additional 12% increase in the market price. Options that have not vested within five years after the date of grant will expire. A summary of the status of the Company's performance stock option plan as of December 31, 2006, and 2005, and changes during the years ended on those dates, is presented below. ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Weighted Weighted Average Average Number of Exercise Number of Exercise Options Price Options Price ------------------------------------------------------------------------- Outstanding at beginning of year 1,273,200 $ 8.68 1,228,500 $ 8.81 Granted - - 147,700 7.77 Forfeited (464,500) 8.77 (103,000) 9.01 Outstanding at end of year 808,700 $ 8.62 1,273,200 $ 8.68 ------------------------------------------------------------------------- The options outstanding at December 31, 2006, have exercise prices ranging from $7.75 to $9.80, or $8.62 on average, and a weighted average remaining contractual life of 6.05 years. There were no options exercisable at the end of December 31, 2006 and 2005. EXECUTIVE STOCK OPTION PLAN. Under the Executive Stock Option Plan, the Company may grant options to executives and certain senior managers for up to 1,000,000 common shares. The Company has 4,000 shares remaining to be granted under this stock option plan and no options were granted under this plan in 2006. The exercise price of each option equals the market price of the Company's stock on the date of grant and the maximum term of an option is ten years. Options to purchase shares of the Company vest as to 25% on the date of grant and 25% on each of the three succeeding anniversaries of the date of grant. A summary of the status of the Company's Executive Stock Option Plan as of December 31, 2006, and 2005, and changes during the years ended on those dates, is presented below. ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Weighted Weighted Average Average Number of Exercise Number of Exercise Options Price Options Price ------------------------------------------------------------------------- Outstanding at beginning of year 41,300 $ 5.93 33,000 $ 5.65 Granted - - 12,300 7.80 Exercised (10,000) 4.79 - - Forfeited - - (4,000) 9.43 Outstanding at end of year 31,300 6.39 41,300 $ 5.93 Options exercisable at end of year 19,000 $ 5.69 20,000 $ 4.91 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The options outstanding at December 31, 2006, have exercise prices ranging from $5.02 to $7.80, or $6.39 on average, and a weighted average remaining contractual life of 3.61 years. EMPLOYEE SHARE PURCHASE PLAN. During 2006, 5,085 (2005; 5,451) common shares were issued under this plan. In the fourth quarter of 2006, the Company cancelled the Employee Share Purchase Plan and, as such, there were no shares reserved under this plan at December 31, 2006 (2005; 155,157). STOCK-BASED COMPENSATION EXPENSE. During the year, the Company recorded $237,000 (2005; $360,000) in stock-based compensation expense. Weighted average assumptions used for grants are presented below: ------------------------------------------------------------------------- ------------------------------------------------------------------------- Assumption ------------------------------------------------------------------------- Dividend yield 0.0% Expected volatility 22.7% Risk-free interest rate 4.2% Expected life 7.5 years ------------------------------------------------------------------------- ------------------------------------------------------------------------- 13. FOREIGN CURRENCY TRANSLATION ADJUSTMENT The foreign currency translation adjustment represents net gains or losses on the translation of the net assets of self-sustaining foreign operations, as well as the net gains or losses related to short-term and long- term borrowings in USD designated as hedges of the net investments in the self- sustaining foreign operations. Included in the foreign currency translation adjustment during 2006 was an unrealized gain of $841,000 (2005; $4,457,000 unrealized loss) pertaining to the translation of the net assets of self-sustaining foreign operations. Also included was a gain of $922,000 (2005; $3,312,000) pertaining to short- term and long-term borrowings in USD, designated as hedges of the net investments in the self-sustaining foreign operations. 14. INCOME TAXES Major components of income tax expense are as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 Current $ 5,147 168 Future income tax recovery relating to origination and reversal of temporary differences (1,789) (4,138) Future income tax expense resulting from change in valuation allowance 602 1,298 ---------------------- $ 3,960 (2,672) ------------------------------------------------------------------------- ------------------------------------------------------------------------- As the Company operates in several tax jurisdictions, its income is subject to various rates of taxation. The provision for income taxes differs from the amount that would have resulted from applying the statutory income tax rates to income before taxes as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Amount % Amount % ------------------------------------------------------------------------- Income tax expense computed at statutory rates $ 2,122 36.1 $ (4,749) 36.1 Effect of differing foreign tax rates (247) (4.2) (19) 0.1 Manufacturing and processing tax credit 169 2.9 642 (4.9) Effect of future tax rate reductions 1,900 32.3 - - Change in valuation allowance (602) (10.3) 1,298 (9.9) Permanent differences 198 3.4 163 (1.2) Large corporations tax - - 400 (3.0) Other tax differences 420 7.2 (407) 3.1 ------------------------------------------------------------------------- $ 3,960 67.4 $ (2,672) 20.3 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The tax effects of temporary differences that give rise to significant portions of the future tax assets and future tax liabilities at December 31, 2006, and 2005 are presented below. ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Future income tax assets Capital assets $ 16,765 19,948 Accounts payable and accrued liabilities 1,332 1,642 Derivatives 2,607 - Loss carry forwards 1,774 2,214 Other 2,782 3,513 ---------------------- 25,260 27,317 Less valuation allowance 8,550 9,152 ---------------------- Future income tax assets $ 16,710 18,165 ------------------------------------------------------------------------- Future income tax liabilities Accrued benefit costs $ 2,077 2,401 Inventory 1,936 2,480 Intangibles 1,680 1,679 Deferred exchange 343 388 Other 266 1,264 ---------------------- Future income tax liabilities $ 6,302 8,212 ---------------------- ---------------------- Net future tax asset $ 10,408 9,953 ------------------------------------------------------------------------- Classified as: Future income tax assets - current $ 3,644 1,126 Future income tax assets - non-current 12,837 16,047 ---------------------- $ 16,481 17,173 ---------------------- ---------------------- Future income tax liabilities - current 1,212 2,355 Future income tax liabilities - non-current 4,861 4,865 ---------------------- $ 6,073 7,220 ------------------------------------------------------------------------- $ 10,408 9,953 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The Company has approximately $1,508,000 in non-capital loss carry forwards, which are available to reduce future Canadian income taxes otherwise payable. The Company has recognized $754,000 of these non-capital loss carry forwards. The expiry of these losses is as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2014 $ 84 2015 383 2016 1,041 ------------------------------------------------------------------------- $ 1,508 ------------------------------------------------------------------------- ------------------------------------------------------------------------- In addition, the Company has approximately $7,946,000 in capital loss carry forwards, which are available to reduce future Canadian taxable capital gains. None of these capital losses have been recognized. 15. EMPLOYEE FUTURE BENEFITS The Company has retirement plans that provide for defined benefits for all non-unionized employees other than certain employee groups in the U.S., Canada and Europe who are members of defined contribution plans. The defined benefit plans are funded pension plans. Effective December 31, 2006, the Company amended certain of its Canadian defined benefit pension plans, in particular the Primary Group and Marketing and Manufacturing Group plans, to provide a defined contribution accrual from January 1, 2007 onward for all members of those plans. The members of these plans were also given a one-time option to convert their accrued defined benefits under these plans to an opening balance in the new defined contribution provisions. As these plan amendments curtail defined benefit accrual and will lead to a settlement of a portion of the defined benefit obligation, there will be an estimated specific, one time adjustment of $1,965,000 arising in 2007, to reflect an estimated $2,886,295 valuation allowance, a $572,000 curtailment gain and a $349,000 settlement gain on conversion. The Company measures its benefit obligations and the fair value of plan assets as at October 31 of each year. The effective dates of the most recent actuarial valuations and those of compulsory future valuations to ensure the funded status of these plans are: ------------------------------------------------------------------------- Date of Most Recent Date of Compulsory Actuarial Valuation Actuarial Valuation ------------------------------------------------------------------------- Primary Group pension plan December 31, 2006 December 31, 2009 Marketing and Manufacturing Group pension plan December 31, 2006 December 31, 2009 Executive pension plan December 31, 2006 December 31, 2009 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The following table describes the Company's commitments and costs for these employee future benefits: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Other Other Pension Benefit Pension Benefit Plans Plans Plans Plans ------------------------------------------------------------------------- Plan assets Market value at beginning of year $ 74,919 74,050 Actual return on plan assets 6,652 7,100 Employer contributions 13 19 Employee contributions 547 556 Obligation in respect of transfers 132 - Benefits paid (3,650) (4,885) Other - (1,921) ---------------------------------------------- Market value at end of year 78,613 74,919 ------------------------------------------------------------------------- Plan obligations Accrued benefit obligations at beginning of year 70,489 3,816 62,254 2,893 Adjustment to opening obligations due to change in service period (149) - - - Current service cost 2,591 173 2,609 155 Obligation in respect of transfers 132 - - - Interest cost 3,669 207 3,667 198 Benefits paid (3,650) (100) (4,885) (130) Actuarial (gains) losses (5,921) - 6,844 - Curtailment income (180) - - - Other - - - 700 ---------------------------------------------- Accrued benefit obligations at end of year 66,981 4,096 70,489 3,816 ------------------------------------------------------------------------- Plan surplus (deficit) End of year market value less accrued benefit obligations 11,632 (4,096) 4,430 (3,816) Unamortized transitional (asset) obligation (5,875) 885 (6,782) 1,011 Unamortized net actuarial loss 4,282 811 12,227 847 ---------------------------------------------- Accrued benefit asset (obligations) $ 10,039 (2,400) 9,875 (1,958) ------------------------------------------------------------------------- Benefit plan expense (income) Current service cost, net of employee contributions $ 2,044 173 2,053 155 Interest cost 3,669 207 3,667 198 Actual return on plan assets (6,652) - (7,100) - Actuarial (gains) losses on benefit obligations (5,921) - 6,844 - Curtailment gain (88) - - - ---------------------------------------------- Benefit (Income) cost before adjustments to recognize the long-term nature of plans (6,948) 380 5,464 353 ------------------------------------------------------------------------- Adjustments to recognize the long-term nature of plans: Difference between expected return and actual return on plan assets for the year 1,431 - 2,095 - Difference between actuarial gains (losses) recognized for year and actual actuarial gains (losses) on benefit obligations for year 6,273 36 (6,768) 12 Amortization of transitional (asset) liability (907) 126 (907) 182 ------------------------------------------------------------------------- Net benefit plan (income) expense $ (151) 542 (116) 547 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Included in the above market value of plan assets and accrued benefit obligations at year-end are the following amounts in respect of benefit plans with accrued benefit obligations in excess of plan assets. ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Market value of plan assets $ 2,146 2,142 Accrued benefit obligations 2,886 3,043 ------------------------------------------------------------------------- Funded status - plan deficit $ (740) (901) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Plan assets at year-end consisted of: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Asset Category Equity Securities(1) 60.6% 58.1% Debt Securities 37.6% 39.3% Other 1.8% 2.6% ------------------------------------------------------------------------- 100.0% 100.0% ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) Equity Securities do not include Company common shares. Weighted average actuarial assumptions used in the calculations of employee future benefits are as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Other Other Pension Benefit Pension Benefit Plans Plans Plans Plans ------------------------------------------------------------------------- Benefit obligations as of December 31 Discount rate 5.25% 5.25% 5.25% 5.25% Rate of compensation increase 4.0% - 4.0% - Benefit costs for years ended on December 31 Discount rate 5.25% 5.25% 6.0% 6.0% Expected long-term rate of return on plan assets 7.5% - 7.5% - Rate of compensation increase 4.0% - 4.0% - Annual rate of increase in covered health care benefits - 7.5% - 7.5% Remaining service period of active employees (years) 10-14 13 10-14 13 ------------------------------------------------------------------------- ------------------------------------------------------------------------- A 1% change in the expected health care cost trend rate would have the following impacts: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 1% 1% Increase Decrease ------------------------------------------------------------------------- Impact on current service and interest costs $ 59 (45) Impact on accrued benefit obligations 615 (534) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Cash payments for employee future benefits for the years ended December 31 are as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Pension benefit plan contributions $ 13 19 Benefits paid on other benefit plans 100 130 ------------------------------------------------------------------------- The total expense for the Company's defined contribution plans for 2006 was $1,131,000 (2005; $1,368,000). 16. SEGMENTED INFORMATION The Company operates within two distinct business units: the Primary Group and The Marketing and Manufacturing Group. This structure supports a customer and product management focus and decentralized decision-making. Both business units have specific activities and mandates with the common goal of providing the best products and value to all FPI customers. The Primary Group manages the Company's harvesting, primary processing, and international sales and marketing of seafood. The Marketing and Manufacturing Group manages the Company's value added processing operations, global seafood sourcing, and culinary research and development, and is also the Company's North American sales and marketing arm. The Company evaluates performance and allocates resources based on segment gross profit. All inter-segment transactions are recorded at an exchange amount and are eliminated upon consolidation. In the first quarter of 2006, the Company changed its internal reporting structure such that The Seafood Company, which was previously managed by the Marketing and Manufacturing Group, is currently managed as part of the international sales and marketing of seafood products by the Primary Group. The results of The Seafood Company are therefore included in the Primary Group's results for the year ended 2006, as compared to the year ended December 31, 2005 where its results were included in the Marketing and Manufacturing Group's results. The segmented assets at December 31, 2005 presented in this note reflect this change in reportable segments. This realignment impacts comparative results as The Seafood Company was acquired on September 2, 2005, therefore, comparative results have been reclassified to conform with the presentation adopted for the current year. SEGMENTED OPERATIONS AND ASSETS. ------------------------------------------------------------------------- 2006 ------------------------------------------------------------------------- Marketing and Primary Manufacturing dollars in thousands Group Group Consolidated ------------------------------------------------------------------------- Total sales Canada $ 175,216 150,205 325,421 Inter-segment (93,037) (28,522) (121,559) -------------------------------------- 82,179 121,683 203,862 -------------------------------------- United States 33,045 335,766 368,811 Inter-segment (5,338) (4,576) (9,914) -------------------------------------- 27,707 331,190 358,897 -------------------------------------- Europe 184,251 - 184,251 -------------------------------------- Foreign exchange gain on hedging contracts 5,840 - 5,840 -------------------------------------- Net sales to customers 299,977 452,873 752,850 -------------------------------------- Segment gross profit $ 40,001 43,550 83,551 ------------------------------------------------------------------------- Capital expenditures $ 6,174 464 6,638 Amortization of capital assets $ 10,827 3,388 14,215 Goodwill $ 10,447 - 10,447 Total assets $ 315,357 106,413 421,770 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2005 ------------------------------------------------------------------------- Marketing and Primary Manufacturing dollars in thousands Group Group Consolidated ------------------------------------------------------------------------- Total sales Canada $ 229,955 168,749 398,704 Inter-segment (112,028) (54,299) (166,327) -------------------------------------- 117,927 114,450 232,377 -------------------------------------- United States 66,244 427,795 494,039 Inter-segment (8,327) (7,091) (15,418) -------------------------------------- 57,917 420,704 478,621 -------------------------------------- Europe 117,092 816 117,908 -------------------------------------- Foreign exchange gain on hedging contracts 4,755 - 4,755 -------------------------------------- Net sales to customers 297,691 535,970 833,661 -------------------------------------- Segment gross profit $ 24,018 46,685 70,703 ------------------------------------------------------------------------- Capital expenditures $ 6,578 4,627 11,205 Amortization of capital assets $ 11,058 3,324 14,382 Goodwill $ 9,171 - 9,171 Total assets $ 339,482 198,594 538,076 ------------------------------------------------------------------------- ------------------------------------------------------------------------- NET SALES TO CUSTOMERS BY PRODUCT CATEGORY. ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Primary Group Primary processed product Groundfish $ 19,524 56,894 Shellfish 73,915 98,677 Other 2,472 9,045 ---------------------- 95,911 164,616 Value added product Shellfish 63,738 17,286 ---------------------- 63,738 17,286 ---------------------- Globally sourced product Groundfish 14,449 22,091 Shellfish 117,583 86,122 Other 2,456 2,821 ---------------------- 134,488 111,034 ---------------------- Foreign exchange gain on hedging contracts 5,840 4,755 ---------------------- 299,977 297,691 ---------------------- Marketing and Manufacturing Value added product Groundfish 147,796 140,144 Shellfish 74,501 101,153 ---------------------- 222,297 241,297 ---------------------- Globally sourced product Shellfish 159,504 220,962 Other 71,072 73,711 ---------------------- 230,576 294,673 ---------------------- 452,873 535,970 ---------------------- Total sales $ 752,850 833,661 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CAPITAL ASSETS BY GEOGRAPHIC AREA. ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Canada $ 105,195 136,613 United States 15,094 17,535 Europe 12,996 11,529 ---------------------- $ 133,285 165,677 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 17. EARNINGS PER COMMON SHARE ------------------------------------------------------------------------- in thousands, except per share amounts 2006 2005 ------------------------------------------------------------------------- Net income (loss) $ 1,915 (10,478) Basic Weighted average number of common shares outstanding 14,429 14,940 ---------------------- Per share amount $ 0.13 (0.70) ---------------------- Diluted Weighted average number of common shares outstanding 14,429 14,940 Impact of outstanding stock options 3 - ---------------------- 14,429 14,940 ---------------------- Per share amount $ 0.13 (0.70) ------------------------------------------------------------------------- Common shares totalling 821,000 (2005; 1,314,500) shares, issuable under the terms of the Company's stock option plans, have not been included in the calculations of diluted earnings per share for the years ended December 31, 2006, and December 31, 2005, as their effect is anti-dilutive. The following table presents pro-forma net income (loss), earnings per share, and diluted earnings per share using the fair value method of accounting for stock-based compensation. The pro-forma adjustments presented below pertain to awards granted on or after January 1, 2002, but before January 1, 2003. Starting January 1, 2003, the Company changed its accounting policy with respect to stock options granted to employees as described in note 1. ------------------------------------------------------------------------- in thousands, except per share amounts 2006 2005 ------------------------------------------------------------------------- Net income (loss) $ 1,915 (10,478) Pro-forma adjustments - (38) ---------------------- Pro-forma net income (loss) $ 1,915 (10,516) ---------------------- Basic Weighted average number of common shares outstanding 14,429 14,940 ---------------------- Pro-forma earnings per share amount $ 0.13 (0.70) ---------------------- Diluted Weighted average number of common shares outstanding 14,429 14,940 Impact of outstanding stock options 3 - ---------------------- 14,429 14,940 ---------------------- Pro-forma diluted earnings (loss) per share amount $ 0.13 (0.70) ------------------------------------------------------------------------- The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with weighted average assumptions used for grants, as presented below: ------------------------------------------------------------------------- Assumption ------------------------------------------------------------------------- Dividend yield 0.0% Expected volatility 22.7% Risk-free interest rate 4.2% Expected life 7.5 years ------------------------------------------------------------------------- 18. COMMITMENTS AND CONTINGENCIES OPERATING LEASES. The Company has long-term lease agreements for certain cold storage facilities, office space, computer operating systems, and equipment, the latest of which expires in 2014. These leases generally contain renewal options for periods ranging from one year to five years and require the Company to pay all executory costs such as maintenance and insurance. Future minimum lease payments (excluding executory costs) under these operating leases for the next five years will be approximately as follows: ------------------------------------------------------------------------- 2007 $ 3,614 2008 2,931 2009 2,449 2010 2,153 2011 1,933 ------------------------------------------------------------------------- LETTERS OF CREDIT. The Company has documentary letters of credit outstanding as at December 31, 2006, of USD $3,924,000 (2005; USD $13,426,000) related to the procurement of inventories. The Company also has various standby letters of credit outstanding as at December 31, 2006 totalling $3,752,000 (2005; $3,705,000). GUARANTEES. As at December 31, 2006, the Company has guaranteed $667,000 of a marine mortgage by KFL, a jointly controlled entity. The marine mortgage is secured by a vessel that has a net book value of $3,394,000 (2005; $3,540,000). CAPITAL ASSET COMMITMENTS. As at December 31, 2006, the Company had $275,000 (2005; $491,000) in outstanding commitments for various ongoing capital projects. LEGAL PROCEEDINGS. From time to time, the Company is involved in various litigation matters arising in the ordinary course of business. The Company has no reason to believe that the disposition of any such current matters could reasonably be expected to have a material adverse impact on the Company's financial position, results of operations, or the ability to carry on any of its business activities. During 2006, charges were laid against the Company by the Government of Newfoundland and Labrador in relation to its export practices of Yellowtail Flounder. Management is presently not able to assess or predict the scope or outcome of these charges. Accordingly, no provision has been included in these financial statements. 19. FINANCIAL INSTRUMENTS FORWARD EXCHANGE AND OPTION CONTRACTS. At December 31, 2006, the Company held the following in forward exchange and option contracts, shown in the currency in which they are denominated: ------------------------------------------------------------------------- ------------------------------------------------------------------------- Outstanding To Average To Average unaudited - December 31, Expire Rate Expire Rate in thousands 2006 2007 (CAD) 2008 (CAD) ------------------------------------------------------------------------- North American Operations Hedge Contracts USD sale - forwards 7,250 7,250 1.1291 - - USD purchase - forwards 14,910 13,434 1.1322 1.476 1.1266 USD purchase options expandables 5,000 5,000 1.1410 - - EURO sale - forwards 135 135 1.4128 - - GBP sale - forwards 4,500 4,500 2.1180 - - Non-Hedge Contracts USD sale written options-barrier 15,000 15,000 1.1400 - - USD sale written options 21,000 21,000 1.1800 - - USD sale barrier options 100,000 100,000 1.1270 - - USD sale options expandables 5,000 5,000 1.1410 - - GBP sale written options 15,000 15,000 2.0552 - - Euro sale written options 8,000 8,000 1.3935 - - Euro sale barrier options 16,000 16,000 1.4806 - - Yen sale barrier options 1,000,000 1,000,000 116.50 - - ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- Outstanding To Average To Average unaudited - December 31, Expire Rate Expire Rate in thousands 2006 2007 (GBP) 2008 (GBP) ------------------------------------------------------------------------- U.K. Operations Hedge Contracts USD purchase - collar options 24,000 24,000 1.8875 - - Non-Hedge Contracts USD purchase barrier option 3,000 3,000 1.8500 - - ------------------------------------------------------------------------- ------------------------------------------------------------------------- Mark-to-market exchange gains associated with contracts outstanding at December 31, 2006, amounted to $10,859,000 (2005; $4,865,000). In 2006, the Company terminated certain of its forward foreign exchange contracts and option agreements that had been designated and accounted for as cash flow hedges. The net gain of $2,024,000 (2005; $3,426,000 net gain) realized on the termination of these instruments has been deferred and is being amortized into income over the same period as the corresponding cash flows that had been hedged by the original contracts. Amortization recognized in income during 2006 was $4,805,000 (2005; $645,000). The fair market value of contracts that do not qualify as hedges are included in the financial statements as noted below based on their nature and are marked-to-market each period. ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Prepaid expenses and other $ 475 3,312 Other assets - 880 Accounts payable and accrued liabilities 10,070 1,409 ------------------------------------------------------------------------- During 2006, the Company reported a loss of $1,726,000 (2005; $6,931,000 income) relating to net realized and unrealized gains on its non-hedge contracts. INTEREST RATE RISK MANAGEMENT. The Company entered into interest rate swap agreements in order to manage the risk associated with interest rate movement on floating rate long-term debt. As at December 31, 2006, the Company had outstanding interest rate swaps to hedge long-term debt as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- Notional Currency Rate Mark-to-Market Expiry Date ------------------------------------------------------------------------- $ 11,765 USD 3.65% $ 280 May 9, 2008 23,513 CAD 4.93% (236) May 9, 2008 6,932 CAD 5.09% (86) May 29, 2008 3,574 CAD 5.14% (54) July 3, 2008 1,838 CAD 5.09% (26) August 5, 2008 1,350 CAD 5.14% (23) October 30, 2008 2,612 CAD 4.89% (37) February 6, 2009 2,583 CAD 4.58% (25) August 20, 2009 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The mark-to-market amounts represent the amounts that would be paid by the Company if the transactions were terminated at December 31, 2006. For the year ended December 31, 2006, net interest expense from interest rate swaps amounted to $267,000 (2005; $1,186,000). CREDIT RISK. The Company is exposed to credit risk with respect to accounts receivable from customers. The Company has credit evaluation, approval, and monitoring processes intended to mitigate potential credit risks and maintains provisions for potential credit losses that are assessed on an ongoing basis. FPI's largest customer accounts for approximately 11% of total sales. As a result of consolidation of large customers in recent years, the top ten customers now account for approximately 45% of total consolidated sales annually. 20. RELATED PARTY TRANSACTIONS In the normal course of business, the Company has transactions with companies with common directors and a company in which FPI holds an equity investment, as follows: ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Transactions Sales of product $ 457 195 Purchases of products and services 9,164 12,175 Commissions and royalties 1,300 1,622 Payments of the Company's proportionate share of vessel modifications and related equipment purchases of a jointly controlled asset - 2,551 Other 164 320 ------------------------------------------------------------------------- These transactions are measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. The balance due to and due from affiliates outlined below are non-interest bearing and under normal credit terms, as would have applied with unrelated parties, and have arisen from the transactions referred to above. These balances are included in accounts receivable and accounts payable on the Company's balance sheets. ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Balances Receivable from companies with common directors $ 191 - Receivable from a company in which FPI holds an equity investment 3,007 6,896 Payable to companies with common directors 963 2,269 ------------------------------------------------------------------------- 21. SUPPLEMENTAL CASH FLOW INFORMATION ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Cash paid during the year for: Interest $ 13,853 12,383 Income taxes 3,569 1,498 ------------------------------------------------------------------------- 22. POTENTIAL SALE OF CERTAIN ASSETS In a series of announcements commencing January 11, 2007, the Company disclosed publicly that preliminary discussions had been held with several interested parties with respect to the potential sale of certain FPI assets. An Independent Committee of the Board of Directors was struck to evaluate these offers. National Bank Financial was engaged to assist and advise in this exercise. In accordance with its mandate, the Independent Committee reviewed the merits of each of these offers and prepared recommendations for the full Board of Directors. The Board subsequently met to consider the recommendations of the Independent Committee, and began a process of related discussions with the Government of Newfoundland and Labrador. Under provincial legislation, any associated transaction would require government approval. 23. COMPARATIVE FIGURES Certain amounts for 2005 have been reclassified to conform with the presentation adopted for 2006.

For further information:

For further information: Investors: Beverley Evans, Chief Financial
Officer, (709) 570-0351, bevans@fpil.com; Media: Russ Carrigan, Corporate
Communications, (709) 570-0130, rcarrigan@fpil.com; www.fpil.com

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