Menu Foods Income Fund
TSX : MEW.UN

Menu Foods Income Fund

May 11, 2006 09:00 ET

Menu Foods Income Fund Announces 2006 First Quarter Results

TORONTO, ONTARIO--(CCNMatthews – May 11, 2006) -

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

Menu Foods Income Fund (the"Fund") (TSX:MEW.UN) announced today its financial results for the quarter ended March 31, 2006.

The financial results for the quarter ended March 31, 2006 will be discussed at Menu Foods Income Fund's annual meeting. The annual meeting is to be held today, May 11, 2006 at 2:00pm at the Metro Toronto Convention Centre, Room 206AB, located at 255 Front Street West, Toronto, Ontario. The meeting will be chaired by Robert Luba, Chairman and Trustee of Menu Foods Income Fund. Robert will be joined by Paul Henderson, Menu's President and Chief Executive Officer; Mark Wiens, Menu's Executive Vice President and Chief Financial Officer; Randall Copeland, Menu's Executive Vice-President of Sales and Marketing; Dr. Richard Shields, Menu's Executive Vice-President of Technical Services; Chris Mifflin, Menu's Executive Vice-President of Operations and Bill Grant, Menu's Executive Vice-President of Corporate Purchasing and Logistics.



MESSAGE to UNITHOLDERS
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Below we present, to unitholders of Menu Foods Income Fund, our report
for the first quarter ended March 31, 2006. The table below reports selected
highlights of the quarter's results:

Quarter ended
March 31,
2006 2005
($ millions) ($ millions)

Sales 93.9 84.8
Income before non-controlling interest 2.1 3.0
EBITDA 8.8 8.3
Distributable cash 5.7 5.0
Distributions declared - 9.1
Distributions declared per Trust unit ($) - 0.3150
Distributions declared per Class B unit ($) - 0.3150


The 2006 first quarter results show marked improvement over the Fund's performance in late 2005. While the Fund continues to experience the adverse effects of rising costs and the continued strengthening of the Canadian dollar, relative to its United States counterpart, the significant increase in demand by the Fund's largest customer has positively impacted the first quarter's results. In this context:

- Sales increased by 10.7% or $9.1 million, when compared with last year, due in large part to an 11.2% increase in volume (expressed in cases of 24 cans or pouches), partially offset by the continued effect of the higher Canadian dollar. Approximately 82% of this volume improvement arises from sales of cans to the Fund's largest customer. Management estimates that 50% to 60% of the increase in can volume to this customer can be attributed to an increase in inventory carried by that customer.

- EBITDA of $8.8 million was $0.5 million or 6.4% better than in the first quarter of 2005 and represents a significant improvement over the $5.6 million of EBITDA generated in the fourth quarter of 2005. EBITDA was positively impacted by various factors including the increase in sales and improvements in manufacturing efficiencies, partially offset by the effects of higher raw material costs that could not be passed on to customers.

- The Fund generated $5.7 million in distributable cash during the quarter. Since distributions have been suspended, the Fund used this distributable cash to fund operations and reduce its outstanding indebtedness with its Lenders.

During the first quarter, the Fund finalized agreements 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 note facilities, going forward. In addition to modifying existing covenants and introducing a sliding scale of interest charges, the amended agreements require that the Fund not pay distributions until it is in compliance with certain covenants set out in its former credit facilities, including a total debt to EBITDA ratio of 3 to 1 or less. The Fund is required to use its excess cash to reduce its indebtedness until this level of leverage is achieved. Thus the cash generated in the first quarter has been applied to reduce the Fund's operating line of credit, and as required by the agreement, will be offered to its Lenders as a permanent reduction in the Fund's long- term debt.

Management remains encouraged by the positive events that are already impacting the Fund's 2006 results. The long-awaited price increase on canned product sold to the Fund's United States private-label customers, which will be effective in the second quarter of 2006, has been implemented. The new or expanded business that was announced in late 2005 has commenced on schedule. These two factors, combined with management's focus on cost reduction, are expected to contribute to an increase in the Fund's distributable cash in 2006, as compared to 2005.

We continue to appreciate the support of our investors, customers and suppliers and the ongoing dedication of our employees and look forward to reporting our progress next quarter.

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 ended March 31, 2006)

Presentation of Financial Information

The following discussion and analysis of the financial results of Menu Foods Income Fund (the "Fund") is dated as of May 11, 2006 and is supplementary to and should be read in conjunction with the unaudited consolidated financial statements for the quarters ended March 31, 2006 and 2005.

Menu Foods Income Fund (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.

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 March 31,
2006 2005
$ $
Sales 93,854 84,787
Cost of sales 82,011 74,602
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Gross profit 11,843 10,185
Selling, general and administrative expenses 6,967 5,581
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Income before the undernoted 4,876 4,604
Financial expenses 2,839 1,435
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Income before income taxes and non-controlling
interest 2,037 3,169
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Current income taxes 216 298
Future income taxes (298) (123)
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Total income taxes (82) 175
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Income before non-controlling interest 2,119 2,994
Non-controlling interest of Class B
Exchangeable Units 816 1,313
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Net income for the period 1,303 1,681
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Basic net income per Trust Unit 0.073 0.104
Diluted net income per Unit 0.073 0.104

Distributions per Trust Unit - 0.3150
Distributions per Class B Unit - 0.3150

Basic weighted average number of Trust Units
outstanding (000's) 17,767 16,160
Diluted weighted average number of Units
outstanding (000's) 28,944 28,918

Average US/Cdn exchange rate per Bank of Canada 0.8663 0.8150


Operating Results for the Quarter Ended March 31, 2006

Sales for the quarter ended March 31, 2006, were $93.9 million, up 10.7% or $9.1 million compared to the same quarter last year. This increase is attributable to:

1. a 13.0% increase in can volume resulting in a sales increase of $8.5 million primarily due to a 76.6% increase in can sales volumes to Menu's largest customer. Management believes that 50% to 60% of the increase in can volume to this customer is due to a build in their inventory. While a further increase in their levels of can inventory may occur in the second quarter of 2006, the inventory build is not expected to continue into the second half of 2006 and may in fact reverse;

2. the strengthening of the Canadian dollar relative to the United States dollar had the effect of reducing sales by $5.2 million relative to the first quarter of 2005;

3. a 5.2% increase in pouch volume resulting in a sales increase of $0.9 million. This represents a resumption of growth in this packaging format, albeit at a slower rate than in the past;

4. the effect of pricing adjustments to pass 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 $4.5 million; and,

5. take-or-pay agreements in the first quarter of 2006 had the affect of increasing sales by $0.4 million.

Overall, volume (expressed in cases of 24 cans or pouches) was up 11.2% compared to the quarter ended March 31, 2005. Can volume, which represented 78.7% of Menu's volume in the first quarter of 2006, expanded by 13.0% (equating to an increase in total volume of 10.0%). This increase was primarily attributable to the 76.6% increase in the first quarter of 2006 in case volume of canned wet pet food to Menu's largest customer, which increased first quarter can volume and total volume by 11.9% and 9.2%, respectively. On a comparative basis, it should be noted that sales to this same customer during the first quarter of 2005 had been down 33.9% from the same quarter in 2004. Sales of cans to new customers or increased sales of cans to other existing customers, combined to represent an increase in can volume of 1.1%. This comparative increase would have been even greater but for the effect of a Canadian co-pack customer, who relied on Menu for its supply of certain products for sale in the Canadian market in the first quarter of 2005, who opted to reduce its dependence on Menu and self-manufacture that product in its United States facilities. This decision, which was effective in the second quarter of 2005, reduced can volumes, relative to the first quarter of 2005, by 2.0%. By comparison, during the first quarter of 2005 can volume had been adversely effected by inventory reduction programs initiated by two other key customers, which had the effect of reducing can volumes by 3.9%, when compared to 2004. These inventory reduction programs did not recur in 2006.

In addition to the increase in case sales of canned wet pet food as described above, sales of Menu's pouch product, following a period of comparative decline during the fourth quarter of 2005, once again increased over the same period in the prior year. During the first quarter of 2006, case sales of the pouch product, which represented 21.3% of total volume, grew by 5.2% (equating to an increase in total volume of 1.2%) compared to the first quarter of 2005.
Gross profit increased by $1.7 million (or 16.3%) for the quarter ended March 31, 2006, compared to the prior year. This increase is attributable to:

1. Effect of Change in Sales Volume. As previously noted, total volume for the first quarter increased by 11.2%. This change in sales volume increased gross profit by $1.4 million.

2. Foreign Exchange Effect on Sales. The strengthening of the Canadian dollar relative to the United States dollar during the quarter had the effect of reducing sales by approximately $5.2 million and that translated into a reduction in gross profit of $0.8 million for the quarter ended March 31, 2006;

3. Take-or-Pay Agreement. In 2006, the quarter's sales included an accrual under a take-or-pay agreement having the affect of increasing comparative gross profit by $0.4 million;

4. Price and Cost Increases/Adjustments. The rising cost of certain inputs to production, including raw and packaging materials, utilities, labour and benefits, as well as the rising cost of freight, have increased cost of sales, when compared to the first quarter of 2005. However, in the first quarter of 2006, the impact of these cost increases was more than offset by the favourable effect of improved operating efficiencies and other variables, including selling price increases to co-pack customers, all of which combined to increase gross profit by $0.9 million;

In January 2006, Menu followed a leading national brand manufacturer and announced a price increase on canned products sold to its United States private-label customers. While costs continue to rise, this price increase, which will be effective in the second quarter of 2006, 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. As a consequence of initiating this price increase, the Fund lost some business with one of its customers, which represents approximately 1.5% of total annual volume. This lost business will impact gross profit by approximately 1.0% on an ongoing basis;

5. Increase in Amortization. The amortization of capital projects completed in the past year resulted in an increase in the amortization associated with the cost of goods sold of $0.2 million versus the first quarter of 2005.

Selling, general and administrative expenses for the quarter ended March 31, 2006 increased by $1.4 million compared to the prior year. This increase is partially attributed to the absence of any gain on foreign currency forward contracts (which are "marked-to-market") that benefited the first quarter of 2005 by $0.5 million. In 2005, foreign currency forward contracts were entered into to hedge distributions. When distributions were suspended during the fourth quarter of 2005, any outstanding contracts were settled. No contracts were in place during the first quarter of 2006. In addition, the Fund's Canadian operation's experienced a $0.6 million loss on its United States dollar exposure in working capital, compared to the first quarter of 2005.

The balance of the increase in selling, general and administrative expenses, relative to the same period of 2005, reflects the increase in unit- based compensation in the first quarter of 2006, principally due to the termination of the former long-term incentive plan.

The foregoing resulted in EBITDA (See Note A) of $8.8 million for the quarter ended March 31, 2006, an increase of $0.5 million (or 6.4%) compared to the same period in 2005. 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. Menu estimates that 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.

Menu estimates that absent the impacts of its hedging program in 2005, the strengthening of the Canadian dollar during the first quarter of 2006 versus the same period in 2005 reduced EBITDA by approximately $0.6 million and Distributable Cash by approximately $0.5 million. Under its program for hedging distributions, in 2005 the Fund entered into foreign exchange contracts for the period through July 2006. Any outstanding contracts were settled in December 2005, following the decision to suspend distributions. During the quarter ended March 31, 2005, the Fund realized a nominal gain on matured contracts and had unrealized gains of $0.47 million on contracts that had yet to mature. These gains are recorded in selling, general and administration expenses.

Amortization (which is included in cost of sales and SG&A expense) in the first quarter of 2006 was $0.3 million higher than in 2005. This increase is directly attributable to the $5.1 million of capital expenditures made during the twelve month period ended March 31, 2006 together with the full quarter amortization of the $6.0 million of capital expenditures made during the quarter ended March 31, 2005, offset by the effects of the strengthening of the Canadian dollar relative to the United States dollar.

Financial expenses were $1.4 million greater during the quarter ended March 31, 2006, than in the first quarter of 2005. This increase reflects higher average borrowings in 2006 together with the higher interest rates and the amortization of the fees arising from the amended Agreements with its Lenders, which were concluded during the quarter.

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 recovery during the quarter as compared to the 5.5% rate in the first quarter of 2005.

Income before non-controlling interest of Class B Exchangeable Units ("Class B Units") for the quarter ended March 31, 2006, was $2.1 million, compared to $3.0 million for the quarter ended March 31, 2005.

Liquidity

During the quarter ended March 31, 2006, the Fund generated cash flow from operations of $6.0 million, offset by a reduction in cash flow of $4.6 million as a result of changes in non-cash working capital items. The increase in non-cash working capital items related primarily to a $7.2 million increase in accounts receivable and a $6.0 million increase in inventories, offset by an $8.6 million increase in accounts payable. The increase in inventories and accounts payable reflects the purchasing of raw materials in advance of announced price increases, together with the traditional buildup of inventory prior to the upcoming maintenance shutdowns. The increase in accounts receivable is consistent with the sales activity in the final month of the quarter.

For the quarter ended March 31, 2006, the Fund, as required by its amended Agreements with its Lenders, did not declare or pay any distributions on the Trust Units or on the Class B Units. The Fund will not be able to pay any distributions until it is in compliance with the covenants set out in its former credit facilities, including a total debt to adjusted EBITDA ratio of 3 to 1 or less. As discussed in notes 7 and 8 to the consolidated financial statements, the Fund is expected to use its excess cash to reduce its indebtedness until this level is reached. Since inception, the pay-out ratio (including the distributions declared on the Class B Units) is 94.9%.

The Fund operates utilizing its US$30 million bank facility, of which US$20.0 million was drawn and US$0.6 million was committed at March 31, 2006. Cash flow from operations together with the unutilized operating credit facilities are expected to be sufficient to fund Menu's ongoing operating requirements and capital expenditures.

Capital Resources

During the quarter ended March 31, 2006, Menu spent $0.7 million on property, plant and equipment. Capital expenditures of a maintenance nature, which totaled $0.3 million for the first quarter of 2006, were financed from the cash flow of the business. These maintenance capital expenditures were over and above the $3.5 million (2005 - $3.4 million) for labour and parts expended by Menu for the ongoing repairs and maintenance of its plants that have been expensed 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, 2003 13,259,823 12,631,915
Options exercised during the year 380,413 -
Issuance during the year 2,500,000 -
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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
Options exercised during the quarter 2,575 -
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March 31, 2006 17,768,734 11,133,655
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--------------------------


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 March 31, 2006, 72,108 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 under the Fund's Long-Term Incentive Plan for the benefit of 22 individuals.

During the quarter ended March 31, 2006, 959,296 unit options with an exercise price of $4.56 were granted to 41 executives and employees and 6,000 unit options with an exercise price of $5.25 were granted to one employee. These options vest over three years and will expire in May 2009. The option plan under which these options were granted, which authorizes 2,815,000 units, is subject to Unitholder approval at the Annual and Special Meeting of Unitholders scheduled for May 11, 2006.

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 during the second quarter of 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 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 March 31, 2006 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 March 31, 2006, the Fund had $23,434 drawn on its operating facility and $99,280 of senior secured notes outstanding. Each of these facilities has financial covenants and cross default provisions that must be met.

On February 28, 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 adjusted EBITDA increases. Management of the Fund believes that it will be able to comply with these amended terms and conditions 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 private-label 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 in the past), 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 and other costs without the benefit of a timely price increase to its private- label 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 adjusted 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.

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 first quarter and since the inception of the Fund:



Since
Inception
For the Quarter ended (May 22, 2002)
March 31 to March 31
2006 2005 2006
$'000's $'000's $'000's

Net income 1,303 1,681 (27,165)
Adjust for:
Goodwill impairment loss - - 93,415
Non-controlling interest of
Class B Exchangeable Units 816 1,313 (9,955)
Amortization of property, plant
and equipment 3,823 3,556 56,113
Amortization of supply contract 132 137 2,106
Future income taxes (298) (123) 4,600
Current income taxes 216 298 1,322
Interest 2,839 1,435 20,408
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EBITDA 8,831 8,297 140,844
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Since
Inception
For the Quarter ended (May 22, 2002)
March 31 to March 31
2006 2005 2006
$'000's $'000's $'000's

Cash flow from operating
activities 1,406 3,095 89,523
Adjust for:
Change in non-cash working capital
items 4,615 3,022 31,931
Maintenance capital expenditures (281) (1,093) (9,217)
Principal repayments (6) (37) (549)
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Distributable Cash 5,734 4,987 111,688
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Menu Foods Income Fund
Consolidated Balance Sheets
(All figures expressed in thousands of Canadian dollars, unaudited)

As at
March 31, December 31,
2006 2005
$ $
Assets

Current assets
Cash - 5,790
Accounts receivable
Trade 23,787 17,298
Other 2,932 2,133
Inventories (note 3) 55,872 49,475
Prepaid expenses and sundry assets 1,717 1,318
Income taxes recoverable 245 550
Future income taxes (note 14) 1,556 1,701
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Total Current Assets 86,109 78,265
Property, plant and equipment (note 4) 104,704 107,622
Goodwill (note 5) 71,972 71,972
Other assets (note 6) 5,525 5,374
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Total Assets 268,310 263,233
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Liabilities

Current liabilities
Bank indebtedness (note 7) 23,434 29,309
Accounts payable and accrued liabilities 27,347 18,803
Current portion of long-term debt (note 8) 3,203 24
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Total Current Liabilities 53,984 48,136
Long-term debt (note 8) 96,153 98,912
Future income taxes (note 14) 13,619 13,996
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Total Liabilities 163,756 161,044
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Class B Exchangeable Units (note 9) 32,455 31,639
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Unitholders' Equity

Trust Units (note 10) 170,471 170,454
Contributed surplus (note 12) 294 272
Deficit (87,527) (88,830)
Foreign currency translation adjustment (11,139) (11,346)
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Total Unitholders' Equity 72,099 70,550
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Total Liabilities and Unitholders' Equity 268,310 263,233
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The accompanying notes are an integral part of these consolidated
financial statements.



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

Quarter ended
March 31,
2006 2005

$ $

Sales 93,854 84,787
Cost of sales (note 15) 82,011 74,602
-------------------------------------------------------------------------
Gross profit 11,843 10,185
Selling, general and administrative expenses 6,967 5,581
-------------------------------------------------------------------------
Income before the undernoted 4,876 4,604
Financial expenses (note 13) 2,839 1,435
-------------------------------------------------------------------------
Income before income taxes and non-controlling
interest 2,037 3,169
-------------------------------------------------------------------------
Current income taxes 216 298
Future income taxes (298) (123)
-------------------------------------------------------------------------
Total income taxes (note 14) (82) 175
-------------------------------------------------------------------------
Income before non-controlling interest 2,119 2,994
Non-controlling interest of Class B
Exchangeable Units 816 1,313
-------------------------------------------------------------------------
Net income for the period 1,303 1,681
Deficit - beginning of period (88,830) (19,182)
Distributions (note 11) - (5,093)
-------------------------------------------------------------------------
Deficit - end of period (87,527) (22,594)
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Deficit comprises:
Accumulated net (loss) income (27,338) 27,705
Accumulated distributions (60,189) (50,299)
-------------------------------------------------------------------------
(87,527) (22,594)
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Basic net income per Trust Unit $ 0.073 $ 0.104
Diluted net income per Trust Unit $ 0.073 $ 0.104

Basic weighted average number of Trust Units
outstanding (note 10) 17,766,989 16,159,984
Diluted weighted average number of Trust Units
outstanding (note 10) 28,944,413 28,918,087

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



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

Quarter ended
March 31,
2006 2005

$ $
Cash provided by (used in)
Operating activities
Net income for the period 1,303 1,681
Adjustments for non-cash items
Non-controlling interest of Class B
Exchangeable Units 816 1,313
Amortization of property, plant and equipment 3,823 3,556
Amortization of supply contract 132 137
Amortization of deferred financing costs 65 51
Unit-based compensation 325 17
Gain on sale of property, plant and equipment (29) -
Mark-to-market adjustment (116) (515)
Future income taxes (298) (123)
-------------------------------------------------------------------------
6,021 6,117
Change in non-cash working capital items
Accounts receivable (7,215) (922)
Inventories (5,955) (2,205)
Prepaid expenses and sundry assets (396) (117)
Income taxes recoverable 310 273
Accounts payable and accrued liabilities 8,641 (51)
-------------------------------------------------------------------------
1,406 3,095
-------------------------------------------------------------------------
Financing activities
Change in bank indebtedness (5,875) 15,103
Issuance of Trust Units, net 8 124
Long-term debt repayments (6) (37)
Deferred financing charges (625) -
Distributions paid to Trust Units - (5,088)
Distributions paid to Class B Exchangeable Units - (6,632)
-------------------------------------------------------------------------
(6,498) 3,470
-------------------------------------------------------------------------
Investing activities
Purchase of property, plant and equipment (741) (6,030)
Other assets - (535)
Other assets - (535)
Proceeds from sale of property, plant and equipment 43 -
-------------------------------------------------------------------------
(698) (6,565)
-------------------------------------------------------------------------
Decrease in cash (5,790) -
Cash - beginning of period 5,790 -
-------------------------------------------------------------------------
Cash - end of period - -
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Supplementary information

Income taxes (refunded) paid (40) 108
Interest paid 1,818 1,232

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


Menu Foods Income Fund

Notes to Consolidated Financial Statements

March 31, 2006

(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.

These consolidated financial statements are based on accounting principles consistent with those used and described in the annual consolidated financial statements as at December 31, 2005, and should be read in conjunction with those consolidated financial statements. The disclosures contained in these unaudited interim consolidated financial statements may not include all requirements of Canadian generally accepted accounting principles for annual statements.

Accounting measurements at interim dates involve greater reliance on estimates than at year-end. In the opinion of management, the accompanying unaudited interim consolidated financial statements include all adjustments of a normal recurring nature to present fairly the financial position of the Fund as at March 31, 2006.

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 of a customer's canned wet pet food requirements 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 (2006 - $397; 2005 - $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 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 a 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 March 31, 2006, the Fund has concluded that there were no asset retirement obligations associated with its assets.



3. Inventories
As at
March 31, December 31,
2006 2005

$ $
Raw materials and packaging 18,821 16,462
Finished goods 37,051 33,013
---------------------------------------------------------------------
55,872 49,475
---------------------------------------------------------------------
---------------------------------------------------------------------

4. Property, plant and equipment

March 31, 2006
Accumulated
Cost amortization Net
$ $ $
Land 5,261 - 5,261
Buildings 43,892 5,522 38,370
Machinery and equipment 91,200 35,191 56,009
Other property and equipment 14,226 10,337 3,889
Equipment under capital lease 97 83 14
Construction-in-progress 1,161 - 1,161
---------------------------------------------------------------------
155,837 51,133 104,704
---------------------------------------------------------------------
---------------------------------------------------------------------


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
---------------------------------------------------------------------
---------------------------------------------------------------------


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 30 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 by $93,415 during the year ended December 31, 2005. This charge was a non-cash item and did not impact the Fund's credit facilities.



6. Other assets

March 31, 2006
Accumulated
Cost amortization Net
$ $ $
Supply contract 5,859 1,817 4,042
Deferred financing charges 2,473 990 1,483
Deferred long-term incentive
plan (note 12) 518 518 -
---------------------------------------------------------------------
8,850 3,325 5,525
---------------------------------------------------------------------
---------------------------------------------------------------------


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
---------------------------------------------------------------------
---------------------------------------------------------------------


7. Bank indebtedness

The banking agreement provides the Fund with a US$30,000 operating facility of which $23,434 (US$20,063) was drawn as at March 31, 2006 (December 31, 2005 - $29,309 (US$25,201)).

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) (the "Lenders"). During 2005, the Fund was not in compliance with certain covenants contained in these agreements. The Fund obtained waivers of these breaches from its bankers and forbearance from its senior secured noteholders and on February 28, 2006 entered into amended agreements (the "Agreements") with its Lenders. The Agreements, 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. The Fund is in compliance with its covenants at March 31, 2006. As part of these renegotiations, the Fund agreed to pay US$75 in fees to the bank, plus all associated legal expenses. The bank operating facility is a 364-day revolving term facility, which expires on February 27, 2007.

Pursuant to its amended banking agreement, when the Fund's total debt to EBITDA ratio (the "Leverage Ratio"), as defined in the amended banking agreement, is less than or equal to 3 to 1, this operating facility bears interest at Canadian prime rate (5.50% as at March 31, 2006), U.S. base rate (7.75% as at March 31, 2006) or Euro rate plus 1.50% (6.50% as at March 31, 2006) (the "Base Rates") depending on the currency advanced. When the Leverage Ratio increases above 3 to 1, but is less than or equal to 4 to 1 the Base Rates increase by 1%. Similarly, should the Leverage Ratio be greater than 4 to 1 the Base Rates increase by 1.25%. In addition, the Fund is precluded from paying distributions to its Unitholders at any time the Leverage Ratio exceeds 3 to 1. Furthermore, the amendments enable the bank to reduce the operating facility by its pro rata share of available excess cash each quarter. For the quarter ended March 31, 2006 this amounts to $746.

The Fund has pledged, on a pari pasu basis with its noteholders, as security for bank indebtedness, all moveable property and book debts and, in addition, has signed a general security agreement.

At March 31, 2006, The Fund has an outstanding letter of credit in the amount of $648 (US$555) (March 31, 2005 - $671 (US$555)).



8. Long-term debt

As at
March 31, December 31,
2006 2005
$ $
Senior secured notes (a) 99,280 98,855
Obligation under capital lease (b) 76 81
---------------------------------------------------------------------
99,356 98,936
Less: Current portion 3,203 24
---------------------------------------------------------------------
96,153 98,912
---------------------------------------------------------------------
---------------------------------------------------------------------


a) Senior secured notes

On October 31, 2003, the Fund closed a private placement offering for US$85,000 in floating rate senior secured notes (the "Notes Facility"). The notes are repayable on October 31, 2010 with interest payable quarterly. The Fund has pledged, on a pari pasu basis with its banker, 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 banker (note 7) and senior secured noteholders. During 2005, the Fund was not in compliance with certain covenants contained in these agreements. The Fund obtained waivers of these breaches from its bankers and forbearance from its senior secured noteholders and on February 28, 2006 entered into amended Agreements with its Lenders. The Agreements, 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. The Fund is in compliance with its covenants at March 31, 2006. As part of the renegotiations, the Fund agreed to pay, in 2006, US$468 in fees to the noteholders, plus all associated legal expenses.

Pursuant to the terms of the amended agreement, when the Fund's Leverage Ratio is less than or equal to 3 to 1, this Notes Facility bears interest at floating rate, three-month LIBOR plus 155 basis points. When the Leverage Ratio increases above 3 to 1, but is less than or equal to 4 to 1 this rate increases to three-month LIBOR plus 255 basis points. Similarly, should the Leverage Ratio be greater than 4 to 1 this rate increases to three-month LIBOR plus 305 basis points. From January 1, 2006 until April 29, 2006 the interest rate was fixed at three-month LIBOR plus 355 basis points. In addition, the Fund is precluded from paying distributions to its Unitholders at any time the Leverage Ratio exceeds 3 to 1.

In the meantime, the Fund is required to use a portion of its excess cash to reduce its indebtedness until this level of leverage is achieved. Specifically, the amended agreement requires the Fund to offer 50% of its excess cash (as defined in the amended agreement) to its Lenders each quarter, with a further 25% to be offered after the year end. In the case of the noteholders, this equates to $3,178 for the quarter ended March 31, 2006.

During the quarter ended March 31, 2006, the Fund fixed interest rates at 5.35% on US$50,000 through to October 2010 (note 19).

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 (2005 - $14).



Minimum lease payments: As at
March 31, December 31,
2006 2005
$ $

2006 24 32
2007 32 32
2008 31 31
---------------------------------------------------------------------
Total minimum lease payments 87 95
Less: Amounts representing interest at
10.40% (6.60% - 2004) 11 14
---------------------------------------------------------------------
Balance of obligation 76 81
Less: Current portion 25 24
---------------------------------------------------------------------
51 57
---------------------------------------------------------------------
---------------------------------------------------------------------

9. Class B Exchangeable Units
Number Carrying
of units value
$
Class B Exchangeable Units of MFLP
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 (6,522)
---------------------------------------------------------------------
December 31, 2005 11,133,655 31,639
Share of net income for the period 816
---------------------------------------------------------------------
March 31, 2006 11,133,655 32,455
---------------------------------------------------------------------
---------------------------------------------------------------------


The Class B Exchangeable 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. Distributions subordinated amounted to $4,151. 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 March 31, 2006. These same unitholders 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, 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 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
Exercise of options
during the quarter
ended (note 12)
March 31, 2006 2,575 17 - 17
---------------------------------------------------------------------
March 31, 2006 17,768,734 181,771 11,300 170,471
---------------------------------------------------------------------
---------------------------------------------------------------------


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 March 31, 2006 (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 March 31,
2006 2005
Weighted average number of
Trust Units outstanding -
basic 17,766,989 16,159,984
Weighted average number of
Class B Units outstanding -
basic (note 9) 11,133,655 12,631,915
Dilutive effect of options (note 12) 43,769 126,188
---------------------------------------------------------------------
Weighted average number of units
outstanding - diluted 28,944,413 28,918,087
---------------------------------------------------------------------
---------------------------------------------------------------------


11. Distributions

No distributions were declared to Trust Units during the quarter ended March 31, 2006 (2005 - $5,093 ($0.315 per unit)).

No distributions were declared to Class B Units during the quarter ended March 31, 2006 (2005 - $3,979 ($0.315 per unit)).

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.

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.

During the quarter ended March 31, 2006, 959,296 unit options with an exercise price of $4.56 were granted to 41 employees and 6,000 unit options with an exercise price of $5.25 were granted to one employee subject to approval by Unitholders of the Fund. These options vest over three years and will expire in May 2009. The option plan under which these options were granted, which authorizes 2,815,000 units, is subject to Unitholder approval at the Annual and Special Meeting scheduled for May 11, 2006. Compensation expense of $31 was recognized for the quarter ended March 31, 2006 which was added to contributed surplus. Total compensation expense to be recognized under this plan is estimated to be $985.

The fair value of the Trust Unit options was determined using the Black-Scholes model, incorporating a 3.90% risk free interest rate, at a 34% volatility factor, 3.33% expected distributions and expected life 39 months. On this basis, each Trust Unit option was valued at $1.02.

A summary of option activities since January 1, 2005 is as follows:



Weighted
Range of average
Number exercise exercise
of options prices prices

December 31, 2004 202,346 2.977 2.977
Exercise of options during
quarter ended
March 31, 2005 (41,573) 2.977 2.977
June 30, 2005 (8,829) 2.977 2.977
September 30, 2005 (77,261) 2.977 2.977
---------------------------------------------------------------------
December 31, 2005 74,683 2.977 2.977
Options granted during quarter
ended
March 31, 2006 965,296 4.56-5.25 4.564
Exercise of options during
quarter ended
March 31, 2006 (2,575) 2.977 2.977
---------------------------------------------------------------------
Ending balance 1,037,404 2.977-5.250 4.620
---------------------------------------------------------------------
---------------------------------------------------------------------

The outstanding options are summarized as follows:

Vested options
Options outstanding outstanding
Weighted Weighted
average average
remaining remaining
Number life Number life
Exercise price
2.977 72,108 9 months 72,108 9 months
4.560 959,296 38 months -
5.250 6,000 38 months -
---------------------------------------------------------------------
1,037,404 72,108
---------------------------------------------------------------------
---------------------------------------------------------------------

Contributed surplus attributed to Trust Unit options

March 31, December 31,
2006 2005
$ $
Opening balance 272 808
Compensation expense recognized for unit
options 31 -
Options exercised (9) (536)
---------------------------------------------------------------------
Ending balance 294 272
---------------------------------------------------------------------
---------------------------------------------------------------------


As the Trust Unit options are exercised, the associated contributed surplus is reclassified to Trust Units (note 10).

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 exceeded $33,500 and $34,000 for the 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 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. In February 2005, 36,390 Trust Units were purchased for $518 for the benefit of 22 individuals of which 6,330 units had vested by December 31, 2005. The Compensation and Corporate Governance Committee determined that during the quarter ended March 31, 2006, all outstanding units vested to the participants and the Incentive Plan was replaced by the unit option plan.



13. Financial expenses

Quarter ended March 31,
2006 2005
$ $
Interest on senior secured notes 1,986 1,113
Interest on term loans and bank indebtedness 401 276
Interest on capital leases 2 3
Net gain on interest rate swap (116) (45)
Amortization of deferred financing charges
and associated costs 570 51
Other, net (4) 37
---------------------------------------------------------------------
2,839 1,435
---------------------------------------------------------------------
---------------------------------------------------------------------


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 operations and deficit reflects an effective rate that differs from the combined Canadian federal and provincial rates for the following reasons:



Quarter ended March 31,
2006 2005
$ $
Income before income taxes 2,037 3,169
Income of the Fund subject to tax in the
hands of recipients - (3,125)
---------------------------------------------------------------------
Income of subsidiary entities subject to tax 2,037 44
---------------------------------------------------------------------
Income taxes at statutory rate 702 15
Increase (decrease) resulting from:
Effect of foreign tax rate (392) (416)
Large corporations tax - 70
Deductions not previously recognized (759) -
Valuation allowance 769 769
Other and permanent differences (402) (263)
---------------------------------------------------------------------
(82) 175
---------------------------------------------------------------------
---------------------------------------------------------------------

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

As at
March 31, December 31,
2006 2005
$ $
Current future income tax assets:
Accounts receivable, accounts payable and
accrued liabilities 336 290
Inventory provisions 1,220 1,411
---------------------------------------------------------------------
1,556 1,701
---------------------------------------------------------------------
---------------------------------------------------------------------
Long-term future income tax liabilities:
Property, plant and equipment 16,260 16,849
Withholding tax on foreign retained earnings 377 331
Tax benefits of loss carry-forwards (5,637) (5,984)
Valuation allowance 2,537 1,768
Other 82 1,032
---------------------------------------------------------------------
13,619 13,996
---------------------------------------------------------------------
---------------------------------------------------------------------

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 $65 for the quarter
ended March 31, 2006 (2005 - $68). These expenses are included in
cost of sales.

16. Obligations under operating leases

Future minimum payments under operating leases at March 31, 2006 are
as follows:

$
2006 1,237
2007 803
2008 708
2009 536
2010 243
---------------------------------------------------------------------
3,527
---------------------------------------------------------------------
---------------------------------------------------------------------


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 $414 for the quarter ended March 31, 2006 (2005 - $482).

18. Segmented information

The Fund's operations fall into one reportable business segment. The Fund is principally engaged in the manufacture of 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 March 31,
2006 2005
$ $
Sales
Canada
Domestic 12,336 14,197
Foreign 27,386 16,325
Intersegment transfers 3,393 1,790
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43,115 32,312
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United States
Domestic 56,907 56,789
Foreign 261 411
Intersegment transfers 32,578 17,382
---------------------------------------------------------------------
89,746 74,582
---------------------------------------------------------------------
132,861 106,894
Elimination of intersegment transfers (35,971) (19,172)
Discounts (3,036) (2,935)
---------------------------------------------------------------------
93,854 84,787
---------------------------------------------------------------------
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As at
March 31, December 31,
2006 2005
$ $
Property, plant and equipment
Canada 33,562 33,423
United States 122,275 121,268
---------------------------------------------------------------------
155,837 154,691
Less: Accumulated amortization 51,133 47,069
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104,704 107,622
---------------------------------------------------------------------
---------------------------------------------------------------------


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 March 31, 2006 and December 31, 2005 the Fund did not have any outstanding foreign currency forward contracts.

The Fund has fixed interest rates on a portion of its indebtedness (note 8). The mark-to-market value of the contract at March 31, 2006 resulted in an unrealized gain of $116 (December 31, 2005 - $nil), which is included in accounts payable on the consolidated balance sheet, and credited to interest expense during the period.

Fair value of financial instruments

The carrying values of cash, trade and other receivables, accounts payable and accrued liabilities 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 24% of its sales to one customer and has approximately 42% of its sales to its three largest 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