Menu Foods Income Fund
TSX : MEW.UN

Menu Foods Income Fund

February 15, 2006 12:22 ET

Menu Foods Income Fund Announces 2005 Fourth Quarter and Year-End Results

TORONTO, ONTARIO--(CCNMatthews - Feb. 15, 2006) -

NOT FOR DISTRIBUTION TO U.S. NEWSWIRE SERVICES OR FOR DISSEMINATION IN THE UNITED STATES

Menu Foods Income Fund (TSX:MEW.UN) announced today its financial results for the fourth quarter and year ended December 31, 2005.

A conference call to review these results will take place tomorrow, February 16, 2006 at 8:30 a.m. EST (Toronto time). The conference call will be chaired by Paul Henderson, Menu's President and Chief Executive Officer. Paul will be joined on the call by Mark Wiens, Menu's Executive Vice-President and Chief Financial Officer.

To access the conference call in real time, please call 416-644-3414 or 1-866-250-4910. A replay will be available from approximately one hour after the end of the conference call until March 2, 2006 by dialing 416-640-1917 or 1-877-289-8525, using passcode 21170560 followed by the number sign. A live audio webcast of the conference call is also available; it can be accessed by entering www.newswire.ca/webcast on an Internet browser. A replay of the webcast will be available for 90 days, it can be accessed by entering www.newswire.ca/webcast on an Internet browser.



MESSAGE to UNITHOLDERS
-------------------------------------------------------------------------

We present, to unitholders of Menu Foods Income Fund, our report for the
fourth quarter ended December 31, 2005. The table below reports selected
highlights of the quarter's results:

<<
Quarter ended Year ended
December 31, December 31,
2005 2004 2005 2004
($ millions) ($ millions) ($ millions) ($ millions)

Sales 84.8 91.3 346.9 380.7
Income before
non-controlling
interest and
goodwill impairment
loss 0.7 5.8 4.7 23.1
Goodwill impairment
loss 23.1 -- 93.4 --
EBITDA 5.6 11.6 25.0 46.2
Distributable cash 3.9 10.0 16.3 38.7
Distributions declared 2.1 9.0 21.5 35.4
Distributions declared
per Trust unit ($) 0.1000 0.3150 0.8900 1.2600
Distributions declared
(net of subordinated
amounts) per Class B
unit ($) 0.0277 0.3150 0.5262 1.2600


Performance during the quarter continued to reflect the challenging business environment that impacted the Fund during 2005. During the fourth quarter:

- Sales declined by 7.1% or $6.5 million when compared with last year, due in large part to the decline in volume and the significant appreciation of the Canadian dollar relative to the United States dollar.

- Volume (expressed in cases of 24 cans or pouches) decreased by 7.6% compared to last year. Approximately 88% of this decline can be attributed to a reduction in pouch sales to Menu's largest customer, as that customer reduced its inventory position.

- EBITDA of $5.6 million was $6.0 million or 51.7% less than last year. EBITDA was negatively impacted by the factors above, together with a $0.7 million write-off of inventory, and the continued absorption of higher raw material and manufacturing costs that could not be passed on to customers.

In January 2006, following a price increase announced by a leading national brand manufacturer, Menu announced a price increase on its canned products sold to its private-label customers in the United States. While costs continue to rise, this price increase should enable Menu to recover much of the margin erosion experienced over the past two years on the sale of cans to United States private-label customers.

- The net loss reflected a $23.1 million impairment in goodwill that arose upon application of the assessment required under Canadian generally accepted accounting principles. This impairment charge had no impact upon EBITDA or the Fund's ability to generate distributable cash or the ability to pay future distributions or on its credit agreements.

Total distributions declared during the fourth quarter of 2005 correspond to a pay-out ratio of 53.5% reflecting the cessation of distributions by the Fund in December 2005.

As previously reported, the Fund secured a new commitment from a major customer (that includes take-or-pay provisions) that should compensate for much of the decline in can volume experienced in the first half of 2005. Sales under that new agreement as well as sales to new customers and expanded programs with existing customers were all commenced by January 2006. The combination of these new customers and expanded programs are expected to positively impact the Fund's performance.

The Fund was also very pleased to announce that it reached agreements in principal with its banks and holders of its senior secured notes, which among other things, define the terms and conditions governing the Fund's US$30 million bank and US$85 million senior secured note facilities, going forward. The financial statements have been prepared based upon the agreements in principal, and accordingly, the senior secured notes continue to be reflected as long-term debt. Finalization of these arrangements is subject to completion of definitive agreements satisfactory to all parties. The conclusion of these arrangements will stabilize the Fund's current financial position.

We continue to appreciate the support of our investors, customers and suppliers and the ongoing dedication of our employees, in these difficult times.

Paul K. Henderson

President and Chief Executive Officer

Menu Foods GenPar Limited

Administrator of Menu Foods Income Fund


Management's Discussion and Analysis of Financial Results

(For the quarter and year ended December 31, 2005)

Presentation of Financial Information

The following discussion and analysis of the financial results of Menu Foods Income Fund (the "Fund") is dated as of February 15, 2006 and is supplementary to and should be read in conjunction with the unaudited consolidated financial statements for the quarters and years ended December 31, 2005 and 2004.

The Fund is the indirect owner of Menu Foods Limited ("Menu"), the leading North American private label/contract manufacturer of wet pet food products. The Fund's results include those of Menu, its subsidiaries, affiliates and the partnerships which conduct its day-to-day business.

Where applicable, financial information contained herein is prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and is reported in Canadian dollars.

The nature of the Fund's operations does not give rise to many critical accounting estimates. The most significant accounts where such estimates might apply are accounts receivable, inventory and goodwill. In the case of accounts receivable and inventory, required provisions and/or reserves are specific in nature. In the case of goodwill, impairment is assessed based upon estimated fair value of the business, determined by reference to the trading value of the Fund's units, which is allocated to goodwill and other identifiable tangible and intangible assets, based upon their respective fair values.

Certain statements in this Management's Discussion and Analysis of Financial Results are "forward-looking statements," which reflect management's expectations regarding the Fund and Menu's future growth, results of operations, performance, business prospects and opportunities. Such forward- looking statements reflect management's current beliefs and are based on information currently available to management. Many factors could cause results to differ materially from the results discussed in the forward-looking statements, including risks related to dependence on key suppliers, economic conditions, competition, regulatory change, foreign exchange rates and interest rates, among others. Although the forward-looking statements are based on what management believes to be reasonable assumptions, the Fund and Menu cannot assure investors that actual results will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this report, and neither the Fund nor Menu assumes any obligation to update or revise them to reflect new events or circumstances.

Overall Performance and Results of Operations

The following table highlights selected comparative results (all figures, except per unit amounts, expressed in thousands of Canadian dollars)



For the quarter ended For the year ended
December 31, December 31,
2005 2004 2005 2004
$ $ $ $
Sales 84,842 91,334 346,932 380,712
Cost of sales 77,055 77,423 313,681 324,667
---------------------------------------------------
Gross profit 7,787 13,911 33,251 56,045
Selling, general and
administrative
expenses 6,108 6,198 24,532 25,231
---------------------------------------------------
Income before the
undernoted 1,679 7,713 8,719 30,814
Goodwill impairment
loss 23,120 - 93,415 -
Financial expenses 2,047 976 6,916 4,268
---------------------------------------------------
Income (loss) before
income taxes and
non-controlling
interest (23,488) 6,737 (91,612) 26,546
---------------------------------------------------
Current income taxes 86 308 69 1,194
Future income taxes (1,130) 597 (2,980) 2,234
---------------------------------------------------
Total income taxes (1,044) 905 (2,911) 3,428
---------------------------------------------------
Net (loss) income
before non-
controlling interest (22,444) 5,832 (88,701) 23,118
Non-controlling
interest of Class B
Exchangeable Units (8,647) 2,572 (34,036) 10,401
---------------------------------------------------
Net (loss) income for
the period (13,797) 3,260 (54,665) 12,717
---------------------------------------------------
---------------------------------------------------

Basic net (loss)
income per Trust Unit (0.777) 0.205 (3.201) 0.828
Diluted net (loss)
income per Unit (0.777) 0.203 (3.201) 0.821
Distributions per
Trust Unit 0.1000 0.3150 0.8900 1.2600
Distributions (net of
subordinated amounts)
per Class B Unit 0.0277 0.3150 0.5262 1.2600

Basic weighted average
number of Trust Units
outstanding (000's) 17,766 15,925 17,077 15,354
Diluted weighted
average number of
Units outstanding
(000's) 28,920 28,716 28,889 28,145

Average US/Cdn
exchange rate per
Bank of Canada 0.8524 0.8192 0.8255 0.7683


Operating Results for the Quarter Ended December 31, 2005

Sales for the quarter ended December 31, 2005, were $84.8 million, down 7.1% or $6.5 million compared to the same quarter last year. This decline is attributable to:

1. the strengthening of the Canadian dollar relative to the United States dollar as compared to that relationship for the same quarter in the prior year had the effect of reducing sales by $2.7 million relative to the fourth quarter of 2004;

2. a 7.6% decrease in volume resulting in a net sales decrease of $6.6 million relative to the fourth quarter of 2004;

3. the impact of periodic price increases to pass the effects of increasing costs onto Menu's co-pack customers, together with a price increase to Menu's Canadian private label customers initiated in the first quarter of 2005, changes to sales mix and other variables, had the effect of increasing sales on a comparative basis by $1.9 million; and,

4. the prior year's fourth quarter sales included a repayment of $0.3 million under a take-or-pay agreement (this agreement ended in the fourth quarter of 2004). The fourth quarter of 2005 reflects revenue of $0.6 million under a new take-or-pay agreement with the same customer. The combined impacts of these payments in the fourth quarter of 2005 had the effect of increasing sales by $0.9 million relative to the same period last year.

Overall, volume (expressed in cases of 24 cans or pouches) was down 7.6% compared to the quarter ended December 31, 2004. Approximately 88% of this decline can be attributed to a reduction in fourth quarter sales of pouches to Menu's largest customer, as advised in Menu's third quarter report.

Can volume, which represented 79.2% of Menu's volume in the fourth quarter of 2005, contracted by 3.7% (equating to a decline in total volume of 2.8%). This decline is primarily attributable to a Canadian co-pack customer, who had relied upon Menu for its supply of certain products for sale in the Canadian market, and who opted to reduce its dependence on Menu and self- manufacture that product in its United States facilities. This loss of business had the effect of reducing can volume by 2.2% compared to the fourth quarter of 2004. The volume of canned wet pet food sold to the balance of Menu's customers decreased by 1.5% (equating to a 1.2% decrease in total volume).

As advised last quarter, case sales of the pouch product during the fourth quarter of 2005, which represented 20.8% of total volume, declined by 19.9% compared to the prior year's fourth quarter. This decline in volume resulted primarily from a 71.4% decline in pouch sales to Menu's largest customer (equating to a decline in total pouch volume of 27.8%). As reported last quarter, this customers planned reduction in pouch inventory in its distribution system, more than offsetting the continued growth of Menu's pouch sales to other customers. The comparative difference with the fourth quarter of 2004 is amplified because this same customer was building inventory throughout its system during the fourth quarter of 2004 to support their January 2005 launch of pouches. Pouch sales to this customer are anticipated to return to historic levels by the second quarter of 2006. The decrease in pouch case sales had the effect of decreasing Menu's total volume for the quarter by 4.8%.

Gross profit decreased by $6.1 million (or 44.0%) for the quarter ended December 31, 2005, compared to the prior year. This decrease is attributable to:

1. Foreign Exchange Effect on Sales and Cost of Sales. The strengthening of the Canadian dollar relative to the United States dollar during the quarter had the effect of reducing sales by approximately $2.7 million and that translated into a reduction in gross profit of $0.3 million for the quarter ended December 31, 2005;

2. Effect of Change in Sales Volume. As previously noted, total volume for the fourth quarter declined by 7.6%, which reduced gross profit by $1.3 million.

3. Cessation of Take-or-Pay Agreement. In 2004, the fourth quarter's sales included a repayment under a take-or-pay agreement (which expired October 31, 2004) which, together with an amount due under a new take-or-pay agreement with the same customer in 2005, had the effect of increasing comparative gross profit by $0.9 million;

4. Inventory write-down. On May 20, 2003 a single case of Bovine Spongiform Encephalopathy was discovered in Alberta Canada. This incident resulted in the closure of the United States border to Canadian-made pet food manufactured before that date. At the time of the closure, Menu's Canadian operation had inventory on hand that was originally intended for sale to its United States customers and which could not be shipped as a result of that border closure. During the fourth quarter of 2005, Menu recorded a provision against all such inventory still on hand resulting in an expense of $0.7 million during the quarter;

5. Price and Cost Increases. During the past year, the cost of certain inputs to production, including raw and packaging materials, labour and benefits, utilities and freight increased and adversely impacted cost of sales, when compared to the fourth quarter of 2004. In accordance with the arrangements with its co-pack customers, Menu has been able to recover some of these cost increases through periodic pricing adjustments. In addition, during the first quarter of 2005, Menu followed the national brands and initiated a price increase to its Canadian private label customers to recover cost increases realized to that point in time. Unfortunately, the effects of price increases have fallen far short of the cost increases experienced during the quarter, with the net result of reducing gross profit in the fourth quarter of 2005, by $4.7 million; and

6. Increase in Amortization. The amortization of capital projects completed in the past year offset by the rise in the value of the Canadian dollar relative to its US counterpart, resulted in only a nominal increase in the amortization associated with the cost of goods sold versus the fourth quarter of 2004.

Selling, general and administrative ("SG&A") expenses for the quarter ended December 31, 2005 were down $0.1 million when compared to the prior year. On a comparative basis, SG&A spending in the fourth quarter of 2005 benefited from the stronger Canadian dollar as well as lower bonus expense reflecting the lower earnings in 2005 than in 2004.

The foregoing resulted in EBITDA (See Note A) of $5.6 million for the quarter ended December 31, 2005, a decrease of $6.0 million (or 51.7%) compared to the same period in 2004. The strengthening of the Canadian dollar, relative to the United States dollar, has reduced: sales, gross margin, SG&A expenses, amortization, interest and EBITDA. Menu estimates that, before considering the impacts of its hedging program, each change of $0.01 in the cost of the Canadian dollar changes EBITDA by approximately $0.12 million and Distributable Cash (see Note A) by approximately $0.09 million, on a quarterly basis. These estimates differ from those previously reported to reflect the change in contribution by the Fund's United States dollar denominated business during 2005.

In order to mitigate the impacts of short term fluctuations in foreign exchange on Distributable Cash, the Fund had implemented a hedging program under which United States dollar denominated cash flow was hedged, for periods of up to one year, by way of foreign currency forward contracts. This approach removed some of the uncertainty associated with generating cash flow in United States dollars while paying distributions in Canadian dollars. Since the program hedged distributions, which are capital in nature, it did not qualify for hedge accounting.

Menu estimates that, absent its hedging program, the strengthening of the Canadian dollar during the fourth quarter of 2005 versus the same period in 2004 reduced EBITDA by approximately $0.4 million and Distributable Cash by approximately $0.3 million. Under its program for hedging distributions, the Fund had entered into foreign exchange contracts to hedge distributions through to July 2006. Each quarter these contracts were marked to market, with the change in value charged to selling, general and administrative expenses. With the suspension of distributions in December 2005, the contracts extending into 2006 were no longer required and these were sold for a gain of $0.2 million. In addition, during the quarter ended December 31, 2005, the Fund realized a gain of $0.2 million on matured contracts.

Amortization (which is included in cost of sales and SG&A expense) in the fourth quarter of 2005 was nominally higher than in 2004. This principally reflects the combined effects of the strengthening of the Canadian dollar, relative to the United States dollar as compared to the prior year, offset by the amortization on the $10.4 million of capital expenditures made during the twelve months ended December 31, 2005 together with the full period amortization on the $6.3 million of capital expenditures made during the quarter ended December 31, 2004.

Under generally accepted accounting principles in Canada, goodwill is subject to an annual impairment test that, for the Fund, takes place as at September 30 of each year. The application of current accounting principles at September 30, 2005 identified impairment in the carrying value of goodwill and a $70.3 million write-down was taken at that time. In addition, the Fund reviews goodwill whenever events or changes occur that suggests impairment in its carrying value. Since the Fund's units continued to trade below the value used in the September 30, 2005 impairment test, a fair value assessment was repeated as at December 31, 2005 and goodwill was written-down by a further $23.1 million. This charge is a non-cash item and does not impact EBITDA, Distributable Cash or the Fund's credit facilities. No impairment in the value of the Fund's intangible assets or property, plant and equipment has been identified.

Financial expenses were $1.1 million greater during the quarter ended December 31, 2005, than in the fourth quarter of 2004. In the fourth quarter of 2005 the Fund recorded a loss on its interest rate swaps of $0.1 million, compared to a gain of $0.1 million in 2004. In the fourth quarter of 2005, financial expenses also include bank and professional fees associated with waiver and forbearance agreements obtained during the quarter of $0.2 million and reflect the sliding scale of increased interest rates (100 basis points) agreed to by the Fund as part of the waiver arrangement with its bankers. In addition, higher interest rates incurred on the Fund's variable rated bank indebtedness and senior secured notes, together with higher average amounts borrowed under the bank facility, when compared to the prior year, accounted for virtually all of the increase in financial expenses.

The Fund operates using a number of different legal structures (e.g. partnerships, trusts, corporations etc.) in a number of jurisdictions. Each of these structures and jurisdictions is subject to income tax at different rates. The effective tax rate can vary from quarter-to-quarter, depending upon the taxing jurisdiction and the legal structure in which the income is earned. As a consequence, the Fund's effective tax rate reflects a significant recovery during the quarter as compared to the 12.9% effective rate of tax realized for all of fiscal 2004.

During 2004, the United States had an incentive program that provided "accelerated" tax depreciation in respect of capital additions put in service during that year. The absence of these tax incentives for the current year has resulted in a draw-down of the future income taxes liabilities set up in prior years.

The net loss before non-controlling interest of Class B Exchangeable Units ("Class B Units") for the quarter ended December 31, 2005, was $22.4 million, compared to net income of $5.8 million for the quarter ended December 31, 2004.

Operating Results for the Year Ended December 31, 2005

Sales for the year ended December 31, 2005, were $346.9 million, down 8.9% or $33.8 million compared to the same period last year. This decrease is attributable to:

1. the strengthening of the Canadian dollar relative to the United States dollar as compared to that relationship for the same period in the prior year had the effect of reducing sales by $22.9 million relative to 2004;

2. a 5.1% decrease in volume resulting in a net sales decrease of $19.4 million relative to the year ended December 31, 2004;

3. the impact of a price increase to Menu's private label customers initiated in the second quarter of 2004 in the United States and the first quarter of 2005 in Canada, as well as the effect of passing through cost increases to Menu's co-pack customers, together with changes to sales mix and other variables, had the effect of increasing sales by $7.4 million; and

4. the net impact of payments under take-or-pay agreements has been to increase sales by $1.1 million relative to the same period in 2004.

Overall, volume (expressed in cases of 24 cans or pouches) was down 5.1% compared to the year ended December 31, 2004. Can volume, which represented 76.9% of Menu's volume in 2005, contracted by 9.7% (equating to a decline in total volume of 7.9%). This decline was primarily attributable to the 20.7% decline, in 2005, in case volume of canned wet pet food to Menu's largest customer, which reduced the overall can volume for the year by 4.0%. Volume was also negatively impacted during 2005 because: during the first quarter, two other key customers initiated an inventory reduction program within their organizations and, during the second quarter, a Canadian co-pack customer, who had relied upon Menu for its supply of certain products for sale in the Canadian market, decided to reduce its dependence on Menu and self-manufacture that product in its United States facilities. This loss of business together with reduced sales to existing customers, particularly within the pet specialty and supermarket channels, whose private label sales were impacted by the national brand promotional activity during the period, account for the balance of the decline.

The lower case sales of canned wet pet food as described above, was partially offset by the continued growth in sales of Menu's pouch product. During 2005, case sales of the pouch product, which represented 23.1% of total volume, grew by 14.5% compared to the year ended December 31, 2004. This increase in pouch case sales had the effect of increasing Menu's volume for 2005 by 2.8%.

Gross profit decreased by $22.8 million (or 40.7%) for the year ended December 31, 2005, compared to the prior year. This decrease is attributable to:

1. Foreign Exchange Effect on Sales. The strengthening of the Canadian dollar relative to the United States dollar during 2005 had the effect of reducing sales by approximately $22.9 million and that translated into a reduction in gross profit of $3.0 million for the year ended December 31, 2005;

2. Effect of Change in Sales Volume. As previously noted, total volume for the year declined by 5.1%, which reduced gross profit by $3.3 million.

3. Impact of Take-or-Pay Agreements. The net impact of take-or-pay agreements during 2005 and 2004 has been to increase comparative gross profit by $1.1 million;

4. Inventory write-down. At December 31, 2005 Menu still had inventory on hand that related to pre-May 20, 2003 (the date when a single case of Bovine Spongiform Encephalopathy was discovered in Alberta). Since this inventory was not saleable in the United States, it proved to be a challenge to sell in the normal channels available to Menu. Throughout 2005, as efforts to sell this inventory were underway, Menu made provisions amounting to $0.9 million;

5. Price and Cost Increases. During the past year, the cost of certain inputs to production, including raw and packaging materials, labour and benefits, utilities and freight increased and adversely impacted cost of sales, compared to 2004. In accordance with the arrangements with its co-pack customers, Menu has been able to recover some of these cost increases through periodic pricing adjustments. Furthermore, during the first quarter of 2004, Menu followed the national brands and initiated a price increase to its United States customers to recover cost increases incurred to that point in time. Similarly, during the first quarter of 2005, Menu initiated a price increase to its Canadian customers. Unfortunately, the effects of these price increases have fallen far short of the cost increases experienced during 2005, with the net effect of reducing gross profit by $16.1 million; and

6. Increase in Amortization. The amortization of capital projects completed in the past year offset by the rise in the value of the Canadian dollar relative to its US counterpart resulted in an increase in the amortization associated with the cost of goods sold of $0.6 million versus 2004.

SG&A expenses for the year ended December 31, 2005 decreased by $0.7 million compared to the prior year. This decrease reflects savings of approximately $1.2 million due to lower SG&A spending in 2005 compared to the prior year, primarily as a result of the stronger Canadian dollar as well as lower bonus expense reflecting the lower earnings in 2005. These savings were offset by the $0.5 million increase in the foreign exchange losses on Menu's United States dollar exposure in working capital, net of the mark-to-market gains on forward foreign exchange contracts entered into to hedge distributions.

The foregoing resulted in EBITDA (See Note A) of $25.0 million for the year ended December 31, 2005, a decrease of $21.2 million (or 45.9%) compared to the same period in 2004. The strengthening of the Canadian dollar, relative to the United States dollar, has reduced sales, gross margin, selling, general and administrative expenses, amortization, interest and EBITDA. The Fund estimates that each change of $0.01 in the cost of the Canadian dollar changes EBITDA by approximately $0.48 million and Distributable Cash (see Note A) by approximately $0.36 million, on an annual basis. These estimates differ from those previously reported to reflect the change in contribution by the Fund's United States dollar denominated business during 2005. The Fund estimates that the strengthening of the Canadian dollar during 2005 versus the same period in 2004 reduced EBITDA by approximately $2.7 million and Distributable Cash by approximately $2.1 million.

In order to mitigate the impacts of short term foreign exchange fluctuations on Distributable Cash, the Fund had implemented a hedging program under which United States dollar denominated cash flow was hedged, for periods of up to one year, by way of foreign currency forward contracts. This approach removed some of the uncertainty associated with generating cash flow in United States dollars while paying distributions in Canadian dollars. Since the program hedged distributions, which are primarily capital in nature, it did not qualify for hedge accounting. With the decision to suspend distributions in December 2005, this hedging program has been discontinued.

Amortization (which is included in cost of sales and SG&A expense) in 2005 was $0.9 million higher than in 2004. Amortization increased reflecting the amortization on the $10.4 million of capital expenditures made during the twelve months ended December 31, 2005 and the full period amortization for the $31.7 million of capital expenditures made during the year ended December 31, 2004. However, this increase was largely offset by the effects of the strengthening of the Canadian dollar, relative to the United States dollar.

When the Fund purchased its interest in Menu Foods Limited Partnership, $165.4 million of the purchase price was assigned as goodwill on the consolidated financial statements. Under generally accepted accounting principles in Canada, goodwill is subject to an annual impairment test that, for the Fund, takes place as at September 30 of each year. Since the Fund's units were trading at September 30 and through to October 31 at lower than their book value, the application of current accounting principles identified an impairment in the carrying value of goodwill. Following a fair value assessment of other assets, at September 30, 2005, goodwill was written down by $70.3 million. During the remainder of 2005, the Fund's units continued to trade below the value used in the September 30, 2005 impairment test. Accordingly, the fair value assessment was repeated at December 31, 2005 and a further write-down of $23.1 million was taken during the fourth quarter. These two write-downs amounted to $93.4 million or 56.5% of the Fund's book value as presented in the consolidated financial statements immediately prior to the first write-down. This charge is a non-cash item and does not impact EBITDA, Distributable Cash or the Fund's credit facilities. No impairment in the value of the Fund's intangible assets or property, plant and equipment has been identified.

Financial expenses were $2.6 million greater during the year ended December 31, 2005, than in 2004. Interest expense during the third and fourth quarters of 2005 reflects the sliding scale of increased interest rates agreed to by the Fund as part of the waiver arrangement with its bankers, together with fees of $0.2 million associated with waiver and forbearance agreements. Higher interest rates incurred on the Fund's variable rated bank indebtedness and senior secured notes, together with higher average amounts borrowed under the bank facility, when compared to the prior year, accounted for virtually all of the increase. In addition, the Fund's policy of recording unrealized gains and losses on its outstanding interest rate swaps directly to the income statement had the Fund recording a gain of $0.3 million in 2004, while in 2005 the Fund recorded a loss of $0.3 million resulting in a year over year net change of $0.6 million.

The Fund operates using a number of different legal structures (e.g. partnerships, trusts, corporations, etc.) in a number of jurisdictions, each of which is subject to income tax at different rates. This means that the effective tax rate can vary from quarter-to-quarter, and year-to-year, depending upon the taxing jurisdiction and the legal structure in which the income is earned. During 2005, the Fund's effective tax rate fluctuated materially as a result, and reflects a significant recovery as compared to the 12.9% effective tax rate for all of fiscal 2004.

The net loss before non-controlling interest of Class B Exchangeable Units ("Class B Units") for the year ended December 31, 2005, was $88.7 million, compared to net income of $23.1 million for the year ended December 31, 2004.

Liquidity

During the year ended December 31, 2005, the Fund generated cash flow from operations of $18.9 million, coupled with an increase in cash flow of $6.1 million as a result of changes in non-cash working capital items. The decrease in non-cash working capital items primarily resulted from an $8.0 million reduction in inventory and a $1.2 million decrease in accounts receivable offset by a $3.5 million reduction in accounts payable. The reduction in inventory reflects the higher level of can inventory carried in the fourth quarter of 2004 in anticipation of specific capital projects to be undertaken in the first quarter of 2005 in two of the Fund's United States facilities. While these projects were underway, the facilities were shut down. This higher level of inventory was intended to enable the Fund to maintain customer service levels during the scheduled shutdowns. As no such projects were planned for the first quarter of 2006, there was no corresponding requirement for the higher inventory levels at the end of 2005. The higher levels of inventory in the final quarter of 2004 also resulted in a higher level of accounts payable that did not recur in 2005. The decrease in accounts receivable is consistent with the timing of sales activity and subsequent collections.

With the Trustees' approval of the Fund's audited consolidated financial statements for 2004, the board of directors of Menu Foods GenPar Limited (the Administrator of the Fund) declared that the Class B Units were no longer subordinate to the Trust Units. However, in the second quarter of 2005, certain holders of Class B Units agreed to forego their entitlement to the majority of their distributions beginning with the distribution payable for the month of May 2005 and ending with the distribution payable for the month of February 2006. Such Unitholders are entitled to a reimbursement of such foregone distributions only to the extent that the Fund generates sufficient Distributable Cash. For the year ended December 31, 2005, the Fund announced distributions on the Trust Units of $15.0 million ($0.890 per unit) and paid $16.7 million. During this same period, the Fund announced distributions on the Class B Units of $10.7 million ($0.890 per unit).Certain Class B Unitholders agreed to subordinate their right to $4.2 million of distributions and the Fund paid $10.5 million in distributions.

During the fourth quarter, the pay-out ratio was 53.5%. However, during the first and second quarters of 2005, the Fund paid out distributions in excess of its Distributable Cash. Consequently, for the year ended December 31, 2005, the pay-out ratio (including the distributions on the Class B Units) was 131.9% (and 100.1% since inception).

During 2005 the Fund breached certain covenants in its Agreements with its bankers and noteholders (collectively the "Lenders"). On December 20, 2005, the Fund's Lenders waived these breaches or agreed to forbear until February 28, 2006, with the stipulation that monthly distributions be discontinued until the Fund was in compliance with the covenants in its Agreements with its Lenders. As a result of the Fund's performance during 2005, the Fund's subsidiaries are not permitted to incur additional indebtedness without the prior written consent of the Lenders.

The Fund is currently operating using cash on hand and cash generated by the business. Management believes that the cash on hand, together with cash that it is generating, will be sufficient to fund ongoing operations.

On February 7, 2006 the Fund reached agreements in principal with its bank and the holders of its senior secured notes, which among other things, define the terms and conditions governing the Fund's US$30 million bank and US$85 million senior secured notes facilities, going forward. Finalization of these agreements is subject to completion of definitive agreements satisfactory to all parties. Management expects that the Agreements will be amended to reflect the agreements in principal by February 28, 2006. Thereafter, the Fund will be able to avail itself of additional credit available under these Agreements. The debt owing to the noteholders has been classified as long-term in the financial statements since the Fund anticipates that the amended Agreements reflecting the changes set out in the term sheets will be finalized prior to the issuance of the annual financial statements for the year ended December 31, 2005.

Capital Resources

During the year ended December 31, 2005, Menu invested $10.4 million in property, plant and equipment. The largest expenditures during this period ($6.8 million) reflected equipment purchases to expand pouch capacity as part of a multi-phase expansion initiated in 2004. The final phase of this capital project was completed during the second quarter of 2005 and all related costs have now been reflected as capital additions.

Capital expenditures of a maintenance nature, which totaled $2.4 million for 2005, were financed from the cash flow of the business. These maintenance capital expenditures were over and above the $15.2 million (2004 - $15.5 million) for labour and parts incurred by Menu for the ongoing repairs and maintenance of its plants that have been expensed during 2005 as part of cost of sales.

Outstanding Units

The following table highlights the number of Units outstanding:



Class B
Exchangeable
Trust Units Units

December 31, 2002 13,044,584 12,631,915
Options exercised during the year 215,239 --
-------------------------
December 31, 2003 13,259,823 12,631,915

Options exercised during the year 380,413 --
Issuance during the year 2,500,000 --
-------------------------
December 31, 2004 16,140,236 12,631,915

Conversion of Class B Units during the year 1,498,260 (1,498,260)
Options exercised during the year 127,663 --
-------------------------
December 31, 2005 17,766,159 11,133,655
-------------------------
-------------------------


Menu Foods Corporation (the former parent company of Menu) had a stock option plan pursuant to which there were outstanding options issued to 61 of its directors, executive officers and key employees. In connection with the initial public offering and acquisition, these options were exchanged for Trust Unit options in the Fund having equivalent terms and conditions. As at December 31, 2005, 74,683 vested Trust Unit options, having a weighted-average exercise price of $2.977 per unit, were outstanding. These Trust Unit options expire in November and December 2006. In February 2005, 36,390 units were purchased on the open market under the Fund's Long-Term Incentive Plan for the benefit of 22 individuals.

Outlook

Cost and Price Increases

In the United States, in early 2004, and in Canada, in early 2005, Menu initiated price increases to its private-label customers, following the price increases taken by the leading national brands. Since the time of those increases, Menu has continued to experience increases in certain operating and administrative costs. Rising costs of steel and aluminum mean higher can costs, while the strengthening of the Euro has increased the cost of empty pouches purchased by Menu. Higher utility costs, together with increases in property insurance and medical benefits (both escalating at rates well above inflation) have pushed the cost of operating higher. Higher fuel costs, together with new legislation in the United States on work hours for truck drivers and trucking delays crossing the Canadian/United States border have increased the cost of delivery. In January 2006, following a price increase announced by a leading national brand manufacturer, Menu announced a price increase on its canned products sold to its private-label customers in the United States. This price increase will be effective by late March 2006 and, while costs continue to rise, should enable Menu to recover much of the margin erosion experienced over the past two years on the sale of cans to United States private-label customers.

Largely as a consequence of the last hurricane season in the United States, commencing in the third quarter of 2005 and continuing for the rest of 2005, the Fund experienced significant increases in delivery costs, as well as in the cost of natural gas used in its production process. While some abatement in fuel surcharges has occurred, the demand for truckers in the hurricane affected regions of the United States means that it will remain challenging to hire truckers at reasonable rates. The Fund anticipates this situation will continue, at least, for the early part of 2006.

For the contract-manufacturing portion of Menu's business, most of these increases are automatically passed on to customers (albeit with some timing delays). However, for its private-label business, Menu's practice, with respect to price increases, has been to follow the brand leaders. While this practice at times squeezes Menu's margins (as it did in 2005), it none-the- less helps to ensure that Menu's products are competitively priced at retail.

Menu expects that input costs for its products in both Canada and the United States will continue to rise. Aluminum cans in particular are expected to increase in cost throughout 2006, as the cost of aluminum continues to rise. The price increase announced in January 2006 will help to mitigate the impact that rising costs over the past two years have had on margins. However, absent regular price increases in the future, Menu expects that its margins will continue to be squeezed.

Bovine Spongiform Encephalopathy ("BSE")

On May 20, 2003, a single case of BSE was discovered in Alberta, Canada. This incident resulted in the closure of the United States border to Canadian-made pet food. As discussed previously, Menu's response to this closure adversely impacted the Fund's financial performance for its second, third and fourth quarters of 2003. Two additional cases of BSE were discovered in Canada on January 2 and 11, 2005. The latter case involved an animal born after the feed ban in Canada should have prevented feed exposure to the animal. One more case was confirmed January 22, 2006 in a 6-year old crossbred cow, which was also born well after the feed ban was initiated and this case is still under investigation.

On December 23, 2003, the USDA announced the discovery of a single case of BSE in Washington State, USA. This animal was subsequently found to be of Canadian origin. The first case of BSE in a cow born in the United States was a 12-year old Brahma-cross beef cow harvested on November 15, 2004. Because of some testing method results discrepancies the case was not made public until June 2005. This was the first cow identified to be infected with BSE in nearly 400,000 cattle that had been tested in the United States over the past year.

The most recent case is significant as it clearly identifies BSE as a North American rather than Canadian issue and supports that the incidence is likely quite low. Both the United States and Canadian governments are working toward a strengthened feed ban to further reduce risk of BSE transfer. Depending on the final outcome, this could impact the pricing situation with respect to beef products because of additional competition for a more limited raw material supply.

With respect to finished product, the border remains open to pet food transfer. However, there remain significant differences with respect to raw material supply in Canada compared to the United States. The former can only use beef materials originating in the United States or BSE-free countries such as New Zealand, and with respect to the United States, only certain materials approved by the Canadian Food Inspection Agency ("CFIA"). The United States, on the other hand, can use any beef materials other than certain tissues identified as Specified Risk Materials which are thought to be highly infective with respect to BSE. The source of these raw materials can even include Canadian cattle.

Both governments have been made aware of this serious discrepancy and hopefully logic will prevail to once again allow the use of Canadian beef in Canadian pet food manufacturing facilities.

In addition to this Canadian border closure, Mexico had closed its border to United States-made pet food. During the last quarter of 2005, the Mexican government approved Menu's registration of certain products that allowed it to resume shipment to its Mexican customers. While only about 1% of Menu's sales are transacted with customers in that country the reopening of the border represents a positive development.

Subordination and Distribution

The Fund has two classes of units: (a) publicly traded Trust Units and (b) privately held Class B Exchangeable Units (the "Class B Units"). The Declaration of Trust established that the Class B Units' rights to distributions were subordinated to those of the public Trust Units until such time as certain conditions were satisfied. These conditions were met by February 2005, since which time, except as discussed below, the Class B Units have no longer been subordinated to the publicly traded Trust Units.

On May 11, 2005 certain holders of Class B Units (including senior management), representing more than 11 million units, agreed to forego a portion of their distributions until February 2006. Specifically, holders of approximately 3.4 million units have agreed to forego all distributions, while holders of approximately 7.7 million units have agreed to forego receipt of distributions in excess of $0.02 per unit. In addition, those same holders of more than 11 million Class B Units have agreed to forego their entitlement to convert into Trust Units until February 2006. Such unitholders shall be entitled to a reimbursement of such foregone distributions, which at December 31, 2005 amounted to $4.2 million, only to the extent that the Fund generates sufficient Distributable Cash in the future.

Financial Covenants

Most of the Fund's outstanding debt is represented by its operating facility and senior secured notes. As at December 31, 2005, the Fund had $29,309 drawn on its operating facility and $98,855 of senior secured notes outstanding. Each of these facilities has financial covenants and cross default provisions that must be met. Since June 30, 2005, the Fund has not been in compliance with the financial covenants contained in its Agreements with its Lenders. In December 2005 the Fund's Lenders either provided it with waivers of its breaches or agreed to forbear until February 28, 2006.

In February 2006, the Fund reached agreement with its Lenders to continue its operating facility and senior secured notes under modified terms and conditions. As a consequence, the Fund agreed to suspend distributions until it is in compliance with the covenants specified in the original Agreements, to pay consent and amendment fees amounting to US$0.5 million, to change certain covenants and cross-default provisions, and to change the method of charging interest, whereby the rates charged by its Lenders increase as the ratio of debt to EBITDA increases. Management expects that the amendments to the Agreements will be completed and in force by February 28, 2006.

The amendments to the Agreements will enable the senior secured notes to be classified as long-term in the annual financial statements since the noteholders will have unconditionally waived their right to demand repayment of the notes if the Fund continues to be in compliance with the covenants set out in the amended Agreements. Management of the Fund believes that it will be able to comply with these amended covenants throughout 2006.

Risks and Uncertainties

Menu and the Fund are subject to numerous risk factors in its ongoing business. These include reliance on a key customer, absence of long-term sales contracts, customer performance and relationships, foreign exchange fluctuations, governmental regulations and restrictions, reliance on key suppliers, reliance on key personnel, among others. For a review of some of the risks affecting the business, please refer to notes 19 and 20 to the accompanying consolidated financial statements. Additional information about the Fund is available at www.sedar.com.

In the present economic climate, the most significant risks and uncertainties facing the Fund and its ability to re-establish distributions at historic levels, result from the continued strength of the Canadian dollar relative to the United States dollar, and from the ongoing inability to pass input cost increases on to customers in a timely manner. Since a majority of the Fund's operations and assets are in the United States, a "natural" business hedge exists. However, while it is possible to hedge Distributable Cash flow against future fluctuations in the currency (as has been done), it is not possible to hedge business operations, so a continuation of a strong Canadian dollar will have a negative impact on the relative contribution of the Fund's United States denominated business. Similarly, if the Fund must continue to absorb increased raw material costs without the benefit of a price increase to its customers, gross margin will remain depressed and profitability and the Fund's ability to pay distributions will be curtailed. Given the nature of our industry, price increases are largely beyond Menu's control.

The Fund's Lenders will no longer permit the Fund to make any monthly distributions until it is in compliance with the covenants contained in the original Agreements with the Lenders, including a total debt to EBITDA ratio of 3 to 1 or less. There can be no assurance as to either when the Fund can resume monthly distributions, or the amount of the monthly distributions that can be paid at that time.

Note A: EBITDA is not a recognized measure under Canadian generally accepted accounting principles (GAAP). Management believes that in addition to net income, EBITDA is a useful supplemental measure of operating performance as it provides investors with an indication of cash available for distribution prior to debt service, capital expenditures and income taxes. EBITDA, as defined in the Menu Foods Limited Partnership Agreement, is Earnings Before Interest, Taxes, Depreciation, Amortization and Non-controlling Interest.

Distributable Cash is not a recognized measure under GAAP. Management believes that together with net income and EBITDA, Distributable Cash is a useful supplemental measure of operating performance, which provides investors with an indication of cash available for distribution after adjusting for maintenance capital expenditures and certain principal repayments. Distributable Cash is defined as cash flow from operating activities adjusted for changes in non-cash working capital items, maintenance capital expenditures and principal repayments.

Investors should be cautioned, however, that neither EBITDA nor Distributable Cash should be construed as an alternative to net income determined in accordance with GAAP as an indicator of Menu's performance or to cash flows from operating, investing and financing activities as a measure of liquidity and cash flow. Menu's method of calculating EBITDA and Distributable Cash may differ from other companies and, accordingly, EBITDA and Distributable Cash may not be comparable to measures used by other companies.

The following are reconciliations of: Net income to EBITDA and of Cash Flow from Operating Activities to Distributable Cash for the fourth quarter of the Fund:




For the Quarter ended
December 31
2005 2004
$'000's $'000's

Net (loss) income (13,797) 3,260
Adjust for:
Goodwill impairment loss 23,120 -
Non-controlling interest of Class B
Exchangeable Units (8,647) 2,572
Amortization of property, plant and equipment 3,795 3,633
Amortization of supply contract 135 263
Future income taxes (1,130) 597
Current income taxes 86 308
Interest 2,047 976
-------------------------
EBITDA 5,609 11,609
-------------------------
-------------------------

For the Quarter ended
December 31
2005 2004
$'000's $'000's

Cash flow from operating activities 2,648 5,052
Adjust for:
Change in non-cash working capital items 1,612 6,038
Maintenance capital expenditures (318) (1,029)
Principal repayments (42) (49)
-------------------------
Distributable Cash 3,900 10,012
-------------------------
-------------------------

The following are reconciliations of: net income to EBITDA and Cash Flow
from Operating Activities to Distributable Cash for year-to-date and since the
inception of the Fund:

Since
Inception
(May 22,
For the year ended 2002) to
December 31 December 31
2005 2004 2005
$'000's $'000's $'000's

Net (loss) income (54,665) 12,717 (28,468)
Adjust for:
Goodwill impairment loss 93,415 - 93,415
Non-controlling interest of
Class B Exchangeable Units (34,036) 10,401 (10,771)
Amortization of property, plant
and equipment 15,702 14,153 52,290
Amortization of supply contract 553 1,222 1,974
Future income taxes (2,980) 2,234 4,898
Current income taxes 69 1,194 1,106
Interest 6,916 4,268 17,569
--------------------------------------
EBITDA 24,974 46,189 132,013
--------------------------------------
--------------------------------------

Since
Inception
(May 22,
For the year ended 2002) to
December 31 December 31
2005 2004 2005
$'000's $'000's $'000's

Cash flow from operating activities 24,986 19,167 88,117
Adjust for:
Change in non-cash working capital
items (6,091) 22,152 27,316
Maintenance capital expenditures (2,432) (2,520) (8,936)
Principal repayments (157) (148) (543)
--------------------------------------
Distributable Cash 16,306 38,651 105,954
--------------------------------------
--------------------------------------



Menu Foods Income Fund
Consolidated Balance Sheet
(All figures expressed in thousands of Canadian dollars, unaudited)

As at
December 31,
2005 2004

$ $

Assets

Current assets
Cash 5,790 -
Accounts receivable
Trade 17,298 18,716
Other 2,133 2,316
Inventories (note 3) 49,475 59,120
Prepaid expenses and sundry assets 1,318 1,898
Income taxes recoverable 550 259
Future income taxes (note 14) 1,701 1,874
-------------------------------------------------------------------------
Total Current Assets 78,265 84,183
Property, plant and equipment (note 4) 107,622 116,130
Goodwill (note 5) 71,972 165,387
Other assets (note 6) 5,374 6,053
-------------------------------------------------------------------------
Total Assets 263,233 371,753
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Liabilities

Current liabilities
Bank indebtedness (note 7) 29,309 10,398
Accounts payable and accrued liabilities 18,803 21,735
Distributions payable - 5,674
Current portion of long-term debt (note 8) 24 157
-------------------------------------------------------------------------
Total Current Liabilities 48,136 37,964
Long-term debt (note 8) 98,912 102,434
Future income taxes (note 14) 13,996 17,381
-------------------------------------------------------------------------
Total Liabilities 161,044 157,779
-------------------------------------------------------------------------

Class B Exchangeable Units (note 9) 31,639 81,363
-------------------------------------------------------------------------

Unitholders' Equity

Trust Units (note 10) 170,454 160,372
Contributed surplus (note 12) 272 808
Deficit (88,830) (19,182)
Foreign currency translation adjustment (11,346) (9,387)
-------------------------------------------------------------------------
Total Unitholders' Equity 70,550 132,611
-------------------------------------------------------------------------
Total Liabilities and Unitholders' Equity 263,233 371,753
-------------------------------------------------------------------------
-------------------------------------------------------------------------

The accompanying notes are an integral part of these consolidated
financial statements.



Menu Foods Income Fund
Consolidated Statement of Operations and Deficit
(All figures, except per Unit amounts, expressed in thousands of Canadian
dollars, unaudited)

Quarter ended
December 31,
2005 2004

$ $

Sales 84,842 91,334
Cost of sales (note 15) 77,055 77,423
-------------------------------------------------------------------------
Gross profit 7,787 13,911
Selling, general and administrative expenses 6,108 6,198
-------------------------------------------------------------------------
Income before the undernoted 1,679 7,713
Goodwill impairment loss (note 5) 23,120 -
Financial expenses (note 13) 2,047 976
-------------------------------------------------------------------------
Income (loss) before income taxes and
non-controlling interest (23,488) 6,737
-------------------------------------------------------------------------
Current income taxes 86 308
Future income taxes (1,130) 597
-------------------------------------------------------------------------
Total income taxes (note 14) (1,044) 905
-------------------------------------------------------------------------
Income (loss) before non-controlling interest (22,444) 5,832
Non-controlling interest of Class B
Exchangeable Units (8,647) 2,572
-------------------------------------------------------------------------
Net (loss) income for the quarter (13,797) 3,260
Deficit - beginning of quarter (73,257) (17,401)
Distributions (note 11) (1,776) (5,041)
-------------------------------------------------------------------------
Deficit - end of quarter (88,830) (19,182)
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Basic net (loss) income per Trust Unit $ (0.777) $ 0.205
Diluted net (loss) income per Trust Unit $ (0.777) $ 0.203

Basic weighted average number of Trust Units
outstanding (note 10) 17,766,159 15,925,006
Diluted weighted average number of Trust Units
outstanding (note 10) 28,920,261 28,715,655

The accompanying notes are an integral part of these consolidated
financial statements.



Menu Foods Income Fund
Consolidated Statement of Operations and Deficit
(All figures, except per Unit amounts, expressed in thousands of Canadian
dollars, unaudited)

Year ended
December 31,
2005 2004

$ $

Sales 346,932 380,712
Cost of sales (note 15) 313,681 324,667
-------------------------------------------------------------------------
Gross profit 33,251 56,045
Selling, general and administrative expenses 24,532 25,231
-------------------------------------------------------------------------
Income before the undernoted 8,719 30,814
Goodwill impairment loss (note 5) 93,415 -
Financial expenses (note 13) 6,916 4,268
-------------------------------------------------------------------------
Income (loss) before income taxes and
non-controlling interest (91,612) 26,546
-------------------------------------------------------------------------
Current income taxes 69 1,194
Future income taxes (2,980) 2,234
-------------------------------------------------------------------------
Total income taxes (note 14) (2,911) 3,428
-------------------------------------------------------------------------
Income (loss) before non-controlling interest (88,701) 23,118
Non-controlling interest of Class B
Exchangeable Units (note 9) (34,036) 10,401
-------------------------------------------------------------------------
Net (loss) income for year (54,665) 12,717
Deficit - beginning of year (19,182) (12,438)
Distributions (note 11) (14,983) (19,461)
-------------------------------------------------------------------------
Deficit - end of year (88,830) (19,182)
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Deficit comprises:
Accumulated net (loss) income (28,641) 26,024
Accumulated distributions (60,189) (45,206)
-------------------------------------------------------------------------
(88,830) (19,182)
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Basic net (loss) income per Trust Unit $ (3.201) $ 0.828
Diluted net (loss) income per Trust Unit $ (3.201) $ 0.821

Basic weighted average number of Trust Units
outstanding (note 10) 17,077,197 15,354,036
Diluted weighted average number of Trust Units
outstanding (note 10) 28,889,067 28,145,498

The accompanying notes are an integral part of these consolidated
financial statements.



Menu Foods Income Fund
Consolidated Statement of Cash Flows
(All figures expressed in thousands of Canadian dollars, unaudited)

Quarter ended
December 31,
2005 2004

$ $

Cash provided by (used in)
Operating activities
Net (loss) income for the quarter (13,797) 3,260
Adjustments for non-cash items
Goodwill impairment loss 23,120 -
Non-controlling interest of Class B
Exchangeable Units (8,647) 2,572
Amortization of property, plant and equipment 3,795 3,633
Amortization of supply contract 135 263
Amortization of deferred financing costs 223 73
Vesting of long-term incentive plan 35 -
Gain on sale of property, plant and equipment - (65)
Mark-to-market adjustment 526 757
Future income taxes (1,130) 597
-------------------------------------------------------------------------
4,260 11,090
Change in non-cash working capital items
Accounts receivable 2,106 7,226
Inventories (4,325) (6,085)
Prepaid expenses and sundry assets 250 135
Income taxes recoverable 75 243
Accounts payable and accrued liabilities 282 (7,557)
-------------------------------------------------------------------------
2,648 5,052
-------------------------------------------------------------------------
Financing activities
Advance in bank indebtedness - 10,398
Issuance of Trust Units, net - 924
Long-term debt repayments (42) (2,320)
Distributions paid to Trust Units (2,665) (5,008)
Distributions paid to Class B Exchangeable
Units (773) (3,979)
-------------------------------------------------------------------------
(3,480) 15
-------------------------------------------------------------------------
Investing activities
Purchase of property, plant and equipment (351) (6,288)
Other assets (173) (77)
Proceeds from sale of property, plant and
equipment - 164
-------------------------------------------------------------------------
(524) (6,201)
-------------------------------------------------------------------------
Decrease in cash (1,356) (1,134)
Cash - beginning of quarter 7,146 1,134
-------------------------------------------------------------------------
Cash - end of quarter 5,790 -
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Supplementary information

Income taxes paid 52 1,653
Interest paid 1,570 929

The accompanying notes are an integral part of these consolidated
financial statements.



Menu Foods Income Fund
Consolidated Statement of Cash Flows
(All figures expressed in thousands of Canadian dollars, unaudited)

Year ended
December 31,
2005 2004

$ $

Cash provided by (used in)
Operating activities
Net (loss) income for year (54,665) 12,717
Adjustments for non-cash items
Goodwill impairment loss 93,415 -
Non-controlling interest of Class B
Exchangeable Units (34,036) 10,401
Amortization of property, plant and equipment 15,702 14,153
Amortization of supply contract 553 1,222
Amortization of deferred financing costs 422 447
Vesting of long-term incentive plan 218 -
Gain on sale of property, plant and equipment - (65)
Mark-to-market adjustment 266 210
Future income taxes (2,980) 2,234
-------------------------------------------------------------------------
18,895 41,319
Change in non-cash working capital items
Accounts receivable 1,241 (1,540)
Inventories 8,012 (18,748)
Prepaid expenses and sundry assets 570 (65)
Income taxes recoverable (238) 2,745
Accounts payable and accrued liabilities (3,494) (4,544)
-------------------------------------------------------------------------
24,986 19,167
-------------------------------------------------------------------------
Financing activities
Advance in bank indebtedness 18,777 10,398
Issuance of Trust Units, net 380 37,153
Long-term debt repayments (157) (2,702)
Distributions paid to Trust Units (16,678) (19,158)
Distributions paid to Class B Exchangeable
Units (10,501) (16,737)
-------------------------------------------------------------------------
(8,179) 8,954
-------------------------------------------------------------------------
Investing activities
Purchase of property, plant and equipment (10,367) (31,700)
Other assets (650) (80)
Proceeds from sale of property, plant and
equipment - 164
-------------------------------------------------------------------------
(11,017) (31,616)
-------------------------------------------------------------------------
Increase (decrease) in cash 5,790 (3,495)
Cash - beginning of year - 3,495
-------------------------------------------------------------------------
Cash - end of year 5,790 -
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Supplementary information

Income taxes paid (refunded) 222 (1,593)
Interest paid 5,845 3,792

The accompanying notes are an integral part of these consolidated
financial statements.


Menu Foods Income Fund

Notes to Consolidated Financial Statements

December 31, 2005

(All figures, except per Unit amounts, expressed in thousands of Canadian

dollars, unaudited)

1. Description of the business

Menu Foods Income Fund (the "Fund") is an unincorporated open-ended trust, established under the laws of the Province of Ontario by Declaration of Trust dated March 25, 2002 (the "Declaration of Trust"). The Fund was created to hold directly or indirectly, investments in entities engaged in the manufacture and sale of pet food products, including the securities or assets of Menu Foods Limited ("Menu" or the "Company").

Menu was incorporated on May 17, 1971 under the laws of the Province of Ontario. The Company is mainly engaged in the manufacture of wet pet food products, which are sold primarily to retail and wholesale operations in Canada and the United States.

2. Summary of significant accounting policies

a) Basis of presentation

The Fund prepares its consolidated financial statements in accordance with Canadian generally accepted accounting principles.

The consolidated financial statements include the accounts of the Fund and all of its subsidiaries. All inter-company transactions and accounts have been eliminated on consolidation.

b) Use of estimates

The preparation of consolidated financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

c) Cash and cash equivalents

Deposits in banks and short-term investments with original maturities of three months or less are considered cash and cash equivalents. Cash equivalents are carried at cost, which approximates fair market value, due to the short-term nature of these instruments.

d) Inventories

Inventories are valued at the lower of cost, determined on a first-in, first-out basis, and net realizable value.

e) Property, plant and equipment

Property, plant and equipment are carried at cost less accumulated amortization. Cost represents the cost of acquisition or construction, including preparation and testing charges and direct financing costs incurred until the beginning of commercial production. An impairment loss is recognized when the asset's carrying value is no longer recoverable from estimated future undiscounted cash flows. When an impairment loss is recognized, the carrying amount of the asset would be reduced to its estimated fair value. Amortization is calculated using the straight-line method applied to the cost of the assets, at annual rates based on their estimated useful lives, as follows:



Buildings 20 - 40 years
Machinery and equipment 3 - 10 years
Equipment under capital lease 3 - 10 years
Other property and equipment 3 - 20 years


Construction-in-progress represents expenditures incurred for uncompleted projects. Upon completion, the related construction-in- progress is transferred to the appropriate asset class and amortization commences.

f) Future income taxes

The Fund follows the liability method of accounting for future income taxes. Under the liability method, future income tax assets and liabilities are determined based on temporary differences (differences between the accounting basis and the tax basis of the assets and liabilities) and are measured using the currently enacted, or substantively enacted, tax rates and laws expected to apply when these differences reverse. A valuation allowance is recorded against any future income tax asset, if it is more likely than not that the asset will not be realized. Applicable withholding taxes are accrued as foreign sourced income is earned to the extent that the repatriation of earnings from foreign subsidiaries is expected to occur.

g) Research and development

Research expenditures are expensed as incurred. Development expenditures are written off as incurred unless, in the view of management, the expenditures are incurred in the development of products or processes, which are expected to be commercially viable for a period that exceeds one year and have a long-term commercial future. In these cases, development costs are deferred and amortized over the estimated commercial life of the product or process on a straight-line basis, not to exceed five years.

h) Deferred financing charges

Costs associated with the arrangement of long-term financing are deferred and amortized on a straight-line basis over the term of the debt. The amortization is included in financial expenses.

i) Goodwill

Goodwill reflects the price paid for the Menu business in excess of the fair market value of net tangible assets and identifiable intangible assets acquired. Menu operates as one reporting unit for purposes of allocating and evaluating goodwill. The Fund reviews goodwill on an annual basis or at any other time when events or changes have occurred that suggest an impairment of the carrying value. Impairment is recognized when the estimated fair value of the goodwill is lower than the carrying value.

j) Supply contract

The supply contract (the "Contract") consists of an exclusive agreement to supply all the canned wet pet food requirements for Proctor & Gamble/Iams ("P&G/Iams") in the United States and Canada. The Contract is carried at cost less accumulated amortization. Amortization is charged to cost of sales on a straight-line basis, over the estimated term of the Contract, which is ten years. The Contract is evaluated for impairment whenever events or changes in circumstances indicate the carrying value may not be recoverable. An impairment loss is recognized when estimated undiscounted cash flows expected to result from the Contract are less than its carrying value. Should an impairment loss be recognized, the carrying amount of the Contract would be reduced to its estimated fair value.

k) Foreign currency translation

Monetary assets and liabilities denominated in foreign currencies, except those of self-sustaining subsidiaries, are translated at the exchange rate in effect at the consolidated balance sheet date and non-monetary items are translated at historical exchange rates. Operating revenue and expenses are translated at average exchange rates prevailing during the period. Gains or losses arising from these translations are included in net income.

The assets and liabilities of all subsidiaries, which are considered to be self-sustaining operations, are translated at the exchange rate in effect at the consolidated balance sheet date. Revenues and expenses are translated at average exchange rates prevailing during the period. The Fund has designated its United States' dollar loans as a hedge of its net investment in the United States. The loans are translated at the exchange rate in effect at the consolidated balance sheet date. The resulting gains or losses are included in the foreign currency translation adjustment in unitholders' equity.

l) Revenue recognition

The Fund recognizes revenue from the sale of manufactured goods at the time of product shipment. From time to time the Fund enters into contracts with customers to manufacture products on their behalf. In some instances the customers provide a portion of the inventory to be used in the manufacturing process. Accordingly, the Fund includes in sales the invoice price to the customer and includes in cost of sales the Fund's portion of costs incurred when the goods are shipped.

The Fund enters into "Take-or-pay" arrangements with certain customers which require the customer to pay Menu if their purchases do not exceed contracted volumes. These arrangements are reflected in sales (2005 - $1,122; 2004 - $Nil).

m) Supplier rebates

Volume rebates on supplier purchases are recorded throughout the period as a reduction of cost of sales based on management's best estimate of the amounts that will ultimately be collected.

n) Unit based compensation

The Fund expenses awards made under its long-term incentive plan in accordance with the fair value based method.

o) Derivative instruments

Any trading, speculative or non-qualifying hedging derivative financial instruments are recognized in the consolidated balance sheet and measured at fair value, with changes in fair value recognized in net income as charge or credit to selling, general and administrative expenses.

p) Asset retirement obligations

The fair value of a liability for an asset retirement obligation is recognized in the period in which it is incurred, if a reasonable estimate of fair value can be made. The associated retirement costs are capitalized as part of the carrying amount of the long-lived assets and amortized over the life of the asset. As at December 31, 2005, the Fund has concluded that there were no asset retirement obligations associated with its assets.

q) Non-controlling interest

Effective in its fourth quarter of 2004, the Fund adopted the requirements of the Emerging Issues Committee of The Canadian Institute of Chartered Accountants Abstract 151. This abstract described circumstances whereby exchangeable units, previously included in unitholders' equity, should be shown as non-controlling interest. This change in accounting policy was given retroactive application.

3. Inventories



3. Inventories

December 31,
2005 2004

$ $
Raw materials and packaging 16,462 15,794
Finished goods 33,013 43,326
---------------------------------------------------------------------
49,475 59,120
---------------------------------------------------------------------
---------------------------------------------------------------------

4. Property, plant and equipment

December 31, 2005
Accumulated
Cost amortization Net
$ $ $
Land 5,248 - 5,248
Buildings 43,671 5,094 38,577
Machinery and equipment 90,563 32,275 58,288
Other property and equipment 14,069 9,619 4,450
Equipment under capital lease 97 81 16
Construction-in-progress 1,043 - 1,043
---------------------------------------------------------------------
154,691 47,069 107,622
---------------------------------------------------------------------
---------------------------------------------------------------------



December 31, 2004
Accumulated
Cost amortization Net
$ $ $

Land 5,319 - 5,319
Buildings 44,996 3,547 41,449
Machinery and equipment 77,711 21,761 55,950
Other property and equipment 14,107 7,520 6,587
Equipment under capital lease 809 578 231
Construction-in-progress 6,594 - 6,594
---------------------------------------------------------------------
149,536 33,406 116,130
---------------------------------------------------------------------
---------------------------------------------------------------------


5. Goodwill

When the Fund purchased its interest in Menu Foods Limited Partnership, $165,387 of the purchase price was assigned as goodwill in the consolidated financial statements. Under Canadian generally accepted accounting principles, goodwill is subject to an annual impairment test which, for the Fund, takes place as at September 30th of each year. Since the Fund's units were trading at lower than their book value at September 30, 2005 and through December 31, 2005, the application of current accounting principles identified an impairment in the carrying value of goodwill. Following a fair value assessment of other assets, goodwill was written down, for the quarter and year ended December 31, 2005 by $23,120 and $93,415, respectively. This charge is a non-cash item and does not impact the Fund's credit facilities. No impairment in the value of the Fund's identifiable intangible assets or property, plant and equipment has been identified.

6. Other assets



December 31, 2005
Accumulated
Cost amortization Net
$ $ $

Supply contract 5,834 1,677 4,157
Deferred financing charges 1,842 925 917
Deferred long-term incentive
plan (note 12) 518 218 300
---------------------------------------------------------------------
8,194 2,820 5,374
---------------------------------------------------------------------
---------------------------------------------------------------------

December 31, 2004
Accumulated
Cost amortization Net
$ $ $

Supply contract 6,030 1,184 4,846
Deferred financing charges 1,711 504 1,207
---------------------------------------------------------------------
7,741 1,688 6,053
---------------------------------------------------------------------
---------------------------------------------------------------------


7. Bank indebtedness

The banking agreement provides the Fund with a US$30,000 operating facility of which $29,309 (US$25,201) was drawn as at December 31, 2005 (December 31, 2004 - US$7,241 ($8,704)). This operating facility bears interest at Canadian prime rate plus 1.00% (6.00% as at December 31, 2005), U.S. base rate plus 1.00% (8.25% as at December 31, 2005) or Euro rate plus 2.50% (7.32% as at December 31, 2005) depending on the currency advanced. The facility is a 364-day revolving term facility, which has been extended to February 28, 2006.

During 2005, the Fund was not in compliance with certain covenants in its credit agreement with its bankers. The Fund's bankers have waived these breaches until February 28, 2006 with the stipulation that no distributions can be paid until the Fund is once again in compliance with its covenants, including a total debt to EBITDA ratio of 3 to 1 or less.

On February 7, 2006 the Fund reached agreements in principal with its bank and the holders of its senior secured notes (note 8), which among other things, define the terms and conditions governing the Fund's US$30,000 operating facility and US$85,000 senior secured notes facilities, going forward. Finalization of these arrangements is subject to completion of definitive agreements satisfactory to all parties. The Fund has agreed to pay US$75 in fees to the bank, plus all associated legal expenses. In addition, the Fund and the bank have agreed to modify certain covenants and, beginning January 1, 2006, to pay an increased rate of interest based upon a sliding scale that decreases as the Fund's leverage ratio decreases. The interest rate retroactively effective January 1, 2006 will be 125 basis points higher and will decrease until the Fund's total debt to EBITDA ratio is reduced to 3 to 1, at which time it will return to levels under the previous agreement.

The Fund has pledged, as security for bank indebtedness, all moveable property and book debts and, in addition, has signed a general security agreement. The Fund must adhere to certain restrictive covenants and required financial ratios in order to satisfy its obligations under the terms of its financing agreements with both its bankers and senior secured noteholders (note 8), which presently limit borrowings under this facility to the amount drawn as at December 31, 2005 of $29,309. The new banking agreement will enable the Fund to avail of the full operating facility, as long as the Fund is in compliance with its covenants.

At December 31, 2005, The Fund has an outstanding letter of credit in the amount of US$555 ($645) (2004 - US$555 ($667)).



8. Long-term debt

December 31,
2005 2004
$ $

Senior secured notes (a) 98,855 102,170
Obligation under capital lease (b) 81 238
Forgivable loan (c) - 183
---------------------------------------------------------------------
98,936 102,591
Less: Current portion 24 157
---------------------------------------------------------------------
98,912 102,434
---------------------------------------------------------------------
---------------------------------------------------------------------


a) Senior secured notes

On October 31, 2003, the Fund closed a private placement offering for US$85,000 in floating rate, three-month LIBOR plus 155 basis points, (5.80% as at December 31, 2005 and 3.71% as at December 31, 2004) senior secured notes. The notes are repayable on October 31, 2010 with interest payable quarterly. The Fund has pledged, as security for its senior secured notes, all moveable property and book debts and, in addition, has signed a general security agreement. The Fund must adhere to certain restrictive covenants and required financial ratios in order to satisfy its obligations under the terms of its financing arrangements with both its bankers (note 7) and senior secured noteholders. During the fourth quarter, the Fund identified that it had breached certain covenants and as at December 31, 2005 was operating under a forbearance agreement with its noteholders until February 28, 2006.

During 2005, the Fund was not in compliance with certain covenants in its financing arrangement with its senior secured noteholders. The Fund's noteholders have agreed to forbear until February 28, 2006 with the stipulation that no distributions can be paid until the Fund is once again in compliance with its covenants, including a total debt to EBITDA ratio of 3 to 1 or less.

On February 7, 2006 the Fund reached agreements in principal with the holders of its senior secured notes an its bank (note 7), which among other things, define the terms and conditions governing the Fund's US$85,000 senior secured notes facilities and US$30,000 operating facility, going forward. Finalization of these arrangements is subject to completion of definitive agreements satisfactory to all parties. The Fund has agreed to pay US$468 in fees to the note holders, plus all associated legal expenses. In addition, the Fund and the note holders have agreed to modify certain covenants and, beginning January 1, 2006, to pay an increased rate of interest based upon a sliding scale that decreases as the Fund's leverage ratio decreases. The interest rate retroactively effective January 1, 2006 will be 200 basis points higher and will decrease until the Fund's total debt to EBITDA ratio is reduced to 3 to 1, at which time it will return to levels under the previous agreement.

If finalized prior to issuance of the annual financial statements, the amendments to the Agreement will enable the senior secured notes to be classified as long-term in these financial statements, since the noteholders will have unconditionally waived their right to demand repayment of the notes if the Fund continues to be in compliance with the covenants set out in the amended Agreements. Management of the Fund believes that it will be able to comply with these amended covenants throughout 2006.

The Fund had fixed interest rates at 2.93% or 2.97% plus a stamping fee of 155 basis points on US$22,500 which expired in December 2005.

b) Obligation under capital lease

The Fund entered into a capital lease in December 2002, collateralized by certain computer equipment. The lease, which was modified in December 2005, provides for blended monthly payments of $3 (2004 - $14).



Minimum lease payments: December 31,
2005 2004
$ $

2005 - 168
2006 32 84
2007 32 -
2008 31 -
---------------------------------------------------------------------
Total minimum lease payments 95 252
Less: Amounts representing interest at 10.40 %
(6.60% - 2004) 14 14
---------------------------------------------------------------------
Balance of obligation 81 238
Less: Current portion 24 157
---------------------------------------------------------------------
57 81
---------------------------------------------------------------------
---------------------------------------------------------------------


c) Forgivable loan

During 2002, the Fund finalized an agreement whereby the City of Emporia provided incentive money in the form of a non-interest bearing forgivable loan. As at December 31, 2005, the loan was completely forgiven. The outstanding amount on December 31, 2004 was $183 (US$151). Since the incentive arrangement was provided to assist in the construction of the building, the Fund reduced its property, plant and equipment by the amount forgiven, as it was forgiven.

9. Class B Exchangeable Units



Number Carrying
of units value
$

Class B Exchangeable Units of MFLP
December 31, 2003 12,631,915 86,878
Share of net income for the year 10,401
Distributions for the year (note 11) (15,916)
---------------------------------------------------------------------
December 31, 2004 12,631,915 81,363
Conversion of Class B units to Trust units
(note 10) (1,498,260) (9,166)
Share of net loss for the year (34,036)
Distributions for the year (note 11) (6,522)
---------------------------------------------------------------------
December 31, 2005 11,133,655 31,639
---------------------------------------------------------------------
---------------------------------------------------------------------


Except as described below, the Class B Units together with their related Special Trust Units (note 10) can be exchanged on a one-for- one basis with the Fund for Trust Units at the option of the holder.

During the second quarter of 2005, certain holders of Class B Exchangeable Units agreed to subordinate their entitlement to distributions for a ten month period beginning with the distributions in respect of the month of May 2005 and ending with the distributions in respect of the month of February 2006. Such unitholders shall be entitled to a reimbursement of such subordinated distributions before distributions can be increased above 9 cents per unit, per month. No obligation arises to the Fund in respect of these subordinated amounts until it has generated sufficient distributable cash and, accordingly, no amount has been accrued in distributions payable at December 31, 2005. These same unitholders have agreed to forego their entitlement to convert their Class B Exchangeable Units into Trust units until February 2006.

10. Trust Units



Authorized
Unlimited number of Trust Units
Unlimited number of Special Trust Units

Issued
Number Gross Issuance Net
of units proceeds costs proceeds
$ $ $
Trust Units
December 31, 2003 13,259,823 132,000 10,820 121,180
Issued during the
quarter ended
March 31, 2004 2,500,000 36,500 480 36,020
Exercise of
options during
quarter ended
(note 12):
March 31, 2004 32,377 270 - 270
June 30, 2004 33,848 282 - 282
September 30,
2004 3,679 31 - 31
December 31,
2004 310,509 2,589 - 2,589
---------------------------------------------------------------------
December 31, 2004 16,140,236 171,672 11,300 160,372
Conversion of
Class B Units
during the
quarter ended
June 30, 2005
(note 9) 1,498,260 9,166 - 9,166
Exercise of
options during
the quarter
ended (note 12)
March 31, 2005 41,573 347 - 347
June 30, 2005 8,829 58 - 58
September 30,
2005 77,261 511 - 511
---------------------------------------------------------------------
December 31, 2005 17,766,159 181,754 11,300 170,454
---------------------------------------------------------------------
---------------------------------------------------------------------


Special Trust Units

Special Trust Units are used solely for providing voting rights to the holders of Class B Exchangeable Units ("Class B Units") (note 9) and by their terms have voting rights of the Fund. Special Trust Units are not transferable separately from the Class B Units to which they relate. Conversely, the Special Trust Units will automatically be transferred upon a transfer of the associated Class B Units. Each Special Trust Unit entitles the holder thereof to a number of votes at any meeting of Unitholders and holders of Special Trust Units equal to the number of Units that may be obtained upon the exchange of the Class B Units to which the Special Trust Unit relates, but do not otherwise entitle the holder to any rights with respect to the Fund's property or income. The Fund issued 12,631,915 Special Trust Units relating to the Class B Units at the date of acquisition of Menu. There were 11,133,655 Special Trust Units outstanding as at December 31, 2005 (note 9).

Weighted average number of Units outstanding

Basic net income (loss) per Trust Unit is computed by dividing net income for the period by the weighted average number of Trust Units outstanding during the period. Diluted net income (loss) per Trust Unit includes the effect of exercising unit options (note 12), only if dilutive and includes the Class B Exchangeable Units using the "if converted" method.

The following table reconciles the basic weighted average number of units outstanding to the diluted weighted average number of units outstanding:



Quarter ended December 31,
2005 2004

Weighted average number of Trust Units
outstanding - basic 17,766,159 15,925,006
Weighted average number of Class B Units
outstanding - basic (note 9) 11,133,655 12,631,915
Dilutive effect of options (note 12) 20,447 158,734
---------------------------------------------------------------------
Weighted average number of units
outstanding - diluted 28,920,261 28,715,655
---------------------------------------------------------------------
---------------------------------------------------------------------

Year ended December 31,
2005 2004

Weighted average number of Trust Units
outstanding - basic 17,077,197 15,354,036
Weighted average number of Class B Units
outstanding - basic (note 9) 11,761,693 12,631,915
Dilutive effect of options (note 12) 50,178 159,547
---------------------------------------------------------------------
Weighted average number of units
outstanding - diluted 28,889,067 28,145,498
---------------------------------------------------------------------
---------------------------------------------------------------------

11. Distributions

Distributions declared during the year ended December 31, 2005 were
as follows:

Unitholder Record Total Per unit
Date $ $ Paid or payable

Trust Units
January 31, 2005 1,696 0.1050 February 15, 2005
February 28, 2005 1,697 0.1050 March 15, 2005
March 31, 2005 1,700 0.1050 April 15, 2005
April 29, 2005 1,699 0.1050 May 16, 2005
May 31, 2005 1,456 0.0900 June 15, 2005
June 30, 2005 1,592 0.0900 July 15, 2005
July 29, 2005 1,592 0.0900 August 15, 2005
August 31, 2005 886 0.0500 September 15, 2005
September 30, 2005 889 0.0500 October 17, 2005
October 31, 2005 888 0.0500 November 15, 2005
November 30, 2005 888 0.0500 December 15, 2005
---------------------------------------------------------------------
14,983 0.8900
---------------------------------------------------------------------
---------------------------------------------------------------------

During the quarter and year ended December 31, 2004, distributions
declared to Trust Units amounted to $5,041 ($0.315 per unit) and
$19,461 ($1.260 per unit), respectively.

Unitholder Record Total Per unit
Date $ $ Paid or payable

Class B Units
January 31, 2005 1,326 0.1050 February 15, 2005
February 28, 2005 1,327 0.1050 March 15, 2005
March 31, 2005 1,326 0.1050 April 15, 2005
April 29, 2005 1,326 0.1050 August 15, 2005
May 31, 2005 1,137 0.0900 August 15, 2005
June 30, 2005 1,002 0.0900 August 15, 2005
July 29, 2005 1,002 0.0900 November 15, 2005
August 31, 2005 557 0.0500 November 15, 2005
September 30, 2005 557 0.0500 November 15, 2005
October 31, 2005 556 0.0500 November 15, 2005
November 30, 2005 557 0.0500 December 15, 2005
---------------------------------------------------------------------
10,673 0.8900
Distributions
subordinated
(note 9) (4,151)
---------------------------------------------------------------------
6,522
---------------------------------------------------------------------
---------------------------------------------------------------------


During the quarter and year ended December 31, 2004, distributions declared to Class B Units amounted to $3,979 ($0.315 per unit) and $15,916 ($1.260 per unit), respectively.

12. Unit based compensation

Unit option plan

Menu Foods Corporation (the former parent company of Menu) had an executive stock option plan pursuant to which there were outstanding options issued to 61 of its directors, executive officers and key employees. In connection with the Fund's Initial Public Offering and the acquisition of Menu, these options were exchanged for Trust Unit options in the Fund having equivalent terms and conditions. As at December 31, 2005, 74,683 Trust Unit options, all of which were vested and have a weighted average exercise price of $2.977 per unit, were outstanding. The Trust Unit options will expire in November and December 2006.



December 31,
2005 2004

Opening balance 202,346 582,759
Exercised (127,663) (380,413)
---------------------------------------------------------------------
Ending balance 74,683 202,346
---------------------------------------------------------------------
---------------------------------------------------------------------


The fair value of the Trust Unit options was determined as part of the cost of the acquisition of Menu Foods Limited Partnership ("MFLP") using the Black-Scholes model, incorporating a 4.25% risk free interest rate, at a 35% volatility factor and 11.75% expected distributions. On this basis, each Trust Unit option was valued at $5.36. The valuation of total Trust Unit options, after allowing for expected forfeitures, aggregated to $4,776, which was included as contributed surplus at the acquisition date.

Contributed surplus attributed to Trust Unit options



December 31,
2005 2004
$ $

Opening balance 808 2,847
Options exercised (536) (2,039)
---------------------------------------------------------------------
Ending balance 272 808
---------------------------------------------------------------------
---------------------------------------------------------------------


As the Trust Unit options are exercised, the associated contributed surplus is reclassified to Trust Units (note 10). During the quarter and year ended December 31, 2005, $Nil and $536 were reclassified to Trust Units (2004 - $1,664 and $2,039).

Long-term incentive plan

In 2003, the Fund adopted a discretionary long-term incentive plan (the "Incentive Plan") for the 2003, 2004 and 2005 financial years in which trustees, directors, officers and employees (collectively the "Participants") were all eligible to participate. Pursuant to the Incentive Plan, the Fund could contribute an amount, equal to 14.286% of the amount by which distributable cash, as defined by the Declaration of Trust for a calendar year exceeds $33,500 and $34,000 for calendar years 2004 and 2005, respectively, to a trust on behalf of the Participants in the Incentive Plan. The trust would then purchase Units, on the open market, equal in value to the amount contributed. Units would be awarded to Participants based on determinations made by the Compensation and Corporate Governance Committee of Menu Foods GenPar Limited's Board of Directors (the "Committee"). Once purchased, the Committee would determine the number of Units acquired on behalf of each Participant based on the amount contributed to the Trust on their behalf. Units awarded will vest over a three-year period, subject to the provisions of the Incentive Plan.

If the employment of a Participant is terminated prior to the final vesting of the Units attributed to such Participant, such Participant's unvested Units shall be sold and the net proceeds returned to the Fund. The Fund intends to review the Incentive Plan for calendar year 2006 and beyond. In February 2005, 36,390 Trust Units were purchased for $518 for the benefit of 22 individuals.

13. Financial expenses



Quarter ended December 31,
2005 2004
$ $

Interest on senior secured notes 1,408 879
Interest on term loans and bank indebtedness 194 105
Interest on capital leases 2 10
Net loss (gain) on interest rate swap 133 (104)
Amortization of deferred financing charges 223 73
Other, net 87 13
---------------------------------------------------------------------
2,047 976
---------------------------------------------------------------------
---------------------------------------------------------------------


Year ended December 31,
2005 2004
$ $

Interest on senior secured notes 5,057 3,299
Interest on term loans and bank indebtedness 1,106 596
Interest on capital leases 11 197
Net loss (gain) on interest rate swap 266 (266)
Amortization of deferred financing charges 422 447
Other, net 54 (5)
---------------------------------------------------------------------
6,916 4,268
---------------------------------------------------------------------
---------------------------------------------------------------------


14. Income taxes

Income tax obligations relating to distributions from the Fund are obligations of the unitholders and, accordingly, no provision for income taxes has been made in respect of distributed income of the Fund. A provision for income taxes is recognized for the Fund's subsidiaries that are subject to tax, including large corporations tax.

The provision for income taxes in the consolidated statement of income and deficit reflects an effective rate that differs from the combined Canadian federal and provincial rates for the following reasons:



Quarter ended December 31,
2005 2004
$ $

Income (loss) before income taxes (23,488) 6,737
Goodwill impairment loss 23,120 -
Income of the Fund subject to tax in the
hands of recipients (3,152) (2,584)
---------------------------------------------------------------------
Income (loss) of subsidiary entities
subject to tax (3,520) 4,153
---------------------------------------------------------------------
Income taxes at statutory rate (1,214) 1,432
Increase (decrease) resulting from:
Effect of foreign tax rate (3) (528)
Large corporations tax - 45
Valuation allowance 114 424
Other and permanent differences 59 (468)
---------------------------------------------------------------------
(1,044) 905
---------------------------------------------------------------------
---------------------------------------------------------------------


Year ended December 31,
2005 2004
$ $

Income (loss) before income taxes (91,612) 26,546
Goodwill impairment loss 93,415 -
Income of the Fund subject to tax in the
hands of recipients (10,375) (11,258)
---------------------------------------------------------------------
Income (loss) of subsidiary entities
subject to tax (8,572) 15,288
---------------------------------------------------------------------
Income taxes at statutory rate (2,956) 5,271
Increase (decrease) resulting from:
Effect of foreign tax rate (2,209) (1,969)
Large corporations tax (205) 205
Valuation allowance 1,082 53
Other and permanent differences 1,377 (132)
---------------------------------------------------------------------
(2,911) 3,428
---------------------------------------------------------------------
---------------------------------------------------------------------

The tax effects of temporary differences that give rise to the future
tax assets and future tax liabilities are:

December 31,
2005 2004
$ $

Current future income tax assets:
Accounts receivable, accounts payable and
accrued liabilities 290 373
Inventory provisions 1,411 1,903
Share of net partnership income not yet
subject to tax - (402)
---------------------------------------------------------------------
1,701 1,874
---------------------------------------------------------------------
---------------------------------------------------------------------
Long-term future income tax liabilities:
Property, plant and equipment 16,849 18,030
Withholding tax on foreign retained
earnings 331 245
Tax benefits of loss carry-forwards (5,984) (1,624)
Valuation allowance 1,768 686
Other 1,032 44
---------------------------------------------------------------------
13,996 17,381
---------------------------------------------------------------------
---------------------------------------------------------------------


The benefits of these future tax loss carry-forwards expire between 2008 and 2010.

15. Other expenses and income

Research and development expenses amounted to $62 and $256 for the quarter and year ended December 31, 2005 (2004 - $69 and $295). Employment incentive grants amounting to $232 (US$200) (2004 - $235 (US$200)) were earned in the fourth quarter of each year. These expenses and grants are included in cost of sales.

16. Obligations under operating leases



$
2006 1,847
2007 979
2008 884
2009 711
2010 316
Thereafter -
---------------------------------------------------------------------
4,737
---------------------------------------------------------------------
---------------------------------------------------------------------


17. Employee benefit plans

The Fund sponsors a 401(K) retirement savings plan in the United States for all eligible employees and a registered defined contribution pension plan for all eligible Canadian employees. The Fund has no past service pension liabilities.

Under the above plans, contributions are made by plan members, with varying matching contributions from the Fund.

The total expense related to these plans was $369 and $1,633 for the quarter and year ended December 31, 2005 (2004 - $339 and $1,654).

18. Segmented information

The Fund's operations fall into one reportable business segment. The Fund is principally engaged in the manufacture of private-label wet pet food products, where it serves major customers on a North American basis. Geographic segment information is presented below.

Accounting policies relating to each geographic operating segment are identical to those used for the purposes of these consolidated financial statements. Intersegment sales are made at values that approximate those prevailing in the markets, less a distribution margin. The point of invoicing and the location of the assets determine the geographic areas.



Quarter ended December 31,
2005 2004
$ $

Sales
Canada
Domestic 10,342 14,405
Foreign 22,576 22,192
Intersegment transfers 4,675 5,235
---------------------------------------------------------------------
37,593 41,832
---------------------------------------------------------------------
United States
Domestic 55,661 57,547
Foreign 198 230
Intersegment transfers 29,316 21,349
---------------------------------------------------------------------
85,175 79,126
---------------------------------------------------------------------
122,768 120,958
Elimination of intersegment transfers (33,991) (26,584)
Discounts (3,935) (3,040)
---------------------------------------------------------------------
84,842 91,334
---------------------------------------------------------------------
---------------------------------------------------------------------

Year ended December 31,
2005 2004
$ $

Sales
Canada
Domestic 49,647 54,079
Foreign 79,561 96,220
Intersegment transfers 12,052 15,149
---------------------------------------------------------------------
141,260 165,448
---------------------------------------------------------------------
United States
Domestic 228,836 242,726
Foreign 898 1,347
Intersegment transfers 89,920 95,558
---------------------------------------------------------------------
319,654 339,631
---------------------------------------------------------------------
460,914 505,079
Elimination of intersegment transfers (101,972) (110,707)
Discounts (12,010) (13,660)
---------------------------------------------------------------------
346,932 380,712
---------------------------------------------------------------------
---------------------------------------------------------------------



December 31,
2005 2004
Property, plant and equipment $ $
Canada 33,423 33,117
United States 121,268 116,419
---------------------------------------------------------------------
154,691 149,536
Less: Accumulated amortization 47,069 33,406
---------------------------------------------------------------------
107,622 116,130
---------------------------------------------------------------------
---------------------------------------------------------------------


Given the nature of the Fund's operations, goodwill relates to the Fund as a whole and cannot practicably be allocated on a geographic basis.

19. Financial instruments

Credit risk

The Fund, in the normal course of business, reviews significant new customers' credit history and financial statements before extending credit and performs regular reviews of its existing credit performance.

Foreign exchange and interest rate risks

The Fund generates significant cash flows in foreign currency and is therefore exposed to risks relating to foreign exchange fluctuations. It is also subject to risks relating to interest rate fluctuations. In order to reduce these risks, the Fund uses derivative financial instruments, which are not held or issued for speculative purposes.

As at December 31, 2005 and 2004, the Fund did not have any outstanding foreign currency forward contracts.

The Fund had fixed interest rate contracts on a portion of its indebtedness which expired on December 31, 2005. The mark-to-market value of the contracts as at December 31, 2005 was $Nil (December 31, 2004 - $17) and resulted in a loss, including the impact of the amortization on the transitional amount, of $133 and $266 for the quarter and year ended December 31, 2005, respectively (2004 - gains of $104 and $266), which were charged to interest expense during the periods.

Fair value of financial instruments

The carrying values of cash, trade and other receivables, accounts payable and accrued liabilities, distributions payable and income taxes payable and recoverable approximate their fair values because of the near maturity of these instruments. The carrying value of long-term debt bearing interest at variable rates (note 8) approximates its fair value because effective rates represent the rates that would be used to calculate fair value.

20. Economic dependence

The Fund has approximately 18% of its sales to one customer and has approximately 37% of its sales to the top three customers. Other than these customers, the Fund does not have a significant exposure to any individual customer. The Fund relies on a single supplier for the majority of its can requirements. Should this supplier fail to deliver in a timely manner, delays and/or shutdowns of the Fund's operations could result.

%SEDAR: 00017624E

Contact Information

  • Menu Foods GenPar Limited
    Mark Wiens
    Chief Financial Officer
    (905) 826-3870