PREMIUM BRANDS INCOME FUND. First Quarter 2007

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1 PREMIUM BRANDS INCOME FUND Management s Discussion and Analysis First Quarter 2007 OVERVIEW Premium Brands owns a broad range of leading branded specialty food businesses with manufacturing and distribution facilities located in British Columbia, Alberta, Saskatchewan, Manitoba and Washington. In addition, the Fund owns proprietary food distribution and wholesale networks through which it sells both its own products and those of third parties to approximately 20,000 customers. The Fund s family of brands includes Grimm s, Harvest, McSweeney s, Bread Garden, Hygaard, Hempler s, Quality Fresh Foods, Gloria s Fresh and Harlan s. The following discussion should be read in conjunction with the Fund s 2006 audited consolidated financial statements and the notes thereto, which are prepared in accordance with Canadian generally accepted accounting principles ( GAAP ), the related Management s Discussion and Analysis, and the Fund s 2006 Annual Information Form. These documents, as well as additional information on the Fund, are filed electronically through the System for Electronic Document Analysis and Retrieval ( SEDAR ) and are available online at All amounts are expressed in Canadian dollars except as noted otherwise. The information presented is current to May 10, FORWARD-LOOKING STATEMENTS This discussion and analysis includes forward-looking statements with respect to the Fund, including its business operations strategy and financial performance and condition. These statements generally can be identified by the use of forward-looking words such as may, could, should, would, will, expect, intend, plan, estimate, project, anticipate, believe or continue, or the negative thereof or similar variations. Although management believes that the expectations reflected in such forward-looking statements are reasonable and represent the Fund s internal expectations and belief at this time, such statements involve unknown risks and uncertainties which may cause the Fund s actual performance and results in future periods to differ materially from any estimates or projections of future performance or results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the Fund s expectations include, among other things: (i) seasonal and/or weather related fluctuations in the Fund s sales; (ii) changes in the cost of raw materials used in the production of the Fund s products; (iii) changes in consumer

2 preferences for food products; (iv) competition from other food manufacturers and distributors; and (v) new government regulations affecting the Fund s business and operations. The Fund disclaims any intention or obligations to revise forward-looking statements whether as a result of new information, future developments, or otherwise. SUPPLEMENTAL DISCLOSURE EBITDA, distributable cash and net funded debt are not terms defined under GAAP. As a result, these terms as defined by the Fund may not be comparable to similarly titled measures presented by other publicly traded entities, nor should they be construed as alternatives to other earnings measures determined in accordance with GAAP. The Fund believes that EBITDA is a useful indicator of the amount of cash generated by the Fund s operating businesses prior to financing and income tax related costs. The following table provides a reconciliation of EBITDA to net earnings from continuing operations: (in thousands of dollars) 13 weeks 13 weeks ended ended Mar 31, 2007 Apr 1, 2006 Earnings from continuing operations before non-controlling interest 2,485 2,105 Depreciation of capital assets (1) 1,449 1,269 Interest and other financing costs (2) Amortization of intangible and other assets (1) Income tax provision (recovery) (2) (25) 10 EBITDA 4,597 4,018 (1) Amount added back as this is a non-cash expense for the period. (2) Amount added back as this is a financing or tax related charge. The Fund believes that distributable cash is a useful indicator of the amount of cash available for distribution to its unitholders from a specific operating period. The following table provides a reconciliation of distributable cash to cash flows from continuing operations: (in thousands of dollars) 13 weeks 13 weeks Four quarters ended ended ended Mar 31, 2007 Apr 1, 2006 Mar 31, 2007 Cash flows from continuing operations 4,864 2,128 22,028 Change in non-cash working capital (1) (704) 1,365 (870) Payments received on notes receivable (2) Maintenance capital expenditures (3) (519) (379) (2,027) Non-controlling interest (4) (112) (8) (357) Principal debt repayments (5) (3) (32) (83) Distributable cash 3,561 3,150 19,124 (1) Cash used for increases in the Fund s working capital is funded through draws on its operating lines of credit while cash resulting from decreases in its working capital is used to pay down its operating lines of credit. (2) Amount represents principal payments received on notes receivable. (3) Amount represents the portion of the Fund s capital expenditures that are funded from cash generated by its operations. (4) Amount represents the portion of the Fund s cash flows that is attributable to non-controlling interests. (5) Amount represents the portion of the Fund s payments on long-term debt that is funded from cash generated by its operations. 2

3 The Fund believes that net funded debt is a useful indicator of its financial strength. The following table provides the calculation of net funded debt: (in thousands of dollars) Mar 31, 2007 Dec 31, 2006 Cheques outstanding Bank indebtedness 5,632 5,424 Current portion of long-term debt Deferred financing fees (1) Long-term debt 11,588 11,670 18,574 18,239 Less cash and cash equivalents 1,221 1,940 Net funded debt 17,353 16,299 (1) As a result of the Fund s adoption of the Canadian Institute of Chartered Accountants new accounting rules for financial instruments at January 1, 2007, deferred financing fees, which were previously included in other assets, have been retroactively reclassified as a reduction to long-term debt. RESULTS OF OPERATIONS Sales from continuing operations for the first quarter of 2007 were up $5.2 million or 11.1% to $52.3 million as compared to $47.1 million in The majority of the increase was due to $2.8 million or 6.0% organic growth of the Fund s core specialty food products and acquisitions, which accounted for $2.7 million of the sales increase. The Fund s sales were also favourably impacted by an early Easter in 2007, as compared to 2006, which resulted in incremental sales of approximately $0.5 million. These increases were partially offset by a $0.8 million decrease in sales of mainstream processed meats due to the Fund s decision to exit certain lower margin product categories part way through the first quarter of The Fund s gross profit margin remained relatively stable at 31.9% for the first quarter of 2007 as compared to 32.5% in the first quarter of The slight decrease was primarily due to a large portion of the Fund s first quarter sales growth coming from sales to large food retailers, which generate lower gross profit margins due to the lower selling and distribution costs associated with these sales, and traditionally lower margins on the incremental sales associated with the early Easter in These decreases were partially offset by a net overall improvement in the efficiency of the Fund s manufacturing operations. As a percentage of sales, selling, general and administrative expenses for the quarter decreased to 23.1% from 23.9% in the first quarter of 2006 due primarily to the changes in the Fund s sales mix discussed above and to the Fund s higher sales relative to the fixed nature of certain administration costs. These decreases were offset partially by increased fuel related costs. The Fund s EBITDA improved to $4.6 million from $4.0 million in the first quarter of 2006 representing a 14.4% increase while the Fund s EBITDA as a percentage of sales rose to 8.8% from 8.5% in the first quarter of The improvement in both the Fund s EBITDA and EBITDA margin reflects the successful implementation of the Fund s core specialty food products and distribution strategies. The Fund s depreciation expense increased by $0.2 million to $1.4 million primarily due to its purchase of a new production facility in Ferndale, Washington in the third quarter of Discontinued operations had no loss or earnings in 2007 due to the shut down of these operations in August Net earnings for the quarter were $2.4 million or $0.14 per unit as compared to $1.8 million or $0.12 per unit in the first quarter of

4 Segmented Information The Fund is made up of a variety of specialty food businesses, consisting of both manufacturing and distribution operations, most of which are highly integrated and are characterized by substantial cooperation, cost allocation and sharing of assets. As a result, the operating performance and other financial information presented on the Fund s two reporting segments, as defined under GAAP, does not necessarily represent what each of the segments would report if they were operating independently. The Fund s revenue and operating earnings (defined as earnings from continuing operations before interest and other financing costs, income taxes and non-controlling interest) by reportable segment are as follows: (in thousands of dollars) 13 weeks ended 13 weeks ended Mar 31, 2007 Apr 1, 2006 Revenue: Defined Specialty Foods 43,808 39,851 Other 8,535 7,269 52,343 47,120 Operating earnings (loss): Defined Specialty Foods 3,924 3,872 Other Corporate (1,407) (1,437) 2,897 2,630 The Defined Specialty Foods segment s sales for the first quarter of 2007 increased by $4.0 million or 9.9% to $43.8 million while its earnings increased by $0.1 million to $3.9 million. The increase in this segment s sales was due to $1.8 million in sales resulting from acquisitions, $1.7 million in organic growth and approximately $0.5 million in additional sales resulting from an early Easter in 2007 relative to These increases were partially offset by a $0.1 million decrease in sales of mainstream processed meat products. The increase in the Defined Specialty Foods segment s earnings was due to its higher sales levels partially offset by higher costs associated with the implementation of a new seven day work cycle at its Richmond, BC production facility and higher fuel related costs. The Fund implemented the new seven day work week cycle for the Richmond, BC plant, which significantly increased the plant s capacity, in anticipation of higher sales in the second and third quarters. The Other segment s sales for the first quarter of 2007 increased by $1.3 million or 17.4% to $8.5 million while its earnings increased by $0.2 million to $0.4 million. The increase in the Other segment s sales was due to $1.1 million in organic growth and $0.9 million in sales resulting from acquisitions, partially offset by a $0.7 million decrease in exports of mainstream processed meat products. The increase in the Other segment s earnings was due primarily to its higher sales levels combined with improved production efficiencies in its U.S. operations. SUMMARY OF QUARTERLY RESULTS The following is a summary of selected quarterly consolidated financial information. All amounts except EBITDA are derived from the Fund s unaudited consolidated interim financial statements for each of the eight most recently completed quarters and are prepared in accordance with GAAP. See the Supplemental Disclosure section above for details on the calculation of EBITDA. 4

5 (millions of dollars Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 except per unit/share amounts) Revenue EBITDA Income trust conversion costs Earnings before discontinued operations: Total Per unit/share Loss from discontinued operations (0.4) (0.6) (8.1) (0.3) (0.4) (0.7) Earnings (loss): Total (5.8) Per unit/share (0.44) The Fund s quarterly results are subject to seasonal fluctuations. In general terms, results are weaker in the first quarter due to poor weather conditions and reduced consumer spending in general, peak in the spring and summer months due to favourable weather conditions and higher consumer demand resulting from increased outdoor activities and travelling, and decline in the fourth quarter due to poor weather conditions. With the exception of the fourth quarter of 2006, the Fund s sales and EBITDA have shown consistent improvement on a comparative quarter to quarter basis reflecting the successful implementation of its core specialty food and distribution strategies. The lower sales and EBITDA in the fourth quarter of 2006, as compared to the fourth quarter of 2005, was largely due to severe winter weather conditions across a large portion of western Canada that resulted in missed deliveries and reduced consumer activity at the store level. In the third quarter of 2005, the Fund completed its conversion to an income trust structure resulting in $3.0 million in income trust conversion costs and a significant reduction in the Fund s income tax expense in each subsequent quarter. In the fourth quarter of 2005 the Fund s remaining discontinued operation incurred a loss of $8.1 million due primarily to the writedown of its assets to net realizable value and the accrual of certain exit costs. The discontinued operation was shut down in the third quarter of 2006 resulting in no loss or earnings from discontinued operations in each subsequent quarter. LIQUIDITY AND CAPITAL RESOURCES The Fund s primary uses of cash, and how these uses are funded, are as follows: Cash distributions to unitholders. Cash distributions are financed primarily through operations, however as an income trust, a key objective of the Fund is to maintain a steady cash distribution to its unitholders, which is achieved by basing its monthly cash distributions on an annual rate divided into twelve equal monthly payments. As a result, it is possible that in some months its cash distribution to unitholders may exceed the distributable cash generated by its operations due to the seasonality of its business, or unexpected short term shocks to one or more of its operations. Under these circumstances the Fund s revolving credit facility can be used to balance its cash needs. Acquisition of small-to-medium sized businesses that complement the Fund s specialty food and distribution based strategies. The source of financing for an acquisition depends primarily on the size of the transaction. Smaller acquisitions are generally financed through the Fund s existing credit facilities while larger acquisitions can be financed through a variety of financing sources including existing credit facilities and the issuance of new debt and/or equity. 5

6 Capital expenditures. The Fund s capital expenditures can be categorized into two types: project capital expenditures and maintenance capital expenditures. Project capital expenditures are capital expenditures that are expected to generate a minimum return on investment of 15% through increased production capacity and/or improved operating efficiencies. Maintenance capital expenditures include all capital expenditures that do not qualify as a project capital expenditure and consist mainly of expenditures necessary for maintaining the Fund s existing level of production capacity and operating efficiency. Maintenance capital expenditures are financed primarily through operations while project capital expenditures are generally funded through the Fund s credit facilities, however, larger expenditures, such as the building of a new plant or a major expansion of an existing plant may also be funded through the issuance of new debt and/or equity. Maintenance of the Fund s truck fleet. The Fund currently operates a fleet of approximately 120 trucks which service customers across western Canada. Primarily all of the trucks utilized in this fleet are leased under a full maintenance operating lease program and, as a result, the full cost of maintaining the Fund s fleet is funded through operations and expensed in the calculation of the Fund s EBITDA. Working capital. In general terms the Fund s accounts receivable and inventories turn over rapidly and are financed through its revolving credit facility and terms on its trade purchases. The Fund s working capital needs generally peak in the spring and summer months and around festive holiday seasons, e.g. Easter, Thanksgiving and Christmas, as inventories and accounts receivable are built up due to increased consumer demand. Credit Capacity At March 31, 2007 the Fund had the following unutilized credit capacity: (in thousands of dollars) Credit Net Unutilized Facilities Bank Credit Indebtedness Capacity (1) Revolving credit facilities 26,700 4,411 22,289 Non-revolving credit facilities 7,000 4,000 3,000 33,700 8,411 25,289 (1) Defined as bank indebtedness less cash and cash equivalents. The Fund s ability to draw on its credit facilities is subject to being in compliance with the terms of its lending agreements which include, among other things, the following financial covenants: Covenant Requirements Funded debt to EBITDA ratio < 2.5 : 1.0 Current ratio (1) > 1.5 : 1.0 Interest coverage ratio > 5.0 : 1.0 (1) Under the terms of its lending agreement, bank indebtedness is excluded from current liabilities in the calculation of the Fund s current ratio as this debt is not due until July At March 31, 2007 the Fund was in compliance with the terms of its lending agreements. As it is the Fund s practice to renegotiate the terms of its credit facilities approximately one year in advance of their maturity, it intends to renegotiate in 2007 approximately $32.0 million in utilized and unutilized credit facilities that mature in July The Fund expects the new credit facilities to be 6

7 similar or larger in size and to have similar or more favourable terms as compared to its existing credit facilities. Cash Flows from Operating Activities For the first quarter of 2007 the Fund s continuing operations generated $4.9 million in cash, $0.7 million of which was the result of a reduction in the Fund s non-cash working capital levels. The decrease in non-cash working capital was due to the seasonal build up of trade accounts payable combined with the general timing of accounts payable and accrued liability payments, partially offset by seasonal increases in accounts receivable and inventory. Cash Flows from Financing Activities The Fund used $4.7 million for financing activities in the first quarter of 2007 consisting of $5.1 million for distributions to the Fund s unitholders partially offset by $0.4 million resulting from a combination of draws on the Fund s credit facilities and increased outstanding cheques. Cash Flows from Investing Activities The Fund used $0.9 million for investing activities in the first quarter of 2007 consisting of $1.0 million for capital expenditures partially offset by cash generated from miscellaneous items including payments on long-term notes receivable and employee unit purchase loans. The $1.0 million spent on capital expenditures consisted of $0.5 million for maintenance capital expenditures and $0.5 million for a variety of project capital expenditures. Financial Position Current assets at the end of the first quarter of 2007 increased to $47.3 million as compared to $45.1 million at the end of the first quarter of 2006 primarily due to higher working capital levels associated with the Fund s increased sales partially offset by a $2.3 million decrease in the current portion of long-term notes receivable, a $0.8 million decrease in prepaid expenses and a $0.8 million decrease in current assets of discontinued operations. The decrease in the current portion of long-term notes receivable was due to the repayment in the second quarter of 2006 of advances to the builder of the Fund s new production facility in Ferndale, Washington. The decrease in prepaid expenses was due to reductions in a variety of items including equipment deposits and customer rebates, while the decrease in current assets of discontinued operations was due to the shut down and liquidation of the Fund s last discontinued operation in August Net funded debt at the end of the first quarter of 2007 increased to $17.4 million as compared to $16.3 million at December 31, 2006 primarily due to cash and operating loans being used to finance a portion of the Fund s investing and financing activities during the quarter. In general terms, due to the seasonality of the Fund s business, its cash flows from operating activities in the first quarter are generally lower than the cash required for its financing and investing activities. Accounts payable and accrued liabilities increased to $23.9 million at the end of the first quarter of 2007 as compared to $19.4 million at the end of the first quarter of 2006 due to the Fund s increased sales and to the general timing of certain accounts payable and accrued liability payments. DISTRIBUTABLE CASH The Fund s distributable cash for the trailing four quarters ended March 31, 2007 was $19.1 million as compared to declared cash distributions of $19.1 million resulting in a payout ratio of 100%. The high payout ratio was due to the majority of the proceeds raised from an issuance of 2,444,280 units in late 7

8 2006 not yet being invested at March 31, The Fund intends to use the capital raised from this issuance for acquisitions and project capital expenditures, which are expected to increase its distributable cash and therefore reduce its payout ratio, however, in the interim the increased number of units outstanding is resulting in a high payout ratio. Excluding the impact of the new units issued, and normalizing for the additional interest expense that would have been incurred had the new units not been issued, the Fund s payout ratio would have been approximately 95.9% for the trailing four quarters. Looking forward, based on the Fund s existing organic growth initiatives, it expects to achieve its targeted payout ratio of 85% to 90% within the next twelve to eighteen months. Due to Premium Brands conversion to an income trust structure occurring in July 2005 there are no comparative numbers for the trailing four quarters ended April 1, The Fund s distributable cash for the first quarter of 2007 increased by $0.4 million to $3.6 million from $3.2 million in the first quarter of 2006 due primarily to an improvement in the cash generated by its operations. Declared cash distributions for the quarter increased to $5.1 million as compared to $4.4 million in the first quarter of 2006 due to the issuance of 2,444,280 new units in October The Fund s monthly distribution has remained constant at $0.098 per unit since its conversion to an income trust structure in July The Fund s high payout ratios for the first quarters of both %, and %, were solely due to the seasonality of its business. The Fund intends to continue its current monthly cash distribution of $0.098 per unit with the objective of increasing it once it has achieved its targeted payout ratio range of 85% to 90%. Maintenance Capital Expenditures The capital expenditures used in the calculation of distributable cash generally represent the expenditures incurred during the applicable period to maintain the Fund s production capacity. For the next several years the Fund expects, subject to increases resulting from acquisitions, its maintenance capital expenditures to remain in the $2.0 million to $2.5 million range. The Fund s actual capital maintenance expenditures could, however, exceed this range for a variety of reasons including changes in regulatory requirements, unexpected material equipment breakdowns or uninsured damage to buildings or equipment. In the event that its maintenance capital expenditures did exceed the expected levels then the Fund s cash distributions could be adversely impacted. Tax Assets For % of the Fund s cash distributions were classified as a return on capital and the remaining 40% as a return of capital. Based on the Fund s tax assets, which at December 31, 2006 included approximately $46 million in cumulative eligible capital expenditures (deductible at a rate of 7% per year for tax purposes) and $45 million in undepreciated capital costs, the Fund is well positioned to continue to provide tax shelter to its unitholders. It will, however, be potentially re-evaluating its tax strategies pending the outcome of proposed changes by the Minister of Finance to the rules governing the taxation of publicly traded income trusts (see Proposed Tax Changes ). Proposed Tax Changes On October 31, 2006, the federal Minister of Finance announced new proposals that, if enacted, would change the manner in which certain publicly traded income trusts and the distributions from such trusts, are taxed. In the current form, these proposals will not apply to certain trusts until January 1, 2011, however, they indicate that while there is no intention to prevent the normal growth of an income trust, any undue expansion would be viewed as abusive tax avoidance and may cause the grandfathered period to be rescinded. 8

9 Following the October 31, 2006 announcement, the Department of Finance issued a press release on December 15, 2006 entitled Guidance Provided on Normal Growth for Income Trusts and Other Flow Through Entities wherein it provided guidelines as to what would be considered normal growth as opposed to undue expansion. Under these guidelines a grandfathered trust is permitted to increase its equity capital through the issuance of new equity during the grandfathered period by the greater of $50 million per year and the safe harbour amount, where the safe harbour amount for a particular trust is 40% of its market capitalization on October 31, 2006 for 2007 and 20% of its market capitalization on October 31, 2006 for each of 2008, 2009 and On March 29, 2007 the federal government tabled Bill 52 which, if enacted, will result in the implementation of the proposed tax changes in essentially the form outlined above. Provided that the growth of the Fund during the grandfathered period does not exceed the normal growth guidelines, the tabled legislation, if enacted in its current form, will change the manner in which the Fund and its distributions are taxed beginning January 1, More specifically, starting in 2011 the Fund will be subject to entity level taxation that will reduce the amount of cash available for distribution to its unitholders. Based on the proposed rate of entity level taxation, the tax on income (other than taxable dividends) distributed by the Fund to its unitholders would approximate the tax rate applicable to income earned by Canadian public corporations. The applicable rate in 2011 would be based on tax rates at that time. Currently, based on information released by the Department of Finance, the applicable rate in 2011 would be 31.5% but this is subject to change between now and Distributions received by the Fund s unitholders beginning January 1, 2011 would be characterized as eligible dividends received from a Canadian public corporation. Generally, individual unitholders resident in Canada would be subject to tax based on the enhanced gross-up and dividend tax credit applicable to eligible dividends and, assuming such unitholders are subject to the highest marginal rate of tax, would receive an after-tax return from their now reduced distribution of income approximately equal to the after-tax return if the pre-tax income of the Fund had been distributed directly to and taxed in the hands of the unitholders. However, reduced distributions will be an absolute cost to other types of unitholders including pension funds, registered retirement savings plans and non-residents who would not benefit from characterization of the distributions as dividends. In regards to the normal growth guidelines, the Fund s market capitalization on October 31, 2006 was approximately $188.0 million resulting in a safe harbour amount of approximately $75 million in 2007 and $50 million in each of 2008, 2009 and Presently the Fund does not expect to exceed the normal growth guidelines during the grandfathered period, however, there is always the possibility that a change in circumstances may result in the Fund losing its grandfathered status and as a result no assurance can be given that the Fund will be able to maintain its grandfathered status through to January 1, Loss of this status may result in material adverse tax consequences for the Fund and/or its unitholders. OUTLOOK For 2007 the Fund expects to continue growing its core specialty food sales at an annual organic rate of 7% to 8% based on three key growth initiatives: the development of new specialty food products, the introduction of new products sourced from other suppliers into the Fund s distribution networks and geographical expansion into the U.S. Pacific Northwest and central Canada. In addition, the Fund intends to continue to pursue its successful acquisition strategy, which focuses on small to medium sized businesses that complement its existing manufacturing and/or distribution businesses, or expand its distribution capabilities. The Fund s projected EBITDA range for 2007 is $25 million to $26 million with a projected EBITDA margin of approximately 11%; its expected maintenance capital expenditures for 2007 are between $2.0 million and $2.5 million; and its estimated collection on notes receivable is approximately $0.5 million. 9

10 Contractual Obligations The Fund s significant contractual obligations at March 31, 2007 were as follows: There- (in millions of dollars) Total after Long-term debt Operating leases Total OFF BALANCE SHEET ARRANGEMENTS All of the Fund s off balance sheet arrangements are included above under the Contractual Obligations section. TRANSACTIONS WITH RELATED PARTIES During the first quarter of 2007, pursuant to a long-term supply agreement, the Fund purchased approximately $0.2 million of labels from Tapp Technologies Inc., a company in which the Fund holds a note receivable with a carrying value of $0.5 million and certain officers and directors of the Fund hold a minority interest. All such transactions were in the normal course of business and completed on market terms. As part of the Fund s strategies to further align the interests of management with those of the Fund s unitholders, in the fourth quarter of 2006 the Fund provided certain members of management with non-interest bearing recourse loans, the proceeds of which were used to purchase the Fund s units in the open market on behalf of these individuals. The employee unit purchase loans have monthly principal payments equal to 55% of the monthly distribution received on the purchased units, are secured by the purchased units and are due upon the termination of the individual s employment or if the individual sells the units. The total amount of the employee unit purchase loans issued was $1,500,000 and the balance outstanding at March 31, 2007 was $1,476,000. PROPOSED TRANSACTIONS There have been no significant business developments to date in RISKS AND UNCERTAINTIES The Fund is subject to a number of risks and uncertainties related to both its business and its legal structure that may have adverse effects on its results of operations and financial position and in turn its ability to make cash distributions. These risks and uncertainties include: seasonal and/or weather related fluctuations in the Fund s sales; changes in the cost of raw materials used for the Fund s products; changes in Canadian income tax laws; changes in consumer preferences for food products; competition from other food manufacturers and distributors; new government regulations; and other factors as discussed in the Fund s Annual Information Form, which is filed electronically through the System for Electronic Document Analysis and Retrieval (SEDAR) and available online at CRITICAL ACCOUNTING ESTIMATES The preparation of the Fund s consolidated financial statements requires management to make certain estimates and assumptions, which are based on the Fund s experience and management s 10

11 understanding of current facts and circumstances. These estimates affect the reported amounts of assets, liabilities, contingencies, revenues and expenses included in the Fund s consolidated financial statements and may differ materially from actual results. Significant areas requiring the use of management estimates include: Inventories. Inventories are valued at the lower of cost and net realizable value, where cost includes raw materials, manufacturing labour and overhead. Inherent in the determination of the cost of inventories are certain management judgments and estimates. Intangible assets and goodwill. The Fund assesses the impairment of goodwill and intangible assets with an indefinite life on an annual basis and finite life intangible assets whenever events or changes in circumstance indicate that the carrying value may not be recoverable. Factors which the Fund considers could trigger an impairment review include significant underperformance relative to plan, a change in the Fund s business strategy, or significant negative industry or economic trends. Capital assets. Capital assets are recorded at cost then depreciated over their estimated useful life. Redundant assets are recorded at the lesser of cost less accumulated depreciation and estimated fair market value. A significant amount of judgment is required to estimate the useful life of an asset as well as the fair market value of a redundant asset. NEW ACCOUNTING POLICIES Effective January 1, 2006 the Fund retroactively adopted the CICA Emerging Issues Committee Abstract 156 Accounting by a Vendor for Consideration Given to a Customer (including a reseller of the vendor s products). As a result, the Fund has classified certain consideration provided to its customers as a reduction of revenue rather than as a selling, general and administrative expense. Effective January 1, 2007, the Fund adopted the Canadian Institute of Chartered Accountants (CICA) Handbook Section 1530 Comprehensive Income. Under this new accounting standard, other comprehensive earnings (loss) is used to record revenues and expenses that are not required to be included in earnings, such as gains and losses on net financial assets and on the foreign currency translation of self-sustaining foreign operations. In accordance with the new standard, $2.9 million relating to unrealized losses resulting from the translation of self-sustaining operations which had previously been classified as unrealized foreign currency translation adjustment within unitholders equity is now presented within accumulated other comprehensive loss. Also effective January 1, 2007, the Fund adopted the CICA Handbook Section 3855 Financial Instruments - Recognition and Measurement. Under this new accounting standard, financial assets classified as receivables and loans are measured at amortized cost using the effective interest method with any resulting gains or losses being recognized in earnings. In addition, financing fees that are directly attributable to the issuance of long-term debt are classified as a reduction of long-term debt. In accordance with this new standard, the Fund reduced the value of certain financial assets by a total of $0.7 million with the offsetting amount being charged to opening accumulated earnings; and its December 31, 2006 balance sheet was adjusted to reflect the reclassification of $0.2 million in deferred financing fees from other assets to long-term debt. Also effective January 1, 2007 the Fund adopted the CICA Handbook Section 3865 Hedges. Under this new accounting standard the Fund s existing hedging relationships continue to qualify for hedge accounting as they are considered to be cash flow hedges. As a result, changes in the fair value of these hedging relationships, to the extent they are effective, are recorded in other comprehensive earnings (loss) and are only recognized in earnings when the hedged item is realized. Any ineffectiveness in the hedging relationship is recognized in earnings immediately. The Fund s opening accumulated other comprehensive loss was reduced by $0.4 million to reflect the cumulative change in the fair value of the hedged items from inception of the hedges to January 1,

12 FINANCIAL INSTRUMENTS The Fund has exposure to U.S. dollar currency exchange risk due to annual inventory purchases of approximately US$10 million from U.S. based suppliers and is therefore exposed to fluctuations in the Canadian dollar relative to the U.S. dollar. In order to reduce the risk associated with currency fluctuations the Fund has entered into forward foreign exchange contracts that cover approximately 100% of its U.S. dollar requirements for 2007 and approximately 30% of its U.S. dollar requirements for 2008 at an average exchange rate of Canadian dollars per U.S. dollar. The Fund has designated these foreign currency contracts as hedges and, correspondingly, an unrealized gain on them of $0.3 million at March 31, 2007 and a $0.1 million unrealized loss for the 13 weeks ended March 31, 2007, have been recognized in the consolidated statement of accumulated other comprehensive loss and the consolidated statement of comprehensive earnings, respectively. OTHER Outstanding Units The total units and exchangeable units outstanding as of May 10, 2007 were 17,443,917 consisting of 16,843,917 units and 600,000 exchangeable units. Disclosure Controls and Procedures As required by Multilateral Instrument , the Fund s management has evaluated and determined that there were no changes to the Fund s internal controls over financial reporting during the interim period ending March 31, 2007 that have materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting. Responsibilities of Management and Board of Directors Management is responsible for the reliability and timeliness of content disclosed in the Management s Discussion & Analysis ( MD&A ), which is current as of May 10, It is the responsibility of the Audit Committee to provide oversight in reviewing the MD&A and the Board of Trustees to approve the MD&A. The Board of Trustees and the Audit Committee review all material matters relating to the necessary systems, controls and procedures in place to ensure the appropriateness and timeliness of MD&A disclosures. Additional Information Additional information, including the Fund s Annual Information Form, has been filed electronically through the System for Electronic Document Analysis and Retrieval (SEDAR) and is available online at Dated: May 10,